Slideset 1: Chapters 1-4 Wolfgang Schwarzbauer

Transcription

1 Slideset 1: Chapters 1-4 Wolfgang Schwarzbauer

2 Roadmap Introduction Chapter 1 Demand and Supply Chapter 2 The Concept of Elasticity Chapter 3 The Theory of Individual Behavior Chapter 4 2

3 Economics of Effective Management Chapter 1 Identify Goals and Constraints Recognize the Role of Profits Understand Incentives Understand Markets Recognize the Time Value of Money Use Marginal Analysis Chapter 1 3

4 Goals and Constraints Manager A person who directs resources to achieve a stated goal. Economics The science of making decisions in the presence of scare resources. Managerial Economics The study of how to direct scarce resources in the way that most efficiently achieves a managerial goal. Chapter 1 4

5 Recognize the Role of Profits Profits are a signal of how well capital is being used Measurement: Accounting Profits Total revenue (sales) minus dollar cost of producing goods or services; Reported on the firm s income statement Economic Profits Total revenue minus total opportunity cost Chapter 1 5

6 Opportunity Costs Accounting Costs The explicit costs of the resources needed to produce produce goods or services Opportunity Cost The cost of the explicit and implicit resources that are foregone when a decision is made Chapter 1 6

7 Incentives Bonuses Promotions Profit-sharing Stock options Chapter 1 7

8 Market Interactions Consumer-Producer Rivalry Consumers attempt to locate low prices, while producers attempt to charge high prices Consumer-Consumer Rivalry Scarcity of goods reduces the negotiating power of consumers as they compete for the right to those goods Producer-Producer Rivalry Scarcity of consumers causes producers to compete with one another for the right to service customers The Role of Government Chapter 1 8

9 What determines firm behaviour/ strategy? Rivals New Entrants Substitutes Suppliers Customers Chapter 1 9

10 Time Value of Money The Present value (PV) of an amount (FV) to be received at the end of n periods when the perperiod interest rate is i : PV = FV 1 + i n Chapter 1 10

11 Present Value of future streams Present value of a stream of future amounts (FV t ) received at the end of each period for n periods: PV = T t=1 FV t 1 + i t Chapter 1 11

12 Net Present Value Suppose a manager can purchase a stream of future receipts (FV t ) by spending C 0 dollars today. The NPV of such a decision is PV = C 0 + Reject if NPV is negative Accept if NPV is positive T t=1 FV t 1 + i t Chapter 1 12

13 Marginal Analysis Control Variables (Q): Output Price Product Quality Advertising R&D Basic Question: How much of the control variable should be used to maximize net benefits? Chapter 1 13

14 Costs vs. Benefits Net Benefits = Total Benefits -Total Costs Profits = Revenue Costs Chapter 1 14

15 Costs vs. Benefits (2) Marginal Benefit (MB) Change in total benefits arising from a change in the control variable, Q: MB = B Q i.e. the slope (calculus derivative) of the total benefit curve Marginal Costs (MC) Change in total costs arising from a change in the control variable, Q: MC = C Q i.e. the slope (calculus derivative) of the total cost curve Chapter 1 15

16 Marginal Principle To maximize net benefits, the managerial control variable should be increased up to the point where MB = MC MB > MC means the last unit of the control variable increased benefits more than it increased costs MB < MC means the last unit of the control variable increased costs more than it increased benefits Chapter 1 16

17 The geometry of optimization Chapter 1 17

18 Demand & Supply Chapter 2 18

19 The Demand Function A demand function can be represented by Q x d = f P X, P Y, M, H P X price of good x P Y price of good y M income H value of any other variable Chapter 2 19

20 Determinants of Demand (shifters) Income Prices of substitutes Prices of complements Advertising Population Consumer expectations Chapter 2 20

21 The Supply Function A supply function can be represented by Q X S = f P X, P r, W, H P X price of the good P r price of technologically related goods W price of a particular input H other variables affecting supply Chapter 2 21

22 Determinants of Supply (shifters) Input prices Technology or government regulations Number of firms Substitutes in production Taxes Producer expectations Chapter 2 22

23 Taxes and Supply excise taxes taxes on each unit sold, collected from the supplier; shifts the supply curve up by the amount e.g. 0.2 euros/ unit: ad valorem tax (=according to the value) i.e. a percentage tax; VA Tax Chapter 2 23

24 Taxes and Supply (2) p p p(1+ t) P q q excise tax ad valorem tax Chapter 2 24

25 Applications The financial press reports that the prices of PC components are expected to fall by 5-8 percent over the next six months. Case 1: You manage a small firm that manufactures PCs. Case 2: You manage a small software company. Chapter 2 25

26 What is the big picture? Chapter 2 26

27 Implications for case 1 PC prices are likely to fall, and more computers will be sold Details to worry about contracts/suppliers? inventories? human resources? marketing? do I need quantitative estimates? Chapter 2 27

28 Implications for case 2 (software maker) Use analysis like that for case 1 to deduce that lower component prices will lead to a lower equilibrium price for computers a greater number of computers sold How will these changes affect the Big Picture in the software market? Software prices are likely to rise, and more software will be sold Chapter 2 28

29 Impact of lower PC prices on the software market Chapter 2 29

30 The Concept of Elasticity Chapter 3 30

31 Elasticity How responsive is variable G to a change in variable S E G,S = %ΔG %ΔS an increase in S by 1 percent leads to a change in G by x percent E G,S > 0 G and S are positively related E G,S < 0 G and S are negatively related Chapter 3 31

32 Uses of Elasticities Pricing Managing cash flows Impact of changes in competitors prices Impact of economic booms and recessions Impact of advertising campaigns. Chapter 3 32

33 Example 1: Pricing and Cash Flows According to a report, AT&T s own price elasticity of demand for long distance services is AT&T needs to boost revenues in order to meet it s marketing goals. To accomplish this goal, should AT&T raise or lower its price? Chapter 3 33

34 Answer: Lower price! Since demand is elastic, a reduction in price will increase quantity demanded by a greater percentage than the price decline, resulting in more revenues for AT&T. What would happen if the elasticity was -0.5? Chapter 3 34

35 Quantifying the Change If AT&T lowered price by 3 percent, what would happen to the volume of long distance telephone calls routed through AT&T? Calls would increase by percent! E Qx d,p X = 8.64 = %Q x d = %Q d x = %Q x d Chapter 3 35

36 Types of Demand - Elasticities Q d x = f P X, P Y, M, H Price Elasticity of demand E Qx d,p X = %Q x d = Q d x P X %P X P d X Q x Cross-Price Elasticity of demand E Qx d,p Y = %Q x d = Q d x P Y %P Y P d Y Q x Income Elasticity of demand E Qx d,m = %Q x d %M = Q d x M M Q x d 36 Chapter 3

37 Linear Demand Elasticities Q x d = α 0 + α X P X + α Y P Y + α M M + α H H Own price elasticity Cross-price elasticity Income elasticity α X P X Q x α Y P Y Q x α M M Q x Chapter 3 37

38 Non-linear Demand Elasticities Q x d = cp X β X P Y β Y M β MH β H ln Q x d = β 0 + β X ln P X + β Y ln P Y + β M ln M + β H ln H Own price elasticity Cross-price elasticity Income elasticity β X β Y β M Chapter 3 38

39 Price elasticity of demand and Total Revenue P elastic inelastic MR = P 1+E E D Q MR Chapter 3 39

40 Factors affecting own price elasticity available substitutes (the more the more elastic) time (more inelastic in short term) expenditure share (small proportion of income more inelastic) Chapter 3 40

41 The Theory of Individual Behavior Chapter 4 41

42 Roadmap 1. Consumer Behavior Indifference Curve Analysis Consumer Preference Ordering 2. Constraints The Budget Constraint Changes in Income Changes in Prices 3. Consumer Equilibrium 4.Indifference Curve Analysis & Demand Curves Individual Demand Market Demand Chapter 4 42

43 Consumer Behavior Consumer Opportunities The possible goods and services consumer can afford to consume. Consumer Preferences The goods and services consumers actually consume. Given the choice between 2 bundles of goods a consumer either Prefers bundle A to bundle B: A B Prefers bundle B to bundle A: A B Is indifferent between the two: A B Chapter 4 43

44 Consumer Preference Ordering Properties 1. Completeness For any two bundles A,B we either have A B, A B, A B. 2. More is better (non-satiation) If bundle has at least as much of every good as bundle B and more of some good, A B. 3. Transitivity For any three bundles A, B and C and if A B and B C then A C, similarly if A B andb C then A C. 4. Diminishing Marginal Rate of Substitution As a consumer obtains more of good X, the rate at which she is willing to substitute X for Y decreases. Chapter 4 44

45 Indifference Curve Analysis Indifference Curve A curve that defines the combinations of 2 or more goods that give a consumer the same level of satisfaction. Marginal Rate of Substitution The rate at which a consumer is willing to substitute one good for another and stay at the same satisfaction level. Chapter 4 45

46 The Budget Constraint Y M P Y Y = M P Y P X P Y X P X X + P Y Y M Y = M P Y P X P Y X M P X X Chapter 4 46

47 Changes in the Budget Constraint Changes in Income Increases lead to a parallel outward shift in the budget line; decreases to a parallel inward shift Changes in Price A decrease in the price of X rotates the budget line counter-clockwise Chapter 4 47

48 Consumer Equilibrium The consumption bundle is the affordable bundle that yields the highest level of satisfaction; MRS = P X P Y, or the slope of the budget line equals the slope of the indifference curve Chapter 4 48

49 Complements & Substitutes Y X & Y are substitutes Y X & Y are complements Y 1 Y 2 Y 2 Y 1 X 1 X 2 X X 1 X 2 X Chapter 4 49

50 Normal & Inferior Goods Y Y Inferior Good Normal Good X 2 X 1 X X 1 X 2 X Chapter 4 50

51 Price change details Two effects are at work when the price of a good changes Substitution effect A(n) decrease (increase) in the price of good X makes it cheaper (more expensive) relative to good Y so that she will want to spend more (less) on good X. Income effect Due to the decrease (increase) in the price of good X the real value of the consumer s income increases (decreases) such that she can spend more on both goods X and Y. The overall effect of a price change will depend on the relative sizes of substitution and income effects end the direction of the income effect. Chapter 4 51

52 Some small applications BOGOF vs. 50%-off Y Initial budget line BOGOF budget line X Chapter 4 52

53 Advantages of BOGOF Original Choice is half a pizza With a deal, the new budget line is extended Price = zero (between 1 and 2) Must buy at least a whole pizza, after 2 pizzas regular price again Consumer is induced to buy more pizza at, prize of the first pizza stays the same Chapter 4 53

54 Variation on BOGOF A newspaper circular advertised the following special on Goodyear tires: Buy three, get the fourth tire for free limit one free tire per customer. If a consumer has $500 to spend on tires and other goods and each tire usually sells for $50, how does this deal impact the consumer s opportunity set? Chapter 4 54

55 Variation on BOGOF (2) Chapter 4 55

56 Frequent Buyer Program A Bagel company offers a frequent buyer program whereby a consumer receives a stamp each time he purchases one dozen bagels for $5. After they accrue 10 stamps, they receive one dozen bagels for free. The manager knows bagels are normal goods. Given this information, construct the budget set for a consumer who has $150 to spend on bagels and other goods. Does this program have the same effect on the consumption of bagels that would occur if the Manager simply reduced the price of one dozen bagels by 3%? Chapter 4 56

57 Frequent Buyer Program Chapter 4 57

58 Individual Demand Curve An individual s demand curve is derived from each new equilibrium point found on the indifference curve as the price of good X is varied. Chapter 4 58

59 Market Demand Curve The market demand curve is the horizontal summation of individual demand curves. It indicates the total quantity all consumers would purchase at each price point Chapter 4 59

60 Fin.. 60