Lesson 1.1 (Chp 1 - 2) Flashcards
formula for Expected net present value of profits
sum of (total revenue in time t - total cost at time t / (1 + i)^t)
economists definition of profit
profit over and above what the owner’s labour and capital in the business could be used elsewhere (opportunity cost)
what is principal agent problem?
where managers (agents) pursue their own interests at the cost of the owners (principals)
draw demand-supply curve
y axis is price, x axis is quantity demanded, Demand curve is downward sloping, supply curve is upward sloping
what does the demand curve show?
total demand for a product at various prices, not for a specific firm; pertains to a specific time period
5 factors that affect demand curve
income; prices of substitutes and complements, advertising expenses, product quality, government fiat
how do we interpret elasticity of demand
how a 1% change in price affects QD
elasticity of demand formula
n = (dQ/dP) * (P/Q) = % change in quantity / % change in price = (-1/b) * (a - bQ / Q)
why are elasticities of demand negative?
since demand curve is downward sloping
classify elastics of demand
n > -1 -> inelastic, 1% change in price –> less than 1% change in Q
n = -1 -> unitary elastic, 1% change in price –> 1% change in Q
n < -1 -> elastic, 1% change in price -> more than 1% change in Q
where on demand curve is price inelastic?
to the bottom
price elasticity of 0
demand curve vertical, QD unaffected by price
price elasticity of - infinity
demand curve horizontal, unlimited amount sold at a price, nothing sold at other prices
price equation
P = a - bQ
demand equation
Q = a/b - 1/bP
total revenue equation
TR = P x Q = aQ - bQ^2
marginal revenue formula
MR = derivative of TR fn with respect to Q = a - 2bQ = P(1 + 1/n)
MR curve vs Demand curve
MR curve has the same y intercept as demand curve, but slope is 2x demand curve
for what quantities/MR will demand be price elastic
MR is positive, Q < a / 2b
for what quantities/MR will demand be unitary elastic
MR = 0, Q = a / 2b
for what quantities/MR will demand be price inelastic
MR negative, Q > a / 2b
explain normal goods vs inferior goods
normal - income rises, demand rises (income elasticity of demand is +ve); inferior - income rises, demand lowers (income elasticity of demand is -ve)
explain substitute goods vs complementary goods vs independent goods
substitute - cross price elasticity of demand +ve, complementary - cross price elasticity of demand -ve; independent - cross price elasticity of demand 0
what happens to price elasticities when demand curve is linear?
vary along the demand curve
explain constant elasticity demand function
elasticities are constant regardless of values of the variables (using exponents)
explain the exponents in the constant elasticity demand function
own price elasticity of demand is negative, cross price elasticity either positive or negative, income elasticity is mostly positive, advertising elasticity is positive
when is TR maximized?
MR = 0
when is advertising not a waste of money?
if n > 1 (MR is positive)
how does managerial economics differ from microeconomics
microeconomics focuses on description, managerial economics is prescriptive
2 things managerial economics does
is an integrative course - brings various functional areas of business together in a single analytical framework; and exhibits economies of scope - integrates material from other disciplines and reinforces and enhances understanding of those subjects
what is the managerial objective
make choices that increase value of firm
3 managerial choices
- influence TR by managing demand
- influence TC by managing production
- influence relevant interest rate by managing finances and risk
3 managerial constraints
available tech, resources scarcity, legal or contractual limitations
what are 2 measures of profit
economic profit, accounting profit
3 traits of accounting profit
historical cost, legal compliance, reporting requirements
3 traits of economic profit
market value, opportunity or implicit cost, more useful measure for managerial decision making
profit and its affect on managers
1) measures quality of managers decision making skills
2) encourages good management decisions by linkage with incentives
3 sources of profit
innovation, risk taking, exploiting market inefficients
source of profit: innovation
producing products that are better than existing products in terms of functionality, tech and style
source of profit: risk taking
future outcomes and their likelihoods are unknown as are the reactions of rivals
source of profit: exploiting market inefficiencies
building barriers to entry, employing sophisticated pricing strategies, diversifying, making good strategic production decisions
how can you address the principal-agent problem
give managers a financial stake in the business
explain moral hazard
moral hazard exists when people behave differently when they are not subject to the risks associated with their behaviour
how does moral hazard relate to managers
managers who do not maximize the value of a firm may do so because they do not suffer as a result of their behaviour
define market
a group of firms and individuals that interact with each other to buy or sell a good
define demand function
QD relative to Price, holding other possible influences constant
what does the market rely on
binding, enforceable contracts
define supply function
quantity supplied relative to price, holding other possible influences constant; for period of time
influences held constant for the supply function
tech and cost of production inputs (land, labour, capital)
define equilibrium
when the market is in balance because everyone who wants to purchase the good can and every seller who wants to sell the good can
define invisible hand
when no gov agency is needed to induce producers to drop or increase prices
define market demand schedule
table showing the total quantity of the good purchased at each price
determinants of market demand curve
consumer taste, consumer income, population size, time period
is primary objective of a firm’s owner to maximize firm’s profit or firm’s value?
value
Information on the quantities that would be purchased at different prices, holding all other factors constant, in a given time period from a group of firms is shown in a:
market demand curve
The demand for costume jewelry has been estimated to be Q = 100P^(–2)E^2, where E is the price of real gem jewelry. Costume jewelry and real gem jewelry are:
cross price elasticity of demand = 2 -> substitute
define elasticity
Measures the percentage change in one factor given a small (marginal) percentage change in another factor
define demand elasticity
Measures the percentage change in quantity demanded given a small (marginal) percentage change in another factor that is related to demand
cross price elaticity of demand formula
(dQx)/d(Qy) (Py/Px)
what is cross price elasticity of demand when the goods are substitutes?
n > 0
cross price elasticity of demand when the goods are independent
n = 0
What is the relationship between economic and accounting profit?
economic profit may be less than or equal to accounting profit
where is there excess supply
prices above equilibrium price
