INTRODUCTION

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 TC t Value of firm (1 i ) t t 1

n

EXAMPLE: VALUE OF THE FIRM

Suppose that Chevron Corporation makes projections of profits (expected profits) over the next five years:

2011 2012 2013 2014 2015

= $18,690 million = $15,560 million = $14,935 million = $20,125 million = $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

$24,585 1:.03 5

Value of the firm discounted back to the present

85,653 = $_____________ million

EXPECTED VALUE MAXIMIZATION

Expected value maximization relates to the various functional departments of the firm; also illustrates the value of forecasting
TR: TC: i: marketing department, primary responsibility for promotion and sales production department, primary responsibility for costs 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. = 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 owner-entrepreneur.

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 b net income for this firm was $3,729 million. What was the profit margin for the American Express Company?
$3,729 $27,136

Profit Margin =

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 $36,708

100 = 32.4%