Introduction To Economic Decision Making, Lecture Notes - Managerial Economics, Study notes for Managerial Economics. University of Michigan (MI)

Managerial Economics

Description: INTRODUCTION TO ECONOMIC DECISION MAKING, EXAMPLES OF MANAGERIAL DECISIONS, SIX STEPS TO DECISION MAKING, SALES MAXIMIZATION VS PROFIT MAXIMIZATION, SOCIAL RESPONSIBILITY OF BUSINESS
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ECN 469: Managerial Economics Professor Mark J. Perry
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CHAPTER 1 - INTRODUCTION TO ECONOMIC DECISION MAKING
Opening quote, see page 1.
Decision making is at the heart of most important business and govt. problems.
Examples:
High-tech company: Undertake a promising but expensive R & D program?
Petrochemical Manufacturer: Cut price in response to increased competition?
Telecommunication Co: What bid to make for govt. contract?
Food company: Introduce a new food product after mixed test-marketing?
Fed Govt.: Stricter rollover standards for SUVs?
City Govt.: Allocate funds to construct harbor tunnel for increased traffic flow?
Fed Govt.: Increase funding for cancer research?
Important question: What is the alternative?”
All decisions are economic decisions involving what comparison?
Managerial Economics (ME) is the analysis of major management decisions using the tools and
concepts of economics: supply and demand and cost, resource allocation, efficiency, cost-benefit,
trade-offs, competition, strategic behavior, industry organization, market structure, etc. Managerial
Economics (ME) is the study of the economic framework and the economic tools used to make
management decisions, in both the private and public sector. For example, think of the thousands of
decisions that get made every month at GM, Genesee County, Hurley Hospital, UM-F, YWCA, etc.
ME provides a formal, systematic decision-making framework that facilitates and enhances sound
decision making within organizations.
ME focuses on the prescriptive approach to managerial decision, meaning a very applied approach
(instead of theoretical) to analyzing practical decisions actually faced by businesses and governments.
Most of the analytical methods covered in ME were developed in response to important, actual real-
world, recurring managerial decisions, such as optimal pricing (e.g., pricing in the airline industry
taking into account consumer demand, profit maximization, elasticity, rivals’ reactions), forecasting
(GM forecasting demand to determine optimal production, pricing, advertising, etc.), capital budgeting
(PV comparison of current costs versus expected future benefits), cost-benefit analysis of regulation or
legislation, etc. ME applies the principles of economics to help us understand how decisions are made
in the public and private sectors.
EXAMPLES OF MANAGERIAL DECISIONS
1. Multinational Production and Pricing. Consider U.S. automaker like GM with production
facilities in 50 countries and sales in almost 200 countries! To maximize profits, what decisions does
ECN 469: Managerial Economics Professor Mark J. Perry
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GM have to make in regard to pricing and production? See example in book, two markets for sales and
production of vehicles for an automaker (p. 3).
2. Forecasting. In the 1980s, Disney decided to enter the European market by investing billions of
dollars to build a new theme park somewhere in Europe, including 5000 hotel rooms, office space,
homes, golf course, etc. Decisions included where to locate in Europe, what attractions to offer, how to
modify Disney for the European market, how to finance the investment, etc. A major part of the initial
decision-making involved forecasting variables such as:
a.
b.
c.
d.
e.
After opening in 1992, the project had many problems including: lower than expected attendance,
higher than expected costs, cultural issues such as alcohol and beards, etc. The original forecasts
turned out to be overly optimistic. Euro Disney illustrates the important role of forecasting in
managerial decisions.
3. R & D decisions. Pharmaceutical companies continually face very important R&D decisions; they
are putting up millions of dollars in research in most cases at least a decade before any revenue is
generated. Average time for FDA approval? There is extreme uncertainty about the outcome of
research, the cost of the research and the potential market value of a new product, so they are faced
with decision-making under uncertainty. In the case in the book, a drug company is faced with two
alternative research approaches to developing a drug to dissolve blood clots, which would potentially
generate huge profits. The case illustrates a common management issue: an investment with large
fixed costs (FC) but small variable costs (VC) versus an investment with small FC but large VC. High
tech approach (High FC, low VC) vs. Low tech approach (Low FC, High VC).
4. Credit Risk. Credit cards are very profitable, sometimes 3X more profitable than ordinary lending
(12-18% for credit cards vs. 4-8% for mortgages and car loans), but credit cards are more risky. Why?
Credit scores and credit-analysis software can be used to supplement human decision-making, and
measure credit risk, and predict what?
5. Market entry, competition, market structure. Giant book retailers Barnes & Noble and Borders
have been engaged in a cutthroat retail battle across the country, like in other industries such as:
a.
b.
c.
Intense competition between dominant firms (superstores) in an industry results in many interesting
issues affecting decisions. If Borders enters a new market, will Barnes & Noble follow? Can an
incumbent erect barriers to entry? How to best compete against your rival, on which dimension to
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