Essay About Firm’S Ability And Cost-Benefit Principlean

Managerial Economics
Managerial Economics – Study Guide: Chapters 1-7CHAPTER 1:Cost-Benefit PrincipleAn economic agent should undertake an action if and only if the marginal benefit is greater than the marginal costIgnore sunk costsConsider your next best optionsOpportunity Cost (Marginal Thinking)Compare Marginal Benefit to Marginal CostEx:  MBA Program – BenefitsLearningEntertainingChecking out the professorPaid tuition (SUNK COST)Allocation DecisionsIllustrate how economic changes affect a firm’s ability to earn an acceptable returnApply to an individual firm the three basic questions faced by a countryEconomicsThe study of the behavior of human beings in producing, distributing and consuming material goods and services in a world of scarce resourcesManagementThe science of organizing and allocating a firm’s scarce resources to achieve its desired objectiveManagerial EconomicsThe use of economic analysis (i.e. statistics and math) to make business decisions involving the best use (allocation) of an organization’s scarce resourcesRelationship to other business disciplinesMarketingDemand, price elasticityFinanceCapital budgeting, breakeven analysis, opportunity cost, value addedManagement scienceLinear programming, regression analysis, forecastingStrategyTypes of competition, structure-conduct-performance analysisManagerial accountingRelevant cost, breakeven analysis, incremental cost analysis, opportunity costQuestions that managers must answer:What are the economic conditions in our particular market?National market?Global market?Market structure?Supply and demand?Technology?What are economic conditions in our particular market?Government regulations?International dimensions?Future conditions?Macroeconomic factors?Should our firm be in this business?If so, at what price?…and at what output level?How can we maintain a competitive advantage over other firms?Cost-leader?Product differentiation?Market niche?Outsourcing, alliances, mergers?International perspective?(Risk is the chance that actual future outcomes will differ from those expected)What are the risks involved?Exchange rates (for companies in international trade)?Political risk (for firms with foreign operations)?Economics of a businessRefers to the key factors that affect the firm’s ability to earn an acceptable rate of return on its owners’ investmentCompetition TechnologyCustomers Change:  the four-stage modelSTAGE I (the ‘good old days’)Market dominanceHigh profit marginCost plus pricing…changes in technology, competition, customers force firm into Stage IISTAGE II (crisis)Cost managementDownsizingRestructuring…’re-engineering’ to deal with change sand move firm into Stage IIISTAGE III (reform)Revenue managementCost cutting has limited benefitfocus on ‘top-line’ growthStage IV (recovery)Revenue plus…revenue grows profitablyMicroeconomicsThe study of individual consumers and producers in specific markets:Supply and demandPricing of outputProduction processCost structureDistribution of incomeMacroeconomicsThe study of the aggregate economy, especially:National output (GDP)UnemploymentInflationFiscal and monetary policiesTrade and finance among nationsResourcesInputs (factors) of production, notably:LandLaborCapitolEntrepreneurshipAlso referred to as the technology constant in the AK modelAllocation decisions must be made because of scarcity.  Three choices:What should be produced?Begin or stop providingGoods / services (productionHow should it be produced?Hiring, staffing, capital budgetingResourcingFor whom should it be produced?Target the customers most likely to purchase (marketing)EntrepreneurshipThe willingness to take certain risks in the pursuit of goalsManagementThe ability to organize resources and administer tasks to achieve objectivesCHAPTER 2 – The Firm and its Goals:Learning ObjectivesUnderstand the rationale for existence of firmsExplain economic goals and optimal decision makingDescribe the ‘principal-agent’ problemDistinguish between profit maximization and shareholder wealth maximizationApply market value Added and Economic Value AddedThe FirmA collection of resources that is transformed into products demanded by consumersProfit is the difference between revenue received and costs incurred Accounting v. EconomicTransaction CostsIncurred when entering into a contractInvestigationNegotiationEnforcing ContractsTransportation costsInfluencesUncertaintyFrequency of recurrenceAsset specificity Limits to Firm SizeEconomies of ScaleCRSDRSIRSEconomics of AgglomerationLegal / Market ShareAdditional Limits:Tradeoff between extrernal transactions and the cost of internal operationsCompany chooses to allocate resources so total cost is minimumOutsourcing of peripheral, non-core activities[pic 1]Coase & the InternetRonald Coase 1937 tradeoff between internal costs and external transactionsCoase TheoremSearch costs (Search Theory in labor Markets)Profit maximization hypothesisThe primary objective of the firm (to economists) is to maximize profitsOther goals:Market shareRevenue GrowthShareholder ValueShort-run v. Long-runNothing to do directly with calendar timeShort-runFirm can vary amount of some resources but not othersGenerally capital is fixedLong-runFirm can vary amount of all resourcesAt times, short-run profitability will be sacrificed for long-run purposesEconomic goalsMarket share / growth rateProfit marginReturn on investment / return on assetsTechnological advancementCustomer satisfactionShareholder ValueNon-economic objectivesGood work environmentQuality products and servicesCorporate citizenship / social responsibilityDo companies maximize profit?Criticism:  companies do not maximize profits but instead merely aim to satisfice, which means to achieve a satisfactory goal, one that may not require the firm to ‘do its best’Two forces affect satisficing:Position and power of stockholdersShareholders are concerned with performance of entire portfolio and not individual stocksLess informed about the firm than managementInstitutional shareholders monitor Stockholders are not likely to take any action if earning a ‘satisfactory return’Position and power of managementHigh-level managers may own very little of the firm’s stockManagers tend to be more conservative because jobs will likely be safe if performance is steady, not spectacularCan be fired for reversalManagers may be more interested in maximizing own income and perks Management incentives may be misaligned (ie.e revenue not profits)Principal-Agent ProblemDivergence of objectivesThere is no perfect solution (Holmstrom)Incentive schemes / rulesEfficiency wages (Stiglitz)ObservationCounter-arguments which support the profit maximization hypothesisLarge stockholdings held by institutions (mutual funds, banks, etc.)scrutiny by professional analysts Stock market disciplineif managers do not seek to maximize profits, firms face threat of takeoverIncentive effectThe compensation of many executives is tied to stock priceStream of Profits (cash flows) over timeThe value of the stream depends on when cash flows occurRequires the concept of the time value of moneyA dollar earned in the future is worth less than a dollar earned todayFuture cash flows must be ‘discounted’ to find present equivalent valueThe discount rate (k) is affected by riskTwo major types of riskBusiness RiskInvolves variation in returns due to the ups and downs of the economy, the industry and the firmFinancial RiskConcerns the variation in returns that is induced by ‘leverage’LeverageThe proportion of a company financed by debtThe higher the leverage, the greater the potential fluctuations in stockholder earningsFinancial risk is directly related to the degree of leverageThe present price of a firm’s stock should reflect the discounted value of the expected future cash flows to shareholders (dividends)