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Managerial Economics - Textbook Notes.docx

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COMM 295

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COMM 295 – Managerial Economics Chapter 1 – Introduction • Managerial Economics – applications of economic analysis to managerial decision- making • Economics – study of decision-making in presence of scarcity • Market – buyers trade with sellers • Model – description of relationship between 2 + economic variables • Theory – use model to test hypothesis Chapter 2 – Supply and Demand • Demand – consumers: price, income, price of related goods • Supply – firms: price, cost of inputs , technology in production • Market equilibrium – consumer’s demand + producer’s supply = market price + quantity • Shocks to equilibrium – changes that affects demand (income, etc) or supply (input- prices, etc) alter market price and quantity • Government policies – shift supply or demand o Restrict prices or quantity o Taxes – gap between price consumer pay and firms receive 2.1 – Demand • Substitute: Coke vs. Pepsi • Complement: iPod and online music • Law of demand – consumer demand more of a good if price lower o Slope downwards • Movements along demand curve – changes in price  quantity demanded • Shift of demand curve – price of substitute goods o = movement along supply curve o $ substitute increases, demand for good increases o Income increases, demand for good increases • Calculus – e.g. Q = 160 – 40p dQ =−40 dp  Derivative of demand with respect to price is negative 2.2 – Supply • The supply curve o Technological advancement: produce good at lower cost o Government rules and regulation o Cost of production • Movements along supply curve – Price increases  firms supply more • Shift supply curve – key factor of production more expensive to produce o = Movement along demand curve 2.3 – Market Equilibrium • Market participants able to buy and sell as much as they want – don’t want to change behaviour 2.5 – Effects of Government Interventions • Price ceilings – market forces would drive up market price (to where excess demand is eliminated), but government price ceiling causes shortage – persistent excess demand • Price floors – excess supply o E.g. minimum wage • Specific taxes – lowers equilibrium quantity, raises price paid by consumers, lowers price received by sellers Chapter 3 – Empirical Methods for Demand Analysis 3.1 – Elasticity • Elasticity – % change in a variable divided by the associated % change in another variable • Price elasticity of demand - % change in quantity demanded (Q), divided by % change in price (p) ∆Q/Q ∆Q p ε= = ∆ p/p ∆p Q • Arc price elasticity – uses average price and average quantity as denominator ∆Q/Q ́ ε= ∆ p/́p • Point elasticity – elasticity at specific price-quantity combination ε= dQ p dp Q • ε • Inelastic – 0 > > – 1 o % change in quantity is smaller than % change in price • Horizontal demand curve – identical good, perfect substitute • Vertical demand curve – essential goods – have to and will pay anything to get Income elasticity of demand - % change in quantity demanded to % change in income ∆Q/Q ∆Q Y ε= = ∆Y/Y ∆Y Q • Normal good – good for which quantity demanded increase as income rises o Positive income elasticity of demand o E.g. avocados, music downloads • Inferior good – good for which quantity demanded falls as income rises o Negative income elasticity o E.g Kraft dinner • Cross-price elasticity of demand - % change in quantity demanded divided by % change in price of another good o Negative – people buy less of a good if price of other good rises  E.g. price of cream increases, consume less coffee  Complements o Positive – as price rises of one good, buy more of substitute good 3.2 – Regression Analysis • Estimate relationship between dependent variable (e.g. quantity demanded), and 1+ explanatory variables (price, income) • Demand function – quantity is a function of price o Q = a + bp (where b is -ve), we can rearrange this expression to obtain p = -a/b + Q/b. • Inverse demand function – price is a function of quantity o p = -a/b + Q/b = g + hQ, where g = -a/b and h = 1/b • When we observe actual data it would not normally lie on straight line: p = g + hQ + e o e =“error” – difference between the proposed linear relationship and actual observation o non-price factors that can’t hold fixed (random variations in # buyers on particular day) • Residual – vertical distance between the actual price and the “predicted” price obtained from the regression line • Ordinary least squares (OLS) method makes the sum of squared residuals as small as possible. • R Statistic – share of dependent variable’s variation explained by the explanatory variables o Goodness of fit o How well estimated regression line fits the data o Between 0 and 1 2 o E.g. R = 0.54, shows 46% of variation in demand is due to random errors Chapter 4 – Consumer Choice 4.1 – Consumer Preferences • Bundle/market basket – consumer allocate available budget by taste or preference • Completeness – prefer one to another or both equally (indifference), not indecisive • Transitivity – rational, one prefers bundle A to B, and B to C, then he must prefer A to C. • More is better – more of a good is better than less • Indifference curve – set of all bundles of goods that a consumer views as being equally desirable • Indifference map – set of indifference curves that summarize consumer’s tastes/preferences o Bundles on indifference curves farther from origin are preferred to those on indifference curves closer to origin o There is an indifference curve through every possible bundle o
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