Managerial Economics Study Guide

what is economic profit?

The difference between total revenue and total opportunity cost

what is the difference between economic profit and accounting profit?

the first is the difference between total revenue and total opportunity cost while the other is the amount of money taken in from sales minus the cost of producing goods or services

whta is an example of economic profit vs accounting profit?

You run a lemonade stand. After paying for lemons and cups, the money left is accounting profit. But if you could've earned wages at another job and rented your stand space, subtract those too—that remainder is economic profit.

what is opportunity cost?

the value of the next best alternative that you give up when making a choice

what are the 7 principles of effective managerial decision making?

1.Identify goals and constraints 2. Recognize the nature and importance of profits 3. Understand incentives 4. Understand markets 5. Recognize the time value of money 6. Use marginal analysis 7. Make data driven decisions

According to the 7 principles of effective managerial decision making, how do you identify goals and constraints?

1. Goals must be well defined 2. Firms overall goal is to maximize profits 3. Constraints make it difficult to achieve goals 4. Available technology & prices of inputs

what is marginal analysis?

a decision-making process that weighs the additional benefits of a choice against its additional costs

when is a decision optimal?

when the marginal benefit (MB) equals the marginal cost (MC) of consuming or producing one more unit

what is the MB = MC rule?

MB= change in total benefit/change in quantity;

a firm invests $10,000 and receives $12,000 in one year at 10% discount rate. find the NPV

PV= FV/(1+i)^n; PV= 12,000/(1+0.10)^1= 10,909.09

what is the law of demand?

The quantity of a good consumers are willing and able to purchase increases (decreases) as the price falls (rises) making price and quantity demanded are inversely related

what does a downward sloping demand mean?

lower price leads to a higher quantity demanded, and a higher price leads to a lower quantity demanded

what causes movements along the demand curve?

ONLY price changes

what are the demand shifters?

1. income 2. price of related goods 3. advertising and consumer tastes 4. population 5. consumer expectations 6. other factors like trends

how does income effect the demand curve?

for normal goods as income increases demand increases; for inferior goods as income decreases demand increases

how does the price of related goods effect the demand curve?

a higher price of the substitute increases demand for the other good; a higher price of the complement decreases demand for this good; a lower price of the complement increases demand.

how do advertising and tastes shift the demand curve?

More favorable views increase demand; less favorable views decrease demand

how do expectations shift the demand curve?

if future prices are expected to be higher demand increases and vice versa

what are normal goods?

as income increases demand also increases

what is an example of a normal good?

luxury cars or items

what are inferior goods?

as income decreases demand increases

what is an example of inferior goods?

instant noodles or fast foods

what is consumer surplus?

is the extra value that consumers derive from a good but do not pay extra for

whats an example of consumer surplus?

You'd happily pay $20 for a concert ticket, but the price is $12.

what is producer surplus?

the amount producers receive in excess of the amount necessary to induce them to produce the good

what is an example of producer surplus?

A farmer would sell a pound of apples for $3 at minimum (that's her marginal cost), but the market price is $5.

what is the law of supply?

As the price of a good rises (falls), the quantity supplied of the good rises (falls)

what might cause a supply curve to slope upward?

producing extra units typically gets costlier at the margin

what does changing only price lead to?

changes in quantity supplied causing a movement along the supply curve

what does changing other factors other than price lead to?

changes in supply and a shift of the entire supply curve

what are the supply shifters?

1. input prices 2. technology/gov regulation 3. number of firms entering and exiting 4. substitues in production 5. taxes 6. producer expectations

what is a price ceiling?

he maximum legal price that can be charged in a market

whats an example of a price ceiling?

apartment rent control

what is a price floor?

the minimum legal price that can be charged in a market

whats an example of a price floor?

legal minimum wage

what is own-price elasticity of demand?

Measures the responsiveness of a percentage change in the quantity demanded of good X to a percentage change in its price

total revenue test when demand is elastic?

a price increase (decrease) leads to a decrease (increase) in total revenue

total revenue test when demand is inelastic?

a price increase (decrease) leads to an increase (decrease) in total revenue

total revenue test when demand is unitary elastic?

total revenue is maximized

how does marginal revenue relate to elasticity?

Price cuts help when demand is elastic, hurt when inelastic

if elasticity is > 1, what should managers do with price to increase revenue?

lower the price

if elasticity is = 1, what should managers do with price to increase revenue?

total revenue is maximized and revenue wont increase by changing price

E > 1

elastic

E < 1

inelastic

E = 1

unitary elastic

with cross price elasticity of demand what does it mean when E>0?

then X and Y are substitutes

with cross price elasticity of demand what does it mean when E < 0

then X and Y are complements

what is cross price elasticity?

Measures the responsiveness of a percent change in demand for good X due to a percent change in the price of good Y

what is income elasticity?

Measures the responsiveness of a percent change in demand for good X due to a percent change in income

what does it mean if with income elasticty if E > 0?

then X is a normal good

what does it mean if with income elasticity if E < 0?

then X is an inferior good

what is perfectly elastic?

Flat (price moves a hair, quantity moves a lot

what is perfectly inelastic?

Upright (price moves, quantity doesn't

what is the difference between short run and long run in production?

one input is fixed and constrain a manager's decisions while the other inputs are variable and can be adjusted by a manager

what is total product (TP)?

Maximum level of output that can be produced with a given amount of inputs

what is average product (AP)?

a measure of the output produced per unit of input

what is marginal product (MP)?

the change in total product or output attributable to the last unit of an input

what is the law of diminishing returns?

When at least one input is fixed, adding more of another input eventually produces smaller and smaller increases in output

what are isoquants?

Isoquants are curves that show all the different input combinations (e.g., labor and capital) that can produce the same level of output

what are isocosts?

all the labor-capital combinations that cost the same total amount

what is the cost-minimization input rule?

Produce at a given level of output where the marginal product per dollar spent is equal for all inputs

what are fixed costs?

costs do not change with changes in output

what are variable costs?

costs that change with changes in output

what are total costs?

FC + VC(Q)

what are sunk costs?

cost that is forever lost after it has been paid like a car

what are economies of scale?

declining portion of the long-run where the average cost of a unit produced is reduced as the amount of output is increased

what are economies of scope?

exist when the total cost of producing Q1 and Q2 together is less than the total cost of producing each of the type of output separately

what are diseconomies of scale?

rising portion of the long-run average cost curve that occurs at a point beyond the best operating level when the cost of each additional unit made increases

what are constant returns to scale?

the middle point where the long-run average cost curve remains constant as output increases

what is an example of economies of scope?

A dairy uses the same milk processing, refrigeration, and delivery network to make milk, cheese, and yogurt—doing them together is cheaper than running each separately

what is spot exchange?

method of procuring inputs that is an informal relationship between a buyer and seller in which neither party is obligated to adhere to specific terms for exchange

what are contracts?

a method of procuring inputs that is a formal relationship between a buyer and seller that obligates the buyer and seller to exchange at terms specified in a legal document

what is vertical integration?

a method of procuring inputs where a firm produces the inputs required to make its final product

what is an example of spot exchange?

purchased 300 computer chips from a firm that ran an advertisement in the back of a computer magazine

what is an example of a contract?

legally obligated to purchase 300 computer chips each year for the next 3 years from AML. The price paid in the first year is $200 per chip, and the price rises during the second and third years by the same percentage by which the wholesale price index rises during those years.

what is an example of vertical integration?

manufactures its own motherboards and computer chips for its personal computers

what are transaction costs?

cost associated with acquiring an input that is in excess of the amount paid to the input supplier

what is an example of transaction costs?

the cost of searching for a supplier and negotiating a price

what are impacts of transaction costs on the firm and management?

Transaction costs determine whether a firm buys, contracts, or integrates—and they drive managers to design incentives and monitoring to minimize total cost

what are specialized investments?

a hidden transaction cost expenditure that must be made to allow two parties to exchange but has little or no value in any alternative use

what is the "hold-up" problem?

an implication of specialized investments where The hold-up problem occurs when one party can 'hold up' another for the value of a prior commitment, potentially leading to underinvestment

what is the principal-agent problem?

if the owner is not present to monitor the manager, how can she get the manager to do what is in her best interest? Owners must incent managers since they are not present to monitor

what are incentive mechanisms to the manager-worker principal-agent problem?

1. profit sharing

2. revenue sharing

3. piece rates

4. time clocks

5. spot checks

what is market structure factor 1?

number of firms

what is market structure factor 2 technology?

where there are labor-intensive industries or capital-intensive industries; same firms= similar cost structures while different firms= one firm has a cost advantage

what is market structure factor 3 demand and market conditions?

low demand may imply few firms while high demand may imply many firms

what is market structure factor 4?

capital requirements, patents, and economies of scale can create barriers to entry

how to measure industry concentration?

four-firm concentration and Herfindahl-Hirschman index

what is perfect competition (agriculture)?

no single buyer or seller that influences the market price, entry and exit for new firms are relatively easy

what is monopolistic competition? (restaurants)

a market structure with many firms selling differentiated, rather than identical, products, allowing each firm some degree of control over its price, while also competing with many rivals, like a competitive market

What is an oligopoly? (car industry)

multiple firms have significant market power and differentiate themselves through branding

What is a monopoly? (energy companies

one firm creating the control and lording it over others, no direct competition, they set prices, government regulation can be used to prevent abuse by these monopolies

how are patents a barrier to entry?

Legal exclusivity on an invention blocks imitators for the patent term; lets a firm be the sole seller (often creating a legal monopoly)

how are economies of scale a barrier to entry?

Large fixed costs and falling average costs over a wide output range favor big incumbents; entrants must reach large scale to be cost-competitive (can yield natural monopoly)

how are capital requirements a barrier to entry?

High upfront investment (plants, networks, R&D, advertising) deters entrants who can't raise funds at acceptable risk/cost