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ECON > 01 - Fundamentals > Flashcards

01 - Fundamentals Flashcards

1
Q

Economics

A

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

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2
Q

Manager

A

A person who directs resources to achieve goals.

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3
Q

Managerial Economics

A

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

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4
Q

Resources

A

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

Natural Resources
Labor
Capital
   Human
   Social
   Cultural
Management - entrepreneurial ability
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5
Q

Capital

A 
Things used to produce other things.
   Equipment
   Human Capital
   Social Capital
   Cultural Capital
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6
Q

Scarcity

A

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.

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7
Q

Constraints

A

The artifacts of scarcity.

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8
Q

Theory

A

Used to make sense of complex reality.

Like a map - simplified to point of optimal effectiveness.

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9
Q

Nominal Price

A

Price denominated in money.

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10
Q

Real Price

A

The nominal price adjusted for the changing value of money.

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11
Q

Real Wage calc.

A

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.
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12
Q

Self Interest

A

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

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13
Q

Explicit Costs

A

Same as Accounting Costs. Direct outlays of the firm.

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14
Q

Implicit Costs

A

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

Time is the best example.

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15
Q

Accounting Cost

A

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

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16
Q

Opportunity Cost

A

Same as economic costs which include implicit and explicit costs.

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17
Q

Economic Costs

A

Accounting (explicit) costs + implicit costs.

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

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18
Q

Economic Profit

A

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

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19
Q

Effective Manager - Goals

A

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

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20
Q

Effective Manager - Profits

A

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

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21
Q

Effective Manager - Incentives

A

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.

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22
Q

Effective Manager - Markets

A

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

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23
Q

Effective Manager - Present Value

A

Understand present value analysis and the timing of decisions.

24
Q

Sunk Costs

A

Costs already incurred that cannot be recovered.

Not relevant to current decisions.

Calculated as original cost minus what can be recovered.

25
Q

Effective Manager - Activity

A

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

26
Q

Five Forces

A

Developed by Michael Porter

Forces that impact level growth and sustainability of profits.

Entry
Substitutes and Compliments
Power of Buyers
Power of Sellers
Rivalry
27
Q

Five Forces Objectives

A
  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.

28
Q

Five Forces 1

Entry

A 
Resource costs
Speed of adjustment
Sunk costs
Network effects - cell coverage
Reputation
Switching costs
Govt. constraints
29
Q

Five Forces 2

Substitutes and Complements

A

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

30
Q

Five Forces 3

Power of Buyers

A 
Buyer concentration
Value of substitute choices
Relationship specific investments
Customer switching costs
Govt. constraints
31
Q

Five Forces 4

Power of Input Suppliers

A 
Supplier concentration
Productivity of input choices
Relationship specific investments
Supplier switching costs
Govt. constraints
32
Q

Five Forces - 5

Industry Rivalry

A 
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

33
Q

Competitive Impact on Industry

A

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.

34
Q

Principals of Incentives

A
  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.
35
Q

Disruptive Innovation Objectives

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

A
  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.
36
Q

Present value of a single future value. PV

A

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.

37
Q

Present value of a stream of future values. PV

A

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.

38
Q

Net Present Value NPV

A

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.

39
Q

Present value of Indefinitely Lived Assets. PVasset

A

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.

40
Q

Profit Maximization Principal

A

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.

41
Q

Estimating value of firms with constant growth rate.

A

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

42
Q

Marginal Principle

Marginal Analysis:
One of the most important management tools!

Optimal decisions involve comparing the marginal (incremental) benefits with the marginal costs.

A

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

43
Q

B(Q)
C(Q)
N(Q)

MB(Q)
MC(Q)
MNB(Q)

A 
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)
44
Q

Discrete Decisions

A

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

45
Q

Optimal Output Level

A

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

46
Q

Marginal Benefit

A

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.

47
Q

Marginal Cost

A

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.

48
Q

Marginal Net Benefits

A

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)

49
Q

Maximizing Net Benefits vs Maximizing Total Benefits

A

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.

50
Q

Continuous Decisions

A

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
51
Q

Continuous Variable Analysis

A

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.

52
Q

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.

A
  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.
53
Q

Incremental Decisions

Yes/No decisions

A

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.

54
Q

Keys to effective decision making.

A
  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.

55
Q

A strong incentive structure:

A

Aligns worker and employer interests

Offers bonuses based on firm performance

Best implemented locally

56
Q

Profits improve total welfare by:

A

Inducing market entry generating competition and choices.

Signaling where scarce resources are most valued.

ECON (11 decks)

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