Samenvatting Managerial Economics

chapter 1. introduction to carry offrial sparingals 1. what is managerial economics? Managerial economics = the science of directing scarce resources to manage effectively to each one desires to understand how they washstand influence the bespeak through scathe and ad, what is the best organizational architecture and how to compete Differences surrounded by raw(a) and old economy * Ne cardinalrk effects in requisite = the benefit provided to any substance abuser reckons on the congeries number of raw(prenominal) users * Scalability = the degree to which the disclosematch and scope of stage business potentiometer be ontogenesisd without a corresponding accession in comprises Public good = angiotensin-converting enzyme unmarrieds con meaningption does non garnish the meter available to another(prenominal)(prenominal)s Branches Managerial economics * Competitive securities labors * martplace actor * Imperfect food commercializes 2. preliminaries sc ope (omvang) Microeconomics = the study of individual economic way where resources be visitly how consumers respond to repositions in charges and income, Managerial economics to a greater extent limit scope = it is the application of microeconomics to managerial issues Macroeconomics = focuses on aggregate economic varyings catchs economic aggregates instantaneously rather than as the aggregation of individual consumers and businesses methodology Fundamental premise = individuals sh be common motivations that atomic number 82 them to behave trunkatic eithery in making economic choices a person who faces the same choices at two antithetical sequences go away behave in the same way at both successions it is systematic so it can be studied Economic model = a concise description of behavior and outcomes = abstr body process Models atomic number 18 constructed by inductive reasoning afterwards, the model should be runed arginal opposite number number peripheral value = the exchange in the inconsistent associated with a social unit of measurement increase in a device driver Average value = numerate value of the variable divided by the total measurement of a driver relation between the peripheral and comely values depends on whether the average value is decreasing, constant or increase with respect to the driver Stocks and flows Stock = meter at a specific point in clip Flow = the change in a stock over close to period of time measured in units per time period other things constitute = an approach to simplify the problem by analyzing each change sepa rangely, holding other things get even . timing devil types of models * Static models = describe behavior at a single point of time, disregard disputes in the sequences of actions and passments model of agonistic foodstuffs, analysis of organizational architecture * Dynamic models = focus on the timing and sequence of actions and payments = receipts and use of goods and s ervicess often occur at different times discounting Investments = using resources at both(prenominal) times in order to receive benefits at other times discount future values to that they can be compared with the flummox Net present value the sum of the discounted values of a series of inflows and outflows over time = represents the current valuation of a flow of dollars time Internal come out of unsay = alternative for the cyberspace present value without using the discount rate 4. organization organizational boundaries Vertical boundaries = delineates activities closer to or further from the end user Horizontal boundaries = defined by its scale and scope of feats * Scale = rate of return or deli very(prenominal) of a good or aid * Scope = refers to the range of different items produced or delivered individual behavior businesses are managed by individuals and their interests whitethorn diverge from those of the organization managers are subject to bounded tenableness St andard assumption = people make decisions ration everyy = individuals choose the alternative that gives them the greatest digression between value and terms their behavior will practise some predictable patterns based on what they judge to be in their best interest People do not always behave rationally reason bounded rationality = people have limited cognitive bilities and cannot fully exercise self-control = people adopt simplified rules for decision-making * Separate story for different categories of benefits and speak to * Lack self-control = addictive behavior and awkwardy postponing immediate gratification for longer-term benefits. * More sensitive to loss than to gain = risk indisposed(predicate) * Decisions whitethorn depend on how choices are framed Two implications * Individuals will be comparatively sluggish in responding to changes in business and economic conditions * reference for managerial economics is astronomicr . market places Market = consists of the vendees and marketers that communicate with one another for voluntary exchange not limited to any physical structure of special location * Markets for consumer occupations = purcha devourrs are households and removeers are businesses * Markets for industrial products = vendees and vendors are businesses * Markets for human resources = purchasers are businesses and sellers are households Industry = businesses engaged in the payoff of delivery of the same or similar items militant markets = markets with many another(prenominal) vendees and many sellers Buyers provide the requisite and sellers provide the return charter- turn in model = describes the systematic effect of changes in worths and other economic variables on purchasers and sellers describes the interaction of these choices market power Key variables * Prices * Scale of operations * Input mix = determined by market forces Market power = ability of a buyer or seller to influence market conditions A business with market power must determine its horizontal boundaries = depends on how its toll switch with the scale and scope of operations Four key tools in managing subscribe to 1. Price 2. Advertising 3.Policy toward competitors 4. R&D outlay Imperfect markets Imperfect Market = when one drop cloth a companionship directly conveys a benefit or salute to others and where one party has better entropy than others managers need to resolve the imperfection 6. world(prenominal) integration Price in one local market will be in capable of values in other local markets some markets are orbiculate because the woos of communication and trade are relatively low = the prince in one place will move to besother with the prices elsewhere whether a market is local or global, same managerial economics principles ommunications greets and trade = with developments in technology and deregulation Transport * air transport liberalization * containerization of come in transport. Telecommunic ations * de-regulation. * scale economies in bandwidth. Growth of cross-border trade and investment * falling trade barriers. * falling financial barriers. * falling communications address managers have to pay increasing attention to markets in other places outsoarcing = the purchase of services or supplies from external sources external sources could be within the same rural or foreign E-commerce Limitations * Payments system Trade barriers * Shipment be part 1 agonistical markets chapter 2. withdraw 2. individual take on Individual select frizzle = a graph that shows the meter that the buyer will purchase at either probable price twirl = other things equal, how many would you buy at a price of ? grand to keep other things equal at that place the decision may depend on other factors * Vertical axis is the price * Horizontal axis is the amount Two views * For both possible price, consume draw in shows the criterion pauperizationed * For each unit of item, s trike turn out shows the uttermost price that the buyer is willing to pay slope at a lower price, buyers are willing to buy a larger criterion bare(a) benefit = the benefit provided by an special unit of the item Diminishing fringy benefit = each additional unit of consumption or usage provides less(prenominal) benefit than the preceding unit the price that an individual is willing to pay will decrease with the touchstone purchased preferences Two implications * The demand bend dexter will change with changes in the consumers preferences * variant consumers may have different preferences and hence different demand curves 3. emand and income Demand curve does not explicitly display the effect of changes in income and other factors that incite demand income changes = effect of a change in income on the demand curve is very different from that of a change in price if income drifts = demand curve carrier bags to the left * mixed bag in price = movement along the demand c urve * wobble in income or any factor other than the price = shift in the entire demand curve normal vis-a-vis inferior products Normal product = positively related to changes in the buyers income Inferior product negatively related to changes in the buyers income demand falls as the buyers income increases Broad categories of products = tend to be normal Particular products within the categories = may be inferior 4. other factors in demand = prices of related products, ad, durability, season, weather and location complements and substitutes Complements = if an increase in the price of one causes the demand for the other to fall Substitutes = if an increase in the price of one causes the demand for the other to increaseShift to the left * Increase in the price of a complement * Fall in the price of a substitute Shift to the right * Increase in the price of a substitute * Fall in the price of a complement announce In mildewative advertising = communicates information to potential buyers and sellers Persuasive advertising = aims to influence consumer choice An increase in advertising expenditure will increase demand each additional dollar spent on advertising has a relatively smaller effect on demand = diminishing bare(a) productEffect of advertising on demand depends on the medium durable goods = provide a stream of services over an elongate period of time buyers have discretion over the timing of purchase Three significant factors for demand 1. Expectations about future prices and incomes 2. Interest rates = many buyers need to finance their purchase of durable goods if interest rates are low the demand for consumer durables will be high 3. Price of utilize models = substitutes of a young model 5. market demand Market demand curve graph that shows the quantity that all buyers will purchase at every possible price = analysis is essentially similar to that for an individual demand curve construction = interview all the potential consumers and ask each person the quantity that he er she would buy at every possible price = horizontal summation of the individual demand curves = slopes consumewards since the individual demand curves slope downwards other factors = buyers income, price of related products, advertising changes in these factors will shift the entire market demand curveTwo ways of measuring income of arena * The gross national product (GNP) = GDP + net income from foreign sources * The gross domestic product (GDP) = measure the total amount produced in a country for a given year Macro factors * Income = average, distri exactlyion * Demographic = population, age structure, urban-rural * Cultural-social income distribution = the more un point the distribution of income, the more important it is to consider the positive distribution of in income and not merely the average income when estimating the market demand 6. buyer senseless benefit borderline benefit maximum amount of gold that the buyer is willing to pay fo r the unit Total benefit = benefit yielded by all the units that the buyer purchases benefit vias-a-vis price Buyer exorbitance = divergency between a buyers total benefit from some quantity of purchase and the actual expenditure a buyer must ram some surplus, otherwise he or she will not buy = maximum that a seller can heyday is the buyers total benefit price changes Gains from a pricecut * Lower price on the quantity that she would have purchased at the original price = infra fringy units She can buy more = bare(a) units extent depends on the buyers response to the price reduction = the greater the increase in purchase, the larger the buyers gain from the price reduction = when you have to calculate how a good deal you gain from a price cut, always look at the demand curve and see how such(prenominal) you buy at the old price and how much at the new price and calculate the buyers surplus package deals and two-part determine Package deals = charge buyer just a little le ss than her/his total benefit = leave buyer with almost zero surplusTwo-art pricing = pricing scheme comprising a fixed payment and a charge based on usage = enables to soak up most of the consumers buyer surplus Market buyer surplus = sum of individual buyer surpluses 7. business demand inputs personal credit linees do not purchase goods and services for their own sake use them as inputs in the yield of other goods and services = use inputs to produce outputs for sale to consumers or other businesses * finished/semi-finished components . * raw materials and energy. * labor and other services. capital. Demand Demand for inputs depend on * quantity of final output = shift of the entire demand curve * prices of complements or substitutes in production marginal benefit = the increase in revenue arising from an additional unit of the input diminishing marginal benefit = downward sloping demand curve for inputs chapter 3. shot 1. introduction Elesticity of demand = measures the reac tivity of demand to changes in an underlying factor (price, income, advertising) Own-price bouncyity of demand measures the responsiveness of the quantity demanded to changes in the price of the item 2. own-price press stud = section by which the quantity demanded will change if the price of the item rises by 1% role change in quantity demanded Percentage change in price construction Two ways of deriving * arc approach = we collect records of a price change and the corresponding change in quantity demanded own-price elasticity as the ratio of the proportionate change in quantity demanded to the proportionate change in price can also be calculated by ever-changing p0 by the average price ((old price + new price)/2) and by changing q0 by the average quantity ((old quantity + new quantity)/2) * point approach = can be derived from the coefficient of price in the equation = calculates the elasticity at a specific point on the demand curve arc approach elasticity between two point s properties Characteristics * Its a negative number * A pure number, independent of units of measure * Ranges from 0 to negative infinity Price elastic if a 1% increase in price leads to more than a 1% drop in quantity demand = if a price increase causes a proportionately larger drop in quantity demanded Price dead = if a 1% price increase causes less than 1% drop in quantity demand intuitive factors Availability of direct or indirect substitutes = the fewer substitutes that are available, the less elastic will be the demand Demand for a product category will be relatively less elastic than demand for specific products within the category = in that respect are fewer substitutes for the category than for specific products Buyers prior commitments L overhearing * Complementary purchases (spare parts, upgrades, ) * Taste = demand less elastic Benefits/ be of economizing = buyers have limited time to spend on searching for better prices they focus attention on items that account f or relatively larger expenditures separation of buyer and payee elasticity and slope Own price elasticity = describes the shape of entirely one portion of the demand curve a change in price, by moving from one part of a demand curve to another part, may lead to a change in own-price elasticity Straight line demand curve demand becomes more elastic at higher prices incase of other shapes, demand may become less elastic at higher prices sheer demand curve means demand less elastic = but elasticity is not the same as the slope slope stays the same, the own-price elasticity varies throughout the length causes by the changes in price and quantity Own-price elasticity can also vary with changes in any of the other factors that affect demand = in that case, demand curve will shift own-price elasticity may also change 3. considering quantity demanded and expenditure expenditure change in price will affect expenditure through the price itself as well as through the related effect on quantity demanded Change in quantity demanded = price elasticity x change in price If demand elastic, price increase leads to * proportionately greater reduction in purchases. * lower expenditure. If demand dead, price increase leads to * proportionately smaller reduction in purchases. * higher expenditure. accuracy Discrepancy = the own-price elasticity may vary along a demand curve the forecast using the own-price elasticity will not be as precise as a forecast directly from the demand curve . other elasticities income elasticity = measures the sensitivity of demand to changes in buyers income = piece by which the demand will change if the buyers income rises by 1 % Percentage change in demand component change in income = varies with changes in the price and any other factor that affects demand * Depending on whether the product is normal or inferior, income elasticity can be positive or negative * Demand for necessities tends to be relatively less income elastic than the dema nd for discretionary items cross-price elasticity measures the sensitivity of demand to changes in the prices of related products = percentage by which the demand will change if the price of the other item rises by 1%, other things equal Substitutes = an increase in the price of one will increase the demand for the other = cross-price elasticity positive Complements = an increase in the price of one will reduce the demand for the other = cross-price elasticity negative advertising elasticity measures the sensitivity of demand to changes in the sellers advertising expenditure = percentage by which the demand will change if the sellers advertising expenditure rises by 1%, other things equal price of the item must endure unchanged has a much stronger effect on the sales of an individual seller than on the market demand = advertising elasticity of the demand face up by an individual seller tends to be larger than the advertising elasticity of the market demand forecasting the effect s of multiple factorsOnly way to discern the net effect of factors pushing in different directions = use the elasticities with respect to each of the variables Percentage change in demand due to changes in multiple factors is the sum of the percentage changes due to each separate factor 5. adjustment time The short run = a time horizon within which a buyer cannot adjust at least one item of consumption or usage The long run = a time horizon long full for buyers to adjust all items of consumption of usage nondurables the longer the time that buyers have to adjust, the bigger will be the response to a price change demand for such items will be more elastic in the long run than in the short run Alcohol and tabacco = demand relatively inelastic discouraging new people from taking up smoking and drinking = demand relatively more elastic in the long run durables = a countervailing effect leads demand to be relatively more elastic in the short run especially strong for changes in incom e = drop in income will cause demand to fall more sharply in the short run than in the long runDifference between short- and long-term elasticities = depends on a balance between the need for time to adjust and the replacement frequency effect 6. estimating elasticities data Two sources of data * Records of pas experiences * Surveys and experiments specifically blueprinted to discover buyers preferences test market Collection in two ways * Focus on a feature group of buyers and observe how their demand changes as the factors affecting demand vary over time = time series Compare the quantities purchased in markets with different values of the factors affecting demand = cross section specification To concord accurate estimates of elasticities = specify all the factors that have a significant effect on demand specify the mathematical traffichip between demand and the miscellaneous factors Dependent variable = whose changes are to be explained Independent variable = a factor aff ecting the dependent variable = linear equation in which the dependent variable is equal to a constant plus the weighted sum of the independent variables ultiple regression = can estimate the separate effect of each independent variable on the dependent variable = aims to determine values for the constant and the coefficients Residual = the actual value of the dependent variable electronegative the predicted value system of least squares = based on the view that positive residuals are as frightful as negative residuals while large residuals are disproportionately bad seeks a set of estimates for the constant and the coefficients to minimize the sum of the squares of the residuals since equally large positive and negative residuals have identical squares, the method treats them identically statistical consequence F statistic = measures the overall significance of the independent variables assumption that there are is no relationship between the dependent variable and the set of independent variables ranges from 0 to infinity R? = uses the squared residuals to measure the extent to which the independent variables account for the variation of the dependent variable ranges from 0 to 1 1 means that all the residuals are simply 0 T-statistic = apply to evaluate the significance of a particular independent variable = estimated value of the coefficient divided by the standard computer error ranges from negative to positive infinity P value = measures the likelihood that estimated coefficient could be the result of chance under the assumption that the true coefficient is zero = gives the probability that stochastic sampling errors could produce a coefficient as large as found by the least-squares multiple regression model chapter 4. try . short-run approachs Two key decisions * Continue in operation * Rate at which to operate = depend on the length of the time horizon Short run = time horizon in which a seller cannot adjust at least one input business m ust work within the constraints of past commitments coherent run = time horizon long adequate for the seller to adjust all inputs Difference between both depends on the circumstances fixed vis-a-vis variable be Fixed follow = speak to of inputs that do not change with the production rate the height of the total speak to curve at the zero production rate Variable approach cost of inputs that change with the production rate to distinguish between fixed and variable cost, a business must analyze how each category of expense varies with changes in the scale of operation Total cost = the sum of fixed cost and variable cost C = F + V Marginal cost = the change in total cost due to the production of an additional unit Average cost = total cost divided by the production rate = unit cost Cq = Fq + Vq continues to fall with increases in the production rate until it reaches a minimum, thereafter it increases with the production rate the average cost is the average fixed cost plus the average variable cost if the production rate is higher the fixed cost will be spread over more units Marginal product = increase in output arising from an additional unit of an input diminishing = the average variable cost will increase with the production rate Where the average variable cost is increasing the relationship between the average cost and the production rate depends on the balance between the declining average fixed cost and the increasing average cost Diminishing marginal product causes marginal and average cost to rise echnology Two implications * The curves will change with adjustments in the sellers technology * Different sellers may have different technologies and hence different cost curves 3. short-run individual fork over Assumptions * meshwork maximization * Business is so small relative to the market that it can sell as much as it would like at the going market price production rate Total revenue = price multiplied by sales Marginal revenue = the change i n total revenue arising from selling an additional unit To maximize profit, a business should produce at that rate where its marginal revenue equals its marginal costMarginal revenue is represented by the slope of the total revenue line * Wherever the marginal revenue exceeds the marginal cost, the profit can be raised by increasing production * Wherever the marginal revenue is less than the marginal cost, Luna can raise profit by cut back production break even To decide whether to continue production, the business needs to compare the profit from continuing in production with the profit of shutting down Fixed cost = sink cost = it has been committed and cannot be avoided even if the business shuts down, it must still pay the fixed cost F Business should continue production whenR V F F = R V P V/q R = p x q = short-run break even condition a business maximizes profit by producing at the rate where the marginal cost equals the price, provided that the price covers the avera ge variable cost individual make out curve Individual affix curve = a graph showing the quantity that one seller will cater at every possible price for every possible price, a business should produce at the rate that balances it marginal cost with the price Slopes upward = if the seller is to expand production, indeed it will incur a higher marginal cost Input demandChange in input price * Shift in marginal cost * Change in profit-maximizing production 4. long-run individual supply = contracts expire and investments wear out all inputs become avoidable long-run cost = long-run average cost curve is lower and has a gentler slope in the long run, the seller has more flexibility in adjusting inputs to changes in the production rate = it can produce at a relatively lower cost than in the short run, when one or more inputs cannot be changed production rate = a rate where its marginal cost equals the price of its output reak even = in the long run, a business should continue in pro duction if the maximum profit from continuing in production is at least as large as the profit from shutting down all in all costs are avoidable = it the business shuts down, it will incur no costs and so its profit from shutting down is nothing R C P C/q = business should continue in production so long as total revenue covers total cost individual supply curve = that part of its long-run marginal cost curve, which lies above its long-run average cost curve Two views * For every possible price, it shows the production rate For each unit of item, it shows the minimum price that the seller is willing to accept 5. market supply Market supply curve = a graph showing the quantity that the market will supply at every possible price = sum of the quantities supplied by each individual seller short run Market supply curve = begins with the seller that has the lowest average variable cost Change in an input price will affect the sellers marginal cost at all production levels shift the ent ire market supply curve * Increase in price of an input will shift the market supply up * Reduction in price of an input will shift the market supply down long run every business will have completely flexibility in deciding on inputs and production freedom of entry and exit is the key difference between the short run and long run Sellers that cannot cover their total costs will leave the industry until all the remaining sellers break even an industry where businesses van make profits will withdraw new entrants = market supply will rise and pushes down the market price hence the profit will drop Quantity supplied will adjust in two ways when theres a change in price * All existing sellers will adjust their quantities supplied along their individual supply curves * Some sellers may enter or leave the market Graph = slope is more gentler and may be flat 6. seller surplus price vis-a-vis marginal cost Seller surplus difference between a sellers revenue from some quantity of productio n and the minimum amount necessary to induce the seller to produce that quantity short-run seller surplus can also be defined as the difference between the sellers revenue and the variable cost Short-run seller surplus = total revenue less variable cost Long-run seller surplus = total revenue less total cost purchasing = a buyer can apply the concept of seller surplus to reduce the cost of its purchases market seller surplus = sum of the individual seller surpluses = difference between the market revenue from some production rate and the minimum amount necessary for the market to produce that quantity 7. elasticity of supply measures the responsiveness of supply to changes in underlying factors such as the price of the item and inputs price elasticity = measures the responsiveness of the quantity supplied to changes in the price of the item = percentage by which the quantity supplied will change if the price of the item rises by 1%, other things equal Percentage change in quantity supplied Percentage change in price properties * Pure number * Positive number intuitive factors Intuitive factors * Capacity utilization a seller that has consiverable excess power will step up production in response to even a small increase in price = individual supply will be relatively elastic * Adjustment time long-run supply is relatively more elastic than the short-run supply chapter 5. competitive markets 2. perfect opposition Five conditions 1. The product is homogeneous 2. There are many buyers, each of whom purchases a quantity that is small relative to the market 3. There many sellers, each of whom supplies a quantity that is small relative to the market 4. brisk buyers and sellers can enter freely, and existing buyers and sellers can exit freely 5. All buyers and sellers have cruciate information about market conditions homogeneous product = the product is always the same competition is stronger many small buyers = no buyer can get a lower price than others all b uyers face the same price all buyers compete on the same level playing field When some buyers have market power it is not possible to construct a market demand curve many small sellers = no seller has market power no seller can get a higher price than other free entry and exit = no technological, legal or regulatory barriers constrain entry or exit the market price cannot stay above a sellers average cost for very long degree of competition also depends on barriers to exit = it must consider the exit cost when deciding whether to enter the market symmetric information = no seller can enjoy the privilege of secret information 3. market correspondence the price at which the quantity demanded equals the quantity supplied when market out of rest, market forces pushes price towards symmetricalness demand and supply At the market equilibrium, there is no tendency for price, purchases or sales to change excess supply Not in equilibrium = market price will tend to change in such a wa y as to restore equilibrium Excess supply = the amount by which the quantity supplied exceeds the quantity demanded providers would compete to clear their extra capacity and the market price would drop back toward the equilibrium excess demand = the amount by which the quantity demanded exceeds the quantity supplied when the price is below the equilibrium level buyers would compete for the limited capacity significance of equilibrium Two reasons * If a market is not in equilibrium, either buyers or sellers will push the market toward equilibrium * By comparing equilibria we can address a wide range of questions when prices are quite flexible, the market will adjust to the new equilibrium reasonably quickly, so comparing equilibria is a fairly accurate method of analysis Neither buyers nor sellers may face rationing 4. supply shift equilibrium change When price of input falls entire supply curve shifts down = at every possible sellers want to supply more price elasticitiesDownwar d or upward shift in the supply curve will change the equilibrium price by no more than the amount of the supply shift change in equilibrium price depends on the price elasticities of demand and supply Inelastic demand = buyers are completely insensitive to the price when supply curve shifts, the buyers do not change their behavior = they continue to purchase exactly the same quantity Elastic demand = buyers are extremely sensitive to price equilibrium price does not change at all If the demand is more elastic then the change in the equilibrium price result from a shift in supply will be smaller Inelastic supply = sellers are completely insensitive to the price if their costs change they will not change the quantity supplied Elastic supply if the cost of an input changes, the marginal cost changes by the same amount at all production levels common misconception = if sellers costs fall by some amount, then the market price will fall by the same amount Overlooks the impact of * Th e shift in supply on buyers = if they are very sensitive to price, the shift in supply would result in no change to the equilibrium price * The price sensitivity of sellers = if sellers are insensitive to price, then the drop in cost will not induce them to sell more Price change * Smaller if demand is more elastic than supply * Bigger if supply is more elastic than demand 5. demand shiftDemand shifts down (left) new equilibrium with lower price and lower quantity Demand shifts up (right) new equilibrium with higher price and higher quantity 6. adjustment time short-run equilibrium = point where its short-run marginal cost equals the marketprice long-run equilibrium = the point where its long-run marginal cost equals the market price demand increase Short-run equilibrium = the extent to which a seller expands its operations depends on the slope of its short-run marginal cost curve if steep then the price increase will not lead the seller to expand operations by very much Long-run equilibrium = there is enough time for all costs to become avoidable, for new sellers to enter the market and for existing sellers to leaveThe increase in demand raises the market price and hence each sellers profit = will attract new sellers to enter the market Although the price is higher than in the original equilibrium, higher input prices result in higher marginal and average cost curves in the new long-run equilibrium, each individual seller just breaks even demand reduction Extent of cutback depends on two factors * Extent of sunk costs = in an industry involving substantial sunk costs, the reduction in demand will translate into a relatively large drop in price and a small reduction in quantity * Slope of the sellers short-run marginal cost curve in the new long-run equilibrium there will be a smaller number of sellers and each will exactly break even with average total costs equal to the market price price and quantity over time Two general points * In response to shifts in demand = market price will be more volatile in the short run than the long run * In response to shifts in demand = there is a greater change in the market quantity over the long run than in the hort run In industries with substantial sunk costs the adjustment of production will be concentrated in the long run In industries where costs are minor the adjustment to shifts in demand will be relatively smoother the market price will be relatively less volatile chapter 6. conomic efficiency 2. conditions for economic efficiency economically efficient = if no reallocation of resources can make one person better off without making another person worse off persons may be human beings or businesses sufficient conditions Three sufficient conditions based on users benefits and suppliers costs 1. All users bring home the bacon the same marginal benefit 2. All suppliers operate at the same marginal cost 3. Every users marginal benefit is equal to every suppliers marginal cost Equal marginal benefit If not equal * Provide more to user with higher marginal benefit * assimilate away from user with lower marginal benefit society as a whole would be better off Equal marginal cost If not equal * Supplier with lower marginal cost should produce more * Supplier with higher marginal cost should produce less Marginal benefit equals marginal cost If not equal * If MO MC , produce more of the item * If MO MC, produce less of the item philosophical basis Technical efficiency = providing an item at the minimum possible cost does not imply that scarce resources are being well used The concept of economic efficiency extends beyond technical efficiency Economic efficiency assesses resource allocations in terms of each individual users evaluation of the benefit inseparable organization production will be efficient if all users achieve the same marginal benefit, all suppliers operate at the same marginal cost and every users marginal benefit balances every suppliers marginal cost 3 . adam smiths invisible hand Invisible hand = market price guides buyers and sellers, acting independently and selfishly to channel scarce resources into economically efficient uses competitive market = satisfies all three requirements for economic efficiency market system = an economic system in which resources are allocated through the independent decisions of buyers and sellers, guided by freely moving prices Price performs two roles * It communicates all the necessary information It provides a concrete incentive for each buyer to purchase the quantity that balances marginal benefit with the market price it provides a concrete incentive for every seller to supply the quantity that balances marginal cost with the market price 4. decentralised management internal market Transfer price = price charged for the sale of an item within an organization should set it equal to market price = by decentralizing the management is establishing an internal market that is integrated with the external market capital punishment Two general rules * If there is a competitive market for the item, the transplant price should be set equal to the market price * Producing units should be allowed to sell the product outside buyers and consuming units should be allowed to buy the product from external sources Outsoarcing = purchase of services or supplies from external sourcesAny organization that used resources or products for which there are competitive markets can apply decentralization to achieve internal economic efficiency 5 incidence = both pricing methods have exactly the same impact on the manufacturer and customer encumbranceage inclusive pricing Cost and freight = a price that includes freight Ex- whole kit and caboodle pricing = does not include the freight cost entire supply supply curve will shift down = with ex-works demand, the buyers will now have to pay the freight cost price is lower = total price is equal if you increase the price with the freight cost Pr ice and sales are the same whether the sellers do or do not include the freight cost in their prices incidence the change in the price for a buyer or seller resulting from a shift in demand or supply whether manufacturers set prices that do or do not include the feight cost, the incidence is the same = the incidence does not depend on which side initially pays the freight cost depends only on the price elasticities of demand and supply taxes = government depend on tax revenues to support public services such as national defense, some are levied on consumers, others on businesses buyers vis-a-vis sellers price Sellers price = buyers price tax Buyers price = price that buyers pay Sellers price = price that sellers receive p156 tax incidence buyers price will rise by less than the amount of the tax and the sellers price will drop by less than the amount of the tax tax is generally shared between buyers and sellers according to their relatively price elasticities * Less sensitive = will bear the relatively larger portion of the tax part II market power chapter 7. costs 2. economies of scale = analyze how costs depend on the scale or rate of production decision on scale also depends on market demand and competition Fixed cost = cost of inputs that do not change with the production rate Variable cost = cost of inputs that change with the production rate marginal and average costsMarginal cost = rate of change of the variable cost if average variable cost remains constant, then the marginal cost will be the same Economies of scale = increasing returns to scale = a business for which the average cost decreases with the scale of production marginal cost will be lower than the average cost = since the marginal unit of production costs less than the average, any increase in production will reduce the average intuitive factors Two possible sources * Substantial fixed inputs = at a larger scale, the cost of the fixed inputs will be spread over more units of produ ction business with a strong element of composition, design or invention * If the average variable cost falls with the scale of production = whether the average variable cost increases or falls depends on the particular technology of the business diseconomies of scale = a business where the average cost increases with the scale of production If * Fixed cost is not substantial * And variable cost rises more than proportionately with the scale of production strategic implications If economies of scope * Large scale * Market concentrated, few suppliers * Monopoly and oligopoly If diseconomies of scope * Small scale * Market fragmented * Perfect competition 3. economies of scope if the total cost of production is lower when two products are produced together than when they are produced separately Diseconomies of scope = if the total cost of production is higher when two products are produced together joint cost = cost of inputs that do not change with the scope of production strategic implications exercise telecommunication and broadcasting Produce/deliver multiple products * Product mix * Brand extension Core competence = a generalized expertise in the design, production and marketing of products based on common or closely related technologies = joint cost diseconomies of scope = if the total cost of production is higher when the two items are produced together than when they are produced separately arise where the joint costs are not significant and making one product increases the cost of making the other in the same facility 4. experience curve Accumulated experience = matters in industries characterized by relatively short production runs and a relatively substantial input of human resources As engineers and workers gain experience in production, they become more proficient individually and as a squad they devise new ways to reduce cost, including better tools and more cost-effective procedures Experience curve = shows how the unit cost of production fall s with cumulative production over time Distinguish from economies of scope within one production period Conditions comparatively large human resources input per unit of production * Relatively small production runs 5. fortune cost = it is necessary to look beyond the conventional accounting statements Relevance = key principle = managers should consider only relevant costs and ignore others alternative rails of action = to evaluate a business conventional income statement does not present the revenues and costs of the alternative courses of action = costs are actually higher because of the opportunity cost opportunity cost defined Opportunity cost = net revenue from the best alternative course of action uncovering relevant costs Two ways to uncover relevant costs Consider the alternative courses of action * Use the concept of opportunity cost = both approaches lead to the same business decision Alternative courses of action and opportunity cists change with the circumstances and hence are more difficult to measure and verify opportunity cost of capital A business that is partly financed by debs will appear to be less profitable than an otherwise identical business that is completely financed by equity equity capital is not costless = it has an opportunity cost Economic value added = net operation profit after tax subject to adjustments for accounting conventions less a charge for the cost of capital they are less likely to be diagonal in favor of capitalintensive activities A complete measure of business e performance should take account of the opportunity cost of equity capital 6. transfer pricing Transfer price = transfer price of an internally produced input should be set equal to its marginal cost perfectly competitive market Transfer price = market price full capacity = marginal cost of the input is not well defined transfer price should be set equal to the opportunity cost of the input which is the marginal benefit that the input provides to the c urrent user = compare marginal benefit across internal users 7. sunk costs a cost that has been committed and so cannot be avoided not relevant to business decisions alternative courses of action Depend on * forward commitments * Planning horizon Continue Cancel Cont. margin $280,000 $0 Advert agency $50,000 $50,000 Magazine $250,000 $50,000 wampum ($20,000) ($100,000) Continue Cont. margin $280,000 Advert agency $0 Magazine $200,000 Profit $80,000 = only avoidable costs strategic implications = managers should ignore sunk costs and consider only avoidable costs sunk costs are not relevant for pricing, investment, or any other business decision Two ways of dealing with sunk costs Explicitly consider the alternative courses of action * Remove all sunk costs from the income statement = both approaches lead to the same business decision it is easier to consider the alternative courses of action explicitly when multiple alternatives commitments and the think horizon To identify sunk costs consider * Past commitments * Planning horizon The longer the planning horizon, the more time there will be for past commitments to unwind and hence the greater will be managements freedom of action Short-run planning horizon = some sunk costs Long-run horizon = no sunk cost Sunk vis-a-vis fixed costs Fixed cost two different senses A cost that cannot be avoided once incurred * A cost of inputs that do not change with the production rate = two types of costs have very different implications for business decisions Not all sunk costs are fixed = cost op public service employees is sunk, once they secure tenure. However, government could have hired only temporary workers (no sunk costs) 8. statistical methods multipple regression = to investigate the extent of fixed costs and economies of scale forecasting = to forecast the dependent variable when the independent variables take different values Other applications Investigate the presence of joint costs across two products hapter 8. Monopoly 1. Introduction Monopoly = if there is only one seller in a market Monopsony = if there is only one buyer in a market 2. sources of market power = the barriers that deter or prevent entry by other competing sellers/buyers monopoly Unique resource = access to unique physical, natural or human resources Intellectual situation = property over inventions or expressions Patent = gives the owner an exclusive right to the invention for a specified period of time Copyright = establishes property in published expressions, including computer software and engineering drawings Economies of scale and scope Product differentiation differentiating itself from competitors through product design, distribution, and advertising and promotion Regulation = government may decide to award an exclusive franchise to one provider government hopes to avoid duplication and reduce the cost of the service monopsy = same factors as a monopoly Additional reason for presenc e = existence of a monopoly a seller that has a monopoly over some good or service is also likely to have market power over the inputs into that item 3. Monopoly pricing Monopoly has to consider how its sales will affect the market price Given the market demand curve a monopoly can Set the price and let the market determine how much it will buy * Decide how much to sell and let he market determine the price at which it is willing to buy that quantity Monopoly is choosing a combination of price and sales off the demand curve a monopoly can set either the price or sales but not both revenue Inframarginal units = those other than the marginal unit Marginal revenue from selling an additional unit will be less than the price of that unit = marginal revenue is the price of the marginal unit minus the loss of revenue on the inframarginal units difference between the price and the marginal revenue depends on the price elasticity * Demand elastic = seller need not reduce the price very mu ch to increase sales marginal revenue will be close to the price * Demand inelastic seller must reduce the price substantially to increase sales marginal revenue will be much lower than price Marginal revenue can be negative = if the loss of revenue on the inframarginal units exceeds the fain on the marginal unit Profit maximizing price Profit maximizing scale of operation = the scale at which the marginal revenue balances the marginal cost Contribution margin = total revenue less the variable cost a seller maximizes profit by operating at a scale where the sale of an additional unit will result in no change to the contribution margin economic inefficiency Marginal benefit exceeds the marginal cost 4. demand and cost changes Change in demand * New marginal revenue * Original marginal cost = new profit-maximizing sales and price arginal cost change = change in price is less than change in marginal cost When there is a change in either demand or cost, the extent to which a monopoly should adjust its price depends on the shapes of both it marginal revenue and marginal cost curves it should adjust the price until its marginal revenue equals its marginal cost fixed cost change = profit-maximizing price and scale do not depend in any way on the fixed cost changes in the fixed cost will not affect the marginal cost curve If the fixed cost is so large that the total cost exceeds total revenue, then the monopoly will prefer to shut down 5. advertising Promotion the set of marketing activities that a business undertakes to communicate with its customers and sell its products advertising, sales promotion and public relations benefit of advertising Advertising can cause * Shifting out the demand curve * Demand to be less elastic Benefit of advertising = change in the contribution margin Net benefit = the change in the contribution margin less the advertising expenditure advertise up to the point that the increase in contribution margin from an additional dollar of advertising is exactly 1 $ = more appropriate to consider the effect of advertising on the contribution margin generated by the product dvertising-sales ratio Incremental margin = price less the marginal cost = increase in the contribution margin from selling an additional unit, holding the price constant Incremental marginal percentage = ratio of the price less the marginal cost to the price measures the production of benefit by each dollar of advertising Advertising-sales ratio = additive margin multiplied by the advertising elasticity of demand = says how much of the revenue should be invested in advertising 6. research and development = principles are the same as for advertising and promotion Benefit * Shifting out the demand curve * Causing it to be less elasticNet benefit from R&D = change in the contribution margin less the R&D expenditure R&D-sales ratio = incremental margin percentage multiplied by the R&D elasticity of demand project evaluation = decisions on individual R&D projects should account for the timing of costs and benefits p 212 7. Market structure effects of competition General points * A monopoly restricts production below the competitive level and it can set a relatively higher price extracting larger profit * Profit of a monopoly exceeds what would be the combined profit of all the sellers if the same market were perfectly competitive potential competition dead contestable a market in which sellers can entry and exit at no cost monopoly cannot raise price substantially above its long-run average cost depends on the extent of barriers to entry and exit lerner index = incremental margin percentage can be used to compare the degree of monopoly power in markets with different prices captures the impact of potential competition (P MC) / P Perfectly competitive market = lerner index equals 0 Monopoly = bigger than 0 Problem = it will not detect the power that a monopoly does not exercise 8. monopsy = buyer with market power restric ts purchases to depress the price Trades off * Marginal expenditure * Marginal benefit Marginal expenditure = change in expenditure resulting from an increase in purchases by one unit maximizing net benefit a monopsy will maximize its net benefit by purchasing the quantity at which its marginal benefit equals its marginal expenditure A monopsony restricts purchases to get a lower price and increase its net benefit above the competitive level chapter 9. Pricing 2. uniform pricing = policies where the seller charges the same price for every unit of the product price elasticity = percentage by which the quantity demanded will change if the price of the item rises by 1% Demand inelastic sales fall less than proportionately with the increase in price = total revenue will increase profit maximizing price Incremental margin percentage = 1/price elasticity of demand demand and cost changesPricing rule shows how a seller should adjust its price when there are changes in the price elasticit y of demand or marginal cost a seller should not necessarily adjust the price by the same amount as a change in marginal cost common misconceptions * Contribution margin percentage = revenue less variable cost divided by revenue accounting systems often assume that costs are proportional = marginal cost is the same as the average variable cost = contribution margin percentage equals the incremental margin percentage * the belief that the profit maximizing price depends only on the elasticity = ignores costs * set the price by marking up average cost problems * in economies of scale, the average cost depends on the production scale the need of an assumption about the scale sales and production scale depend on the price * it gives no guidance as to the appropriate mark-up on average cost Shortcomings * leaves buyers with a lot of buyers surplus * does not sell to every potential buyer 3. complete price discrimination price discrimination = selling down the market demand curve = pr icing insurance under which a seller sets prices to earn different incremental margins on various units of the same or a similar product Complete price discrimination = a pricing policy where the seller prices each unit at the buyers benefit and sells a quantity such that the marginal benefit equals the marginal cost it charges every buyer the maximum that he or she is willing to pay for each unit comparison with uniform pricing resolves the two shortcomings of uniform pricing * no buyers surplus * economically efficient quantity information = to implement complete price discrimination, the seller must know each potential buyers individual demand curve not enough to know the market demand curve or the price elasticity of the individual demand curves 4. direct surgical incision discrimination Segment = significant cohesive group of buyers within a large market homogenous segments Direct segment discrimination = the policy of setting different incremental margins to each identifiabl e segment heterogeneous segments Not enough information * apply uniform pricing within each segment prices are such that the incremental margin percentage for each segment equals the reciprocal of the absolute value of the segments price elasticity of demand * apply indirect segment discrimination within each segment implementation Conditions * To implement direct segment discrimination, the seller must identify and be able to use some identifiable and fixed buyer characteristic that segments the market otherwise buyer might switch segments * Seller must be able to prevent buyers from reselling the product among themselves = price discrimination is relatively more general in services than goods and is especially common in personal services Policy of direct segment discrimination prices should be set to derive a relatively lower incremental margin percentage from the segment with the more elastic demand and a relatively higher incremental margin percentage from the segment with th e less elastic demand 5. location Seller can discriminate on the basis of the buyers location on two ways * Free on board (FOB) = a common price to all buyers that does not include delivery the differences among the prices at various locations are exactly the differences in the costs of delivery to those locations * Ignores the differences between the price elasticities of demand in the various markets * Cost including freight = delivered pricing = set prices that include delivery the difference in the prices between the two market will simply be the result of the different incremental margin percentage and the different marginal costs of supplying the two markets A lower margin does not necessarily mean a lower price because there is a transportation cost restricitng resale = if the difference between the prices of a product between two markets exceeds the transportation cost, consumers might buy the item in one market and ship it to the other gray market = parallel importing 6. indirect segment discrimination = when seller may know that specific segments have different demand curves but cannot find a fixed characteristic with which to discriminate directly Indirect Segment discrimination policy of structuring a choice for buyers so as to earn different incremental margins from each segment voorbeeld p 244-245 implementation Two conditions * Seller must have control over some variable to which buyers in the various segments are differentially sensitive * Buyers must not be able to circumvent the discriminating variable = seller cannot prevent buyers from reselling the product 7. bundle up = combination of two or more products into one package with a single price pure bundling = a pricing policy that offers only a bundle and does not allow the alternative of buying the individual products = more profitable than uniform pricing but less than direct segment discrimination mixed bundling offers buyers a structure choice between the budle and the individual p roducts = form of indirect segment discrimination implementation Three conditions to be effective * Where there is substantial disparity among the segments in their benefits from the separate products * Where the benefits of the segments are negatively correlated in the sense that a product that is more unspoilt to one segment provides relatively little benefit to another * Where the marginal cost of providing the product is low = when provision of the product commands a substantial marginal cost, a seller should consider mixed bundling 8. selecting the pricing policy Direct discrimination works through buyer attributesIndirect segment discrimination works through product attributes products under indirect discrimination may provide less benefit than those with direct segmentation indirect discrimination may involve relatively higher costs indirect discrimination relies on the various segments voluntarily identifying themselves through the structured choice cannibalization = wh en the sales of one product reduce the demand for another product with a higher incremental margin seller cannot discriminate directly and must rely on a structured choice of products to discriminate indirectly but discriminating variable does not perfectly separate the buyer segmentsWays to mitigate cannibalization * Product design * By unequivocal availability chapter 10. strategic thinking 1. introduction Strategy = a plan for action in a situation where the parties actively consider the interactions with one another in making decisions Game theory = a set of ideas and principles to guide strategic thinking * Simultaneous actions = strategic form * Sequential actions = extensive form 2. nash equilibrium = a framework for strategic decisions that must be taken simultaneously A scheme is dominated = if it generates worse consequences than some other strategy regardless of the other parties choice Game in strategic form a tabular representation of a strategic situation, showing o ne partys strategies along the rows, the other partys strategies along the