CHAPTER 1: INTRODUCTION TO MANAGERIAL ECONOMICS MGCR 293 DR. K. SALMASI

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1 CHAPTER 1: INTRODUCTION TO MANAGERIAL ECONOMICS MGCR 293 DR. K. SALMASI

2 COURSE OVERVIEW Managerial Economics (MGCR 293) Summer 2017 Instructor: K. S. Salmasi Ph.D., D.P.A., M.B.A., B.Com. Main Text: The custom text for McGill students of W. Bruce Allen, Neil A. Doherty, Keith Weigelt, and Edwin Mansfield, Managerial Economics: Theory, Applications, and Cases, 8th Edition (2016), W.W.Norton & Company, New York. ISBN Number ( )

3 Supplementary Text: COURSE OVERVIEW Micheal Parkin and Robin Bade, Microeconomics: Canada in The Global Environment, (9th Edition (2016), Pearson Ed. Canada. You can also use the full text of: W. Bruce Allen, Neil A. Doherty, Keith Weigelt, and Edwin Mansfield, Managerial Economics: Theory, Applications, and Cases, 8th Edition (2013), W.W.Norton & Company, New York (we will cover chapters 1-3, 5-12 and 18 of the full text).

4 DEFINING ECONOMICS Economics is the study of how people ALLOCATE their LIMITED RESOURCES to satisfy their UNLIMITED WANTS. Resources are items used to produce goods and services Wants are the goods and services consumed by people

5 MICROECONOMICS VS MACROECONOMICS The study of decision making undertaken by individuals (or households) and firms Individual Markets Wages Prices Pollution The study of the behaviour of the economy as a whole Inflation Taxes Unemployment 5

6 MICROECONOMICS VS MACROECONOMICS Production Prices Income Employment Microeconomics Production/Output in Individual Industries and Businesses How much steel How many offices How many cars Price of Individual Goods and Services Price of medical care Price of gasoline Food prices Apartment rents Distribution of Income and Wealth Wages in the auto industry Minimum wages Executive salaries Employment by Individual Businesses & Industries Jobs in the steel industry Number of employees in a firm Macroeconomics National Production/ Output Total Industrial Output Gross Domestic Product Growth of Output Output Aggregate Price Level Consumer prices Producer Prices Rate of Inflation National Income Total wages and salaries Total corporate profits Employment and Unemployment in the Economy Total number of jobs Unemployment rate

7 A consumer is trying to decide whether to take a vacation. Such a decision would be analyzed in: A. MICROECONOMICS B. MACROECONOMICS C. BOTH MICRO AND MACROECONOMICS D. NEITHER MICRO NOR MACROECONOMICS

8 POSITIVE ECONOMICS Purely descriptive statements or scientific predictions NORMATIVE ECONOMICS Analysis involving judgments

9 The economy seems to be in a recovery, but the unemployment rate has not fallen enough. This is an example of: A. MICROECONOMIC STATEMENT B. POSITIVE ECONOMIC STATEMENT C. NORMATIVE ECONOMIC STATEMENT D. BOTH A AND B E. BOTH A AND C

10 What is Managerial Economics All About? Managerial Economics, is the application of economic theory and the tools of analysis of decision-making science (i.e., mathematical economics & statistics) to analyze how a business, a not-for-profit or governmental entity (such as a firm or an organization) can utilize its limited resources most efficiently.

11 Economic Theory Management Problems Decision Sciences Management Economics Applies and Extends Concepts to Solve Management Problems

12 TOPICS AND QUESTIONS FOR ORAL PRESENTATIONS

Privatization of State- Owned Companies B.C. Hydro has privatized one third of the corporation. What is a Crown corporation? What is privatization? Who benefits from the privatization of B.C. Hydro? Do you think a hydro-producing firm is a natural monopoly?

13 Privatization of State- Owned Companies B.C. Hydro has privatized one third of the corporation. What is a Crown corporation? What is privatization? Who benefits from the privatization of B.C. Hydro? Do you think a hydro-producing firm is a natural monopoly? Why or why not? What happened to hydro rates, producer surplus, and consumer surplus as a result of privatization? The CEO of B.C. Hydro said that the privatization deal increased performance and saved money for the ratepayers. Do you agree with this statement?

14 MONTREAL AS AN AEROSPACE CLUSTER Canada is a market leader in regional aircraft, with 260 aerospace firms located in the Greater Montreal area. vwhat is a an industrial cluster? veconomical analysis of the factors leading to the success of this cluster. vwhich is Montreal s competitive advantage over other world regions? vimportance and contribution of top universities in business development.

15 OPEC OPEC is the biggest oil cartel 1. Overview and Background of OPEC 2. What is a cartel? 3. Why is it difficult for a cartel to collude and make monopoly profits? 4. Is there any benefit to OPEC if the member countries increase production and suspend output quotas? 5. Why does OPEC have spare capacity? Why are not all countries producing oil at capacity levels? 6. The present situation & the future of OPEC

16 Air Canada Describe the market for domestic air travel in Canada. vhow does Air Canada determine the prices for its tickets? vshow on a figure how a cut in the salary paid to Air Canada s pilots will change Air Canada s average variable cost, average fixed cost, average total cost, marginal cost, and economic profit. vdo you think it is important for Canada to have a national airline? Why or why not? vis a national airline a public good? Should the government financially support Air Canada?

Canada s Fastest Growing Companies Please check the Profit 500list. http://www.profitguide.

17 Canada s Fastest Growing Companies Please check the Profit 500list. Choose 3 companies from the list as Case studies, and answer the following main questions. (Up to 3 different groups can chose this topic) vexplain the Causation and Effectuation Theory. vwhat specific characteristics of these firms stand out? Have technology, resources, innovation (R&D), or others internal factors played a significant role in high growth? (Identify, list and briefly discuss) vare age of the firms, characteristics of employees, pricing techniques used, innovative quality of products or services systematically related to high-growth? (Study trends and briefly document them) vis there something about the location, industry, industry structure, or the market environment that attracts and maintains these firms and helps them to grow faster? (identify, list and briefly discuss)

18 Canada vs. U.S. University Tuition The role of education costs in attracting students... vis education considered as a Public Good? vimpact of Tuition Costs in Academic Quality. vtuition vs. Inflation vsources of University Revenues vwhy International students pay different fees? vcase Study among some famous universities

NOT-FOR-PROFIT ORGANIZATIONS The Not-for-Profit sector growth in Canada. vreasons, economical and social analysis. vits importance in developed economies.

19 NOT-FOR-PROFIT ORGANIZATIONS The Not-for-Profit sector growth in Canada. vreasons, economical and social analysis. vits importance in developed economies. vmanagement of this organizations, differences with traditional businesses. Financial constraints vs social needs: where to help and why? vfunding of the sector, the role played by the government and by individuals (personal donations, etc.).

AUTO SALES Auto Sales are increasing... vwhat is the cross elasticity of demand? vis the cross elasticity of demand between cars that are fuel efficient and the price of fuel positive or negative?

20 AUTO SALES Auto Sales are increasing... vwhat is the cross elasticity of demand? vis the cross elasticity of demand between cars that are fuel efficient and the price of fuel positive or negative? vis the income elasticity of trucks negative or positive? Why? vwhy are truck sales increasing despite the rising price of fuel? vdo you think the cross elasticity of demand for trucks with respect to the price of fuel is positive? Why or why not? vhttp://

FISH MARKET IN CANADA In Canada, the local fishing industries create more than 120,000 direct jobs in a $ 5 bn per year business. Economical analysis of the seafood market in Canada.

21 FISH MARKET IN CANADA In Canada, the local fishing industries create more than 120,000 direct jobs in a $ 5 bn per year business. Economical analysis of the seafood market in Canada. Price structure, influence of export market in local price. Importance of marketing in the food market, change in consumer preferences over periods of time. Comparison with other staple foods products market s behaviour.

22 CHARGING FEES FOR WEBSITES Many websites are now charging fee vwhat is total utility? What is marginal utility? vif websites that you currently visit for free begin to charge a fee, what effect will this have on your total utility and your marginal utility? vhow do you determine the number of websites to visit when websites have free access? vwhen websites charge a fee, explain using marginal utility theory how you determine how many websites to access. vwhen websites charge a fee, explain using???

23 REAL ESTATE MARKET IN MONTREAL vcurrent Market Situation vbuyers Market or Sellers Market? vdemand for Revenue/Residential Housing vhouse Ownership Rate by Household Income vmajor Events that has Impacted Consumer Confidence in Quebec vrent & Government Controls vmortgage Rates and Housing Cycle vfuture Real Estate Market in Montreal

24 QUESTIONS?

25 The Theory of the Firm A theory indicating how a firm behaves and what its goals are Traditionally, theory of the firm used to assume that the main objective of a company is to Maximize its profits A more recent version of this theory assumes that the main objective of a company is to Maximize its wealth (value)

26 The Theory of the Firm Managerial Objective: Make choices that increase the value of the firm. The value of the firm is defined as the PRESENT VALUE of expected future profits

27 Present Value of Expected Future Profits

28 The Theory of the Firm Managerial Choices Influence total revenue by managing demand (appropriate prices Influence total cost by managing production & cost Influence the relevant interest rate by managing finances and risk Managerial Constraints Available technologies Resource scarcity Legal or contractual limitations

29 WHAT IS PROFIT? Two Measures of Profit Accounting Profit Historical costs Legal and Reporting Requirements Economic Profit Market Value Opportunity, or implicit cost More useful measure for managerial decision making

30 SOURCES OF PROFIT Innovation Producing products that are better than existing products in terms of functionality, technology, and style Risk Taking Future outcomes and their likelihoods are unknown, as are the reactions of rivals. Exploiting Market Inefficiencies Building barriers to entry, employing sophisticated pricing strategies, diversifying, and making good strategic production decisions

31 The Principal-Agent Problem Separation of Ownership and Control Owners want to maximize the value of the firm Managers want more compensation and less accountability Divergence is the principal-agent problem The interests of a firm s owners and those of its managers may differ, unless the manager is also an owner

32 Suppose that you are asked to select an investment project from the three following choices. Which project would you select and why? GROUP ACTIVITY: CAPITAL INVESTMENT PROJECT A PROJECT B PROJECT C $1,000,000 $1,000,000 $1,000,000 RETURN (Y1) $200,000 $120,000 $350,000 RETURN (Y2) $220,000 $180,000 $250,000 RETURN (Y3) $220,000 $350,000 $210,000 RETURN (Y4) $300,000 $420,000 $200,000 RETURN (Y5) $240,000 $430,000 $200,000 32

33 Supply & Demand: A First Look

34 THE DEMAND CURVE The demand curve shows the amount of a commodity that buyers would like to purchase at various prices Vertical axis measures price (P) paid per unit in dollars Horizontal axis measures quantity (Q) demanded in number of units per time period

35 DOWNWARD-SLOPING DEMAND CURVE The demand curve slopes downward demonstrating that consumers are willing to buy more at a lower price as the product becomes relatively cheaper...

36 THE HORIZONTAL SUMMATION OF TWO DEMAND SCHEDULES Price Per Diskette Buyer 1 Quantity Demanded Buyer 2 Quantity Demanded Combined Quantity Demanded

37 THE HORIZONTAL SUMMATION OF TWO DEMAND SCHEDULES

38 A Shift in the Demand Curve When demand increases the quantity demanded will be greater at each price

39 Non-Price Demand Determinants 1) Income 2) Tastes and preferences Branding: use of advertising, product differentiation, product quality, better customer service and so forth to create strong brand images that buyers have a strong preference for their goods. 3) The price of related goods Complements Substitutes 4) Expectations Future prices & Product availability If buyers believe that the market will change in the future, such as an anticipated tightening of supplies, this may alter purchasing behaviour now. Thus, an expected constriction in supply might increase demand.

40 5) Population (market size) Demographics: A change in the proportions of the population in different age ranges can alter demand in favour of those groups increasing in size (and vice versa). 6) Special circumstances Seasonality: The need for goods varies by time of year depending on climate and weather conditions. For instance, the consumer's demand for wool clothes increases in winter and decreases in summer. Or, there is a strong demand for lawn mowers in the Spring, but not in the Fall.

41 SHIFTS IN DEMAND A change in one or more of the non-price determinants (income, tastes, etc.) will lead to a change in demand. This is a shift of the curve. A change in a good s own price leads to a change in quantity demanded. This is a movement along the curve.

42 THE SUPPLY CURVE The supply curve shows how much of a good producers are willing to sell at a given price, holding constant other factors that might affect quantity supplied Law of Supply The price of a product or service

43 INDIVIDUAL PRODUCER S SUPPLY SCHEDULE Price Per Diskette Quantity of Diskettes Supplied

44 INDIVIDUAL PRODUCER S SUPPLY CURVE

45 THE HORIZONTAL SUMMATION OF SUPPLY CURVES Price Per Diskette Quantity Supplied Producer 1 Quantity Supplied Producer 2 Combined Quantity Supplied

46 THE HORIZONTAL SUMMATION OF SUPPLY CURVES

47 A SHIFT IN THE SUPPLY CURVE When supply increases the quantity supplied will be greater at each price

48 Non-Price Supply Determinants 1) Cost of inputs/production factors (such as land, labour, energy, raw materials, etc.) 2) Technology and productivity If there is a technological advancement in one good's production, the supply increases. Other variables may also affect production conditions. For instance, for agricultural goods, weather is crucial that may affect the production outputs. 3) Taxes and Subsidies 4) Price Expectations Sellers' expectation of the future market conditions can directly affect supply. If the seller believes that the demand for his/her product will sharply increase in the foreseeable future, the firm owner may immediately increase production in anticipation of future price increases.

49 SHIFTS IN SUPPLY Changes in Supply Versus Changes in Quantity Supplied A change in one or more of the non-price determinants will lead to a change in supply. This is a shift of the curve. A change in a good s own price leads to a change in quantity supplied. This is a movement along the curve.

50 REAL WORLD EXAMPLES In 2008, fuel prices rose substantially increasing shipping costs. This caused the supply curve of foreign goods to shift to the left. WHY? (less goods could be supplied for the same price) Imported goods became more expensive, however domestic goods benefited from this rise in price The La-Z-Boy, a U.S furniture manufacturer benefited from the rise in oil price since it was faced with less foreign competition (Perloff and Brander text, p. 23)

At P0 the quantity supplied is equal to the quantity demanded at

51 THE MARKET MECHANISM (EQUILIBRIUM) The curves intersect at equilibrium, or market- clearing, price. At P0 the quantity supplied is equal to the quantity demanded at Characteristics Q0 of the equilibrium price: Q D =Q S No shortage No excess supply No pressure on the price to change 51

52 THE MARKET MECHANISM (EQUILIBRIUM) If price is above equilibrium: 1) Price is above the market clearing price 2) Qs > Qd 3) Price falls to the market-clearing price 52

53 THE MARKET MECHANISM: CHANGES IN EQUILIBRIUM When supply and demand change at the same time, the impact on the equilibrium price and quantity is determined by: 1) The relative size and direction of the change 2) The shape of the supply and demand curves 53

THE MARKET MECHANISM: EXAMPLE The real price of eggs fell 59% from 1970 to 1998.

54 THE MARKET MECHANISM: EXAMPLE The real price of eggs fell 59% from 1970 to Supply increased due to reduced cost of production. Demand decreased due to the increasing consumer concern over the health and cholesterol consequences of eating eggs. 54

55 MULTIPLE CHOICE QUESTIONS (1) Managerial economics draws upon all of the following EXCEPT: a. finance. b. microeconomics. c. accounting. d. marketing. e. sociology. Answer e 55

56 MULTIPLE CHOICE QUESTIONS (2) The economic theory of the firm assumes that the primary objective of a firm s owner or owners is to: a. Behave in a socially conscientious manner. b. Maximize the firm s profit. c. Maximize the firm s total sales. d. Maximize the value of the firm. e. All of these are primary objectives. Answer: d

57 MULTIPLE CHOICE QUESTIONS (3) What is the relationship between economic and accounting profit? a. Economic profit is equal to accounting profit. b. Economic profit is greater than accounting profit. c. Economic profit is less than accounting profit. d. Economic profit may be equal to or less than accounting profit. e. Economic profit may be equal to or greater than accounting profit. Answer: d

58 MULTIPLE CHOICE QUESTIONS (4) The market demand schedule shows the quantities that would be purchased, holding all other factors constant, from a group of firms during a given time period: a. at varying prices. b. at varying advertising levels. c. at varying competitors prices and advertising levels. d. at varying prices and advertising levels. e. over different time intervals. Answer: a

59 MULTIPLE CHOICE QUESTIONS (5) Which of the following would be likely to reduce the demand for residential housing? a. High prices for residential housing units. b. High mortgage interest rates. c. High prices for lumber and other construction materials. d. Low unemployment rates. e. Low prices for residential housing units. Answer: b

60 MULTIPLE CHOICE QUESTIONS (6) The owner- supplied labour is a cost that is usually: a. included in both accounting costs and economic costs. b. included in accounting costs but not in economic costs. c. included in economic costs but not in accounting costs. d. not included in either accounting costs or economic costs. e. ignored because it is impossible to place a value on it. Answer: c

61 MULTIPLE CHOICE QUESTIONS (7) The principal agent problem refers to: a. the threat from foreign competition. b. the need to manage inventory more effectively. c. the potential costs of separation of ownership and control. d. the time value of money. Answer: c

62 MULTIPLE CHOICE QUESTIONS (8) The statement Unemployment should be kept at or below 5 percent is. a. a positive statement b. a normative statement c. a prediction d. an assumption Answer: b

63 MULTIPLE CHOICE QUESTIONS (9) Which of the following would a manager NOT use to create market inefficiencies? a. Establishing a brand name. b. Sophisticated pricing strategies. c. Output decisions. d. Building market entry barriers. Answer: a

64 VIDEO RESOURCES

CHAPTER THREE DEMAND AND SUPPLY

CHAPTER THREE DEMAND AND SUPPLY This chapter presents a brief review of demand and supply analysis. The materials covered in this chapter provide the essential background for most of the managerial economic