Mba1014 managers, profits, markets 270413

Go Global !Go Global !Managerial Economics :Managerial Economics :Managers, Profits & Markets

By

Stephen OngStephen OngVisiting Fellow, Birmingham City UniversityVisiting Fellow, Birmingham City UniversityVisiting Professor, College of Management, Visiting Professor, College of Management,

Shenzhen UniversityShenzhen UniversityApril 2013April 2013

AgendaAgenda

1.1. Managers & MarketsManagers & Markets

2.2. The Firm & Profit The Firm & Profit MaximisationMaximisation

3.3. Economic ProfitEconomic Profit

Learning ObjectivesLearning Objectives

To understand the role of To understand the role of managers in decision makingmanagers in decision makingTo understand basic concepts of To understand basic concepts of the market and its structurethe market and its structureTo understand the rationale of To understand the rationale of firms and the firm’s economic firms and the firm’s economic goalsgoalsTo distinguish between To distinguish between economic profit and accounting economic profit and accounting profitprofit

11Managers & MarketsManagers & Markets

EconomicsEconomics

MicroeconomicsMicroeconomics

Branch of economics that Branch of economics that deals with the behaviour of deals with the behaviour of individual economic units—individual economic units—consumers, consumers, firms, firms, workers, andworkers, and investors—investors—as well as the markets as well as the markets that these units comprise.that these units comprise.

MacroeconomicsMacroeconomicsBranch of economics that Branch of economics that deals with aggregate deals with aggregate economic variables, such economic variables, such as as

the level and growth rate the level and growth rate of national output,of national output,

interest rates,interest rates,

unemployment, andunemployment, and

inflation.inflation.

Why should managers study Why should managers study economics?economics?

To develop the economic insight To develop the economic insight necessary to identify your business’ necessary to identify your business’ competitive advantage.competitive advantage.

To identify how the ups and downs in To identify how the ups and downs in economy-wide economic activity will economy-wide economic activity will impact your business.impact your business.

To improve your business’ To improve your business’ profitability.profitability.

Microeconomic Influences Microeconomic Influences on Managerson Managers

How consumer behaviour affects their How consumer behaviour affects their revenue.revenue.

How production technology and input How production technology and input prices affect their costs.prices affect their costs.

How the market and regulatory How the market and regulatory environment in which managers environment in which managers operate influences their ability to set operate influences their ability to set prices and to respond to the prices and to respond to the strategies of their competitors. strategies of their competitors.

Market DemandMarket Demand

DemandDemand is the number of is the number of units of a good or service that units of a good or service that buyers are willing and able to buyers are willing and able to

buy at various pricesbuy at various prices, , when other factors, like, when other factors, like, buyers incomes, tastes and buyers incomes, tastes and preferencespreferences and the prices of and the prices of goods related in consumption goods related in consumption are held constant.are held constant.

Market SupplyMarket Supply

Market supply Market supply is the is the number of units of a good or number of units of a good or service that businesses are service that businesses are willing and able to willing and able to produce produce at various pricesat various prices, when , when other factors, like, other factors, like, resource prices, resource prices, production technology production technology and prices of goods related and prices of goods related in production are held in production are held constant.constant.

Market EquilibriumMarket Equilibrium

In efficient markets with flexible In efficient markets with flexible prices, the market price prices, the market price fluctuates to eliminate fluctuates to eliminate shortages (an excess of quantity shortages (an excess of quantity demanded over quantity demanded over quantity supplied) and surpluses (an supplied) and surpluses (an excess of quantity supplied over excess of quantity supplied over quantity demanded).quantity demanded).

CONSUMERSCONSUMERSConsumers have limited incomes, which can be Consumers have limited incomes, which can be

• spent on a wide variety of goods and services, or spent on a wide variety of goods and services, or • saved for the future. saved for the future.

WORKERSWORKERSWorkers also face constraints and make trade-offs. Workers also face constraints and make trade-offs.

1.1. must decide whether and when to enter the workforce. must decide whether and when to enter the workforce. 2.2. face trade-offs in their choice of employment.face trade-offs in their choice of employment.3.3. decide how many hours per week they wish to work, decide how many hours per week they wish to work,

thereby trading off labour for leisure.thereby trading off labour for leisure.

FIRMSFIRMSFirms also face limits in terms of Firms also face limits in terms of

• the kinds of products that they can produce, and the kinds of products that they can produce, and • the resources available to produce them.the resources available to produce them.

The Themes of MicroeconomicsThe Themes of MicroeconomicsTrade-Offs

Prices and MarketsPrices and Markets

• Microeconomics describes how Microeconomics describes how pricesprices are determined. are determined.

• In a centrally planned economy, prices In a centrally planned economy, prices are set by the are set by the government.government.

• In a market economy, prices are In a market economy, prices are determined by the interactions of determined by the interactions of consumers, workers, and firms. These consumers, workers, and firms. These interactions occur in interactions occur in marketsmarkets——collections of buyers and sellers that collections of buyers and sellers that together determine the price of a goodtogether determine the price of a good.

Theories and ModelsTheories and Models In economics, explanation and In economics, explanation and

prediction are based on prediction are based on theoriestheories. Theories are . Theories are developed to explain observed developed to explain observed phenomena in terms of a set of phenomena in terms of a set of basic rules and assumptions.basic rules and assumptions.

A A modelmodel is a mathematical is a mathematical representation, based on representation, based on economic theory, of a firm, a economic theory, of a firm, a market, or some other entity.market, or some other entity.

What Is a Market?What Is a Market?

MARKET :MARKET : Collection of buyers and sellers that, through their actual or potential interactions, determine the price of a product or set of products.

Market definition : Determination of the buyers, sellers, and range of products that should be included in a particular market.

Arbitrage : Arbitrage : Practice of buying at a lowlow

price at one location and selling at a higherhigher price in another.

Competitive versus Competitive versus Noncompetitive MarketsNoncompetitive Markets

Perfectly Competitive marketPerfectly Competitive marketMarket with many buyers and sellers, so that no Market with many buyers and sellers, so that no

single buyer or seller has a significant impact on single buyer or seller has a significant impact on

priceprice..

Many other markets are competitive enough to be Many other markets are competitive enough to be treated as if they were perfectly competitive.treated as if they were perfectly competitive.

Other markets containing a small number of Other markets containing a small number of producers may still be treated as competitive for producers may still be treated as competitive for purposes of analysis.purposes of analysis.

Finally, some markets contain many producers but Finally, some markets contain many producers but

are are noncompetitivenoncompetitive; that is, individual ; that is, individual

firms can jointly firms can jointly affect the priceaffect the price..

Market PriceMarket PricePrice prevailing in a competitive marketPrice prevailing in a competitive marketIn markets that are not perfectly competitive, In markets that are not perfectly competitive, different firms might charge different prices for the different firms might charge different prices for the same product. This might happen because one firm same product. This might happen because one firm is trying to win customers from its competitors, or is trying to win customers from its competitors, or because customers have brand loyalties that allow because customers have brand loyalties that allow

some firms to charge some firms to charge higher prices higher prices than than others.others.

The market prices of most goods will fluctuate The market prices of most goods will fluctuate over time, and for many goods the over time, and for many goods the

fluctuationsfluctuations can be rapid. This is can be rapid. This is particularly true for goods sold in competitive particularly true for goods sold in competitive markets.markets.

The Extent of a MarketThe Extent of a Market Boundaries of a market, both geographical Boundaries of a market, both geographical

and in terms of range of products produced and in terms of range of products produced and sold within it.and sold within it.

For some goods, it makes sense to talk For some goods, it makes sense to talk about a market only in terms of very about a market only in terms of very restrictive geographic boundaries.restrictive geographic boundaries.

We must also think carefully about the We must also think carefully about the range of products to include in a market.range of products to include in a market.

Market definition is important for two Market definition is important for two reasons:reasons: A A companycompany must understand who its actual and must understand who its actual and

potential competitors are for the various products that potential competitors are for the various products that it sells or might sell in the future.it sells or might sell in the future.

Market definition can be important for public policy Market definition can be important for public policy decisions.decisions.

WHAT IS SWEETER?WHAT IS SWEETER?

THE MARKET FOR SWEETENERSTHE MARKET FOR SWEETENERS In 1990, the Archer-Daniels-In 1990, the Archer-Daniels-

Midland Company (ADM) Midland Company (ADM) acquired the Clinton Corn acquired the Clinton Corn Processing Company (CCP).Processing Company (CCP).

The U.S. Department of The U.S. Department of Justice (DOJ) challenged the Justice (DOJ) challenged the acquisition on the grounds acquisition on the grounds that it would lead to a that it would lead to a dominant producer of corn dominant producer of corn syrup with the power to push syrup with the power to push prices above competitive prices above competitive levels.levels.

ADM fought the DOJ decision, ADM fought the DOJ decision, and the case went to court. and the case went to court. The basic issue was whether The basic issue was whether corn syrup represented a corn syrup represented a distinct market.distinct market.

ADM argued that sugar and ADM argued that sugar and corn syrup should be corn syrup should be considered part of the same considered part of the same market because they are market because they are used interchangeably to used interchangeably to sweeten a vast array of food sweeten a vast array of food products.products.

Diabetics, Sugar, HFCSDiabetics, Sugar, HFCS

Sweet CokeSweet Coke

Wholesale Sugar Market (1982-2010)Wholesale Sugar Market (1982-2010)

Corn & Ethanol Markets (1980– 2010)Corn & Ethanol Markets (1980– 2010)

The Price of SweetThe Price of Sweet

REALITY DOES SUCKREALITY DOES SUCK

TABLE MARKETS FOR BICYCLESMARKETS FOR BICYCLES

TYPE OF BICYCLETYPE OF BICYCLE COMPANIES AND PRICES COMPANIES AND PRICES (2011)(2011)

Mass Market Bicycles:Mass Market Bicycles:Sold by mass merchandiserssuch as Target, Wal-Mart,Kmart, and Sears.

Huffy: $90—$140Huffy: $90—$140Schwinn: $140—$240Schwinn: $140—$240Mantis: $129—$140Mantis: $129—$140Mongoose: $120—$280Mongoose: $120—$280

Dealer Bicycles: Dealer Bicycles: Sold by bicycle dealers – stores that sell only(or mostly) bicycles and bicycle equipment.

Trek: $400—$2500Trek: $400—$2500Cannondale: $500—$2000Cannondale: $500—$2000Giant: $500—$2500Giant: $500—$2500Gary Fisher: $600—$2000Gary Fisher: $600—$2000Mongoose: $700—$2000Mongoose: $700—$2000Ridley: $1300—$2500Ridley: $1300—$2500Scott: $1000—$3000Scott: $1000—$3000Ibis: $2000 and upIbis: $2000 and up

There are actually two different markets for There are actually two different markets for bicycles, markets that can be identified by the bicycles, markets that can be identified by the type of store in which the bicycle is sold.type of store in which the bicycle is sold.

A BICYCLE IS A BICYCLE. OR IS IT?A BICYCLE IS A BICYCLE. OR IS IT?

Casestudy Presentation : Casestudy Presentation : The Global Pharmaceutical industryThe Global Pharmaceutical industry

1.1. Read and prepare the Read and prepare the Casestudy on The Global Casestudy on The Global Pharmaceutical Industry Pharmaceutical Industry (Johnson, Whittington & (Johnson, Whittington & Scholes (2011)) for Scholes (2011)) for discussion and discussion and presentation next week. presentation next week.

2.2. Identify and evaluate the Identify and evaluate the challenges facing global challenges facing global pharmaceutical firms the pharmaceutical firms the External Environment External Environment and Industry analysis – and Industry analysis – PESTEL and Five Forces.PESTEL and Five Forces.

Market StructureMarket Structure

Large Number of FirmsLarge Number of Firms

PerfectPerfectCompetitionCompetition

MonopolisticMonopolisticCompetitionCompetition OligopolyOligopoly MonopolyMonopoly

Single FirmSingle Firm

Perfect Perfect CompetitioCompetitionn Large number of firmsLarge number of firms

Each firm produces an Each firm produces an identical good or identical good or serviceservice

Easy for new firms to Easy for new firms to enter the marketenter the market

Complete information Complete information to all buyers and sellers to all buyers and sellers in the marketin the market

Monopolistic CompetitionMonopolistic Competition

Large number of Large number of firmsfirms

Each firm produces a Each firm produces a good or service that, good or service that, in some significant in some significant way, is differentway, is different

Relatively easy for Relatively easy for new firms to enter new firms to enter the marketthe market

Imperfect Imperfect informationinformation

OligopolyOligopoly Few large, Few large,

mutually mutually interdependent, interdependent, firmsfirms

Firms may produce Firms may produce similar or highly similar or highly differentiated differentiated productsproducts

Significant barriers Significant barriers to new entryto new entry


MonopolyMonopolyOne firm One firm

producing a producing a good or service good or service with no good with no good substitutessubstitutes

New entry is New entry is blockadedblockaded


Real versus Nominal PricesReal versus Nominal Prices

Nominal priceNominal price Absolute price of a good, unadjusted for inflation.Absolute price of a good, unadjusted for inflation.

Real price Real price Price of a good relative to an aggregate measure Price of a good relative to an aggregate measure

of prices; price adjusted for inflation.of prices; price adjusted for inflation.

Consumer Price Index Consumer Price Index Measure of the aggregate price level.Measure of the aggregate price level.

Producer Price Index Producer Price Index Measure of the aggregate price level for Measure of the aggregate price level for

intermediate products and wholesale goods.intermediate products and wholesale goods.

Egg Farmer or College Egg Farmer or College Teacher?Teacher?

THE REAL PRICE THE REAL PRICE OF EGGS vs EDUCATIONOF EGGS vs EDUCATION

TABLE 2 THE REAL PRICES OF EGGS AND OF A COLLEGE EDUCATION

1970 1980 1990 2000 2010

Consumer Price Consumer Price IndexIndex 38.838.8 82.482.4 130.7130.7 172.2172.2 218.1218.1

NoNominaminal Pricesl Prices

Grade A Large Grade A Large EggsEggs $0.61$0.61 $0.84$0.84 $1.01$1.01 $0.91$0.91 $1.54$1.54

College EducationCollege Education $2,112$2,112 $3,502$3,502 $7,619$7,619 $12,976$12,976 $21,550$21,550

Real Prices ($1970)Real Prices ($1970)

Grade A Large Grade A Large EggsEggs $0.61$0.61 $0.40$0.40 $0.30$0.30 $0.21$0.21 $0.27$0.27

College EducationCollege Education $2,112 $2,112 $1,649$1,649 $2,262$2,262 $2,924$2,924 $3,835$3,835

The The realreal prices of eggs in prices of eggs in 1970 dollars 1970 dollars is calculated as follows:is calculated as follows:

While the While the nominalnominal price of price of eggs rose eggs rose during these years, the during these years, the

realreal price of eggs actually price of eggs actually fell.fell.

THE REAL PRICE OF EGGSTHE REAL PRICE OF EGGS

TABLE 2TABLE 2 THE REAL PRICES OF EGGS AND OF A COLLEGE EDUCATIONTHE REAL PRICES OF EGGS AND OF A COLLEGE EDUCATION

19701970 1980 19901990 2000 20102010

Consumer Price Index 38.838.8 82.4 130.7130.7 172.2 218.1218.1

Nominal Prices

Grade A Large Eggs $0.61$0.61 $0.84 $1.01$1.01 $0.91 $1.54$1.54

College Education $2,112$2,112 $3,502 $7,619$7,619 $12,976 $21,550$21,550

Real Prices ($1970)

Grade A Large Eggs $0.61$0.61 $0.40 $0.30$0.30 $0.21 $0.27$0.27

College Education $2,112 $2,112 $1,649 $2,262$2,262 $2,924 $3,835$3,835

The real prices of eggs in The real prices of eggs in 1990 dollars1990 dollars is calculated as follows:is calculated as follows:

TABLE 2TABLE 2 THE REAL PRICES OF EGGS AND OF A COLLEGE EDUCATIONTHE REAL PRICES OF EGGS AND OF A COLLEGE EDUCATION

1970 1980 1990 2000 2010

Consumer Price Index 38.8 82.4 130.7 172.2 218.1

Nominal Prices

Grade A Large Eggs $0.61 $0.84 $1.01 $0.91 $1.54

College Education $2,112 $3,502 $7,619 $12,976 $21,550

Real Prices ($1970)

Grade A Large Eggs $0.61 $0.40 $0.30 $0.21 $0.27

College Education $2,112 $1,649 $2,262 $2,924 $3,835

The percentage change in real price is calculated as follows (in The percentage change in real price is calculated as follows (in 1990 dollars):1990 dollars):

In nominal terms, the minimum wage has In nominal terms, the minimum wage has increased steadily over the past 70 years. increased steadily over the past 70 years. However, in real terms its expected 2010 However, in real terms its expected 2010

level is level is below that of the 1970s.below that of the 1970s.

THE MINIMUM THE MINIMUM WAGEWAGE

I’m lovin’ it

Meanwhile, Oil Prices Meanwhile, Oil Prices ……

Race to the Bottom: Race to the Bottom:

KaroshiKaroshi

Corporate Decision Making: The Toyota PriusCorporate Decision Making: The Toyota Prius

Hybrid cars are more energy efficient than cars with just a Hybrid cars are more energy efficient than cars with just a gasoline engine; the Prius, for example, can get 45 to 55 gasoline engine; the Prius, for example, can get 45 to 55 miles per gallon. The Prius was a big success, and within a miles per gallon. The Prius was a big success, and within a few years other manufacturers began introducing hybrid few years other manufacturers began introducing hybrid versions of some of their cars.versions of some of their cars.

The design and efficient production of the Prius involved The design and efficient production of the Prius involved not only some impressive engineering, but a lot of not only some impressive engineering, but a lot of economics as well.economics as well.

1.1. Toyota had to think carefully about how the Toyota had to think carefully about how the publicpublic would would react to the design and performance of this new product.react to the design and performance of this new product.

2.2. Toyota had to be concerned with Toyota had to be concerned with the cost of the cost of manufacturing manufacturing these cars.these cars.

3.3. Toyota had to think about its relationship to the government Toyota had to think about its relationship to the government and the effects of regulatory policies.and the effects of regulatory policies.

Fuel Fuel EfficiencyEfficiency

RaceRace

Public Policy Design: Public Policy Design: Fuel Fuel Efficiency Standards for the 21Efficiency Standards for the 21stst Century Century

In 1975, the U.S. government imposed regulations designed In 1975, the U.S. government imposed regulations designed to improve the average fuel economy of domestically-sold to improve the average fuel economy of domestically-sold cars and light trucks. The cars and light trucks. The CAFE (Corporate Average Fuel CAFE (Corporate Average Fuel Economy) Economy) standards have become increasingly stringent standards have become increasingly stringent over the years. Designing a fuel efficiency program involves over the years. Designing a fuel efficiency program involves economics :economics :

1.1. Government must evaluate the monetary impact of the Government must evaluate the monetary impact of the

programme on programme on consumersconsumers. .

2.2. To estimate the likely impact of CAFE standards on the To estimate the likely impact of CAFE standards on the

cost of producing cost of producing cars and light trucks. cars and light trucks.

3.3. To ask why problems related to oil consumption are not To ask why problems related to oil consumption are not

solved by our solved by our market-orientedmarket-oriented economy. economy.

22The Firm The Firm

& & Profit MaximisationProfit Maximisation

The FirmThe Firm

A firm is a collection of resources A firm is a collection of resources that is transformed into products that is transformed into products demanded by consumersdemanded by consumers

ProfitProfit is the difference between is the difference between revenue received and costs revenue received and costs incurredincurred

The FirmThe Firm

Transaction costs Transaction costs are are incurred when entering into a incurred when entering into a contractcontract

types of transaction coststypes of transaction costsinvestigationinvestigationnegotiationnegotiationenforcing contractsenforcing contracts

The FirmThe FirmTransaction costs Transaction costs are are

incurred when entering into a incurred when entering into a contractcontract

influencesinfluencesuncertaintyuncertaintyfrequency of recurrencefrequency of recurrenceasset specificityasset specificity

The FirmThe Firm

“Any customer can have a car painted any colour that he wants so long as it is black.”Henry Ford

The FirmThe Firm

Limits to firm sizeLimits to firm sizetradeofftradeoff between between

external transactions external transactions and the cost of and the cost of internal operationsinternal operations

company chooses to company chooses to allocate resources so allocate resources so total cost is minimumtotal cost is minimum

outsourcingoutsourcing of of peripheral, non-core peripheral, non-core activitiesactivities

Toyota Car Factories WorldwideToyota Car Factories Worldwide

Economic goal of the firmEconomic goal of the firm

Profit maximization Profit maximization hypothesis: hypothesis: the primary objective of the firm (to the primary objective of the firm (to economists) is to maximize profitseconomists) is to maximize profits

Other goals include market share, Other goals include market share, revenue growth, and shareholder revenue growth, and shareholder valuevalue

Optimal decision is the one that Optimal decision is the one that brings the firm closest to its goalbrings the firm closest to its goal

Economic goal of the firmEconomic goal of the firm

Short-run Short-run versusversus Long-run Long-runnothing to do directly with calendar nothing to do directly with calendar

timetimeshort-run: firm can short-run: firm can vary amount of vary amount of

some resourcessome resources but not others but not otherslong-run: firm can vary amount of long-run: firm can vary amount of all all

resourcesresourcesat times short-run profitability will at times short-run profitability will

be sacrificed for long-run purposesbe sacrificed for long-run purposes

Goals other than profitGoals other than profit

Economic goalsEconomic goalsmarket share, growth ratemarket share, growth rateprofit marginprofit marginreturn on investment, Return on return on investment, Return on

assetsassetstechnological advancementtechnological advancementcustomer satisfactioncustomer satisfactionshareholder valueshareholder value

““Quality is our lifeline.”Quality is our lifeline.”Akio Toyoda

Goals other than profitGoals other than profit

Non-economic objectivesgood work environmentquality products and services

corporate citizenship, social responsibility Environment, Sustainability & Governance

Do companies maximize profit?Do companies maximize profit?

Criticism: companies do not maximize Criticism: companies do not maximize profits but instead merely aim to profits but instead merely aim to satisfice, which means to achieve a satisfice, which means to achieve a satisfactory goal, one that may not satisfactory goal, one that may not require the firm to ‘do its best’require the firm to ‘do its best’

two forces affect satisficing:two forces affect satisficing:

position and power of position and power of stockholdersstockholders

position and power of position and power of managementmanagement

Position and power of Position and power of managementmanagementhigh-level managers may own high-level managers may own very little of the firm’s stockvery little of the firm’s stock

managers tend to be more managers tend to be more conservative because jobs will conservative because jobs will likely be safe if performance is likely be safe if performance is steady, not spectacularsteady, not spectacular



Position and power of managementPosition and power of management

managers may be more interested in managers may be more interested in

maximizing own income and maximizing own income and

perksperksmanagement incentives may be management incentives may be

misaligned (eg. revenue not profits)misaligned (eg. revenue not profits) divergence of objectives is known as divergence of objectives is known as

‘principal-agent’ ‘principal-agent’ problemproblem


Counter-arguments which support the Counter-arguments which support the profit maximization hypothesisprofit maximization hypothesis

large stockholdings held by institutions large stockholdings held by institutions (mutual funds, banks, etc.) (mutual funds, banks, etc.) scrutiny by professional scrutiny by professional analystsanalysts

stockmarket discipline stockmarket discipline if managers do not seek to maximize if managers do not seek to maximize

profits, firms face profits, firms face threat of threat of takeovertakeover

incentive effect incentive effect the compensation of many executives the compensation of many executives

is tied to is tied to stock pricestock price

Maximizing the wealth Maximizing the wealth of stockholdersof stockholders

Views the firm from the perspective of a Views the firm from the perspective of a

stream of profits stream of profits (cash flows) over (cash flows) over timetime the value of the stream depends on when the value of the stream depends on when

cash flows occur cash flows occur

Requires the concept of the Requires the concept of the time value time value of money: says a dollar earned in the future of money: says a dollar earned in the future is worth less than a dollar earned todayis worth less than a dollar earned today

Managerial Decision Making Managerial Decision Making Question : Finding the Best Question : Finding the Best

HotelHotel Assume there are only Three Hotels. (Assume there are only Three Hotels. (BestBest, ,

Medium, Worst)Medium, Worst) Traveller can visit and compare but cannot Traveller can visit and compare but cannot

go back. go back. What is your strategy to maximise your What is your strategy to maximise your

chances of achieving your goal (chances of achieving your goal (Best Best Hotel)?Hotel)?

BB BB M M W W M M W WM W M W BB W W BB M MW M W W M W BB M M BB

Managerial Decision Making Managerial Decision Making Strategy SolutionStrategy Solution

Strategy: Strategy: Size up the Size up the 1st Hotel but 1st Hotel but bypass it.bypass it.

Stop at the Stop at the 2nd Hotel only 2nd Hotel only if its better if its better than the 1st. than the 1st.

Simulation:Simulation:

Traveller finds BEST Hotel 50% of the time!

B B M M W WB B M M W WM W B W B MM W B W B MW M W B M BW M W B M B

33Economic ProfitEconomic Profit

Economic profitsEconomic profitsEconomic profits and accounting

profits are typically different

accountants measure accountants measure explicit explicit incurred costsincurred costs, as allowed by , as allowed by GAAPGAAP

accountants use accountants use historical costhistorical cost of machinesof machines

Economic profitsEconomic profitsEconomists are concerned with Economists are concerned with

implicit costs, called implicit costs, called opportunity costsopportunity costs

Accordingly, economists use Accordingly, economists use replacement cost of machinesreplacement cost of machines economic costs include economic costs include

historical and explicit historical and explicit (accounting) costs (accounting) costs as well as as well as replacement and implicit replacement and implicit (economic) costs(economic) costs

economic profit is total economic profit is total revenue minus all revenue minus all economic costseconomic costs

ProfitProfit

• Accounting profitAccounting profit• Total revenue less explicit Total revenue less explicit costcost

• Normal profitNormal profit• Equal to implicit cost Equal to implicit cost

• Economic or pure profitEconomic or pure profit• Total revenue less economic Total revenue less economic costcost

Profits ComparedProfits Compared

EconomicEconomicProfitProfit

AccountingAccountingCosts (ExplicitCosts (Explicit

Costs Only)Costs Only)

AccountingAccountingProfitProfit

ExplicitExplicitCostsCosts

Implicit CostsImplicit Costs(Including a (Including a

Normal Profit)Normal Profit)

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EconomicEconomic AccountingAccounting

ConclusionConclusion

“Death from too much work is so Death from too much work is so commonplace in commonplace in JapanJapan that there that there

is a word for it -- is a word for it -- karoshikaroshi..” ..”

The Washington Post, 13 July 2008The Washington Post, 13 July 2008

Casestudy : TESCOCasestudy : TESCO

1.1. Read and prepare the Read and prepare the Casestudy on TESCO Casestudy on TESCO (Johnson, Whittington & (Johnson, Whittington & Scholes (2011)) for Scholes (2011)) for discussion and discussion and presentation next week. presentation next week.

2.2. Identify and evaluate the Identify and evaluate the challenges facing TESCO’s challenges facing TESCO’s global expansion by global expansion by conducting External conducting External Environment analysis Environment analysis (PESTEL);and Industry (PESTEL);and Industry (5+1 Forces) analysis.(5+1 Forces) analysis.

Core ReadingCore Reading

• Keat, Paul G. and Young, Philip KY (2009) Managerial Economics, 6th edition, Pearson

• Samuelson, William F. and Marks, Stephen G.(2010) Managerial Economics, 6th edition, John Wiley

• Pindyck, Robert S. and Rubinfeld, Daniel L.(2013) Microeconomics, 8th edition, Pearson

• Samuelson, P.A. and Nordhaus, W. D. Samuelson, P.A. and Nordhaus, W. D. (2010)(2010)“Economics”“Economics” Irwin/McGraw-Hill, 19Irwin/McGraw-Hill, 19thth EditionEdition

• Porter, Michael E. (2004)Porter, Michael E. (2004)“Competitive Strategy – “Competitive Strategy – Techniques for Analyzing Industries and Competitors”Techniques for Analyzing Industries and Competitors” Free PressFree Press

Questions?Questions?

Mba1014 managers, profits, markets 270413

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