Paciones, Chema - Book Report

MANAGERIAL
ECONOMICS
7th Edition
MBA 203 A: MANAGERIAL ECONOMICS
Book Report
on
Prepared by:
CHEMA C. PACIONES
DR. EDUARDO C. ZIALCITA

Dean/Professor
About the Authors
William Samuelson
Professor, Markets, Public
Policy, and Law
Expertise:
Bargaining, Bidding,
Market Competition,
Negotiations
Education:
Ph D, Harvard University,
Economics, 1978.
BA, Harvard College, Applied
Mathematics, 1974
• Professor of economics and finance in Boston University’s Questroom School of Business.
• After receiving his Ph.D in economics from Harvard University in 1978, Samuelson joined the Boston
University faculty
• In 1996, Samuelson received the Executive MBA Teaching Award.
Stephen G. Marks
Professor of Law
BA magna cum laude,
University of California-
Irvine
JD and PhD in Economics,
University of California-
Berkeley
AREAS OF INTEREST
Corporate, Business &
Transactional Law,
Economics & Law
• Stephen Marks has been a distinguished member
of the Boston University community for many
years.
• Since joining the School of Law faculty in 1988,

Professor Marks has taught courses in
corporations, securities regulation and law and
economics.
“In every practice area, lawyers come face-to-face with corporations.

And economics provides students with a powerful and rigorous tool for
analyzing law and legal institutions.”
• The main highlight of the book Managerial Economics, 7th Edition is
its consistent emphasis on managerial decision making.
– Definition and understanding of Managerial Economics
– Economic Analysis
– Decision Making
– Demand and demand analysis
– Production and cost
– Use of game theory to illuminate the firm’s strategic choices
• Decision making is the prominent learning point of this book.
• The book began by defining that Managerial Economics as the analysis
of major of management decisions using the tools of economics. It also
emphasized that managerial economics applies many familiar concepts
from economics – demand and cost, monopoly and competition,
allocation of resources and economic trade-offs – to aid managers in
making better decisions.
• Six Steps to Decision Making
1. Define the problem
2. Determine the objective
3. Explore the alternatives
4. Predict the consequences
5. Make a choice
6. Perform Sensitivity Analysis
Introduction to Economic Decision Making

 What prevents you from achieving your goal?
 Try and find the most important parts of the problem
 Remain open-minded about the problem and its causes
 Be as specific as possible when thinking about the problem.
 For example - instead of saying "I hate my job," be more

specific about what you don't like, maybe "I don't like working
third shift."
 This first step is just for defining the problem, not for thinking
about solutions yet.
Define the Problem

 What is the decision maker’s goal? How should the decision
maker value outcomes with respect to this goal? What if he or
she is pursuing multiple, conflicting objectives?
 When it comes to economic decisions, it is a truism that “you
can’t always get what you want.” But to make any progress at
all in your choice, you have to know what you want.
Determine the objective

 What are the alternative courses of action?
 What are the variables under the decision maker’s control?
 What constraints limit the choice of options?

 After addressing the question “What do we want?” it is natural to ask,
“What are our options?” Given human limitations, decision makers
cannot hope to identify and evaluate all possible options. Still, one would
hope that attractive options would not be overlooked or, if discovered,
not mistakenly dismissed.
 Moreover, a sound decision framework should be able to
uncover options in the course of the analysis.
Explore the Alternatives

 What are the consequences of each alternative action?
 Should conditions change, how would this affect outcomes?
 If outcomes are uncertain, what is the likelihood of each?
 Can better information be acquired to predict outcomes?
Predict the Consequences

In the majority of decisions we take up, the objectives and
outcomes are directly quantifiable.
 Reach for Wisdom. Where you have not gone before, someone else
has.
 Ignore the Minutia.
 Gauge your Decisions.
 Have Fun.
 Trusted Advisors
Make the Choice

• What features of the problem determine the optimal choice of
action?
• In tackling and solving a decision problem, it is important to
understand and be able to explain to others the “why” of your
decision.
• Thus, sensitivity analysis considers how an optimal decision is
affected if key economic facts or conditions vary.
Perform Sensitivity Analysis

ShouldAssumptions
Should Assumptionsbe
beRealistic?
Realistic?
• The assumption of profit-maximising may be unrealistic or

inaccurate
• However, what matters is the explanatory or predictive power
of a theory (or model), not the descriptive realism of its
assumptions.
• A model built on unrealistic assumptions may give good
predictions.
• Assumptions are a necessary simplifying device
Example: Overtaking
17
• It allows us to make predictions and set
hypotheses
• The predictions can be tested against the
empirical evidence
• The predictions are supported by the empirical
evidence
What Is A “Good” Model?

18
The Use of Economic Models
Positive Economics:-
Derives useful theories with testable propositions
about WHAT IS.
Normative Economics:-
Provides the basis for value judgements on
economic outcomes.WHAT SHOULD BE
19
• Economics in general takes a ‘positive’ and predictive
approach not prescriptive or ‘normative’
– trying to explain “what is” not what “should be”
– the main objective is to understand how a market economy
works
• Not very concerned about the descriptive realism of
assumptions: “I assume X” does not mean “I believe X to
be true”
• Some real tension if the models are used for prescription
– assume “perfect knowledge”: OK for model-building
– cannot say to a manager: “behave AS IF you had perfect
knowledge”
Managerial Economics 20
Economic Analysis
• Comparative Statics
– begin with an initial equilibrium position - the starting point
– change something
– identify the new equilibrium, e.g:in neo-classical model of the firm
• When demand increases?
• When costs rise?
• When a fixed cost increases?
– This is the main purpose of the model -what it was designed to do
• Normative prescriptions
– it will cost me $30 per unit to supply something which will give me $20 per unit in
revenue- should I do it?
– I must pay $20 billion to set up in my industry. Should I charge higher prices to get that
money back?
• Positive and Normative are linked by “if?” IF the aim of the firm is to maximise profit what
will it do/what should it do? 21
What
Whatisisthe
thepurpose
purposeof
ofeconomic
economicanalysis?
analysis?
Why
Whydodowewewant
wantto
toapply
applyeconomic
economicanalysis
analysisto
to
business
businessproblems?
problems?
For the academic economist: to understand, to make
predictions about firm’s behavior The
“positive” approach to theory: What is?
For the businessperson: “to assist decision-making”,
to provide decision-rules which can be applied The
“normative” approach to theory: What should be?
These purposes are different, they can lead to
misunderstanding, and economists are not always
honest about the limitations of their approach for
practical purposes. 22
Whatare
What arethese
theselimitations?
limitations?
If the aim is prediction, unrealistic assumptions

are acceptable and may be needed;
for instance, the firm may be assumed to behave “as if” its managers had
perfect knowledge of its environment
If the aim is to produce decision-rules which can

be applied by practising managers, unrealistic
assumptions will produce decision-rules which
are not operational
for instance, set output and price by MC=MR
23
HowCan
How CanManagerial
ManagerialEconomics
EconomicsAssist
Assist
Decision-Making?
Decision-Making?
1. Adopt a general perspective, not a

sample of one
2. Simple models provide stepping stone to
more complexity and realism
3. Thinking logically has value itself and can
expose sloppy thinking
24
• A powerful “analytical engine”.
• A broader perspective on the firm.
• what is a firm?
• what are the firm’s overall objectives?
• what pressures drive the firm towards profit and away from profit
• The basis for some of the more rigorous analysis of

issues in Marketing and Strategic Management.
Why Managerial Economics? 25

Links between Managerial Economics
and Industrial Economics
In managerial economics, the emphasis is upon

the firm, the environment in which the firm
finds itself, and the decisions which individual
firms have to take.
In industrial economics (or industrial

organization), the emphasis is (or was) upon
the behavior of the whole industry, in which
the firm is simply a component.
26
What is
What is Industrial
IndustrialOrganization?
Organization?
It studies how the performance of an industry is related to

its structure, that is, to the number and size of firms it
contains.
It is the study of markets for goods and of the firms which
produce them. It is the study of industry. It is more
concerned with why markets are structured the way they
are and behave the way they do.
27
Questions Asked in Industrial Organization:
 Why are some markets monopoly-like while
others are competitive?
 How can industry performance and structure
be measured or analyzed?
 How does the performance of individual firms
affect the structure and performance of the
industry in which they operate?
 If industry performance seems deficient but
remediable, which government policies are
likely to help more than they cost?
28
TheStructure-Conduct-Performance
The Structure-Conduct-PerformanceParadigm:
Paradigm:
Basic Conditions: factors which shape the market of the

industry, e.g. demand, supply, political factors
Structure: attributes which give definition to the supply-side of
the market, e.g. economies of scale, barriers to entry, industry
concentration, product differentiation, vertical integration.
Conduct: the behavior of firms in the market, e.g. pricing
behavior advertising, innovation.
Performance: a judgment about the results of market behavior,
e.g. efficiency, profitability, fairness/income distribution,
economic growth.
How can the government improve the performance in an
industry?
29
Basic Conditions
Structure Government
Policy
Conduct
Performance
30
Links between Managerial Economics
and Management Science
Managerial economics: is often concerned with finding optimal
solutions to decision problems.However, the primary purpose
of using models is to predict how firms will behave, not to
advise them what ought to do. Managers are assumed to find
the optimal solutions for themselves and that is how
predictions are made.
Management science: is essentially concerned with techniques for the

improvement of decision-making and hence it is essentially
normative;firms are not assumed to find the optimal solutions for
themselves. They are found by the researchers who then present
them as prescriptions for what the firm should do. 31

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MANAGERIAL

DR. EDUARDO C. ZIALCITA

• Since joining the School of Law faculty in 1988,

“In every practice area, lawyers come face-to-face with corporations.

Introduction to Economic Decision Making

 Try and find the most important parts of the problem

 Remain open-minded about the problem and its causes

 Be as specific as possible when thinking about the problem.

 For example - instead of saying "I hate my job," be more

Define the Problem

Determine the objective

 What are the variables under the decision maker’s control?

 What constraints limit the choice of options?

Explore the Alternatives

Predict the Consequences

Make the Choice

Perform Sensitivity Analysis

• The assumption of profit-maximising may be unrealistic or

What Is A “Good” Model?

If the aim is prediction, unrealistic assumptions

If the aim is to produce decision-rules which can

1. Adopt a general perspective, not a

• The basis for some of the more rigorous analysis of

Why Managerial Economics? 25

In managerial economics, the emphasis is upon

In industrial economics (or industrial

It studies how the performance of an industry is related to

Basic Conditions: factors which shape the market of the

Management science: is essentially concerned with techniques for the

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