GMS 402 Chapter Notes - Chapter 1: Opportunity Cost, Marginalism, Net Present Value
4 Oct 2017
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Isaiah Ferris Fall 2017
GMS402 – Chapter 1 Textbook Notes
• A manager is a person who directs resources to achieve a stated goal.
o This definition includes all individuals who
• (1) direct the efforts of others, including those who delegate tasks within an
organization such as a firm, a family, or a club
• (2) purchase inputs to be used in the production of goods and services such as the
output of a firm, food for the needy, or shelter for the homeless
• (3) are in charge of making other decisions, such as product price or quality
• The primary focus of this book is on the second word in managerial economics.
o Economics is the science of making decisions in the presence of scarce resources.
o Resources are simply anything used to produce a good or service or, more generally, to
achieve a goal.
o Decisions are important because scarcity implies that by making one choice, you give up
another
• Managerial economics, therefore, is the study of how to direct scarce resources in the way that
most efficiently achieves a managerial goal.
o It is a very broad discipline in that it describes methods useful for directing everything from
the resources of a household to maximize household welfare to the resources of a firm to
maximize profits
o The key to making sound decisions is to know what information is needed to make an
informed decision and then to collect and process the data.
• If you work for a large firm, your legal department can provide data about the legal
ramifications of alternative decisions; your accounting department can provide tax
advice and basic cost data; your marketing department can provide you with data on
the harateristis of the arket for our produt; ad our fir’s fiaial aalsts
can provide summary data for alternative methods of obtaining financial capital.
o Ultimately, however, the manager must integrate all of this information, process it, and
arrive at a decision
• In particular, an effective manager must
o (1) identify goals and constraints
• The first step in making sound decisions is to have well-defined goals because
achieving different goals entails making different decisions
• The decision maker faces constraints that affect the ability to achieve a goal
▪ Constraints is an artifact of scarcity
• Differet uits ithi a fir a e gie differet goals; those i a fir’s arketig
department might be instructed to use their resources to maximize sales or market
share, hile those i the fir’s fiaial group ight fous o earigs groth or risk-
reduction strategies.
• Constraints make it difficult for managers to achieve goals such as maximizing profits
or increasing market share.
▪ These constraints include such things as the available technology and the prices
of inputs used in production.
o (2) recognize the nature and importance of profits
• Economic vs. Accounting Profits
▪ A more general way to define profits is in terms of what economists refer to as
economic profits.
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Isaiah Ferris Fall 2017
▪ Economic profits are the difference between the total revenue and the total
opportuit ost of produig the fir’s goods or series.
▪ The opportunity cost of using a resource includes both the explicit (or
accounting) cost of the resource and the implicit cost of giving up the best
alternative use of the resource
▪ Implicit costs are very hard to measure and therefore managers often overlook
them.
• Effective managers, however, continually seek out data from other
sources to identify and quantify implicit costs
• The Role of Profits
▪ A oo isoeptio is that the fir’s goal of aimizing profits is
necessarily bad for society.
▪ Individuals who want to maximize profits often are considered self-interested, a
quality that many people view as undesirable
▪ Hoeer, osider Ada “ith’s lassi lie fro The Wealth of Natios: It is
not out of the benevolence of the butcher, the brewer, or the baker, that we
epet our dier, ut fro their regard to their o iterest.
• Smith is saying that by pursuing its self-interest—the goal of maximizing
profits—a firm ultimately meets the needs of society.
• If you cannot make a living as a rock singer, it is probably because
society does not appreciate your singing; society would more highly
value your talents in some other employment
▪ “iilarl, the profits of usiesses sigal here soiet’s sare resoures are
best allocated.
• When firms in a given industry earn economic profits, the opportunity
cost to resource holders outside the industry increases.
• Owners of other resources soon recognize that, by continuing to operate
their existing businesses, they are giving up profits.
• This induces new firms to enter the markets in which economic profits are
available.
• As more firms enter the industry, the market price falls, and economic
profits decline.
• Thus, profits signal the owners of resources where the resources are most
highly valued by society.
• By moving scarce resources toward the production of goods most valued
by society, the total welfare of society is improved.
• The Five Forces Framework and Industry Profitability
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Isaiah Ferris Fall 2017
▪
o (3) understand incentives
• Within a firm, incentives affect how resources are used and how hard workers work.
▪ To succeed as a manager, you must have a clear grasp of the role of incentives
within an organization such as a firm and how to construct incentives to induce
maximal effort from those you manage
• The first step in constructing incentives within a firm is to distinguish between the
world, or the business place, as it is and the way you wish it were.
▪ Many professionals and owners of small establishments have difficulties
because they do not fully comprehend the importance of the role incentives
play in guiding the decisions of others.
• Fortunately, most business owners understand the problem just described.
▪ The owners of large corporations are shareholders, and most never set foot on
company ground.
▪ How do they provide incentives for chief executive officers (CEOs) to be
effective managers?
• Ver sipl, the proide the ith ietie plas i the for of
ouses. These ouses are i diret proportio to the fir’s profitailit.
• If the firm does well, the CEO receives a large bonus.
• If the firm does poorly, the CEO receives no bonus and risks being
fired by the stockholders
o (4) understand markets
• In studying microeconomics in general, and managerial economics in particular, it is
important to bear in mind that there are two sides to every transaction in a market:
For every buyer of a good there is a corresponding seller.
• The final outcome of the market process, then, depends on the relative power of
buyers and sellers in the marketplace.
• The power, or bargaining position, of consumers and producers in the market is
limited by three sources of rivalry that exist in economic transactions:
▪ Consumer–producer rivalry
• Consumer–producer rivalry occurs because of the competing interests of
consumers and producers.
• Consumers attempt to negotiate or locate low prices, while producers
attempt to negotiate high prices.
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Document Summary
Smith is saying that by pursuing its self-interest the goal of maximizing profits a firm ultimately meets the needs of society. If you cannot make a living as a rock singer, it is probably because society does not appreciate your singing; society would more highly value your talents in some other employment. These (cid:271)o(cid:374)uses are i(cid:374) dire(cid:272)t proportio(cid:374) to the fir(cid:373)"s profita(cid:271)ilit(cid:455). If the firm does well, the ceo receives a large bonus. If the firm does poorly, the ceo receives no bonus and risks being fired by the stockholders (4) understand markets. In studying microeconomics in general, and managerial economics in particular, it is important to bear in mind that there are two sides to every transaction in a market: In a (cid:448)er(cid:455) loose se(cid:374)se, (cid:272)o(cid:374)su(cid:373)ers atte(cid:373)pt to (cid:862)rip off(cid:863) produ(cid:272)ers, a(cid:374)d produ(cid:272)ers atte(cid:373)pt to (cid:862)rip off(cid:863) (cid:272)o(cid:374)su(cid:373)ers: of course, there are limits to the ability of these parties to achieve their goals.
