INTRODUCTION
Nature and Scope of Managerial Economics
(Chapter 1 Hirschey)
Nature and Scope of Managerial Economics
• Definition of Managerial Economics
• Application of economic tools and techniques to business and
administrative decision-making; another term for the title of this
course, namely economic analysis for agribusiness and management.
• Helps decision-makers recognize how economic forces affect
organizations and describes the economic consequences of
managerial behavior. How? By linking economic concepts and
quantitative methods to develop tools for managerial decisionmaking.
• Simply put, managerial economics uses economic concepts and
quantitative methods to solve managerial problems.
• We place emphasis on the practical application of economic analysis
to managerial decision problems; the primary virtue of managerial
economics lies in its usefulness.
Economic Concepts
• Economic concepts:
• influence which products to produce, which costs to consider,
and the prices to charge;
• necessitates the collection, organization, and analysis of
information.
• Emphasis is placed on microeconomic topics, although
macroeconomic relations have implications for managerial
decision-making as well.
Economic decision-making requires the
following:
1) Optimization techniques (calculus-based and linear
programming)
2) Statistical relations
3) Demand analysis and estimation (through regression)
4) Forces of demand and supply
5) Forecasting of firm activities (sales, production, demand,
prices)
6) Risk analysis
Firms
• Firms are useful for producing and distributing goods and
services
• Motivation for firms:
• profit maximization or expected value maximization; free
enterprise depends upon profits and the profit motive
• Expected value of maximization:
• optimization of profits in light of uncertainty and time value of
money.
Value of the firm
•
+… +,
TRt  TCt
Value of firm  
t
(
1

i
)
t 1
n
Example: Value of the firm
• Suppose that Chevron Corporation makes projections of
profits (expected profits) over the next five years:
• 𝜋2011 = $18,690 million
•
•
•
•
𝜋2012 = $15,560 million
𝜋 2013 = $14,935 million
𝜋 2014 = $20,125 million
𝜋 2015 = $24,585 million
Example, cont.
• Let the discount rate be equal to three percent. Calculate the
value of Chevron Corporation today.
• Value of the firm ( in millions)
=
$18,690
1+.03 1
+
$15,650
1+.03 2
+
$14,935
1+.03 3
+
$20,125
1+.03 4
+
• Value of the firm discounted back to the present
85,653
= $_____________
million
$24,585
1+.03 5
Expected value maximization
• Expected value maximization relates to the various functional
departments of the firm; also illustrates the value of
forecasting
•
•
•
TR: marketing department, primary responsibility
for promotion and sales
TC: production department, primary
responsibility for costs
i: finance department, primary responsibility
for the acquisition of capital and hence the
discount factor i.
Total Revenue and Total Costs
• The determination of TR and TC is a non-trivial and often
complex task.
• 𝜋𝑡 = 𝑇𝑅𝑡 − 𝑇𝐶𝑡
• Suppose that a firm produces only one product.
• TRt = PtQt-1 requires the notion of a demand function
• TCt = fixed costst + variable costst
• Variable costs are a function of Q ⇒ TCt = f(Qt)
• Even more complex situation if a firm produces more than one
product.
Firm faces constraints
•
•
•
•
•
•
Skilled labor
Raw materials
Energy
Specialized machinery
Warehouse space
Amount of investment funds available for a particular project or
activity
• Legal /contractual restrictions
• Consequently, optimization techniques with constraints are
important in decision-making
• Linear programming
• Calculus-based optimization
Profit measurement
• Business Profit:
• = TR – TC
• the residual of sales revenue minus the explicit costs of doing
business.
• Economic Profit:
• = business profit minus the implicit costs of capital and any other
owner-provided inputs
• reflects the opportunity cost for the effort of the ownerentrepreneur.
Profit measurement
• Opportunity Costs:
• Owner-provided inputs are a notable part of business profits,
especially among small businesses.
• Profit Margin:
• = business profit (net income)/sales,
• Expressed as a percent
Example: Profit Margin
• In 2007, the sales revenue of the American Express Company
was $27,136 million. The business profit or net income for this
firm was $3,729 million. What was the profit margin for the
American Express Company?
$3,729 𝑚𝑖𝑙𝑙𝑖𝑜𝑛
Profit Margin =
$27,136 𝑚𝑖𝑙𝑙𝑖𝑜𝑛
∗ 100 = 13.7%
Equity
• Return on Equity(ROE)
• business profit (net income)/equity
• Expressed as a percent
• Equity
• total assets – total liabilities = net worth=equity
Example: ROE
• In 2007, the net income for Microsoft Corporation was
$11,909 million. The equity (or net worth) of this firm was
$36,708 million. What is the ROE for Microsoft Corporation?
ROE =
$11,909 𝑚𝑖𝑙𝑙𝑖𝑜𝑛
$36,708 𝑚𝑖𝑙𝑙𝑖𝑜𝑛
∗ 100 = 32.4%