Introduction

Scheme of session
1. Economics and managerial decision making 2. Economics of a business 3. Review of economic terms 4. Approach of Managerial Economics
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Economics and managerial decision making

Economics The study of the behavior of human beings in producing, distributing and consuming material goods and services in a world of scarce resources

Economics and managerial decision making

Management The science of organizing and allocating a firms scarce resources to achieve its desired objectives

Economics and managerial decision making

Managerial economics The use of economic analysis to make business decisions involving the best use (allocation) of an organizations scarce resources

Economics and managerial decision making

Relationship to other business disciplines Marketing: demand, price elasticity Finance: capital budgeting, breakeven analysis, opportunity cost, value added Management science: linear programming, regression analysis, Demand forecasting
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Economics and managerial decision making

Relationship to other business disciplines Strategy: types of competition, structure-conduct-performance analysis Managerial accounting: relevant cost, breakeven analysis, incremental cost analysis, opportunity cost
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Economics and managerial decision making

Questions that managers must answer:


What are the economic conditions in our particular market? market structure? supply and demand? technology?

Economics and managerial decision making

Questions that managers must answer:


What are the economic conditions in our particular market? government regulations? international dimensions? future conditions? macroeconomic factors?
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Economics and managerial decision making

Questions that managers must answer:


Should our firm be in this business? if so, at what price? and at what output level?

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Economics and managerial decision making

Questions that managers must answer:


How can we maintain a competitive advantage over other firms? cost-leader? product differentiation? market niche? outsourcing, alliances, mergers? international perspective?
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Economics and managerial decision making

Questions that managers must answer:


What are the risks involved? shifts in demand/supply conditions? technological changes? the effect of competition? changing interest rates and inflation rates?
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Economics and managerial decision making

Questions that managers must answer:


What are the risks involved? exchange rates (for companies in international trade)? political risk (for firms with foreign operations)?

Risk is the chance that actual future outcomes will differ from those expected
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Economics of a business
The economics of a business refers to the key factors that affect the firms ability to earn an acceptable rate of return on its owners investment The most important of these factors are  competition  technology  customers
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Economics of a business
Change: the four-stage model


Stage I (the good old days) market dominance high profit margin cost plus pricing changes in technology, competition, customers force firm into Stage II ..
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Economics of a business
Change: the four-stage model


Stage II (crisis) cost management downsizing restructuring re-engineering to deal with changes and move firm into Stage III ..
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Economics of a business
Change: the four-stage model


Stage III (reform) revenue management cost cutting has limited benefit focus on top-line growth ..

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Economics of a business
Change: the four-stage model


Stage IV (recovery) revenue plus revenue grows profitably

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Economics of a business
Example: RC Cola Well established company, in stage I
until late 1980s Managed to upgrade in Stage II during late 1980s since mid 1990s, could not make entered in stage III could not updated its image Result:  could not able to compete in emerging markets
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Economics of a business
Example: Gul Ahmed Top Fabric exporter Elimination of quota effect Fell down to number three in late 2000 repositioned itself adopting new strategies

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Economics of a business
Example: Kodak struggled to transition from chemical-based film to digital imaging responded by developing strong cash flows in new product range

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Review of economic terms

Microeconomics is the study of individual consumers and producers in specific markets, especially: supply and demand pricing of output production process cost structure distribution of income
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Review of economic terms

Macroeconomics is the study of the aggregate economy, especially: national output (GDP) unemployment inflation fiscal and monetary policies trade and finance among nations

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Review of economic terms

Resources are inputs (factors) of production, notably: land labor capital entrepreneurship

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Review of economic terms

Scarcity is the condition in which resources are not available to satisfy all the needs and wants of a specified group of people Opportunity cost is the amount (or subjective value) that must be sacrificed in choosing one activity over the next best alternative
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Review of economic terms

Allocation decisions must be made because of scarcity. Three choices: What should be produced? How should it be produced? For whom should be produced?
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Economic System
Capitalism
 

Invisible hand USA Russia

Socialism


Mixed Economy

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Review of economic terms

Economic decisions of the Firm What - begin or stop providing goods/services (production) How - hiring, staffing, capital budgeting (resourcing) For whom target the customers most likely to purchase (marketing)
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Review of economic terms

Entrepreneurship is the willingness to take certain risks in the pursuit of goals Management is the ability to organize resources and administer tasks to achieve objectives

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Global application
Example: Bayer Health Care began over 100 years ago huge changes in technology to survive, the company branched out

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Global application
Example: Trans-world Aviation Dubai based aircraft manufacturing company company transformed itself into a global provider of aviation products & spare parts
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Approach of Managerial Economics

Identify objectives and constraints Conduct marginal analysis Use economic profits Consider incentives Understand markets Recognize the time value of money.

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Approach of Managerial Economics

1. Identify objectives and constraints The role of objectives Resources are scarce: Impose constraints Limit possibilities

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Approach of Managerial Economics

2. Conduct marginal analysis
Why and how marginal analysis: Decide on the basis of marginal benefits and marginal costs. Examples: Discrete decisions: How many machines to buy? Continuous decisions: How much for advertising?

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Approach of Managerial Economics

Use economic profits Accounting profits Economic profits: Opportunity costs. Example:


Operation of a small Fast Food Shop Maximize shareholders value.

Objective:


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Approach of Managerial Economics

Use economic profits Ali runs a small Fast Food restaurant in his Gulshan-e-Iqbal
He owns the building.  Annual revenues are RS100,000  Annual costs are RS 20,000  Annual profit is RS 80,000 This is not the economic profit!


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Approach of Managerial Economics

Use economic profits Ali could have a job earning RS 30,000. Ali could have rented the space for RS 100,000. The economic profit is just: P = 80000 - 30000 -100000 = -50000 Conclusion:


Ali should close the restaurant, rent the space and get the alternative job
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Approach of Managerial Economics

Consider incentives where HR involve People respond to incentives: Incentives must be aligned with objectives. Examples.. next slide

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Approach of Managerial Economics

Consider incentives and signaling
Empirical effects of performance contracts China has used performance contracts on a large Scale. On average, they were negative because of large losses on poorly designed PCs. Successful PCs were those with sensible targets, stronger incentives, longer term, managerial bonds, and in more competitive industries

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Approach of Managerial Economics

Consider incentives and signaling
Siege of Mono by the Castilian army in 1376

Deuladeu Martins ordered that the bread baked from the last flour in the village, to be thrown to their besiegers. Inferring that the villagers had plenty of supplies, the siege was lifted

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Approach of Managerial Economics

Understand markets Demand and supply Conflicting interests between buyers and sellers Understanding markets is key for good

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Approach of Managerial Economics

Recognize the time value of money
Many decisions have monetary implications throughout a long period of time (R&D is a typical example). This raises specific problems. 1RS today is worth more that 1RS one year from now
  

Opportunity cost of capital Use present values Example: R&D of new drugs.

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Approach of Managerial Economics

Recognize the time value of money
R&D of new drugs The development of new drugs is lenghty and costly: 12 years and 802M$ on average (Di Masi et al, J. of Health Economics, 2003). This is a huge investment. Pharmaceutical companies attempt only to develop drugs with very high expected revenues. The result is that no new drugs are developed for typical third world diseases (The Economist)

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Thanks
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