Managerial Econ Flashcards
Managerial Economics
Microeconomic theory applied to management practice. Managers decide how scarce firm resources are allocated to gain maximum results or satisfaction. A mix of economic theory, decision theory and statistics & forecasting.
Demand for Good/Service
Quantities of good/service people are ready to buy at various prices within a given time period (other factors besides price held constant). i.e. willingness & ability to pay
Demand for Good/Service
Quantities of good/service people are ready to buy at various prices within a given time period (other factors besides price held constant). i.e. willingness & ability to pay
Quantity Demanded vs. Demand
quantity demanded is driven by price (once you’re in the store, how many do you want given the cost), demand is the impact of non-price determinants (what’s going to get you to the store).
Qty Demanded - movements along the demand curve
Demand - shifts in the demand curve
Non-Price Determinants of Demand
- Tastes and Preferences
- Income
- Prices of Related Products
- Future expectations (stocks, etc.)
- Number of Buyers
Non-Price Determinants of Demand
- Tastes and Preferences
- Income
- Prices of Related Products
- Future expectations (stocks, etc.)
- Number of Buyers
Quantity Supplied vs. Supply
quantity supplied is driven by price, spully is the impact of non-price determinants.
Qty Supplies - movements along the supply curve
Supply - shifts in the supply curve
Quantity Supplied vs. Supply
Qty Supplies - movements along the supply curve
Supply - shifts in the supply curve
Non-Price Determinants of Supply
- Costs and Technology
- Prices of other goods or services offered by seller
- Future expectations
- Number of sellers
- Weather conditions (floods, etc)
Firm
Basic unit of business decision making. Collection of resources transformed into products demanded by consumers. Firms decide what to produce, how much and for whom.
Decision Theory
With uncertainty regarding outcomes, manager is always confronted with risk. Decision Theory provides a guideline as to the measurement of risk and evaluation of possible consequences.
Decision Theory
With uncertainty regarding outcomes, manager is always confronted with risks. Decision Theory provides a guideline as to the measurement of risk and evaluation of possible consequences.
Statistical Forecasting
Aids in determining possible outcomes of different strategies in order to measure risk. Estimates results of each plan.
Present Value
Allocation decisions are made today but outcomes expected in the future - must discount future expected outcomes:
P = Sum[Di/(1+k)^I]
where Di = value expected in time period (I)
k = discount factor
Other Considerations re: Profit Maximization
- Social entrepreneurship is gaining popularity (being concerned about environment, etc).
- Global competitive environment
- Role of E-commerce and the internet
Marginal Analysis
Even though total values are at the core of any decision but - actions are mostly taken at the Margin of operation.
Finding the relationship among - total values, average value and marginal values
Law of Demand
specifies an inverse relationship between Price of commodity and the Quantity of the commodity demanded. (the exception is luxury goods - defy the concept of demand - “inferior goods”
(Qd = a - Price*X)
Law of Supply
specifies a positive relationship - more of a product will be supplied at higher prices
(Qs = -a + x*Price)
Market Equilibrium
Market condition where the market price equals the market demand (has never happened in real life)
Equilibrium status could be:
1. Static - end of the day, you take a picture
2. Comparative Static - take a pic, look at yesterday’s pic and compare
3. Dynamic - looking at picture instantaneously and constantly
Shortage
Market situation where qty demanded exceeds qty supplied at a price below the equilibrium level
Surplus
Market situation where qty supplied exceeds qty demanded at a price above the equilibrium level
Demand Elasticity
% change in quantity demanded in response to % change in any factor affecting that quantity (e.g. price)
The response which is more sensitive = elastic
E (absolute value) > 1 = elastic
E (absolute value) < 1 = inelastic
Price Elasticity of Demand
change in qty/initial quantity = % change in qty = A
change in price/initial price = % change in price = B
Price Elasticity of Demand = A/B
Two measurements:
- Arc Elasticity - between two market conditions
- Point Elasticity - at a specific market condition
Price Elasticity of Demand
change in qty/initial quantity = % change in qty = A
change in price/initial price = % change in price = B
Price Elasticity of Demand = A/B
Two measurements:
- Arc Elasticity - between two market conditions
- Point Elasticity - at a specific market condition
Point Elasticity
Price elasticity at a specific market condition - don’t want to wait for the change to happen - predicting the market change
Ep = dq/dp * p1/q1
d= derivative of q and p
When the equation of price/qty is linear, becomes: change in Q/change in price * p1/q1
Point Elasticity
Price elasticity at a specific market condition.
Elasticity and Total Revenue
- If Demand is Price Elastic, any price increase would reduce TR
- If Demand is Price Inelastic, any price increase would raise TR
- If Demand is Price Elastic, any price decrease would increase TR
- If Demand is Price Inelastic, any price decrease would decrease TR
Determinants of Price Elasticity
- Availability of substitutes (cigarettes)
- Time for purchasing decision
- Price as a total % of budget (salt example)
- Necessity of the commodity
Other Elastics
Elastics other than price can be measured accordingly - replacing P with the appropriate variable.
Income elasticity must be positive for a normal good…if it’s negative, it’s considered an “inferior good” (i.e. luxury good)
Effects of Elasticity
The response to change in supply is determined, to great extent, by the price elasticity of demand.
Elasticity in the Short/Long Run
Long-run demand (more familiar) will generally be more elastic than in the short-run (less choices, no time for full adjustment to prices)
Perfectly Elastic/Inelastic
Perfectly Elastic - at given price, can sell any amount
Perfectly Inelastic - at qty, can be any price
Cross-Elasticity of Demand
Impact (in percentage terms) on the quantity demanded of a good created by a price change in a related product (everything else constant).
May be positive (products are substitutes for each other) or negative (the products are complements)
Derived Demand
Demand for inputs of production (e.g. labor). Elasticity of derived demand is, therefore, a function of the elasticity of the final good produced by the input.
Demand Estimation
Estimating the impact of a set of variables believed to influence consumers. Try and find numerical estimates for the impact of each variable deemed essential in the quantity demanded of a good.
Two Fundamental Techniques for Demand Estimation
- Market Research (preferable - less math, more in line with management)
- Statistical Technique
Three Basic Methods of Market Research
- Consumer Surveys - pro: lots of info, con: not willing to give accurate answers
- Consumer Clinics - groups given money to buy items to observe impact of factors, con: expensive and subjects aware they are being watched
- Market Experiment - examine consumers in real-market situations, cons: expensive
Two Fundamental Approaches to Statistical Technique
- Correlation Analysis - estimating the degree of association between two variables (simple - 2, multiple - many, partial - 2 in presence of one another)
- Regression Analysis - actually measures the magnitude of the impact (more concrete than correlation)
Correlation Analysis
The coefficient, r, measures the degree of association between two variables - the closer to 1 or -1, the stronger the degree of association.
NOT variables if they are impacting one another
Regression Analysis Steps (5)
- Identification of Variables - brainstorming stage, use coefficients and select variables with the highest (shouldn’t correlate with each other)
- Formulation of the Demand Model - which equation to use? Simpler the better. Linear is always good place to start.
- Collection of the Data - time series forms (data over time) or cross section forms (data from diff regions at same time) - either way, min 30 samples
- Estimation of the Parameters/Coefficients
- Evaluation and testing of the model
Overidentification/Underidentification
Under - not including variables that are important in regression analysis
Over - including more than sufficient variables
(better than under)
Multicollinearity
correlation between two variables can’t be higher than the correlation between either variable and the item studying
Types of Variables
- Qualitative - e.g taste
- Quantitative - e.g. price or advertising budget
- Selective Type - e.g. gender, race, seasonal (dummy variables - for example, use 1/0 for married/single)
- Proxy Variables - when a reasonable variable can not be selected or a measurable variable is needed, get as close as you can (e.g. education = years in school)
Estimation of the Coefficients
Use excel (Data, Data Analysis) to find the estimated demand function (y = x + beta1 + beta2 + beta3…betaN)
R-Squared
Measure of goodness of fit. The closer to 1, the better. Will always improve with more variables.
T-Stat
How many SD’s away - anything above 2 is ok
F (in regression reports)
magnitude of residual as a % of what you have not observed…larger = better (means there’s a higher percentage of what you’ve explained versus what you’ve not explained)
What to do if a variable is bad?
- Expand observations
- Use different sample
- Try to find a proxy for the variable
T-Test/F-Test
Tests of significance
Ho: betaI = 0
Ha: betaI does not equal 0
Want to reject the null
F-test the same but based on the entire equation
How many dummy variables to test?
n-1 when n is the number of alternatives
if you test all but one and non are true, the last one is
Autocorrelation
the similarity between observations as a function of the time lag between them. Likely a result of time-series data.
Theory of Consumer Behavior
Underlying factors affecting the level of consumer demand of a given commodity. Also, how consumers allocate income and how price affects decisions.
We expect increase in price = decrease in qty…elasticity takes it further and tell us the extent.
Two Theories of Consumer Behavior
- Utility Theory - measurement of satisfaction
- Indifference preference theory - behavior is described in terms of preferences of various combinations of good and services depending on the nature (rather than the measurability of satisfaction)
Utility Theory & Law of Marginal Utility
Theory of consumer behavior using measurement of satisfaction (at the point of departure of money) as factor affecting decisions. Unit of measure is utils.
Assumes that satisfaction can be measured.
Employs Law of Marginal Utility - satisfaction diminishes as more is consumed.
Indifference Preference Theory & Indifference Curve
Theory of consumer behavior using consumer preferences of various combinations of goods/services.
Indifference Curve - concave curve showing combinations of goods at same satisfaction levels - budget line is linear line that cuts through it….optimized combination is where they meet.
Budget Constraint
Consumer has a fixed, limited amount of income. Infinite demand, limited income. Price is the constraint.
Utility Maximizing Rule
to maximize satisfaction, a consumer should allocate his or her money so that the last dollar spent on each product, yields the same amount of marginal (extra) utility.
Saving can also be regarded as a commodity that yields utility.
MU/$ = marginal utility per good over the price of each good.
Assumptions (foundation of economic decision)
- Rational Consumer
- Budget Constraints
- Consumer Preferences
Total vs. Marginal Utility
Can use to determine buying pattern (what goods will be bought when)
- If MU increases, total utility increases
- If MU decreases, total utility decreases
Law of Demand
basis is law of diminishing marginal utility…the more we have, the less we want. The first unit of consumption yields more utility, the second less, and so on…
Consumers Surplus Concept
basis is law of diminishing marginal utility. A consumer, while purchasing a good/service, compares the utility of the commodity with that of the price which he has to pay. In most cases, willing to pay more…the difference is Consumer Surplus (measured in satisfaction, not dollars)
