What is MANAGERIAL

ECONOMICS?

MANAGERIAL ECONOMICS
extracts from microeconomic theory those
concepts and techniques that
• enable managers to select
strategic direction, to allocate
efficiently the resources
available to the organization,
and
• to respond effectively to
tactical issues
What is MANAGERIAL
ECONOMICS?
All such managerial decision making
seeks to do the following:
1. Identify the alternatives;
2. Select the choice that
accomplishes the
objective(s) in the most
efficient manner;
3. Taking into account the
constraints, and
4. The likely actions and
reactions of rival
decision makers.
 1. Establish the Objectives
DECION-MAKING 2. Identify the Problem
MODEL 3. Examination of Potential Solutions
The ability to make good 4. Analysis of the Relative Costs and Benefits
decisions is the key to 5. Sensitivity Analysis
successful managerial
performance. 6. Implementation of the Decision
DECION-MAKING MODEL

1. The Responsibilities of Management

• Proactively solving problems in the current business model before they become
crises.
• Selecting strategies to assure the more likely success of the next business model.
(Ex. Blackberry)
• Create organizational structure and culture based on the organization’s mission.
• Responsible for establishing a vision of new business directions and stretch
goals to get there.
• Coordinate integration of marketing, operations and finance functions.
• Managers undertake the critical responsibility of motivating and monitoring
teamwork.
DECION-MAKING MODEL

2. Moral Hazard in Teams

• Teamwork skills and the ability to motivate teams is widely acknowledged as
the single most critical trait of effective managers.
• The essence of teamwork is synergistic value creation in excess of the sum of the
parts.
• Managers in a capitalist economy are motivated to monitor teamwork
ultimately because of their overarching goal to maximize returns to the owners
of the business – that is economic profits.
Economic Profits
• The difference between total
revenue and economic cost.
• Economic cost includes a “ normal”
rate of return on the capital
contributions of the firms.

Economic Cost
• Highest valued alternative
opportunity that is forgone.
• Should always be thought of as
OPPORTUNITY COSTs – the costs of
attracting a resource such as
investment capital from its next best
alternative use.
 Organizational Behavior and MANAGEMENT PROCESS

PLANNING

PERFORMANCE
• Attain
RESOURCES goals
• Products
(6Ms) CONTROLLING ORGANIZING • Services
• Efficiency
• Effective

LEADING

Management Functions
 6Ms RESOURCES

Man
1. Human Resources

Money
2. Financial Resources

Types of Machine
Resources 3. Technological Resources

Materials
4. Material

Methods
5. Intellectual / Conceptual
Minutes
6. Natural Resources
PLANNING
ORGANIZING
LEADING
CONTROLLING
EFFECTIVENESS

EFFICIENCY
Organizational Behavior and the MANAGER’S JOB

• As manager’s engage in the

basic management functions,
managers find themselves
playing variety of different
roles.
• Moreover, in order to perform
the fucntions most effectively
and to to be successful in their
various roles, managers must
also draw upon a set of
critical skills.
 MANAGERIAL ROLES

  
Interpersonal
Informational Decisional Roles
Roles Roles 1.Entrepreneur
• Figure Head • Monitor 2.Disturbance Handler
• Leader
• Disseminator 3.Resource Allocator
• Liaison
• Spokesperson 4.Negotiator
 Interpersonal Roles
• Management jobs are people-intensive
• Managers spend between two-thirds and four-fifths of
their time face-to-face communication with others.

Figure Head Role Leader Role Liaison Role

Role model for the Provides direction to Coordinates activities of his
members of the the activities and or her members with the
activities of other groups w/
organization outputs of his in the organization
subordinates
 Informational Roles

Managers spend much of their time obtaining and
sharing information.

Monitor Role Disseminator Role Spokesperson Role

Responsible for Shares with the Acts as the official
gathering relevant members relevant communicator for the
organization.
information and information the he/she
tracking what is gathers for the
happening inside & improvement of the
outside organization organization.
 Decisional Roles

Managers make decisions.

Entrepreneurial Role Disturbance Resource Allocator

Handler Role Role Negotiator
Role
Develops new Resolves Allocates funds and Makes effective
opportunities for conflict distributes agreements with
the business among resources for various parties
members effective and
efficient use.
• Specialized procedures, techniques and knowledge required to get a job.
• Most important for team leaders and lower level managers.
• Needed to troubleshoot problems that employees cannot handle.
• Less important as managers rise through the managerial ranks, but they are still
important.
Human Skills

• Ability to work well with others On average:

st
• Equally important at all levels of o 1 line managers – 57 % of
st
management, from 1 line to top their time with people
managers. o Middle managers – 63 %
o Top Managers – 78 %
• Ability to think critically and analytically.
• Characterized with the ability to see the big picture of things, understand
their interrelationships and analyse the causes and implications of actions
or situations
Motivation to manage
An assessment of how enthusiastic employees are about
managing work of others
 • Economic profits play an important role in
guiding the decisions made by the thousands
of competing independent resource owners.
THE ROLE OF • The existence of profits determines the type
and quantity of goods and services that are
PROFITS produced and sold, as well as the resulting
derived demand for resources,
Risk-Bearing Theory of Profit
• It is explained in the context of
normal profits, where;
Normal – defined in terms of the
relative risk of alternative
investments.

Temporary Disequilibrium Theory

of Profit
• Firms may find themselves earning
a rate of return above or below the
long-run normal return level.
• This can occur because of
temporary dislocations (shocks) in
various sectors of the economy.
Monopoly Theory of Profit
• In some industries, one
firm is effectively able to
dominate the market and
persistently earn above-
normal rates of return.
• The ability to dominate
the market may arise
from economies of scale,
control of essential
natural resources, control
of critical patents or
governmental restrictions
that prohibit competition.
Innovation Theory of Profit
• Suggests that above normal
profits are the reward for
successful innovations.
• Firms that develop high-quality
products or successfully identify
unique market opportunities are
rewarded with the potential for
above-normal profits.
• Systems should be designed to
ensure that the above-normal
return opportunities furnish
strong incentives for continued
innovation.
Managerial Efficiency Theory
of Profit
• Above-normal profits can
arise because of the
exceptional managerial
skills of well managed
firms.
• Profit performance is
invariably the result of
many factors, including
differential risk,
innovation, managerial
skills, the existence of
monoloy power and
chance occurrences.
OBJECTIVE OF THE FIRM
• profit maximization as an
objective of management are
insightful, but they do not
quantify the timing and risk of
profit streams.
• Shareholder wealth
maximization as an objective
overcomes both these
limitations.
The Shareholder Wealth-Maximization Model of the Firm

• Shareholder wealth is measured by the market value of a firm’s

common stock. which is equal to the present value of all expected future
cash flows to equity owners discounted at the shareholders’ required rate
of return, plus for the firms embedded real options.
SEPARATION OF OWNERSHIP & CONTROL:
THE PRINCIPAL AGENT PROBLEM

• profit maximization &

shareholder wealth
maximization are very useful
concepts when alternative
choices can be easily
identified and when the
associated costs and
revenues can be easily
estimated.
 Divergent Objectives and
Agency Conflict

• As sole proprietorships and closely held business

grow into limited liability corporations, the
owners (principals) frequently delegate decision-
making authority to professional managers (the
agents).
• The manager-agents usually have much less to
lose that the owner-principals, the agents often
seek acceptable levels (rather than a maximum)
of profit and shareholder wealth while pursuing
their own interest
 Agency Problem
• Principal-agent problems arise from the inherent
unobservability of managerial effort combined
with the presence of random disturbance in team
production.
• Separation of ownership (shareholders) and
control (management) in large corporations
permits managers to pursue goals, such as
maximization of their own personal welfare that
are not always in the long-term interests of
shareholders.
IMPLICATIONS OF SHAREHOLDER WEALTH
MAXIMIZATION

• Critics of those who want to align the interests of

managers with equity owners often allege that maximizing
shareholder wealth focuses on short-term payoffs –
sometimes to the detriment of long term profits.
• The goal of shareholder wealth maximization requires a
long-term focus.
• Admittedly, value-maximizing managers must manage
change – sometimes radical changes in competition.
• Shareholder wealth maximization also reflects dynamic
changes in the information available to the public about a
company’s expected future cash flows and foreseeable
risks.
Caveats to Maximizing
Shareholder Value

• Managers should concentrate on

maximizing shareholder value
alone only if three conditions are
met.
1. Complete markets
2. No significant asymmetric
information
3. Know recontracting costs.
• Complete Markets. To directly influence a
company’s cash flows, forward or futures markets
as well as spot markets must be available for the
firm’s inputs, outputs and by products.

• No Asymmetric Information. Monitoring

and coordination problems within the
corporation and contracting problems between
sellers and buyers often arise because of
asymmetric information.
• Known Recontracting Costs. To focus
exclusively on the discounted present value of the
future cash flows necessitates that managers
obtain not only sales revenue and expense
estimates but also forecasts of future
recontracting costs for pivotal inputs.
Residual Claimants
• Why is that the primary duty of
management and board of directors of a
company is to the shareholders
themselves?
• Shareholders have a residual claim on the
firm’s net cash flows after all expected
contractual returns have been paid.
• All the other stakeholders (employees,
customers, bondholders, banks, suppliers. .
.)
• Be very clear, however, that the value of
any company’s stock is quite dependent on
reputation effects.
Goals in the Public Sector and Not-
for-Profit Enterprises
• The value-maximization objective
developed for private sector firms is
not an appropriate objective in the
public se tor or in not-for-profit
(NFP)
• Three (3) characteristics of NFP
Organizizations:
1. No one possesses a right to receive
profit or surplus in an NFP enterprise.
2. NFP enterprises are exempt from
taxes on corporate income.
3. Donations to NFPs are tax deductible,
which gives NFP enterprises an
advantage when competing for
capital.
 1. Maximizing the quantity and quality of
output subject to a break-even budget
constraint.
NFP Objectives
2. Maximizing the outcomes preferred by the
NFPs contributors.
3. Maximizing the longevity of the NFP’s
administration.