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Jul 11

Managerial Economics

A manager has to make demand analysis, anticipate time value of money, detemine supply and demand levels, create a goal for his/her firm and understand the importance of profits, use his/her company’s products’ elsaticity tendencies before produce them in large quantities, maximize it’s profits and minimize production costs. A firm can be merge with another one because of profit maximization target and minimizing it’s cost. Experiences are also important factor for firms’ managers. Dividing it’s departments professionally and observing their working quality and criticizing their actions are the assignment of the manager. Studying “Industrial or Managerial Economics” we can determine basic concepts about industry and understand how to manage a firm successfully.

There are many market places exist and many industries’ try to do with others and this manner creates competitiveness. A great manager has to focus on it’s firm’s weaknesses, strenghts, opportunities in market. Focusing on this basic concepts surface others and these are explained by a Harvard Professor called Micheal Porter who is a leading authority on comapny strategy and the competitiveness of nations and regions. Mr.Porter generate a simply “The five forces framework” and we can simply understand power of buyers and input suppliers, industry rivalry, importance of types of goods and requirements to enter market. How these forces influence industry profitability is the important factor that a manager has to focus on. But the basic point of a firm is that maximize it’s profits and to do that a manager has to know “time value of money” concept. Let’s give an example about time value of money. For instance a firm make good investment and receive $10,000 cash prize from a supplier. Assume that a manager has two options, he/she can receive $10,000 now or he/she can receive $10,000 in three years. Like mmost of us, a manager as an ordinary person, he/she can receive that money today cause there is purchasing power exist right now and waiting make no sense. But using a simple formula a manager can make decision about receiving money today or in the future.

For option A, by receiving $10,000 today, you are secure to increase the future value of your money by investing and receiving interest in a period of time. For option B, the payment received in three years would be your future value. To illustrate, I have created a timeline:

Another important concepts are market forces called demand and supply. When a firm make pricing decisions it has to consider the law of demand. Law of demand states that, if a product’s price increases, the demand for that product will decreases.Of course this law is accepted when there is elasticity exist on that product. Demand is effected from consumers’ income level, price of related goods and from advertising. These three factors shift the demand curve and it change quantity demand for products.Products can be normal or inferior. Normal and inferior goods are related with income and it also effect demand concept directly. If consumers’ income increase and they still demand for a good more than before, so that good is called normal. But if consumers’ income increase and demand for particular goods decrease, these goods are called inferior.

A manager has to consider market manners, input suppliers and consumers behavior during the production process. For the explain market forces: Supply and demand, I will give an example. There is a bread producer called X who has great reputation in the industry. X company supply it’s inputs from a huge farm which produce great wheats. Because of the global warming this farm cannot produce same amount of wheat and X company cannot produce same level of bread. This situation will decrease the number of outputs and bread prices will increase fastly. Because of the high prices and with respect to law of demand, consumers will decrease their demand for X company’s breads. But in this industry the most important factor is the existence substitute of that product. If there is no bread company exist in the industry consumers have to pay the amount that X company stated.

Quantity demand analysis can explain the importance of elasticity and elasticity has three fundamental types like followings: Income elasticity, cross-price elasticity and own price elasticity. These concepts help to a manager about making pricing decisions. As I stated before, normal and inferior goods are related with income. So the income elasticity is about purchasing tendency of a good which will be normal or inferior. In my opinion cross-price elasticity is the most powerful decision making factor for a manager because it’s related with other goods and services which can be substitute of firm’s products. Own-price elasticity is represent the law of demand and if firm change current prices how will demand effect from this decision.

Using elasticity concepts a manager can increase firm’s revenue but the most important point for a firm is profits. As I stated before, a manager has to understand importance of profits. Maximizing profits and minimizing costs is the way to make a firm “valuable”. If there is high profits, the firm will have good reputation (surely sustainable profits is the basic requarment) and it will be valuable. How can a manager maximize profits? Using scarce resources efficiently and using them with less amounts is the way of maximizing profits. But as a manager we have to know that where marginal revenue is equal to marginal cost there is the profit maximization point (MR=MC).
Constructing confidence interval we can use econometrics. Making regression analysis is the assistant of a manager. Briefly explanation of an regression analysis chart can help a manager to make efficient decisions about production process or changing incentives about inputs etc.

Until now a manager benefit from being aware of time value of money, bond between market conditions and elasticity, using regression analysis to understand production process and significancy. Revenue factor effecting from elasticity concept. A manager has to know cross, own or income elasticity for focus on increasing revenue and profits.
Factors of production is the basic concept of an industry. As we learned that production function is : Y=F(K,L). Capital is fixed factor for short run but in long run, the role of these two notions will change. I will use labor factor to explain the theory of individual behavior.Indifferece curve and budget line reflect aspects of demand analysis. Indifference curve represents, how the change in the wage rate will affect the choice between leisure time and work time. The budget line represents all the possible combinations of two goods that can be purchased at given prices and for a given consumer budget. These two concepts’ graph are like the following:

How can a manager use these concepts to increase the value and production of a firm? In our book there is a great case study which explain these two concepts with simple combination. Firstly, wage determiantion process is the most important process to make efficient production. Wage motivate people and change their desire about working process. A rational manager determine wage level with a specific time period but an the price of an additional working hour have to make his/her workers more motivate because they fail leisure time to work. In our textbook the manager pay more if a worker stay more than 8 hours in the firm and every hour he/she pay him/her more than overtime period. Like supply and demand curve, indifference curve and budget line has an equilibrium point where is called consumer equilibrium. From these two curves’ and consumer equilibrium point, a manager can understand for purchasing which rate of product X does a consumer give up from product Y. These simple proportions can rearrange production process and supply of product X & Y.

The point A represents consumer equilibrium. It’s the most efficient point where indifference curve and budget line are intercept. The slope of the indifference curve is called marginal rate of substitution. As I stated that, consumers give up a specific amount of X to purchase more Y. We can say that X & Y are create a bundle and where is more X & Y exist, the consumers will choose that bundle. That’s why A is the point where consumers reach an equilibrium. MRS has an equation like the following:

MRS=Px/Py
To maximize profits a manager has to find a way to minimize costs. The production process and costs is related with average & marginal costs, economies of scale, fixed and sunk costs, time period like short run and long run. To interpreting cost factor like indifference curve and budget line we have isoquant and isocost curves. Converting inputs into output by firm is a production process and during this process a manager has to consider isoquant, isocosts, indifference curves, budget lines etc.

The slope of the isocost line is an area where there is cost minimization exist. Marginal rate of technical substitution (MRTS) has an equilibrium like marginal rate of substitution which is the slope of indifference curve.

MRTS=w/r

Using Cobb-Douglas, Leontief and Linear functions like regression line analysis we can interpret them with statistical techniques to make efficient production process decisions and minimizing costs. Algebratic forms of production functions can measure the amount of inputs and the output level. This informations have importance for manager cause production process is th ekey thing for determining manager is skillful or not. Production processis related with market structure like firms’ size, ,ndustry concentration, technology, demand and market conditions and potential for entry. Cause this factors determine the rivalry and the value of outputs.
To sum up, managerial economics gives informations to a candidate of a manager about production, market and creating a difference during in a competitive market conditions. Using algebratic forms of productivity and interpreting those informations, considering concepts that I briefly mentioned is the important point of the managerial economics. Combining capital, labor and othet input factors (wage, resource prices, advertising etc.) will be more efficinet using managerial economics’ concepts and considering marginal decisions a manager can be more rational. With respect to a principle which says that”rational people think at the margin”, a manager has to be rational and use those concepts to make prodoction process more efficient and use inputs benefically.

References:
• Foundations of Finance, 7/E
Arthur J. Keown, Virginia Polytechnic Instit. and State University
John D. Martin, Baylor University
J. William Petty, Baylor University
• Michael R. Baye, Managerial Economics and Business Strategy, 3e. ©The McGraw-Hill Companies, Inc. , 1999 “Powerpoint slides”