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Principles of Managerial Economics

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Original source: The Saylor Foundation df

Contents

Chapter 1 Introduction to Managerial Economics .....................................................1 1.1 What Is Managerial Economics? ......................................................................................1 1.2 Why Managerial Economics Is Relevant for Managers ..................................................1 1.3 Managerial Economics Is Applicable to Different Types of Organizations ..................2 1.4 The Focus of This Book ......................................................................................................3 1.5 How to Read This Book ......................................................................................................3

Chapter 2 Key Measures and Relationships ...............................................................5 2.1 A Simple Business Venture ...............................................................................................5 2.2 Revenue, Cost, and Profit ..................................................................................................5 2.3 Economic Versus Accounting Measures of Cost and Profit ..........................................6 2.4 Revenue, Cost, and Profit Functions ................................................................................7 2.5 Breakeven Analysis...........................................................................................................10 2.6 The Impact of Price Changes...........................................................................................11 2.7 Marginal Analysis..............................................................................................................14 2.8 The Conclusion for Our Students ...................................................................................16 2.9 The Shutdown Rule ..........................................................................................................17 2.10 A Final Word on Business Objectives ...........................................................................18

Chapter 3 Demand and Pricing ..................................................................................20 3.1 Theory of the Consumer..................................................................................................20 3.2 Is the Theory of the Consumer Realistic? ......................................................................22 3.3 Determinants of Demand................................................................................................23 3.4 Modeling Consumer Demand.........................................................................................24 3.5 Forecasting Demand ........................................................................................................26 3.6 Elasticity of Demand.........................................................................................................28 3.7 Consumption Decisions in the Short Run and the Long Run......................................30 3.8 Price Discrimination .........................................................................................................31

Chapter 4 Cost and Production ..................................................................................34 4.1 Average Cost Curves ........................................................................................................34 4.2 Long-Run Average Cost and Scale ..................................................................................36 4.3 Economies of Scope and Joint Products ........................................................................39 4.4 Cost Approach Versus Resource Approach to Production Planning..........................40 4.5 Marginal Revenue Product and Derived Demand........................................................41 4.6 Marginal Cost of Inputs and Economic Rent .................................................................43 4.7 Productivity and the Learning Curve..............................................................................44

Chapter 5 Economics of Organization .......................................................................47 5.1 Reasons to Expand an Enterprise...................................................................................47 5.2 Classifying Business Expansion in Terms of Value Chains ..........................................48 5.3 Horizontal Integration......................................................................................................50 5.4 Vertical Integration ...........................................................................................................50 5.5 Alternatives to Vertical Integration.................................................................................51 5.6 Conglomerates..................................................................................................................52 5.7 Transaction Costs and Boundaries of the Firm ............................................................53 5.8 Cost Centers Versus Profit Centers ................................................................................54 5.9 Transfer Pricing.................................................................................................................55

5.10 Employee Motivation .....................................................................................................56 5.11 Manager Motivation and Executive Pay ......................................................................58

Chapter 6 Market Equilibrium and the Perfect Competition Model .....................59 6.1 Assumptions of the Perfect Competition Model ..........................................................59 6.2 Operation of a Perfectly Competitive Market in the Short Run ..................................60 6.3 Perfect Competition in the Long Run.............................................................................62 6.4 Firm Supply Curves and Market Supply Curves............................................................63 6.5 Market Equilibrium...........................................................................................................64 6.6 Shifts in Supply and Demand Curves .............................................................................67 6.7 Why Perfect Competition Is Desirable ...........................................................................71 6.8 Monopolistic Competition ...............................................................................................74 6.9 Contestable Market Model ..............................................................................................75 6.10 Firm Strategies in Highly Competitive Markets ..........................................................76

Chapter 7 Firm Competition and Market Structure ................................................78 7.1 Why Perfect Competition Usually Does Not Happen...................................................78 7.2 Monopoly...........................................................................................................................80 7.3 Oligopoly and Cartels .......................................................................................................81 7.4 Production Decisions in Noncartel Oligopolies ............................................................82 7.5 Seller Concentration.........................................................................................................84 7.6 Competing in Tight Oligopolies: Pricing Strategies ......................................................85 7.7 Competing in Tight Oligopolies: Nonpricing Strategies ...............................................87 7.8 Buyer Power ......................................................................................................................90

Chapter 8 Market Regulation .....................................................................................92 8.1 Free Market Economies Versus Collectivist Economies...............................................92 8.2 Efficiency and Equity ........................................................................................................93 8.3 Circumstances in Which Market Regulation May Be Desirable ..................................94 8.4 Regulation to Offset Market Power of Sellers or Buyers .............................................94 8.5 Natural Monopoly ............................................................................................................95 8.6 Externalities.......................................................................................................................96 8.7 Externality Taxes...............................................................................................................97 8.8 Regulation of Externalities Through Property Rights...................................................99 8.9 High Cost to Initial Entrant and the Risk of Free Rider Producers..............................99 8.10 Public Goods and the Risk of Free Rider Consumers ............................................. 101 8.11 Market Failure Caused by Imperfect Information ................................................... 102 8.12 Limitations of Market Regulation .............................................................................. 104 8.13 References ................................................................................................................... 105

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Chapter 1 Introduction to Managerial

Economics

1.1 What Is Managerial Economics?

Available under Creative Commons-NonCommercial-ShareAlike 4.0 International License (http://c licenses/by-nc-sa/4.0/).

One standard definition for economics is the study of the production, distribution, and consumption of goods and services. A second definition is the study of choice related to the allocation of scarce resources. The first definition indicates that economics includes any business, nonprofit organization, or administrative unit. The second definition establishes that economics is at the core of what managers of these organizations do. This book presents economic concepts and principles from the perspective of "managerial economics," which is a subfield of economics that places special emphasis on the choice aspect in the second definition. The purpose of managerial economics is to provide economic terminology and reasoning for the improvement of managerial decisions. Most readers will be familiar with two different conceptual approaches to the study of economics: microeconomics and macroeconomics. Microeconomics studies phenomena related to goods and services from the perspective of individual decision-making entities--that is, households and businesses. Macroeconomics approaches the same phenomena at an aggregate level, for example, the total consumption and production of a region. Microeconomics and macroeconomics each have their merits. The microeconomic approach is essential for understanding the behavior of atomic entities in an economy. However, understanding the systematic interaction of the many households and businesses would be too complex to derive from descriptions of the individual units. The macroeconomic approach provides measures and theories to understand the overall systematic behavior of an economy. Since the purpose of managerial economics is to apply economics for the improvement of managerial decisions in an organization, most of the subject material in managerial economics has a microeconomic focus. However, since managers must consider the state of their environment in making decisions and the environment includes the overall economy, an understanding of how to interpret and forecast macroeconomic measures is useful in making managerial decisions.

1.2 Why Managerial Economics Is Relevant for Managers

Available under Creative Commons-NonCommercial-ShareAlike 4.0 International License (http://c licenses/by-nc-sa/4.0/).

In a civilized society, we rely on others in the society to produce and distribute nearly all the goods and services we need. However, the sources of those goods and services are usually not other individuals but organizations created for the explicit purpose of producing and distributing goods and services. Nearly every organization in our

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