01 - Fundamentals

Question 1

Economics

Answer 1

The study of how people use their scarce resources to try to satisfy their unlimited wants.

Question 2

Manager

Answer 2

A person who directs resources to achieve goals.

Question 3

Managerial Economics

Answer 3

The study of how to direct scarce resources in the way that most efficiently achieves a managerial goal. The goal is primarily maximizing profits.

Question 4

Resources

Answer 4

Anything used to produce a good or service or achieve a goal.

Natural Resources
Labor
Capital
   Human
   Social
   Cultural
Management - entrepreneurial ability

Question 5

Capital

Answer 5

Things used to produce other things.
   Equipment
   Human Capital
   Social Capital
   Cultural Capital

Question 6

Scarcity

Answer 6

You can’t always get all you want for free.

When trying to achieve goals, we will face time and resource constraints.

You can’t choose something without giving up something else.

Drives the economics of conservation.

Question 7

Constraints

Answer 7

The artifacts of scarcity.

Question 8

Theory

Answer 8

Used to make sense of complex reality.

Like a map - simplified to point of optimal effectiveness.

Question 9

Nominal Price

Answer 9

Price denominated in money.

Question 10

Real Price

Answer 10

The nominal price adjusted for the changing value of money.

Question 11

Real Wage calc.

Answer 11

Base yr Wage =
(Today$ / CPI) x Base yr $

Base yr 1993 = $100
CPI = $263
$10 today in 1993?
(10/263)100 = $3.80
So $3.80 in 1993 same as $10 today.

Question 12

Self Interest

Answer 12

People are interested in filling THEIR goals. NOT that they are selfish.

Question 13

Explicit Costs

Answer 13

Same as Accounting Costs. Direct outlays of the firm.

Question 14

Implicit Costs

Answer 14

The cost of giving up the next best or most lucrative use of the resource.

Time is the best example.

Question 15

Accounting Cost

Answer 15

Explicit cost of a resource. The direct outlays of a firm.

Question 16

Opportunity Cost

Answer 16

Same as economic costs which include implicit and explicit costs.

Question 17

Economic Costs

Answer 17

Accounting (explicit) costs + implicit costs.

Economic costs are opportunity costs and include both implicit and explicit costs.

Question 18

Economic Profit

Answer 18

The difference between total revenue and total economic cost.

Also the difference between total revenue and total opportunity cost.

Economic cost is same as opportunity cost which include explicit + implicit costs

Question 19

Effective Manager - Goals

Answer 19

Have well defined and effective goals. Inappropriate goals reduce ability to meet customer needs and make a profit.

Question 20

Effective Manager - Profits

Answer 20

Understand that profits are a signal to where resources are most valued by society.

Question 21

Effective Manager - Incentives

Answer 21

Understand what what incentives people are facing and how they will respond to those incentives.

Remember that not all people will respond the same way to single incentive.

Question 22

Effective Manager - Markets

Answer 22

Understand how markets affect the amount of competition between consumers and producers.

Question 23

Effective Manager - Present Value

Answer 23

Understand present value analysis and the timing of decisions.

Question 24

Sunk Costs

Answer 24

Costs already incurred that cannot be recovered.

Not relevant to current decisions.

Calculated as original cost minus what can be recovered.

Question 25

Effective Manager - Activity

Answer 25

Increase or decrease an activity to the point where the marginal value equals the marginal cost.

Question 26

Five Forces

Answer 26

Developed by Michael Porter Forces that impact level growth and sustainability of profits. ``` Entry Substitutes and Compliments Power of Buyers Power of Sellers Rivalry ```

Question 27

Five Forces Objectives

Answer 27

1. Reduce competition from direct and indirect competitors. 2. Dominate over suppliers and buyers. 3. Reduce threat of new competitors. 4. Innovate through evolutionary improvements. Incrementally improve existing products to maintain hold on existing customers and attract new customers through critical mass. Work toward a monopolistic state.

Question 28

Five Forces 1 Entry

Answer 28

``` Resource costs Speed of adjustment Sunk costs Network effects - cell coverage Reputation Switching costs Govt. constraints ```

Question 29

Five Forces 2 Substitutes and Complements

Answer 29

Value of similar substitutes choices Value of complementary choices Network effects Govt. constraints

Question 30

Five Forces 3 Power of Buyers

Answer 30

``` Buyer concentration Value of substitute choices Relationship specific investments Customer switching costs Govt. constraints ```

Question 31

Five Forces 4 Power of Input Suppliers

Answer 31

``` Supplier concentration Productivity of input choices Relationship specific investments Supplier switching costs Govt. constraints ```

Question 32

Five Forces - 5 Industry Rivalry

Answer 32

``` Concentration of firms Value of service offered by competitor Degree of differentiation Switching cost Timing of decisions Information access Govt. constraints ``` Consumer-Consumer Rivalry Consumer-Producer Rivalry Producer-Producer Rivalry

Question 33

Competitive Impact on Industry

Answer 33

Rivalry increases competition which leads to superior performance. Short run Firms suppress rivals = profits up, comp dn Long run Competitors move in = comp up, profits dn For reasons above, monopolies weaken industry but advantages are usually short lived.

Question 34

Principals of Incentives

Answer 34

1. Incite action or greater effort 2. Determine how resources are used and how hard people work 3. Should increase profits 4. Unintended outcomes arise when customers intemperate offer as negative signal 5. Distinguish between how business is and how you wish it were - goal setting 6. Start by assuming everyone is greedy 7. Design so if employees are working in their best interest, they are also working in firm's best interest.

Question 35

Disruptive Innovation Objectives Disruptive Innovation by Clayton Christensen is a new application of Joseph Schumpeter's Creative Destruction.

Answer 35

1. Begin with novel solution to former need. 2. Introduce in new lower-end market to achieve rapid growth under the radar of established large firms. 3. Dominate firms focus on high-end and overlook threat. 4. Disruptive solution usually has lower performance but accepted as good enough at far lower price. Disrupter attracts all as new standard.

Question 36

Present value of a single future value. PV

Answer 36

The amount that would need to be invested today at the prevailing interest rate to generate the given future value. Present value reflects the difference between the future value and the opportunity cost of waiting. The higher the interest rate (i) the greater the opportunity cost of waiting.

Question 37

Present value of a stream of future values. PV

Answer 37

The present value is the sum of each year's future value estimate. So for each year, divide FV by interest rate estimate to the power of that year.

Question 38

Net Present Value NPV

Answer 38

Same as Present value of a stream of future values MINUS the current cost of the project. Important analysis because large future values may mislead mgr. to believe project is worthy. Must not forget to account for economic costs of project execution. Negative NPV means current funds should be invested elsewhere or costs must be reduced.

Question 39

Present value of Indefinitely Lived Assets. PVasset

Answer 39

If cash flow CF varies, must add up the present value of CF for each year including the first year. If CF is consistent and into perpetuity, simply divide the single year CF by the interest rate.

Question 40

Profit Maximization Principal

Answer 40

Maximizing profits means maximizing value of firm - which is the present value of current and future profits. Similar to PV of indefinitely lived assets. If annual profit varies, must add up the present value of profit for each year including the first year. If profit is consistent and into perpetuity, simply divide the single year profit by the interest rate.

Question 41

Estimating value of firms with constant growth rate.

Answer 41

Adjust each year's projected annual profit by growth rate before dividing by interest rate estimate. Long and short formulas- Subtract any dividends paid from PVfirm for ex-dividend firm value. Short formula and PVfirm adjustment

Question 42

Marginal Principle Marginal Analysis: One of the most important management tools! Optimal decisions involve comparing the marginal (incremental) benefits with the marginal costs.

Answer 42

To maximize net benefits, the manager should increase the managerial control variable up to the point where marginal benefits equal marginal costs. This level of the managerial control variable (Q for qty) corresponds to the level at which marginal bet benefits are zero; nothing more can be gained by further changes to that variable. Do more if MB>MC Do less if MB

Question 43

B(Q) C(Q) N(Q) MB(Q) MC(Q) MNB(Q)

Answer 43

``` Q = the variable under the manager's control - the Control Variable B(Q) = total benefit from producing Q units. C(Q) = total costs from producing Q units. N(Q) = total net benefits N(Q) = B(Q) - C(Q) ``` ``` MB(Q) = change in B(Q) from previous Q MC(Q) = change in C(Q) from previous Q MNB(Q) = change in NB(Q) from previous Q Or MNB(Q) = MB(Q) - MC(Q) ```

Question 44

Discrete Decisions

Answer 44

When the Managerial Control Variable is constrained to whole units rather than fractional or continuous values.

Question 45

Optimal Output Level

Answer 45

Where MB(Q) = MC(Q) or MNB(Q) = 0

Question 46

Marginal Benefit

Answer 46

The additional benefits that arise from use of an additional unit of the managerial control variable. The marginal benefit is derived from the difference of the benefit at current Q minus benefits from prior level of Q. It is the change in benefits between current and most recent qtys. When MB(Q) > MC(Q) it makes sense to produce more because more profits can be reaped.

Question 47

Marginal Cost

Answer 47

The additional costs that arise from use of an additional unit of the managerial control variable. The marginal cost is derived from the difference of the cost at current Q minus costs from prior level of Q. It is the change in costs between current and most recent qtys. When MB(Q) < MC(Q) it does NOT make sense to produce more because increasing costs are mitigating profits.

Question 48

Marginal Net Benefits

Answer 48

The change in net benefits that arise between current and next previous level of Q. Important: May also be calculated by MNB(Q) = MB(Q) - MC(Q)

Question 49

Maximizing Net Benefits vs Maximizing Total Benefits

Answer 49

Total Benefits B(Q) will always exceed Net Benefits N(Q) because N(Q) takes costs into account. For an accurate N(Q) value, make sure economic costs ( explicit + implicit) or accounting and opportunity costs are involved in calculation.

Question 50

Continuous Decisions

Answer 50

Same principles as discrete decisions except managerial control variable can be other than whole units. The slope (rise/run) of a continuos function (benefit or cost) is the derivative (change in function value / change in control variable). ``` MB = dB(Q) / dQ MC = dC(Q) / dQ MNB = dN(Q) / dQ ```

Question 51

Continuous Variable Analysis

Answer 51

Net benefits are maximized at value Q where difference between B(Q) and C(Q) is the greatest. The slope of B(Q) = dB(Q) / dQ or MB The slope of C(Q) = dC(Q) / dQ or MC The slopes of B(Q) and C(Q) are equal (parallel) when N(Q) is maximized which again means Profits are maximized at MB = MC.

Question 52

Steps to find maximum level of net $ benefits and Q to achieve so. Benefit and cost structures will be provided as well as appropriate MB and MC values.

Answer 52

1. Identify optimal Q level - set MB = MC and solve for Q. 2. Determine maximized net benefit by subtracting cost function from benefit function then solve for $$$ with derived optimal Q level from step 1.

Question 53

Incremental Decisions Yes/No decisions

Answer 53

Incremental Revenues are the additional revenues derived from pending decision. Incremental Costs are the additional costs from same project. If IR > IC project is a winner. Don't add sunk costs to IC but should consider implicit or opportunity costs.

Question 54

Keys to effective decision making.

Answer 54

1. Include all costs and benefits. Do not forget opportunity costs. Don't be fooled by sunk costs. 2. Use appropriate present value analysis when decisions span time. 3. Optimal economic decisions are made at the margin using marginal analysis. Ability to achieve goals is always affected by constraints.

Question 55

A strong incentive structure:

Answer 55

Aligns worker and employer interests Offers bonuses based on firm performance Best implemented locally

Question 56

Profits improve total welfare by:

Answer 56

Inducing market entry generating competition and choices. Signaling where scarce resources are most valued.