Managerial Economics MEC 290 Lecture Notes - Lecture 1: Hong Kong Hotel, Ceteris Paribus, Opportunity Cost
13 Dec 2016
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MEC 290 Quiz 1 Study Guide
I. Introduction
A. Basics
1. Focus of MEC
a. The focus of the course is on how microeconomic theories and concepts can
serve/support decisions and actions made by consumers and managers
b. Consumer topics: supply and demand, elasticity, consumer preferences/optimal choice
c. Firm topics: production and cost theory, price and output determination, market
structures, intro to game theory
2. Micro vs. Macro
a. Macroeconomics: aggregates, absolute price levels, have an impact on micro level
b. Microeconomics: price theory, consumer behavior, behavior by firms, markets, industries
3. Construct model and relax assumptions to see how predictions are impacted by such
a. Identify/observe the issue
b. Form a hypothesis
c. Model to help explain the real world with data (predicting real world outcomes)
d. Analyze data and models
e. Draw conclusions on the issue, and make recommendations to address the issue
4. Positive vs. Normative Analysis
a. Positive: using logic and evidence to predict expected/objective outcomes, fact
b. Normative: non-scientific value judgments (desirability), opinion
5. Real vs. Nominal Prices
a. Real = nominal price adjusted for changing value of money (inflation)
b. Nominal = prices as they are, the absolute price, not adjusted for changing value of
money
c. GDP (gross domestic product, a macro variable) is the general or real price level, always
use the real GDP adjusted for inflation
d. CPI (consumer price index) is the typical urban household consumption “basket”
• Can use to adjust for inflation: value (in time of old CPI) * (current CPI/old CPI)
6. Markets
a. Defined as the interplay of all potential buyers and sellers of a particular commodity or
service
B. Opportunity Costs and Production Possibility Frontiers
1. 3 Assumptions of Market Participants
a. Goal Oriented Behavior: interested in fulfilling their own self interest
• People are utility maximizers and companies are profit maximizers
b. Rational Behavior: decision are made with careful deliberations that weigh expected
benefits and costs
c. ***Scarcity of Resources: time, money, and other resources you can think of tend to be
scarce (insufficient resources to satisfy all desires → scarcity)
2. Opportunity Costs and Other Costs
a. Explicit costs = money used in the pursuit of a goal that could otherwise have been spent
on an alternative objective (includes conventional accounting costs)
• Accounting costs = costs reported in companies’ net income statements generated by
accountants
b. Implicit costs = costs associated with the individual’s use of his or her own time and
other resources in pursuit of a particular activity vs. an alternative
c. Economic cost = opportunity cost = explicit costs + implicit costs
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d. Sunk costs = costs that have already been incurred and are beyond recovery
3. Production Possibility Frontier (PPF)
a. PPF is a depiction of all the different combinations of good that a rational actor with
certain personal goals can attain with a fixed amount of resources
b. Constant vs. increasing per unit opportunity cost has an effect on the shape of the PPF
• Constant opportunity costs = linear graph (constant tradeoff between two variables)
• Increasing opportunity costs = concave to the origin
c. On the frontier you are operating fully efficiently
d. If you are beyond the frontier, this is unattainable given the current resources and
technology
e. If inside the frontier, inefficient given the current resources
4. Typical PPF is concave to the origin (increasing opportunity costs)
a. Adding more of one good costs more of other good
b. More realistic because resources are specialized and re-allocation comes at increasing
costs
C. Models of Business Analysis
1. Basics
a. Models of business analysis serve to provide insights into how firms can strategically
improve their competitive position, and for entrepreneurs, the pros and cons associated
with various business ventures
2. SWOT Analysis (may be simplistic on its own)
a. Strengths: characteristics of the business or project that give it an advantage over others
b. Weaknesses: characteristics that place the business or project at a disadvantage relative to
others
c. Opportunities: elements that the business or project could exploit to its advantage
d. Threats: elements in the environment that could cause trouble for the business or project
3. Porter’s 5 Forces
a. A model of analysis that helps to explain why different industries are able to sustain
different levels of profitability
b. The model is widely used to analyze the industry structure and corporate strategy of a
company
c. The forces are frequently used to measure competition intensity, attractiveness and
profitability of an industry or a market
D. Porter’s 5 Forces
1. Competition in the Industry
a. The importance of this force is the number of competitors and their ability to threaten a
company
b. The larger the number of competitors, along with the number of equivalent products and
services they offer, dictates the power of a company
2. Potential of New Entrants into an Industry
a. A company’s power is also affected by the force of new entrants into its market
b. The less money and time it costs for a competitor to enter a company’s market and be an
effective competitor, the more incumbent company’s position may be significantly
weakened
3. Power of Suppliers
a. This force addresses how easily suppliers can drive up the price of goods and services
b. Affected by: # of suppliers of key aspects of a good or service, uniqueness of these
aspects, how much it would cost a company to switch from one supplier to another
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c. The fewer number of suppliers and the more a company depends upon a supplier, the
more power a supplier holds
4. Power of Customers
a. Specifically deals with the ability customers have to drive prices down
b. Affected by: # of buyers/customers a company has, significance of each customer, how
much it would cost a customer to switch from one company to another
c. The smaller and more powerful a client base, the more power it holds
5. Threat of Substitutes
a. Competitor substituted that can be used in place of a company’s products or services pose
a threat
b. For example, if customers rely on a company to provide a tool or service that can be
substituted with another tool or service by performing the task manually, and this
substitution is fairly easy and of low cost, a company’s power can be weakened
E. Chapter 1 Applications
1. 1.1 Real vs. Nominal Presidential Salaries
a. Lincoln vs. Obama’s salary
b. In real money, Obama made less than Lincoln!
2. 1.2 Using Economics to Measure Sports Decisions and Preferences
a. Value of stadiums: franchise benefit and quantified personal values (people can factor in
quality of life and personal preference in addition to economic effects)
b. Takes into account decision and costs and benefits for national choices
c. LeBron chose to move to Miami because no income tax in Fl (making less in real money,
but also the appeal of playing with friends etc)
d. Contingent value methodology (CVM): how much would you pay to keep “x”
• Sample an aggregate in community, gives a “psychic income” a theoretical value on
something from locals
3. 1.4 The profitability of Demolishing a profitable Hong Kong Hotel
a. Opportunity cost taken into consideration
b. Could be making millions with hotel, but even more millions by knocking down and
renting out as corporate office space
4. Class Discussions
a. Parking permits: red is more expensive than yellow, but you have a choice/place a value
on parking in better spots, so you may be inelastic to paying >2x the price
b. Chicago to STL commute: time vs. money value based on how you travel (bus, train, car,
plane etc)
II. Supply and Demand
A. Demand
1. Law of Demand
a. There’s an inverse relationship between price and quantity demanded
• QD = movement along a curve
• Demand = moving the curve
b. If you lower the price of a good, there is a larger quantity of goods consumers wish to
purchase (ceteris paribus)
c. Downward sloping curve shows the inverse relation between price and QD
2. Determinants of Demand
a. Income: generally increase demand with income
• Normal goods: goods whose consumption rises when income rises
• Inferior Goods: goods whose consumption falls when income rises
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Document Summary
Increased compliments, mass production, increased technology for production, increased quantity demanded: then fall in consumption due to adverse health advertising and increased real price of cigarettes due to high taxes/legal fees. If per unit costs are constant, the supply curve is horizontal (infinite price elasticity) If price of good x falls, your purchasing power (real income) goes up, and thus the. If mr > mc, increase production since profits are going up. Q: tangency is where the slope of isocost (pl/pk) is equal to the slope of the isoquant (mpl/mpk, at eq"b point/tangency, the mrts = pl/pk, mpl/mpk = pl/pk or mpl/pl the same for labor and capital) % q/% l), each input"s contribution towards output, increasing or decreasing returns to scale. If the sum of exponents > 1 (increasing returns to scale) If the sum of exponents < 1 (decreasing returns to scale)
