Cheat Sheet Managerial Economics
Theory of the firm: a firm’s objective is to maximize it’s wealth, which is the present value of its future
profits. Calculated as follows:PV
Three fertile profit-generating areas: innovation, risk and market power.
Principal-agent problem: When managers pursue their own objectives, even though this decreases
the profit of the owners.
Shifts in the demand curve are caused by a number of reasons (known as “non-price determinants):
—Changing tastes and preferences
—The price of related goods
—Expectations about the future
Market size (population, advertising, etc)
If consumer has a more important income, or tastes in the product increases, then the demand
curve will shift to the right.
Equilibrium price increase if demand curve shifts right / Equilibrium price decrease if demand curve
Shifts in the supply curve are caused by a number of reasons (known as “non-price determinants):
—Cost on inputs
—Technology and Productivity
—Taxes and Subsidies
If lower-cost production technology is developed, then managers will be willing to sell more units
at any price, then the supply curve will shift to the right.
Equilibrium price increase if supply curve shifts left / Equilibrium price decrease if supply curve shifts
As long as the actual price is greater than the equilibrium price, there is downward pressure on
As long as the actual price is less than the equilibrium price, there is upward pressure on the
Adam Smith: Invisible hand: When no governmental agency is needed to induce producers to drop or
increase their prices.
The marginal value of a dependent variable is the change in this dependent variable (e.g., Q)
associated with a 1-unit change in a particular independent variable (e.g., P)
The average of a function (i.e. average profit) is the total dependent variable divided by the total
Marginal Profit is the change in profit associated with 1 additional unit of output
Average Profit is the total profit per unit of output
The Marginal Value is the slope of the tangent line at a point along the curve. (First Derivative)
If the second derivative is POSITIVE, then the value is a MINIMUM
If the second derivative is NEGATIVE, then the value is a MAXIMUM
Market demand function: The relationship between the quantity demanded and the various factors
that influence this quantity.
Substitutes: an increase in the price of one good increases demand of the other*
Complements: an increase in the price of one good decreases demand of the other*
Independent: an increase or decrease in the price of one good has no effect on demand of the other
Elasticity: The elasticity is defined as the percentage change in the dependent variable in response
to a 1 percent change in the independent variable.
-Inelastic Demand (η greater than -1) : Quantity demanded is not very responsive to changes in
price ---Elastic Demand (η less than -1) : Quantity demanded is very responsive to changes in
-Unitary Elastic (η equal to -1) : Quantity demanded and price change at the same percentage rate
Perfectly elastic goods (η equals infinity)
Has at least one perfect substitute, so consumers will always buy the lowest priced good
Horizontal demand curve
Perfectly Inelastic Goods (η equals 0)
Have no substitutes, and are necessities, so consumers will purchase the same amount regardless of
—Vertical demand curve
-Necessities versus Luxuries: Luxuries are more elastic
-Availability of Close substitutes: more close substitutes means more elastic
-Definition of the market: more narrowly defined market means more elastic
-Time horizon: longer time horizon means more elastic
MR P 1
Income elasticity of demand: percen