Welcome To

Economics 315

Price System and resource Allocation

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Instructor: Morteza RahmatianInstructor: Morteza RahmatianOffice: LH 717Office: LH 717Phone: (714) 278-3859Phone: (714) 278-3859E-mail: mrahmatian@fullerton.eduE-mail: mrahmatian@fullerton.eduWeb Page: Web Page: Business.fullerton.edu/mrahmatian/Business.fullerton.edu/mrahmatian/

Office Hours: T and Th: 2:30 - 4:00 Or by appointment

Managerial Economics:

Definition:

It is the application of the tools of economic theory and decision sciences to see how a firm or organization can achieve its aims and objectives most efficiently.

Management

Economic Theory Decision Sciences

Managerial Economics

Optimal Solutions

a. Microeconomicsb. Macroeconomics

a. Mathematical Economicsb. Econometrics

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Seven examples of Seven examples of Managerial DecisionsManagerial Decisions

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1.1. Pricing PoliciesPricing Policies

A firm can produce and sell a product A firm can produce and sell a product in different market (local or abroad).in different market (local or abroad).

Many factors including, price, cost, Many factors including, price, cost, profit and market share must be taken profit and market share must be taken into consideration. into consideration.

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2.2. 1987 Walt Disney Co. Signed $2 1987 Walt Disney Co. Signed $2 billion contract to built Euro Disney billion contract to built Euro Disney in France. Factors to consider: in France. Factors to consider:

Forecasting Weather Cost Customer service life style

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3.3. Research and DevelopmentResearch and DevelopmentTwo choicesTwo choices

Enhance and improve existing products. (i.e. new and improved Tylenol)

Take a chance on creating a new product. (i.e. drug to cure AIDS)

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4.4. 1985 Time Inc. magazine 1985 Time Inc. magazine

Approved to develop and test a new all picture magazine.

100 personnel using 15 million testing the magazine over 13 markets.

1986 Time Inc. decided against it. Launching such magazine would have cost

$ 100 millions.

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5.5. 1970 Canon Inc. wanted to enter 1970 Canon Inc. wanted to enter copying with Xerox Corp. having copying with Xerox Corp. having 75% of the market world wide.75% of the market world wide.

Imitate and improve, risking possible patent suits.

Develop completely new copier technology aimed at avoiding Xerox patents.

License copier technology from Xerox.

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Canon needed to consider many issuesCanon needed to consider many issues

Barriers to entry Profit potential Degree of competition Price Technology Long run growth prospect

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6.6. Public projects and RegulationsPublic projects and Regulations

Government similar to the private sector is subject to similar constraint optimization.

Regulation is the methodology in which support business and to protect consumers, workers and the environment.

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7.7. 1984-1987 dispute between Texaco 1984-1987 dispute between Texaco and Pennzoil. The largest court awardand Pennzoil. The largest court awardsettlement. Texaco acquired Getty oil and settlement. Texaco acquired Getty oil and wrecked a planned Getty-Pennzoil deal.wrecked a planned Getty-Pennzoil deal.

Pennzoil suit Texaco. Fight it in courts and stand to lose

millions in litigation. Settle out of court and save millions in

legal fees. Use bankruptcy protection.

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Six steps in decision making:Six steps in decision making:

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1.1. Defining the problemDefining the problem

In practice managerial decisions does not come neatly packaged. Rather, they are messy and poorly defined. Thus defining the problem is a key management issue.

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2.2. Determine the objective: What Determine the objective: What is the decision maker’s goal?is the decision maker’s goal?

Market share Cost minimization Largest firm

For public sector, airport, parks, roads,…. Cost Benefit Analysis

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3.3. Explore the alternatives:Explore the alternatives:

What constraints limit the choice of options

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4.4. Predict the consequences:Predict the consequences:

What are the consequences of each alternative action. Should conditions change, how would this affect outcomes.

Sometimes simple arithmetic suffice to predict. Other times need to built a model to predict a more complicated situation

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Model is a simplified description of a Model is a simplified description of a process, relationship or other process, relationship or other phenomena. Elements of a model.phenomena. Elements of a model.

Variables Set of assumptions about other relevant

variables. Hypothesis about the way the specific

variables are related. One or more predictions

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Q Q = = f f (( P, Y, P P, Y, Pcc , P , Pss ))

Q = + 1 P + 2 Y + 3 Pc + 4 Ps

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5.5. Make choices:Make choices:

After all analysis is done, what is the preferred course of action.

Make optimal decision

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6.6. Perform sensitivity analysis: Perform sensitivity analysis:

Sensitivity analysis considers how optimal decision would change if key economic facts or conditions were altered. In tackling and solving a decision problem, it is important to understand and be able to explain the “why” of your decision.

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Sensitivity analysis is usefulSensitivity analysis is useful

Providing insight into the key features of the problem that affect decision.

Tracing the effect of changes in variables about which the manager may be uncertain.

Generating solutions in cases of recurring decisions under slightly modified conditions.

Theory of the Firm

Firm:

It is an organization or entity that combines and organizes resources for the purpose of producing goods and services for sale.

Proprietorship Partnership Corporation

Objective of the Firm:

Profit Maximization

Value of the Firm:

It is the present value of a the firm’s expected future net cash flows

$100

Year OneYear Two$100

Interest Rate = 5 %

$100 today $105 in a year

So one dollar a year from now has a present value of

05.1

1

05.1

1

105

100

1 2 3 4

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Project 1: $100, $20, $10

Project 2: $40, $50, $60

Discount rate = 2%

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Value of the Firm

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Distinction between Accounting & Economic Profit:

Total Profit = TR - TC

Accounting Profit = TR - Explicit Costs

Economic Profit = Accounting Profit - Implicit Costs

= TR - Explicit Costs - Implicit Costs

100 100 +800

Problem 3:

Interest rate (i) = 15%

49.767)15.1(

900

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Problem 12:

Current Job = $30,000 New Job = $40,000

Return From Pharmacy = $200,000

Explicit Cost = 80,000+40,000+10,000+5,000 +8,000

= 143,000

Business Profit = 200,000 – 143,000 = 57,000

Implicit Cost = 40,000 + 2,000 = 42,000

Economic Profit = Business Profit – Implicit cost

= 57,000 – 42,000 = 15,000

(b) Total Revenue now is $200,000 which includes a $15,000 economic profit. So in three years when the new pharmacy will drive down the economic profit to zero, total revenue of the pharmacy will be $200,000 - $15,000 = $185,000.

c. Samantha shall purchase the pharmacy if the present value of the pharmacy is positive.

15,00015,000 15,000– 50,000

57.1372)15.1(

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