Managerial Economics Prelim 1

economics

the science of making decisions with scarce resouces

managerial economics

how to direct scarce resources to satisfy a managerial goal

manager

a person who directs scarce resources to achieve a stated goal

6 principles of effective managers

1. identify goals and constraints
2. recognize the importance of profits
3. profits are a signal
4. understand incentives
5. understand markets
6. recognize time value of money

recognize importance of profits

- maximize profits or firm's value
- economic profit = Total Rev. - Total Cost
- Opportunity cost - explicit cost (monetary) + implicit cost (nonmonetary)

profits are a signal

resources move to where profits are high

understand incentives

- manager must understand how business operates and incentives for manager to excel through the organization (manager progression)
- understand incentives that motivate employees (maximum effort)

understand markets

means by which we exchange goods and services
- consumer-producer rivalry
- consumer-consumer rivalry- bidding against each other, decreases the ability to negotiate
- producer-producer rivalry

recognize the time value of money

- $1 today worth more than $1 in the future
- present value of an amount received in the future is the amount that would have to be invested today at the prevailing interest rate to generate a given future value

Future value equation

FV=PV(1+i)^n

present value equation

PV = FV/(1+i)^t

stream of future payments

FV1/(1+i)^1 + FV2/(1+i)^2 + FV3/(1+i)^3

net present value formula

PV - Current costs

Marginal analysis

- optimal decisions involving comparing the incremental benefits to the marginal costs
- when marginal values shift from the positive to the negative, the variable whose value we are looking at is maximized

marginal values

slope of function

average values

sloe of the ray from the origin

continuous math

first derivative of a function, set = 0, determines if function is a max or min

Rules of derivation

product rule: g(x) * h(x) = h(x)* dg/dx + g(x) * dh/dx

quotient rule: g(x)/h(x)= [h(x) * dg/dx - g(x) * dh/dx]/ h^2(x)

Optimum

reached whenever the derivative of a function=0
- max is reached if the second derivative is negative
- min is reached if the second derivative is positive

optimizing functions with multiple variables

- take partial derivates and set = 0
- measure changes in the dependent variable when an independent variable changes, keeping all other independent variables constant

Constrained optimization

- when only one variable, we can place the constraint directly into the objective function and solve
- with more than 1 variable, restate the constraints so they = 0, restate the objective function as Lagrangian with constraints added in, premultiplied by a Lagrangian multiplier

Demand

total quantity of a good consumers are willing and able to purchase at each price

QD

f(Px, Pz, Y, PoP, A, t, E,...)
- Px = own price
- Pz = price of related goods
- Y = income
- PoP = size of the market and composition of the population
- A= advertising: informative vs persuasive
- t = tastes
- E = expectations

substitutes

used as alternatives
- price increases demand for substitutes increases

complements

used as a package
- price increases, demand for complements decreases

change in quantity demanded

a change in the price causes a movement along a given demand curve

change in demand

a change in a ceteris paribus condition causes a movement to a new demand curve

supply

shows total quantity of a good that producers are willing and able to sell at each price

Qs

f(Px, Pi, T, #, E,...)
- Px = own price
- Pi = price of inputs
- T = technology
- # = number of firms
- E = expectations

equilibrium

interaction among buyers and sellers that arrives at a market price through "mutually beneficial and voluntary exchange

choke price

The price at which quantity demanded is equal to zero

inverse demand

Solving a given demand for P

consumer surplus

difference between what a consumer would be willing to pay and the amount actually paid for the good

total consumer surplus for a market

area below demand but above price

Inverse supply curves

solving a given supply curve for P

Producer surplus

difference between what a producer receives for a unit and what the producer would be able to see it for

government intervention

- price controls
- quantity controls
- regulation

price controls

government doesn't like the market determined price and sets the price at a different level

quantity controls

government doesn't like the market determined quantity and sets quantity at a different level

price floor

government mandated minimum price. to be effective, must be set above market clearing price
- results in a surplus

price ceiling

government mandated max price. to be effective, must be set below market clearing price
- results in a shortage

necessary price

price firms would need to receive in order to produce a given output in the long run
- attract more firms to enter a market

deadweight loss

welfare loss to society from valuing a unit of a good more than it costs to produce it, but it is not being produced

tax

government policy that (typically) increases the price to consumers and decreases the price to producers to curtail behavior
- raise revenue and get consumers and producers to consume and produce less of a good

3 ways of looking at a tax

- the "wedge"
- shifting demand/supply
- Qsoc

wedge approach to taxes

- squeezed between the demand and supply, coming from the left
- sits on top of the supply (from the left) or below the demand (from the left) to "wedge" in between the 2 curves
- consumer expenditures= Pc1*Qe1=A+B+C
- producer revenues= Pp1*Qe1=E
- government revenue= t*Qe1= A+B

shifting demand or supply

- quantity tax
- advalorem tax

quantity tax

- government adds a specific dollar amount to the price of the good
- ex. federal government tax= 18.4 cents per gallon
- Pc= Pp + t
- Pp= Pc - t

advalorem tax

- government adds a specific percent to the price of the good
- ex. state sales tax on goods in Ithaca= 6%
- Pc= Pp(1+t) = Pp +tPp

subsidies

government policy that (typically) decreases the price to consumers and increase the price to producers to promote behavior

3 ways of looking at a subsidy

- the wedge
- shifting demand and supply
- Qsoc

Pp

price producers receive (per unit)

Pc

price consumers pay (per unit)

Qe

quantity exchanged

Qc

quantity consumers wish to buy

Qp

quantity producers wish to sell

difference between taxes and subsidies

- taxes curtail behavior so they work to reduce Q
- subsidies promote behavior so they work to increase Q

subsidy wedge approach

- comes between the demand and supply from the RIGHT

quantity subsidy

Pp = Pc + $

advalorem subsidy

Pp= Pc (1+s)
Pc= Pp/(1+s)

revenues and expenditures subsidy vs tax

- consumer expenditures = Pc1*Qe1
- producer revenue = Pp1*Qe1
- government expenditures = s*Qe1, for tax = t*Qe1

Burden

share (fraction) of the government's revenue from a tax that is due to the higher price to consumers versus the lower price to producers
(wedge comes in from the left)

revenues and expenditures burden

- Government revenue = t * Qe1 = A + B
- Consumer Burden = A/(A+B)
- Producer Burden = B/(A+B)

Benefit

share of the government's expenditures on a subsidy that is due to the higher price to producers versus the lower price to consumers
- wedge comes in from the right
- need to get consumers to consume more= lower price to consumers
- need to get producers to produce more = raise price to consumers
- government makes up the difference

revenues and expenditures benefit

- government expenditures = s * Qe1 = A + B
- Consumer benefit = B/(A + B)
- Producer benefit = A/(A + B)