Chapter 1: Managers, Profits, Markets

Question 1

managerial economics draws on what 2 theories?

Answer 1

microeconomics and industrial organization

Question 2

microeconomics

Answer 2

Study of behavior of individual consumers, business firms, and markets that contributes to our understanding of business practices and tactics

Question 3

business practices or tactics

Answer 3

Routine business decisions managers must make to earn the greatest profit under the prevailing market conditions facing the firm (short-term & necessary for success)

Question 4

industrial organization

Answer 4

focuses on the behavior and structure of firms and industries; foundation for understanding strategic decisions

Question 5

Marginal analysis

Answer 5

evaluating additional costs and benefits of decisions

“the key to the kingdom of microeconomics”
“the key to the kingdom of managerial economics”

Question 6

strategic decisions

Answer 6

Business actions taken to alter market conditions and behavior of rivals in ways that increase and/or protect the strategic firm’s profit (long-term & optional for success)

Question 7

7 economic forces that promote long-run profitability

Answer 7

1. few close substitutes
2. strong entry barriers
3. weak rivalry within market
4. low market power of input suppliers
5. low market power of consumers
6. abundant complementary products
7. limited harmful government intervention

Question 8

opportunity costs

Answer 8

what firm owners must give up to use resources to produce goods and services; value of the best alternative of an input

Question 9

market-supplied resources

Answer 9

Resources owned by others and hired, rented, or leased in resource markets.

Question 10

owner-supplied resources

Answer 10

Resources owned and used by a firm. (trailer trucks owned/paid off)

Question 11

managerial economics

Answer 11

How to use economic analysis to make decisions to achieve firm’s goal of profit maximization.

Question 12

economic theory

Answer 12

helps managers understand real-world business problems; uses simplifying assumptions to turn complexity into relative simplicity; abstract from nonessential items and concentrate on what is relevant

Question 13

total economic costs

Answer 13

Sum of opportunity costs of both market-supplied resources & owner-supplied resources (explicit costs + implicit costs)

Question 14

explicit costs

Answer 14

monetary payments/opportunity costs of using market-supplied resources ($50k for secretary)

Question 15

implicit costs

Answer 15

nonmonetary payments/opportunity costs of using owner-supplied resources (use of trailers for transportation company)

Question 16

equity capital

Answer 16

Money provided to businesses by the owners

Question 17

3 types of implicit costs

Answer 17

1. opportunity cost of cash (equity capital)
2. opportunity cost of using land or capital (owned by the firm)
3. opportunity cost of owner’s time spent (managing firm/pay yourself)

Question 18

economic profit (phi)

Answer 18

total revenue - total economic costs
total revenue - explicit costs - implicit costs

Question 19

accounting profit (phi)

Answer 19

total revenue - explicit costs

Question 20

value of a firm (def)

Answer 20

The price for which the firm can be sold, which equals the present value of future profits

Question 21

value of a firm (eq)

Answer 21

Σ^T _t=1 = π_t / (1+r)^t

π_{t = economic profit expected in period t}

_{r = risk-adjusted discount rate}

_{T = number of years in the life of the firm}

Question 22

risk premium

Answer 22

An increase in the discount rate to compensate investors for uncertainty about future profits

Question 23

common mistakes managers make

Answer 23

1. never increase output simply to reduce average costs
2. pursuit of market share usually reduces profit
3. focusing on profit margin won’t maximize total profits
4. maximizing total revenue reduces profit
5. cost-plus pricing formulas don’t produce profit-maximizing prices

Question 24

principle-agent relationship

Answer 24

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).

Question 25

principal–agent problem

Answer 25

A manager takes an action or makes a decision that advances the interests of the manager but reduces the value of the firm.

Question 26

2 conditions for principal-agent problem

Answer 26

1. manager’s objectives conflict with owners
2. owner has difficulty monitoring managers actions/decisions

Question 27

complete contract

Answer 27

An employment contract that protects owners from every possible deviation by managers from value-maximizing decisions.

Question 28

hidden actions

Answer 28

Actions or decisions taken by managers that cannot be observed by owners for any feasible amount of monitoring effort.

Question 29

moral hazard

Answer 29

A situation in which managers take hidden actions that harm the owners of the firm but further the interests of the managers.

Question 30

internal control mechanisms

Answer 30

1. require managers to hold stipulated amount of firm’s equity
2. increase percentage of outsiders serving on BOD
3. finance corporate investments with debt instead of equity

Question 31

external mechanism

Answer 31

corporate takeovers

Question 32

price-taker

Answer 32

A firm that cannot set the price of the product it sells, since price is determined strictly by the market forces of demand and supply.

Question 33

price-setting firm

Answer 33

A firm that can raise its price without losing all of its sales.

Question 34

market power

Answer 34

A firm’s ability to raise price without losing all sales.

Question 35

market

Answer 35

Any arrangement through which buyers and sellers exchange anything of value.

Question 36

transaction costs

Answer 36

Costs of making a transaction happen, other than the price of the good or service itself.

Question 37

market structure

Answer 37

Market characteristics that determine the economic environment in which a firm operates.

Question 38

economic characteristics for a market

Answer 38

1. number and size of the firms operating in the market
2. degree of product differentiation among competing producers
3. likelihood of new firms entering a market when incumbent firms are earning economic profits

Question 39

perfect competiton

Answer 39

large number of relatively small firms sell an undifferentiated product in a market with no barriers to entr for new firms (price takers; ex. apples)

Question 40

monpolistic competition

Answer 40

large number of firms that are small relative to the total size of the market produce differentiated products without the protection of barriers to entry (price-setters; ex. toothpaste, fast food)

Question 41

oligopoly

Answer 41

just a few firms produce most or all of the market output, so any one firm’s pricing policy will have a significant effect on the sales of other firms in the market (2+; top 4 make up 50% of the market; ex. computers, cell phones, bridge builders)

Question 42

monopoly

Answer 42

single firm protected by some kind of barrier to entry produces a product for which no close substitute exists (price-setters; ex. tap water)

Question 43

globalization of markets

Answer 43

economic integration of markets located in nations around the world.