• The manager:
− A person who directs resources to achieve a goal
• Economics:
− The science of making decisions in the presence of scarce resources”
• Managerial economics:
− The study of how to direct scarce resources in a way that most efficiently
achieves a managerial goal
• Scarcity is important : choices matter because resources are scarce
three legs of a stool
• Balance is important
• Changing one leg risks unbalance
• Neglected in most corporate scandals
Accounting profits versus economic profits
• Accounting profits:
− Difference between revenues and production expenses; shows up in income
statements
• Economic profits:
− Difference between revenues and total costs, including opportunity costs
− More meaningful in managerial decision-making
Opportunity costs:
− To apply a resource to one use means that it cannot be put to another use
(cost of any activity in terms of next-best alternative forgone)
• Alex is a highly-regarded lawyer who earns $200 per hour. She also
worked as typist to put herself through law school. She types 100
words per minute, much faster than john, her current typist. Why did
she hire a typist when she can type faster?
Sunk costs:
− An expenditure which has already been made and cannot be recouped,
whatever the choice
− Relevance: not relevant in making forward-looking decisions (e.g. Go/no go
decisions or price setting) but sunk costs obviously may have had an effect on
financial results
Many economic choices involve some change in behavior. In making decisions, consider
what the extra (marginal) costs and benefits associated with such a change are:
− Marginal costs
− Marginal benefits / marginal revenues
, Incentives affect how resources are used, e.g:
− Profits signal to entrepreneurs which industries to enter
− Incentives influence how hard employees work
− Incentives may influence consumer choice
In market economies, incentives are supplied to individuals and firms by the chance to own
property and to retain some of the profits of working and producing
− So property rights provide incentives
Private property right: socially enforced right to select the uses of an economic good
assigned to a specific person (ownership)
Property rights: “determine who bears risk and who gains or loses from transactions; in
doing so they spur worthwhile investment, encourage monitoring and supervision, promote
work effort and create a constituency for enforceable contracts”
Ownership provides incentives
The standard competitive model
− Rational, self-interested consumers
− Rational, profit-maximizing firms
− Competitive markets
Trade-off for consumers:
− Choosing between goods given budget and time constraints
Indifference curve: what the consumer wants to consume (preferences)
Budget constraint: what the consumer can consume given his income and the prices of
consumer goods
The benefits of organizing production within firms
− Reduction in transactions costs (coase)
Problems of market arrangements:
o Uncertainty
o Complexity of contracts
o Monitoring and enforcing contracts
o Dedicated assets and the hold-up problem
But firms can become large and unwieldy
o Communications costs
o Distorted information
o Decline in organizational efficiency
− A person who directs resources to achieve a goal
• Economics:
− The science of making decisions in the presence of scarce resources”
• Managerial economics:
− The study of how to direct scarce resources in a way that most efficiently
achieves a managerial goal
• Scarcity is important : choices matter because resources are scarce
three legs of a stool
• Balance is important
• Changing one leg risks unbalance
• Neglected in most corporate scandals
Accounting profits versus economic profits
• Accounting profits:
− Difference between revenues and production expenses; shows up in income
statements
• Economic profits:
− Difference between revenues and total costs, including opportunity costs
− More meaningful in managerial decision-making
Opportunity costs:
− To apply a resource to one use means that it cannot be put to another use
(cost of any activity in terms of next-best alternative forgone)
• Alex is a highly-regarded lawyer who earns $200 per hour. She also
worked as typist to put herself through law school. She types 100
words per minute, much faster than john, her current typist. Why did
she hire a typist when she can type faster?
Sunk costs:
− An expenditure which has already been made and cannot be recouped,
whatever the choice
− Relevance: not relevant in making forward-looking decisions (e.g. Go/no go
decisions or price setting) but sunk costs obviously may have had an effect on
financial results
Many economic choices involve some change in behavior. In making decisions, consider
what the extra (marginal) costs and benefits associated with such a change are:
− Marginal costs
− Marginal benefits / marginal revenues
, Incentives affect how resources are used, e.g:
− Profits signal to entrepreneurs which industries to enter
− Incentives influence how hard employees work
− Incentives may influence consumer choice
In market economies, incentives are supplied to individuals and firms by the chance to own
property and to retain some of the profits of working and producing
− So property rights provide incentives
Private property right: socially enforced right to select the uses of an economic good
assigned to a specific person (ownership)
Property rights: “determine who bears risk and who gains or loses from transactions; in
doing so they spur worthwhile investment, encourage monitoring and supervision, promote
work effort and create a constituency for enforceable contracts”
Ownership provides incentives
The standard competitive model
− Rational, self-interested consumers
− Rational, profit-maximizing firms
− Competitive markets
Trade-off for consumers:
− Choosing between goods given budget and time constraints
Indifference curve: what the consumer wants to consume (preferences)
Budget constraint: what the consumer can consume given his income and the prices of
consumer goods
The benefits of organizing production within firms
− Reduction in transactions costs (coase)
Problems of market arrangements:
o Uncertainty
o Complexity of contracts
o Monitoring and enforcing contracts
o Dedicated assets and the hold-up problem
But firms can become large and unwieldy
o Communications costs
o Distorted information
o Decline in organizational efficiency
