Firm's Decision Making, Objectives & Uncertainty Flashcards
Week 1 & 2
What is the point of Managerial Economics?
- The knowledge from microeconomics, accounting and behavioural economics is applied to business decision-making
What are the two main branches of issues that managers face?
- Economic Concepts: Price & Market Structure
- Decision Science: Numerical Analysis
What is a decision? What is the decision-making process?
- Decisions: Conscious Choice against other choices
- The process is listed below:
- Establish/Identify Objectives
- Define the Issue/Constraint
- Identify Possible other Alternatives (Cost/Benefit analysis)
- Evaluate Alternatives & select the best within the constraint
- Perform a sensitivity analysis
- Implement and Monitor
What are the good things about decisions and name some decision models
- The process isn’t always linear, but the firm can revise such action plans as required
- Some decisions may not need this process (if it is a repetitive process- there isn’t need)
- Decision models are either mathematical or schematic- either can be useful
Why do firms exist?
- Transform scarce resources (inputs) into goods & services (output) to minimise transactional costs
- Contractional relationship with parties (suppliers, employees, society, managers)
- Primary goal is to maximise economic profit [Economic Profit = Sales Revenue - Economic Cost (opp. cost)
Name the Profit Theories
- Reward-for-Risk
- Disequilibrium Theory
- Monopoly Theory
- Innovation Theory
- Managerial Efficiency Theory
- Many of these are SR concepts, so ignores TVoM
What is the equation for the Shareholder wealth-maximisation model
- V0 = Σ πt / (1+r) ^t + real value option
- V0 = Firm’s current value
- Σπ = Expected Profits
- (1+r)^t = Require Rate of Returns => Risk sits here
- real value option = cost saving or revenue expansion because of flexibility
What are the issues with predictions?
- We cannot predict everything perfectly => decision-making is characterised by uncertainty
- Decisions are made on estimates/expectations
- Risk & Uncertainty impose opportunity costs on the decision-making process => the attitudes of the decision maker towards risk can change the process
What are sources of Business Risk?
- Costs & Expenses
- Fluctuations in other nations …
- Changes in the technologies
- Economic conditions
What are the basics of probability and what are some properties?
- p(x) = probability of event x
- If p(x) = 1, the event will occur, if p(x) = 0 the event will never occur
- Coherency: If {x1, x2, … xn} is a full set of events then Σ(px) = 1
- Consistency: The event that we believe is most likely to occur should have the highest probability
What is the difference between risk and uncertainty?
- Uncertainty is a situation where the relevant probabilities are unknown
- Risk is where the probabilities are known beforehand
- Often, firms would like to turn uncertainty into risk by estimating the probability of chance events
What is the concept of the Best Estimates?
- Based on the history of similar events
- P(x) = N/n where N = number of trials and n = number of trials when x occurred
- It is subjective, and reflects individuals beliefs, so all probabilities are technically subjective
If project A has outcomes X1,X2,X3 with probabilities P1,P2,P3 (discrete outcomes), then… [Expected values, standard deviations, Coefficient of varience]
- E(x) = μ= x̄ = Σ p(x) times x
- s(x) = σ = rt (Σ [x-E(x)] x p[x])
- C.V (x) = σ/μ
What are attitudes towards risks? Name the types of risk attitudes
- The decision-making process can be affected by the decision maker’s attitudes
- You can be risk averse, risk seeking or risk neutral
What is the ‘Newsboy Problem’? How can you construct it?
- The Newsboy Problem looks at deciding how much newspaper he should sell to maximise profit
- To construct, you put action (supply) along the top and event (demand) along the side
