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What is management?

 Management is what a manager does.

 It is the art of taking work done through others.
Fundamentals oF  It is the art and science of decision-making and leadership
managerial economics  It is the deep coordination of human resources and other
factors of production

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a manager is…… What is economics?

 a person who directs resources to achieve a stated  It is the science of making decisions in the presence of
goal scarce resources.

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ten principles oF economics principle #1: people Face trade-oFFs

All decisions involve trade-offs. Examples:
 It is the science of making decisions in the presence of
scarce resources. 1. A high school graduate deciding to go to college
2. A family deciding to go an international trip
3. A company president deciding to open a company
4. The government expanding the 4Ps beneficiary

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principle #2: the cost oF something is What you principle #3: rational people think at the
give up to get it
margin.
 Making decisions requires comparing the costs Marginal Cost:
and benefits of alternative choices. • Price of the beer
• Calories
 The opportunity cost of any item is whatever must be • Tipsy/Hangover
given up to obtain it. Marginal Benefit
 It is a relevant cost in making decision-making. • Taste
• Quench thirst
• Mingle better with friends

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principle #4: people respond at incentives ten principles oF economics

How do people make decisions?

 Incentive: something that induces a person to act, i.e. the  It is the science of making decisions in the presence of
prospect of a reward or punishment. scarce resources.
 Rational people respond to incentives.
Example:
 When gas prices rise, consumers buy more hybrid cars and
fewer SUVs

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ten principles oF economics managerial economics

How do people make decisions?

 It is the science of making decisions in the presence of  It is the study of how to direct scarce resources in the
scarce resources. It’s a sunk cost. It’s irrelevant in decision making
way that most efficiently achieves a managerial goal.

Marginal Cost

Marginal Benefit > Marginal Cost

(65,000 – 57,000) > 6,000

(60,000 – 55,000) < 6,000

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economics oF eFFective management identiFy goals and constraints

An effective manager must:  Understand the organizations goals and the
1. identify goals and constraints constraints that may arise
2. recognize the nature and importance of profits
3. understand incentives
4. understand markets
5. recognize the time value of money
6. use marginal analysis

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recognize the nature and importance oF proFits recognize the nature and importance oF proFits

 Accounting profits vs. economic profits  Calculating Accounting Profit

o Accounting profits are the total amount of money taken in from o A company has the following financial data for the year;
sales minus the cost of producing goods or services. • Total revenues: $500,00
o Economic profits are the difference between the total revenue • Explicit costs (wages, rent, materials): $300,000
and total opportunity costs of producing the firm’s goods and
services. Calculate the company’s accounting profit for the year.

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recognize the nature and importance oF proFits recognize the nature and importance oF proFits

Suppose you own a building in New York that you could lease out to earn
 Calculating Economic Profit
$100,000 a year or use to run a small business. You resigned from your work
o A company earns a total revenue of $800,000 in a year. The
where you earn $30,000 a year and chose to run a small business instead. At
explicit costs are $600,000. Additionally, the owner could have the end of the year, your revenues from your restaurant were $100,000, with
earned $100,000 by working elsewhere, and the company owns costs amounting to $20,000.
capital that could have generated $50,000 in interest if invested Required:
elsewhere. 1. How much are your accounting profits? $100,000 - $20,000 = $80,000

Calculate the company’s economic profit for the year. 2. What are your explicit costs and implicit costs? Explicit – $20,000
Implicit – $130,000
3. How much are your economic profits? Total Revenue – Total Cost (Explicit + Implicit Cost) = Economic Profits

$100,000 – $150,000 = ($50,000)

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recognize the nature and importance oF proFits recognize the nature and importance oF proFits

Mr. Bean consumes $30,000 per year on painting supplies and storage space. Mr. Bean consumes $30,000 per year on painting supplies and storage space.
He recently received two job offers from a famous marketing firm - one offer He recently received two job offers from a famous marketing firm - one offer
was for $110,000 per year, and the other was for $80,000. However, he was for $110,000 per year, and the other was for $80,000. However, he
turned both jobs down to continue a painting career. Mr. Bean sells 25 paintings turned both jobs down to continue a painting career. Mr. Bean sells 25 paintings
per year at a price of $8,000 each. per year at a price of $8,000 each.
Required: Required:
a. What are his accounting profits? a. What are his accounting profits? (25*$8,000) - $30,000 = $170,000

b. What are his economic profits? b. What are his economic profits? (25*$8,000) – ($30,000+$110,000) = $60,000

*Please note that the total opportunity cost includes both explicit cost and implicit cost of giving up the best alternative use of
the resource.

ss

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recognize the nature and importance oF proFits understand incentives

 Role of profits  Incentives affect how resources are used and how workers
• Profits signal to resource holders where resources are most work.
highly valued by society.
 ” It is not out of the benevolence of the butcher, the brewer, or the
baker, that we expect our dinner, but from their regard to their own
interest.” – Adam Smith

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understand incentives understand incentives

A local gym is trying to increase its membership. To encourage more people to come during A local gym is trying to increase its membership. To encourage more people to come during
these hours, the gym offers a 20% discount on the usual membership fee. The regular these hours, the gym offers a 20% discount on the usual membership fee. The regular
membership fee is $50 per month, and the gym currently has 100 members who pay the full membership fee is $50 per month, and the gym currently has 100 members who pay the full
price. The gym's manager estimates that for every 10% discount offered, the number of price. The gym's manager estimates that for every 10% discount offered, the number of
members will increase by 15%. members will increase by 15%.

1. What is the new membership fee? 1. What is the new membership fee? $40
2. By how many members is the gym’s membership expected to increase due to the 20% 2. By how many members is the gym’s membership expected to increase due to the 20%
discount? discount? 30 members
3. Calculate the gym’s total revenue from memberships after the discount is applied? 3. Calculate the gym’s total revenue from memberships after the discount is applied? $5,200

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understand markets recognize the time value oF money

 Consumer-Producer Rivalry Present Value Analysis

 Consumer-Consumer Rivalry • Present Value (PV) of an amount received in the future is
 Producer-Producer Rivalry the amount that would have to be invested today at the
 Government and the Market prevailing interest rate to generate the future value.

economics oF eFFective management economics oF eFFective management

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recognize the time value oF money recognize the time value oF money

Present Value (Formula) What should be the amount to be invested today to earn
• The present value (PV) of a future value (FV) received in $100 in 10 years at a 7% interest rate?
n years in the future is
FV
PV =
(1+i)n

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recognize the time value oF money recognize the time value oF money

What should be the amount to be invested today to earn Present Value of a Stream (Formula)
$100 in 10 years at a 7% interest rate? • When the interest rate is i, the present value of a stream
of future payments of FV1, FV2,……. FVn is
Answer: FVt
PV = + + + …. or, PV= (1+i)t

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recognize the time value oF money recognize the time value oF money
Present Value of a Stream Present Value of a Stream
You expect to receive the following cash flows from an
investment: Year 1: $3,000, Year 2: $4,000, Year 3: $5,000, 𝑃𝑉 =
$ ,
+
$ ,
+
$ ,
+
$ ,

Year 4: $6,000. The discount rate is 7%. What is the present ( . ) ( . ) ( . ) ( . )

value of these cash flows?

𝑃𝑉 = $14,956.35

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recognize the time value oF money recognize the time value oF money

Net Present Value (Formula)  Key Components of NPV

• The net present value (NPV) of a project is simply the present • Cash Inflows: These are the anticipated earnings or savings
value of the (PV) of the income generated by the project minus generated by the investment or project. They could come from
the current cost of the project (C0). revenues, cost reductions, or any other benefits.
• Cash Outflows: These represent the initial and ongoing costs
𝑁𝑃𝑉 = ∑ − 𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 (C0) associated with the project or investment, such as the initial
capital investment, operating costs, maintenance, etc.

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recognize the time value oF money recognize the time value oF money

 Key Components of NPV  Positive NPV (>0): The investment is expected to generate
• Discount Rate: This is the rate used to discount future cash flows more value than its cost, indicating it’s a profitable venture.
back to their present value. It typically reflects the cost of  Negative NPV (<0): The investment is expected to generate
capital, risk, and opportunity cost of investing in one project less value than its cost, suggesting it’s not a profitable option.
over another.
 NPV = 0: The investment is expected to break even,
• Time Period: The duration over which the cash flows are
expected, usually measured in years. generating enough return to cover its costs.

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STEPS IN CALCULATING NPV Present Value & Net Present Value Exercise

1) Determine the initial investment. XYZ company is considering two projects – Project A
and Project B. Both are a four-year project with
The firm's cost of capital is 10% for each project and
the initial investment amount is ＄10,000. Calculate
2) Determine the time period to analyze. income projections as follows: the NPV of each project and determine in which
3) Determine the cash flows for each time period. project the firm should invest.

4) Determine the discount rate. Year Project Project PVStreams = CF0 + + + +…

5) Discount your cash flows. A B
6) Subtract the PV of the cash flows to the cost of the project. NPV = PVstreams – C0
1 $5,000 $1,000
2 $4,000 $3,000
3 $3,000 $4,000
4 $1,000 $6,750

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recognize the time value oF money

Present Value & Net Present Value Exercise The manager of XYZ Company is planning to purchase a new machine that will
cost $300,000 and has a useful life of 5 years. The machine will yield cost
savings to the company of $50,000 in year 1, $60,000 in year 2, $75,000 in
year 3, and $90,000 in years 4 and 5. What is the PV of cost savings from the
machine if the interest rate is 8%? Should the manager purchase the machine?

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recognize the time value oF money recognize the time value oF money
Cost
Year Savings To compute for the present value (PV) of the cost savings, use the PV formula for streams of
future payments or benefit:
1
2
$50,000.00
$60,000.00 Present Value of Indefinitely Lived Asset (Formula)
3 $75,000.00
4
5
$90,000.00
$90,000.00
PVcost-savings = + + + + • Some decisions generate cash flows that continue indefinitely.
Rate (i) = 8%
Cash flows are identical (CF1=CF2=…)
, , , , ,
PVcost-savings = + + + + PVAsset = CF0 + + + + ….
. . . . .

PVcost-savings = $284,679
or, simply, PVPerpetuity =
NPV = - $ 15,321, Do not purchase the machine. XYZ will be
better of investing the $300,000.

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use marginal analysis use marginal analysis

 Marginal analysis states that optimal managerial decisions  Marginal benefit refers to the additional benefits that arise by
involve comparing the marginal (or incremental benefits of using an additional unit of managerial variable.
a decision with marginal (or incremental) costs.  Marginal cost is the additional costs incurred by using an
additional unit of managerial variable.
 Marginal net benefits are the change in net benefits that arise
from one-unit change in variable.

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use marginal analysis

(1)
Control Variable
(2)
Total
(3)
Total
(4)
Net
(5)
Marginal
(6)
Marginal
(7)
Marginal
notes on marginal analysis
(Q) Benefit Cost Benefit Benefit Cost Net Benefit
B(Q) C(Q) N(Q) MB(Q) MC(Q) MNB(Q)
Given
Given Given (2)-(3) △(2) △(3) (5)-(6)
 Total costs continue to rise every time there is production of
0 0 0 0 0 0 0 additional unit of variable.
1 90 10 80 90 10 80
 Net Benefit NB(Q) is maximized when Marginal Net Benefit
2 170 30 140 80 20 60
3 240 60 180 70 30 40
MNB(Q) is 0.
4 300 100 200 60 40 20  Total Benefit B(Q) is maximized when NB(Q) is 0.
5 350 150 200 50 50 0
6 390 210 180 40 60 -20
7 420 280 140 30 70 -40
8 440 360 80 20 80 -60
9 450 450 0 10 90 -80
10 450 550 -100 0 100 -100

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THANK YOU!

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