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Managerial Economics > Crash Course: Topics 1-3 > Flashcards

Crash Course: Topics 1-3 Flashcards

1
Q

Topic 1

Define Managerial Economics

A

Managerial economics is the study of how to direct scarce resources in a manner that most efficiently achieves a managerial goal.

Managerial economics helps managers recognize how economic forces affects organizations and describes the economic consequences of managerial behaviour.
It also links economic consequences with quantitative methods to develop vital tools for managerial decision making.

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2
Q

Topic 1

Managerial Economics as defined by Douglas

A

Managerial economics is the application of economic principles and methodologies to the decision-making process within the firm or organization.

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3
Q

Topic 1

Define Microeconomics

A

Microeconomics is the study of individual economic behaviour

ie firms and households

It addresses issues such as:
– How consumers respond to changes in prices and income.
– How businesses decide on employment and sales.

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4
Q

Topic 1

Define Macroeconomics

A

Macroeconomics is the branch of economics that focuses on:
The determinants of aggregate economic variables such as:
■ National income
■ Employment
■ Price level
■ Interest rates
■ Exchange rates

And how government economic policy might be used to influence the behaviour of
these aggregates.

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5
Q

Topic 1

Identify the 6 Basic Principles that Comprise Effective Management

A
  1. Identify goals and constraints.
  2. Recognize the nature and importance of profits.
  3. Understand incentives.
  4. Understand markets.
  5. Recognize the time value of money.
  6. Use marginal analysis.
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6
Q

Topic 1

Define Economics

A

The science of making decisions under conditions of scarcity

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7
Q

Topic 1

What is the primary goal of a firm according to the Theory of the Firm?

A

Long-term value maximization, defined as the present value of expected future net cash flows.

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8
Q

Topic 1

What is The Theory of the Firm?

A

The Model of the Business. The theory of the firm examines how businesses operate, make decisions, and allocate resources to maximize objectives such as profits, growth, or stakeholder value. It seeks to explain the rationale behind firms’ existence, structure, boundaries, and behavior within the market.

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9
Q

Identify the 3 key theories under the Theory of the Firm

A
  1. Neoclassical Theory of the firm
  2. Ronald Coase’s Transaction Cost Theory
  3. Oliver Williamson’s theory of the firm
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10
Q

Topic 1

What are criticisms of the Theory of the Firm?

A

Managers may aim to “satisfice” rather than optimize.
Alternative theories propose goals like size or growth maximization.

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11
Q

Topic 1

What does “Identify Goals and Constraints” mean in effective management?

A

Managers must define clear objectives and understand the limitations that prevent achieving those goals.

Constraints, such as scarce resources, create trade-offs and influence decision-making.

Example: A manager’s goal to expand production might be constrained by limited capital or labor.

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12
Q

Topic 1

What are profits, and why are they important?

A

Accounting Profit: Total revenue minus total cost.
Economic Profit: Total revenue minus total opportunity cost.

High profits attract resources to industries most valued by society, enhancing efficiency.

Example: A profitable tech company signals high societal value for its innovative products.

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13
Q

Topic 1

Why are incentives crucial in management?

A

Incentives drive behavior by influencing how resources are used and how hard individuals work.

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14
Q

Topic 1

Identify the types of Incentives

A

Positive Incentives: Bonuses, promotions.
Negative Incentives: Penalties, demotions.

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15
Q

Topic 1

What are the key market forces managers must understand?

A
  • Consumer-Producer Rivalry: Consumers seek low prices; producers seek high prices.
  • Consumer-Consumer Rivalry: Limited goods force consumers to compete.
  • Producer-Producer Rivalry: Producers compete for scarce customers.
  • Role of Government: Regulates and disciplines market activities.
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16
Q

Topic 1

What is the Time Value of Money (TVM)?

A

Money available now is worth more than the same amount in the future due to earning potential.

TVM is used in decision making by calculating Present Value (PV) and Net Present Value (NPV) to assess the worth of future cash flows against current investments.

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17
Q

Topic 1

What is Marginal Analysis?

A

Comparing the additional benefits (marginal benefits) and additional costs (marginal costs) of a decision.

Optimal Decision Rule: Proceed if marginal benefits ≥ marginal costs.

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18
Q

Topic 1

Positive VS Normative Economics

A

Positive Economics: Focuses on “what is” and makes testable predictions.
Normative Economics: Focuses on “what should be” and provides value judgments.

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19
Q

Topic 1

How does economic analysis assist decision-making?

A

By predicting outcomes (positive) and prescribing actions (normative) based on objectives and constraints.

20
Q

Topic 2

Define a firm

A
  • A legal entity entering contracts with distributors, employees, suppliers, and customers.
  • An administrative entity with managers coordinating activities.
  • A collection of resources transformed into products and services.
21
Q

Topic 2

What are the major forms of business organization?

A
  • Sole Proprietorship
  • Partnership (General or Limited)
  • Corporation
22
Q

Topic 2

State Ronald Coase’s Transaction Cost Theory

A

Firms exist to minimize transaction costs (e.g., negotiating contracts, monitoring agreements) associated with market exchanges.

Implication: Firms internalize activities that are too costly to perform through the market.

23
Q

Topic 2

What is Oliver Williamson’s theory of the firm?

A

Williamson’s theory builds on Coase’s ideas by emphasizing the role of governance structures. It examines how firms minimize transaction costs through hierarchies, relational contracts, or hybrid structures.

24
Q

Topic 2

What are the types of governance structures in Williamson’s model?

A
  • Classical Contracting
  • Neoclassical Contracting
  • Relational Contracting (Unified Governance and Obligational Contracting)
25
Q

Topic 2

What factors determine the best governance structure?

A
  • Degree of uncertainty
  • Frequency of transactions
  • Extent of idiosyncratic investment
26
Q

Topic 2

What is Classical Contracting?

A

Transactions with self-liquidating contracts, where parties’ identities are irrelevant.

27
Q

Topic 2

What is Neoclassical Contracting?

A

Incomplete contracts requiring arbitration to handle unanticipated disagreements.

28
Q

Topic 2

What is Relational Contracting?

A

Long-term, complex relationships with two variants:

  • Unified Governance: Internalized transactions.
  • Obligational Contracting: External transactions, such as licensing
29
Q

Identify the theories that address the reasons profits vary amongst firms

A
  1. Frictional Profit Theory
  2. Monopoly Profit Theory
  3. Innovation Profit Theory
  4. Compensatory Profit Theory
30
Q

Topic 2

What is the Frictional Profit Theory?

A

Suggests profits vary due to unanticipated demand or cost shocks, leading to market disequilibrium.

31
Q

Topic 2

What is the Monopoly Profit Theory?

A

Some firms earn above-normal profits due to high barriers to entry (e.g., patents, economies of scale).

32
Q

Topic 2

What is the Innovation Profit Theory?

A

Above-normal profits arise from successful innovation but are reduced by competition over time.

33
Q

Topic 2

What is the Compensatory Profit Theory?

A

Rewards firms for extraordinary efficiency and success in meeting customer needs.

34
Q

Topic 3

What is the Neoclassical Theory of the Firm?

A

States that firms operate with the primary objective of profit maximization. It identifies firms as rational decision-makers that aim to maximia the differenc between total revenue and total cost by determining the optimal level of outpu and pricing.

35
Q

Topic 3

What are the criticisms of the Neoclassical Theory?

A
  • Simplistic Assumptions: Unrealistic assumptions of perfect competition and perfect information.
  • Ignores Managerial Behavior: Overlooks objectives other than profit maximization, such as market share growth or social goals.
  • Static Framework: Fails to account for dynamic changes like innovation, uncertainty, and external influences.
36
Q

Topic 3

Managerial Utility Maximizing Model (Williamson)

A

This model assumes that managers maximize their utility by spending the firm’s resources on:

  • Staff expenses (S): Hiring beyond operational needs.
  • Managerial perks (M): Salaries, benefits, and privileges.
  • Discretionary profits (D): Post-tax profits exceeding shareholder expectations.
37
Q

Topic 3

Profit Maximizing Rate of Growth Model (Baumol, 1967)

A

Firms aim to maximize the present value of future expected profits, which equals:
II = R-C
where Π is profit, R is revenue, and C is cost.

38
Q

Topic 3

The Marris Model (1964)

A

A theory explaining firm behavior as the pursuit of balanced growth by maximizing the growth rate of demand for the firm’s products and the growth rate of the firm’s capital.

39
Q

Identify the primary goal of the firm in the Marris Model

A

The firm’s objective is to maximize balanced growth, which is achieved by balancing:

  • The growth of demand for products (sales growth).
  • The growth of capital (profits and reinvestment).
40
Q

Identify the Key Criticisms of the Marris Model

A
  • Assumes managers and shareholders have harmonious goals, which may not always be true.
  • Oversimplifies the dynamic and competitive nature of real-world markets.
  • Limited applicability to small or non-growth-focused firms.
41
Q

What is the Behavioralist Model of the Firm

A

A theory that explains firm behavior as a result of bounded rationality, conflicting objectives, and adaptive decision-making, rather than purely profit-maximizing actions.

Richard Cyert and James March in their 1963 book A Behavioral Theory of the Firm.

42
Q

Topic 3

What assumptions underlie the Behavioralist Models?

A
  • Separation of ownership and management.
  • Firms operate in uncertainty and cannot achieve maximum efficiency.
  • The firm is a coalition of groups with conflicting interests (e.g., employees, managers, shareholders).

It considers firms as coalitions of conflicting groups and focuses on mechanisms to manage these conflicts.

43
Q

Topic 3

How is conflict resolved in Behavioral Models?

A
  • Monetary payments.
  • Side payments to retain employees.
  • Slack payments (perks).
  • Decentralized decision-making.
  • Sequential attention to prioritize different groups.
44
Q

Topic 3

What is X-Inefficiency?

A

X-inefficiency occurs when a firm produces at higher costs than necessary due to a lack of competitive pressure or inefficiencies in resource management.

Harvey Leibenstein in 1966.

45
Q

Topic 3

Internal VS External Causes of X-Ineffiency

A

Internal
* Shareholders having limited control of management
* Managerial Slack
* Behavioural Factors
* Poor resource allocation
External
* Lack of competition (Monopoly or Oligopoly conditions instead of Perfect competition)

46
Q

Examples of X-Inefficiency

A
  • A monopoly spending excessively on luxury office spaces rather than cost-cutting.
  • Government agencies operating with little concern for budget constraints due to guaranteed funding.
47
Q

Measures reducing X-Inefficiency

A
  1. Increasing Competition
  2. Managerial Oversight
  3. Performance Incentives
  4. Privatization

Managerial Economics (2 decks)

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