January 18, 2006 Reading Baye, Ch. 1 pp 1-14
Lecture 1 Ch 2 pp. 35-57 (for next class)
Problems: Ch. 1: 1, 2, 4, 5, 8,
I. Chapter 1. The Fundamentals of Managerial Economics
Preview:
A. Definition of Topic.
1. Economics
2. Managerial Decisions
B. Components of Effective Decision Making
1. Identify Goals and Constraints:
2. Recognize the Nature and Importance of Profits: Economic profits differ from Accounting profits. . Good decision-making involves the maximization of economic profits.
Lecture______
A. Definition of Topic.
A first topic involves defining the scope of the course:
1. Economics: The study of how societies and individuals allocate scarce resources among competing ends.
Observation: This is a study of allocation decisions. It applies widely to an immense variety of topics. It is not, for example, particularly focused on the decisions of businesses. It applies to profit as well as to non profit institutions.
2. The Manager. A person who directs resources to achieve a stated goal.
Observation: Again, this is a very broad definition. Clearly, you manage your own lives. In business or organizational contexts, managers control resources other than their own time and energy such as
a. The efforts of others
b. Input acquisition and use
c. Output/Pricing decisions
3. Managerial Economics: The study of how to direct scarce resources in the way that most efficiently achieves a managerial goal.
Observation: The difference between this course and, say microeconomics is that it is policy oriented. That is, we focus on giving you tools to make decisions, rather than describing how a market or an economy as a whole works.
B. Effective Management from an Economic Perspective. Economic “tools” are guides to good allocative decision-making. Elements of good decision-making can be divided into six categories
1. Identify Goals and Constraints: This is critical for defining the dimension of the problem.
Objectives are simply what you would like to accomplish. Constraints are the natural (and perhaps unfortunate) consequence of scarcity.
a. Having a well-defined objective in mind when making an allocative decision is critical. (Very concretely, imagine how one might decide to allocate time to this course if it were uncertain whether your intention was to get a good grade or to merely pass)
b. Also, it is necessary to evaluate the constraints available in the decision process. (For example, time is typically the constraint in making personal allocative decisions. Most of our applications will focus on the decisions of a profit-maximizing firm. Here the objective is typically profits. Constraints arise in the form of pricing limitations, and production considerations.)
2. Recognize the Nature and Importance of Profits: When discussing the firm, profits take on a special role. However, when making allocative decisions you must have the correct definition of profits in mind.
a. Accounting Profits
pA = TR - TCA
b. Economic Profits
pE = TR - (TCA +TCI)
The difference in the definitions is implicit costs. Implicit costs are measured in terms of foregone alternatives. Economic costs are the sum of implicit and implicit costs. Economic costs can be measured in terms of choices foregone, or opportunity costs.
Observations
a) The function of economic profits. Accounting profits are not an incorrect definition of profits, just inappropriate for the purpose of making allocative decisions.
Example: Suppose you consider opening a T.J. Cinnamon Franchise in a storefront you own in the VA Center Commons, North of Richmond. Suppose the franchise fee is $20,000 per year, and you must pay $80,000 per year for materials and help. How much must you earn to realize an accounting profit?
Suppose that you must work in the store (and quit your job paying $25,000 per year). Also you could rent the store slot for $1000 per month. If you expected revenues of $120,000 per year, would this be a good allocation of resources?
b) The difficulty of collecting implicit cost information. In fact, it is relatively difficult get good information pertaining to opportunity costs. A legitimate (and important) function of the manager is to do as good a job as possible in collecting this information.
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