Chapter 1

• Managerial Economics applies microeconomic theory to business problems.
• Economic analysis is used to help decision maker understand how different policies and choices will affect the economy.
• Economic theory helps managers understand real-world business problems.
• Economic theory uses simplifying assumptions to turn complexity into relative simplicity.
• Microeconomics is the study of behavior of individual consumers, business firms, and markets that contributes to our understanding of business practices and tactics.
• Business practices or tactics

  Routine business decisions managers must make to earn the greatest profit under prevailing market conditions.
• Industrial Organization


  Specialized branch of microeconomics focusing on behavior and structure of firms and industries. Concerned with the workings of markets and industries, in particular the way firms compete with each other.
• Main goal of industrial organization is to understand how firm strategically interact in well-defined -markets.
• IO is used to observe variables to predict firm behavior in particular markets.
• Strategic Decisions


  Business actions taken to alter market conditions and behavior of rivals in ways that increase and/or protect the strategic firm’s profit.
• While common business practices are necessary for the goal of profit-maximization, strategic decisions are generally optimal actions managers can take as circumstances permit.
• Economic Forces that promotes long-run profitability

  • Few close substitutes
  • Strong entry barriers
  • Weak rivalry within market
  • Low market power of input suppliers
  • Low market power of consumers
  • Abundant complementary products
  • Limited harmful government intervention
• Few Close substitutes


  ➢When a good lacks close substitutes in the market, an increase in price cannot trigger consumers to switch to an alternative since there are only a few or none available.
• Few close substitute examples:

  • Meralco
  • Maynilad
• Strong entry barriers


  ➢Barriers to entry are the obstacles or hindrances that make it difficult for new companies to enter a given market.
• Strong entry barriers example:

  • Oil and gas companies
  • Bank
  • Pharma
• Weak rivalry within markets


  ➢An industry with weak rivalry will have few firms, meaning that there are enough customers for everyone, or will have firms that have each staked out a unique position in the industry, meaning that customers will be more loyal to the firm that best meets their particular needs.
• Weak rivalry within markets

  • Apple
  • Andriod
• Low market power of input and supplies

  ➢Market power refers to a company's relative ability to manipulate the price of an item in the marketplace by manipulating the level of supply, demand, or both.
• Low market power of input and supplies

  The companies in this market structure have no ability to raise prices above the equilibrium price. In fact, any attempt to do so would lead to a loss in sales and profits.
• Low market power of consumers


  ➢Market power refers to a company's relative ability to manipulate the price of an item in the marketplace by manipulating the level of supply, demand, or both.
• Low market power of consumers

  The consumer in this market structure have no ability to lessen pricesbelow the equilibrium price.
• Abundant of Complementary products


  ➢This are products that are typically used together. They are goods that people tend to buy at the same time because they go well together or enhance each other's use.
• Abundant of Complementary products examples:

  • Car and Gas
  • Coffee and Sugar
  • Cellphone and Charger
• Opportunity Cost


  What firm owner must give up to use resources to produce goods and services
• Market-supplied resources

  Owned by others and hired, rented, or leased.
• Owner-supplied resources


  Owned and used by the firm.
• Total economic cost


  Sum of opportunity cost of market-supplied resources and ownersupplied resources.
• Explicit cost


  Monetary opportunity costs of using market-supplied resources.
• Explicit cost


  out-of-pocket costs for a firm. Example: Payment for wages and salaries, rent, or materials
• Implicit Cost


  Nonmonetary opportunity costs of using owner-suppliedresources.
• Implicit cost


  Example: Expanding a factory onto land already owned
• Three Types of Implicit Costs

  ▪ Opportunity cost of cash provided to a firm by its by owners, known as equity capital (money provided to businesses by the owners)

  ▪ Opportunity cost of using land or capital owned by the firm

  ▪ Opportunity cost of owner’s time spent managing or working for the firm
• Explicit Cost of Market-supplied resources + Implicit Cost of Owner-supplied resources = Total Economic cost
• Value of a firm

  ▪ Price of which it can be sold

  ▪ Equal to the present value of expected future profits
• Risk Premium

  An increase in the discount rate to compensate investors for uncertainty about future profits.
• Risk Premium


  The larger the risk, the higher the risk premium, and the lower the firm’s value.
• Some Common Mistake Managers Make

  ▪ Never increase output simply to reduce average costs

  ▪ Focusing on profit margin won’t maximize total profit

  ▪ Cost-plus pricing formulas don’t produce profit-maximizing prices
• Profit Margin Ratio


  Shows you how much you earn after deducting your expenses, similarly to profits.
• Principal-Agent Relationship


  Relationship formed when a business owner (the principal) enters an agreement with an executive manager (the agent) whose job is to formulate and implement tactical and strategic business decisions that will further the objectives of the business owner (the principal).