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Managerial Economics

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Rationale

This course aims at providing students with an understanding of the basic principles and theories in economics.  It also equips students with the ability in analysing real-life situations.  Upon completion of the course, students should be able to apply various economics theories to the current economic trends and developments, which enables them to make economics decision effectively.

 

Managerial Economics (also called business economics), is a branch of economics that applies microeconomic analysis to specific business decisions. As such, it bridges economic theory and economics in practice. It draws heavily from quantitative techniques such as regression and correlation, Lagrangian calculus, linear programming, decision theory, and game theory. It is similar to operations research in this regard, and indeed uses operations research techniques.

If there is a unifying theme that runs through most of managerial economics it is the attempt to optimize business decisions given the firm's objectives and given constraints imposed by scarcity.

Almost any business decision can be analysed with managerial economics techniques, but it is most commonly applied to:

At universities, the subject is taught primarily to advanced undergrads. It is approached as an integration subject. That is, it integrates many concepts from a wide variety of prerequisite courses.

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Learning Outcomes

After completing the course, students will be able to demonstrate

Introduction to Economics

Demand and Supply and their Effects upon Prices and Business Decisions

Theory of Production

Various Types of Market Situations and their Characteristics

The Circular Flow of Economic Activities

Money and Banking

Inflation, Unemployment and Economic Growth

Foreign Trade

Objectives and purposes of organisations

International dimension

 

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Introduction

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Globalisation

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Managers, Profits, and Markets

"Management" (from Old French ménagement "the directing", from Latin manu agere "to lead by the hand") characterises the process of leading and directing all or part of an organisation, often a business, through the deployment and manipulation of resources (human, financial, material, intellectual or intangible). Early twentieth-century management writer Mary Parker Follett defined management as "the art of getting things done through people."

One can also think of management functionally, as the action of measuring a quantity on a regular basis and of adjusting some initial plan, and as the actions taken to reach one's intended goal. This applies even in situations where planning does not take place. From this perspective, there are five management functions: planning, organizing, leading, co-ordinating and controlling. For others though, this definition, while useful, is far too narrow. The phrase "management is what managers do" is also prevalent, conveying the difficulty with which management is defined, the shifting nature of definitions, and the connection of managerial practices with the existence of a managerial cadre or class.

Management is known by some as "business administration", although this then excludes management in places outside business, eg charities and the public sector. University departments that teach management are nonetheless usually called "business schools". The term "management" may also be used as a collective word, describe the managers of an organization, for example of a corporation.

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Profit, from Latin meaning "to make progress", is defined in two different ways. Under capitalism, profit is a positive return made on an investment by an individual or by business operations. Under the Marxist definition it is a mechanism of class exploitation, where surplus value is extracted by capitalists from their workers and suppliers beyond the point where costs are covered.

Microeconomics

Under capitalism, methods of calculation differ between accountants and economists. Often, it is the difference between retail sales price and the costs of manufacture. However, the term is also used more generally to refer to the value added after all the factors of production have been credited their full opportunity cost.

The Profit Motive—enterprises being free to make as much profit as they can given market conditions—is regarded by capitalists to be a good thing. It is held to give firms incentives for allocative efficiency and technical efficiency. This idea is a corollary of the theorems of welfare economics and utility maximisation. However, profits can include economic rents, which do not produce efficiency. For instance, a monopoly can have very high profits but produce less economic welfare. Classical economists use profits to measure the happiness/utility/general welfare, gained by society, and understand that high profits demonstrate the high value of the factors used in the production of such goods.

 

A Market is, as defined in economics, a social arrangement that allows buyers and sellers to discover information and carry out a voluntary exchange of goods or services. Along with a right to own property, it is one of the two key institutions that organize trade. Allowing markets to arrive at a pareto efficient outcome is one of the key components of capitalism.

Free markets can hit economic growth

 

Demand, Supply, and Market Equilibrium

Potential Crude Oil Condensate Supply and Demand

In microeconomic theory, the partial equilibrium Supply and Demand economic model originally developed by Alfred Marshall attempts to describe, explain, and predict changes in the price and quantity of goods sold in competitive markets. The model is only a first approximation for describing an imperfectly competitive market. It formalizes the theories used by some economists before Marshall and is one of the most fundamental models of some modern economic schools, widely used as a basic building block in a wide range of more detailed economic models and theories. The theory of supply and demand is important for some economic schools' understanding of a market economy in that it is an explanation of the mechanism by which many resource allocation decisions are made. However, unlike general equilibrium models, supply schedules in this partial equilibrium model are fixed by unexplained forces.

 

Pricing is one of the four p's of the marketing mix. The other three aspects are product management, promotion, and place. It is also a key variable in microeconomic price allocation theory.

Pricing is the manual or automatic process of applying prices to purchase and sales orders, based on factors such as: a fixed amount, quantity break, promotion or sales campaign, specific vendor quote, price prevailing on entry, shipment or invoice date, combination of multiple orders or lines, and many others. Automated systems require more setup and maintenance but may prevent pricing errors.

Equilibrium Price is the price at which the quantity demanded of a good or service is equal to the quantity supplied. A market that is in a state of equilibrium is considered to be efficient, and is a prerequisite condition of a healthy economy. A simple set of supply and demand curves

Marginal Analysis for Optimal Decisions

CVP stands for Cost-Volume-Profit. The CVP analysis helps understanding the financial impact of basic business decisions.

The main tools used for a CVP analysis are

Break even analysis

Basic Estimation Techniques

Econometrics literally means 'economic measurement'. It is a combination of mathematical economics, statistics, economic statistics and economic theory.

The two main purposes of econometrics are to give empirical content to economic theory and also to empirically verify economic theory. For example, econometrics could empirically verify if, indeed, a given demand curve slopes downward as economic theory would suggest. Empirical content is also applied, in that a numerical value would be given to this slope, while economic theory alone is usually mute on actual specific values.

Arguably the most important tool of econometrics is regression analysis (for an overview of a linear implementation of this framework, see linear regression).

Econometric analysis can often be divided into time-series analysis and cross-sectional analysis. Time-series analysis examines variables over time, such as the effect of interest rates on national expenditure. Cross-sectional analysis studies relationship between different variables at a point in time. For instance, the relationship between income, locality, and personal expenditure. When time-series analysis and cross-sectional analysis are conducted simultaneously on the same sample, it is called panel analysis. If the sample is different each time, it is called pooled cross section data. Multi-dimensional panel data analysis is conducted on data sets that have more than two dimensions. For example, some forecast data sets provide forecasts for multiple target periods, conducted by multiple forecasters, and made at multiple horizons. The three dimensions provide more information than can be gleaned from two dimensional panel data sets.

Econometrics

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Econometric analysis may also be classified on the basis of the number of relationships modelled. Single equation methods rely on the assumption of a causal relationship between the variable of interest (the dependent variable) and the explanatory or exogenous variables. If this assumption is not satisfied, the results may be subject to simultaneous equations bias. A variety of simultaneous equation methods have been developed to take account of the fact that economic variables such as prices and quantities are, in general, jointly determined in market equilibrium.

Much larger econometric models are used in an attempt to explain or predict the behavior of national economies.

A simple example of a relationship in econometrics is:

Personal Expenditure = Propensity to Spend * Income + random error

This statement asserts that the amount a person spends is dependent on his or her income and his or her willingness to spend money. If we can observe personal expenditure and income, techniques such as regression analysis can then be applied to find the value of the coefficients, here just the propensity to spend. The estimated coefficient can then be compared across samples (such as different countries or income brackets) and conclusions made.

The above example can also be used to illustrate the many difficulties facing the applied econometrician. For instance, do we really know that the above relationship is correct? Perhaps the true relationship between personal expenditure and income is non-linear. Even if we know the correct theory, it is not certain we can measure personal expenditure and income correctly. For instance, the value of work by homemakers is not recorded although it contributes to income. There are also a variety of statistical pitfalls that potentially lead to incorrect conclusions. Econometrics has dealt extensively with such issues. Often it turns out to be difficult to fully implement the resulting methods in practice.

See also

 

Workshop

Managerial Economics

Part I: Some Preliminaries

Part II: Demand Analysis

Part III: Production and Cost Analysis

Part IV: Profit-Maximization in Various Market Structures

Part V: Advanced Managerial Decision Making

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Activity

A member of the Clandestine Rebel Clown Army protesting during the week of the July 2005 G8 Summit, held at Gleneagles, near Edinburgh, Scotland.

A member of the Clandestine Rebel Clown Army protesting during the week of the July 2005 G8 Summit, held at Gleneagles, near Edinburgh, Scotland.
Title: Edinburgh Prepares For Influx Of Protestors To G8 Summit. Copyright: Getty Images, available from Education Image Gallery

 

Demand Analysis

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Theory of Consumer Behavior

Drivers of Consumer Behaviour - Conventional Food

Consumer behaviour is the study of how people buy, what they buy, when they buy and why they buy. It is a subcategory of marketing that blends elements from psychology, sociology, sociopsychology, anthropology and economics. It attempts to understand the buyer decision making process, both individually and in groups. It studies characteristics of individual consumers such as demographics, psychographics, and behavioural variables in an attempt to understand people's wants. It also tries to assess influences on the consumer from groups such as family, friends, reference groups, and society in general.

Models of Consumer Behavior

One of the best known of the explanatory 'lain the interactions involved is that of Howard and Sheth. This contains a deal of common sense, although, as is often the case with such models, the rather obscure terminology makes it appear more confusing than it really is. The 'inputs' (stimuli) that the consumer receives from his or her environment are:

  1. significative - the 'real' (physical) aspects of the product or service (which the co make use of)
  2. symbolic - the ideas or images attached by the supplier (for example by advertising)
  3. social - the ideas or images attached to the product or service by 'society' (for example, by reference groups)

The 'outputs' are what happens, the consumer's actions, as observable results of the input stimuli.

Between the inputs and outputs are the 'constructs', the processes which the consumer goes through to decide upon his or her actions. Howard and Sheth group these into two areas:

  1. perceptual - those concerned with obtaining and handling information about the product or service
  2. learning - the processes of learning that lead to the decision itself

The Engel-Kollatt-Blackwell model, as a further example, follows a more mechanistic approach.

In the domain of evolutionary economics, consumers are seen as active agents following rules of behaviour, fairly easy to follow and implement because they require only a limited amount of information and capability of elaboration. For instance, a consumer, being aware of a certain need and believing a certain good category satisfies it, might fix a maximum price he/she can afford and search for the best good available under such a constraint.

A more detailed description of rules of behaviour, dependent also on consumer's income and social group, is available at http://www.economicswebinstitute.org/essays/consumers.htm. More in general, consumer behaviour models and datasets are available at http://www.economicswebinstitute.org/consumerbehaviour.htm.


Such models can help theorists to explain consumer behaviour better, but it can be difficult to put them to practical use.

 

Elasticity and Demand

Elasticity (economics), a general term for a ratio of change. For more specific kinds of elasticity, see: Illustrations of perfect elasticity

Price Elasticity of Supply, In economics, the price elasticity of supply measures the responsiveness of the quantity supplied of a good to its price.

It is measured as the percentage change in supply that occurs in response to a percentage change in price. For example, if, in response to a 10% rise in the price of a good, the quantity supplied increases by 20%, the price elasticity of supply would be 20%/10% = 2. (Case & Fair, 1999: 119).

The quantity of a good supplied can, in the short term, be different from the amount produced, as manufacturers will have stocks which they can build up or run down. In the long run, however, quantity supplied and quantity produced are synonymous.

Various research methods are used to calculate price elasticity:

 Price elasticity of supply

Income Elasticity of Demand, In economics, the income elasticity of demand measures the responsiveness of the quantity demanded of a good to the income of the people demanding the good.

It is measured as the percentage change in demand that occurs in response to a percentage change in income. For example, if, in response to a 10% increase in income, the quantity of a good demanded increased by 20%, the income elasticity of demand would be 20%/10% = 2. (Case & Fair, 1999: 119).

A negative income elasticity of demand is associated with inferior goods; an increase in income will lead to a fall in the quantity demanded and may lead to changes to more luxurious substitutes.

A positive income elasticity of demand is associated with normal goods; an increase in income will lead to a rise in the quantity demanded. A high positive income elasticity of demand is associated with luxury goods.

A zero income elasticity of demand is an increase in income without leading to a change in the quantity demanded of a good.

Many necessities have an income elasticity of demand between zero and one: expenditure on these goods may increase with income, but not as fast as income does, so the proportion of expenditure on these goods falls as income rises. This observation for food is known as Engel's law.

 Income elasticity of demand

In economics, the Cross Elasticity of Demand or Cross Price Elasticity of Demand measures the responsiveness of the quantity demanded of a good to a change in the price of another good.

It is measured as the percentage change in demand for the first good that occurs in response to a percentage change in price of the second good. For example, if, in response to a 10% increase in the price of fuel, the quantity of new cars that are fuel inefficient demanded decreased by 20%, the cross elasticity of demand would be -20%/10% = -2.

In the example above, the two goods, fuel and cars, are complements - that is, one is used with the other. In these cases the cross elasticity of demand will be negative. In the case of perfect complements, the cross elasticity of demand is negative infinity.

Where the two goods are substitutes the cross elasticity of demand will be positive, so that as the price of one goes up the quantity demanded of the other will increase. For example, in response to an increase in the price of fuel, the demand for new cars that are fuel efficient (hybrids for example) will also rise. In the case of perfect substitutes, the cross elasticity of demand is positive infinity.

Where the two goods are independent the cross elasticity demand will be zero, as the price increase the quantity demanded will be zero, an increase in price 'zero quantity demanded'. In case of perfect independence, the cross elasticity of demand is zero.

 The cross-elasticity of demand between Chilean wines and US wines is greater than 0, defining them as substitutable goods.
In economics, Output Elasticity is the percentage change of output (GDP or revenue for a single firm) divided by the percentage change of an input.  
Elasticity of substitution is the elasticity of the ratio of two inputs to a production (or utility) function with respect to the ratio of their marginal products (or utilities). Elasticity of Substitution
Arc Elasticity is the elasticity of one variable with respect to another between two given points. It is used when there is not a general function for the relationship of two variables. Therefore, point elasticity may be seen as an estimator of elasticty; this is because point elasticity may be ascertained whenever a function is defined.

The y arc elasticity of x is defined as:

Arc Elasticity

For comparison, the y point elasticity of x is given by:

Arch Elasticity

The Beta Coefficient, or financial elasticity (sensitivity of the asset returns to market returns, relative volatility), is a key parameter in the Capital asset pricing model (CAPM).

Beta can also be defined as the risk of the stock to a diversified portfolio. Therefore the beta of a stock will be much lower than its (the stock's) standard deviation.

The formula for the Beta of an asset is

Beta of an asset

Yield Elasticity of Bond Value is the percentage change in bond value divided by a one per percentage change in the yield to maturity of the bond. This is equivalent to saying the derivative of value with respect to yield times the (interest rate/value). This is equal to the MacAulay Bond Duration times the discount rate, or the modified bond duration times the interest rate.

If elasticity is below -1, or above 1 if the absolute number is used, it means that the product of the two measures, Value times yield or the interest income for the period will go down

  

 

Demand Estimation and Forecasting

Time Series Analysis

A number of different notations are in use for time-series analysis

A number of different notations are in use for time-series analysis

is a common notation which specifies a time series X which is indexed by the natural numbers.

In statistics and signal processing, a time series is a sequence of data points, measured typically at successive times, spaced at (often uniform) time intervals. Time series analysis comprises methods that attempt to understand such time series, often either to understand the underlying theory of the data points (where did they come from? what generated them?), or to make forecasts (predictions). Time series prediction is the use of a model to predict future events based on known past events: to predict future data points before they are measured. The standard example is the opening price of a share of stock based on its past performance.

Models for time series data can have many forms. Two broad classes of practical importance are the moving average (MA) models, and the autoregressive (AR) models. These two classes depend linearly on previous data points and are treated in more detail in the article on autoregressive moving average models (ARMA). Non-linear dependence on previous data points is of interest because of the possibility of producing a chaotic time series.

Tools for investigating time-series data include:

Econometric Models are used by economists to find standard relationships among aspects of the macroeconomy and use those relationships to predict the effects of certain events (like government policies) on inflation, unemployment, growth, etc... Econometric models generally have a short-run aggregate supply component with fixed prices, and aggregate demand portion, and a potential output component. As an example in the not-too-recent past, the 2000 presidential candidate George W. Bush wanted to know how his planned tax cut would affect the economy. Economists entered the tax into their model and came up with an estimate of the effect. Two famous econometric models are the Federal Reserve Bank econometric model and the DRI-WEFA model. Econometric Models

Economic Surplus

Economic Surplus

The term Surplus is used in economics for several related quantities. The Consumer Surplus is the amount that consumers benefit by being able to purchase a product for a price that is less than they would be willing to pay. The Producer Surplus is the amount that producers benefit by selling at a market price that is higher than they would be willing to sell for.

If the government intervenes, using, for example, a tax or a subsidy, then the graph of supply and demand becomes more complicated and will also include an area that represents Government Surplus.

Combined, the consumer surplus, the producer surplus, and the government surplus (if present) make up the social surplus or the Total Surplus. Total surplus is the primary measure used in Welfare Economics to evaluate the efficiency of a proposed policy.

A basic technique of bargaining for both parties is to pretend that their surplus is less than it really is: sellers may argue that the price they asks hardly leaves them any profit, while customers may play down how eager they are to have the article.

In national accounts, operating surplus is roughly equal to distributed and undistributed pre-tax profit income, net of depreciation.

In heterodox economics, the economic surplus denotes the total income which the ruling class derives from its ownership of society's (productive) assets, which is either reinvested or spent on consumption.

In Marxian economics, the term surplus may also refer to surplus value and surplus labour.


Production and Cost Analysis

Tutorials

Readings

 Examples of Perceptual Map Frameworks

In microeconomics, Production is the act of making things, in particular the act of making products that will be traded or sold commercially. Production decisions concentrate on what goods to produce, how to produce them, the costs of producing them, and optimizing the mix of resource inputs used in their production. This production information can then be combined with market information (like demand and marginal revenue) to determine the quantity of products to produce and the optimum pricing.

(In macroeconomics, production is measured by gross domestic product and other measures of national income and output.)

See also

 

Production and Cost in the Short Run

In Economics, short-run refers to the decision-making time frame of a firm in which at least one factor of production is fixed. Costs which are fixed in the short-run have no impact on a firms decisions.

A generic firm can make three changes in the short-run:

  • Increase production
  • Decrease production
  • Shut down

In the short-run, a profit maximizing firm will:

 Short=Run Average Cost and Short-Run Marginal Cost Functions

 

A very high cost producer

Production and Cost in the Long Run

In Economics, long-run refers to the decision-making time frame of a firm in which all factors of production may be varied.

A generic firm can make these changes in the long-run:

Production and Cost Estimation

Cost Estimation Models are mathematical algorithms used to estimate the costs of a product or project. The results of the models are typically necessary to obtain approval to proceed, and are factored into business plans, budgets, and other financial planning and tracking mechanisms.

These algorithms were originally performed manually but now are almost universally computerized. They may be standardized (available in published texts or purchased commercially) or proprietary, depending on the type of business, product, or project in question. Simple models may use standard spreadsheet products.

Models typically function through the input of parameters that describe the attributes of the product or project in question, and possibly physical resource requirements. The model then provides as output various resources requirements in cost and time.

 Algorithmic Cost Models

Typical applications include:

See also

External links

 


Profit Maximization in Various Market Structures

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In economics, Profit Maximization is the process by which a firm determines the price and output level that returns the greatest profit. There are several approaches to this problem. The total revenue -- total cost method relies on the fact that profit equals revenue minus cost, and the marginal revenue - marginal cost method is based on the fact that total profit in a perfectly competitive market reaches its maximum point where marginal revenue equals marginal cost.

 Profit Maximization - The Totals Approach

 

In economics, the main criteria by which one can distinguish between different Market Forms are: the number and size of producers and consumers in the market, the type of goods and services being traded, and the degree to which information can flow freely. The major market forms are:

These somewhat abstract concerns tend to determine some but not all details of a specific concrete market system where buyers and sellers actually meet and commit to trade.

 

Perfect Competitition

Perfect competition: The horizontal demand curve touches the average total cost curve at the lowest point (see cost curve).

Perfect Competition is an economic model that describes a hypothetical market form in which no producer or consumer has the market power to influence prices. According to the standard economical definition of efficiency (Pareto efficiency), perfect competition would lead to a completely efficient outcome. The analysis of perfectly competitive markets provides the foundation of the theory of supply and demand.

 

Monopolistic Competition is a common market form. Many markets can be considered as monopolistically competitive, often including the markets for books, clothing, films and service industries in large cities.

External links

 

In economics, a Monopoly (from the Latin word monoplium - Greek language monos, one + polein, to sell) is defined as a persistent market situation where there is only one provider of a kind of product or service. Monopolies are characterized by a lack of economic competition for the good or service that they provide and a lack of viable substitute goods.

Monopoly should be distinguished from monopsony, in which there is only one buyer of the product or service; it should also, strictly, be distinguished from the (similar) phenomenon of a cartel. In a monopoly a single firm is the sole provider of a product or service; in a cartel a centralized institution is set up to partially coordinate the actions of several independent providers (which is a form of oligopoly)

Since a monopolist necessarily faces the entire market demand, it faces a downward sloping demand curve

 Introduction to natural monopolies

 

An Oligopoly is a market form in which a market is dominated by a small number of sellers (oligopolists). The word is derived from the Greek for few sellers. Because there are few participants in this type of market, each oligopolist is aware of the actions of the others. Oligopolistic markets are characterised by interactivity. The decisions of one firm influence, and are influenced by, the decisions of other firms. Strategic planning by oligopolists always involves taking into account the likely responses of the other market participants. An oligopoly is a form of economy. As a quantitative description of oligopoly, the four-firm concentration ratio is often utilized. This measure expresses the market share of the four largest firms in an industry as a percentage. Using this measure, an oligopoly is defined as a market in which the four-firm concentration ratio is above 40%. An example would be the supermarket industry in the United Kingdom, with a four-firm concentration ratio of over 70% and the brewery industry also in the UK has a four firm concentration ratio of a staggering 85%. In The U.S. oligopolies include the industries that produce cigarettes, beer, aircraft, motor vehicles, men's slacks, as well as the music recording industry. Principles of MicroEconomics
Game Theory, Strategic Behavior, and Oligopoly In an oligopoly, firms operate under imperfect competition, the demand curve is kinked to reflect inelasticity below market price and elasticity above market price, the product or service firms offer are differentiated and barriers to entry are strong. Following from the fierce price competitiveness created by this sticky-upward demand curve, firms utilize non-price competition in order to accrue greater revenue and market share.

Oligopsony is a market form in which the number of buyers are small while the number of sellers in theory could be large. This typically happens in market for inputs where a small number of firms are competing to obtain factors of production. This also involves strategic interactions but of a different nature than when competing in the output market to sell a final output. Oligopoly refers to the market for output while oligopsony refers to the market where these firms are the buyers and not sellers (eg. a factor market). A market with a few sellers (oligopoly) and a few buyers (oligopsony) is referred to as a bilateral oligopoly.

The terms monopoly (one seller), monopsony (one buyer), and bilateral monopoly have a similar relationship.

In industrialized countries oligopolies are found in many sectors of the economy, such as cars, consumer goods, and steel production. Unprecedented levels of competition, fueled by increasing globalisation, have resulted in the emergence of oligopoly in many market sectors, such as the aerospace industry. There are now only a small number of manufacturers of civil passenger aircraft. A further instance arises in a heavily regulated market such as wireless communications. Typically the state will license only two or three providers of cellular phone services.

Oligopolistic competition can give rise to a wide range of different outcomes. In some situations, the firms may collude to raise prices and restrict production in the same way as a monopoly. Where there is a formal agreement for such collusion, this is known as a cartel. Firms often collude in an attempt to stabilise unstable markets, so as to reduce the risks inherent in these markets for investment and product development. There are legal restrictions on such collusion in most countries. There does not have to be a formal agreement for collusion to take place (although for the act to be illegal there must be a real communication between companies) - for example, in some industries, there may be an acknowledged market leader which informally sets prices to which other producers respond, known as price leadership.

In other situations, competition between sellers in an oligopoly can be fierce, with relatively low prices and high production. This could lead to an efficient outcome approaching perfect competition. The competition in an oligopoly can be greater than when there are more firms in an industry if for example the firms were only regionally based and didn't compete directly with each other.

The welfare analysis of oligopolies suffers, thus, from a sensitivity to the exact specifications used to define the market's structure. In particular, the level of deadweight loss is hard to measure. The study of product differentiation indicates oligopolies might also create excessive levels of differentiation in order to stifle competition.

 The cartel isn't for ever

Desoligopolization is the disappearance of an oligopoly.

Oligopoly theory makes heavy use of game theory to model the behaviour of oligopolies:

See also

External links

 

Strategic Decision Making in Oligopoly Markets

Introduction to Game Theory Game Theory is a hybrid branch of applied mathematics and economics that studies strategic situations where players choose different actions in an attempt to maximize their returns. First developed as a tool for understanding economic behavior and then by the RAND Corporation to define nuclear strategies, game theory is now used in many diverse academic fields, ranging from biology and psychology to sociology and philosophy. Beginning in the 1970s, game theory has been applied to animal behavior, including species' development by natural selection. Because of games like the prisoner's dilemma, in which rational self-interest hurts everyone, game theory has been used in political science, ethics and philosophy. Finally, game theory has recently drawn attention from computer scientists because of its use in artificial intelligence and cybernetics.

In addition to its academic interest, game theory has received attention in popular culture. A Nobel Prize-winning game theorist, John Nash was the subject of the 1998 biography by Sylvia Nasar and the 2001 film A Beautiful Mind. Game theory was also a theme in the 1983 film WarGames. Several game shows have adopted game theoretic situations, including Friend or Foe? and to some extent Survivor. The character Jack Bristow on the television show Alias is one of the few fictional game theorists in popular culture. [1]

Although similar to decision theory, game theory studies decisions that are made in an environment where various players interact. In other words, game theory studies choice of optimal behavior when costs and benefits of each option are not fixed, but depend upon the choices of other individuals.

 

Managerial Decisions in Competitive Markets

Michael E. Porter (born 1947) is an American academic focused on management and economics. He is currently the Bishop William Lawrence University Professor based at Harvard Business School where he leads the Institute for Strategy and Competitiveness.

He received a B.S.E. with high honors in aerospace and mechanical engineering from Princeton University in 1969, where he was elected to Phi Beta Kappa and Tau Beta Pi. He received an M.B.A. with high distinction in 1971 from the Harvard Business School, where he was a George F. Baker Scholar, and a Ph.D. in Business Economics from Harvard University in 1973.

A leading contributor to strategic management theory, Porter's main academic objectives focus on how a firm or a region, can build a competitive advantage and develop competitive strategy. Porter's strategic system consists primarily of:

In 1984, he was one of the co-founders of Monitor Group, a leading global strategy and management consulting firm with headquarters in Cambridge, Massachusetts. In 1994, he founded the Initiative for a Competitive Inner City, a non-profit organization with a mission of fostering economic development in the impoverished inner city.

See also

Industry analysis

 

Managerial Decisions for Firms with Market Power

In economics, Market Power is the ability of a firm to alter the market price of a good or service. A firm with market power can raise price without losing all customers to competitors.

When a firm has market power it faces a downward-sloping demand curve.

In perfectly competitive markets, market participants have no market power. A firm with market power has the ability to individually affect either the total quantity or the prevailing price in the market. If the demand curve is downward sloping (that is, the most common situation where price increases lead to a lower quantity demanded), then the decrease in supply as a result of the exercise of market power creates an economic deadweight loss in comparison with a situation of perfect competition. This is often viewed as socially undesirable, and as a result, many countries have anti-trust or other legislation with the aim of limiting the ability of firms to accrue market power. Such legislation often regulates mergers and sometimes introduces a judicial power to compel divestiture.

A firm usually has market power by virtue of it controlling a large portion of the market. In extreme cases - monopoly and monopsony - the firm controls the entire market. However, market size alone is not a good indicator of market power. Highly concentrated markets may be contestable if there are no barriers to entry or exit, limiting the incumbent firm's ability to raise its price above competitive levels.

Market power gives firms the ability to engage in unilateral anti-competitive behavior. Such behaviour may include predatory pricing, product tying, and creation of overcapacity or other barriers to entry. If no individual participant in the market has significant market power, then anti-competitive behavior can take place only through collusion, or the exercise of a group of participants' collective market power.

 

Real-World Competition and Technology

Building a strong internal brand

Sustainable Competitive Advantage (SCA) A company that is more profitable than its rivals is exploiting some form of competitive advantage. The benchmark for profitability is the company's cost of capital. To consistently make profits in excess of its cost of capital - economic rent - the company must possess some form of sustainable competitive advantage (SCA) to derive firm specific distinctive strategic positioning.

A firm possesses a SCA when it has value creating processes and positions that cannot be duplicated or imitated by other firms that lead to the production of above normal rents. A SCA is different from a competitive advantage (CA) in that it provides a long-term advantage that is not easily replicated. However, these above normal rents can attract new entrants who drive down economic rents. A CA is a position a firm attains that lead to above normal rents or a superior financial performance. The processes and positions that engender such a position (CA) is not necessarily non-duplicable or inimitable. It is possible for some companies to, temporarily, make profits above the cost of capital without sustainable competitive advantage.

 

A key difference between CA and SCA is that the processes and positions a firm may hold are non-duplicable and inimitable when a firm possesses a SCA. Hence a sustainable competitive advantage is one that can be maintained for a significant amount of time even in the presence of competition. This brings us to the question what is a "significant amount of time". A CA becomes SCA when all duplication and imitation efforts have ceased and the rival firms have not been able to create the same value that the said firm is creating.

Analysis of the factors of profitability is the subject of numerous theories of strategy including the five forces model pioneered by Michael Porter of the Harvard Business School.

In marketing and strategic management, sustainable competitive advantage is an advantage that one firm has relative to competing firms. The source of the advantage can be something the company does that is distinctive and difficult to replicate, also known as a core competency. For example P&G' ability to derive superior consumer insights and implement them in managing its brand portfolio. It can also be an asset such as a brand, e.g. Coca Cola or a patent, such as Viagra. It can also simply be a result of the industry's cost structure, for example the large fixed costs that tend to create natural monopolies in utility industries. To be sustainable, the advantage must be:

  1. Distinctive
  2. Proprietary
There are basically three types of assets that help build an SCA. These categories are exhaustive and include all of the company's SCAs.

1) Organization and managerial process

a) Coordination and integration: Coordination among teams in organization is key to organizational success. Interdepartmental coordination and resource sharing to reach a common goal is fundamental to creating "value". Integrating resources is key to the success of firms. Firms that are able to integrate resources see synergistic effects of resources coming together.
 
b) Learning: Organizational learning is key to the success of a firm. It determines how a firm collects, distributes, interprets and responds to market based information collection and changes in the environment. These changes in the environment could be customer based changes, technological developments, legal and government restrictions. Firms have to develop robust market sensing and spanning capabilities to effectively collect information. Once they collect info they have embed this knowledge in the products they produce.
 
c) Reconfiguring and transformation: The environment for firms is constantly changing and constant reconfiguring and transformation is key to forming SCA. A double loop learning and transformation is key to producing innovative products. Innovative capacity of a firm determines how it reacts and learns from market information.

2) Positions: market positions are the assets of a company. Most of them are self explanatory

a) Technological assets
b) Financial assets
c) Reputational assets
d) Structural assets: The structure of a company can determine how it performs. The hierarchy of a company can influence its culture, procedure and routines.
 
3) Paths:
 
a) Path dependencies: At the birth of a company usually accompanied with certain orientations. The progenitor brings certain orientations and attributes that stay with the company for a long time. The path the company takes then determines the development of its competencies.
 
b) Technological opportunities: technology development at a time can determine how a firm can exploit opportunities to form SCA. Very often we see the advent of several technological factors converging into a capability that forms a SCA. An example would be the rise of companies such as Genentech at the turn of the previous century with the advent of gene mapping, significant developments in target selection and databases of previous studies and gene pools.
 

 

Lunar Impact

See also

A Technological Change is a term that is used in economics to describe a change in the set of feasible production possibilities.

A neutral technological change refers to the behaviour of technological change in models. A technological innovation is Hicks neutral (following Hicks (1932)) if the ratio of capital's marginal product to labour's marginal product is unchanged for a given capital to labour ratio. A technological innovation is Harrod neutral (following Hicks (1932)) if the technology is labour-augmenting (i.e. helps labor); it is Solow neutral if the technology is capital-augmenting (i.e. helps capital).

To economists technological change is different from a technical change.

More information on the economic view of technological change can be found in the reference by Jones given below. Mansfield has an old but readable section on technological change as well.

Other views of technological change include Thomas Kuhn's sociological view of scientists working within paradigms and even the concept of memes as proposed by Richard Dawkins. Short summaries of these and other views plus references and suggested reading can be found in Chapter 14 and in the reference section of [1].

 

Policy and Regulation

Antitrust or competition laws are laws which prohibit anti-competitive behavior and unfair business practices. The laws make illegal certain practices deemed to hurt businesses or consumers or both, or generally to violate standards of ethical behavior. Government agencies known as competition regulators regulate antitrust laws, and may also be responsible for regulating related laws dealing with consumer protection.

The term "antitrust" derives from the U.S. law which was originally formulated to combat "business trusts", now more commonly known as cartels. Other countries use the term "competition law". Many countries including most of the Western world have antitrust laws of some form. For example the European Union has its own competition law.

Global Competition Forum - Middle East and Asia

 

Global Competition Forum - Europe

 

Global Competition Forum - North & Central America and the Caribbean

Global Competition Forum - Africa

 

Global Competition Forum - Oceania

 

Case Studies

China Mobile

Exxon Mobil

Microsoft Windows

Wall-Mart

 

 

Advanced Managerial Decision Making

Tutorials

Readings

 

Advanced Techniques for Profit Maximization

Sales Revenue Maximisation

The questions include you interpreting the model output within your answers. In this case, the model output consists of the following;

  • The price
  • The quantity
  • The total revenue
  • The total costs
  • The profit

Your discussion should focus on using the simulations to support the theoretical expectations of your discussion. For instance, you could argue that the consumer is better off when the price is low and the quantity supplied is high (large consumer surplus). Given this assumption then the consumer should be better off if the firm sales maximisation compared to profit maximisation. You can test this expectation using the simulation.

Activity

How does this phone add value?

Image: How does this phone add value?

 

Risk and Uncertainty

Risk is a concept which relates to human expectations. It denotes a potential negative impact to an asset or some characteristic of value that may arise from some present process or from some future event. In everyday usage, "risk" is often used synonymously with "probability" of a loss or threat. In professional risk assessments, risk combines the probability of an event occurring with the impact that event would be and with its different circumstances. However, where assets are priced by markets, all probabilities and impacts are reflected in the market price, and risk therefore comes only from the variance of the outcomes; this startling fact is one of the conclusions of Black-Scholes pricing theory. Integrated Risk Management Framework




Factor Markets

Tutorials

Readings

Factors of Production are resources used in the production of goods and services in economics. Classical economics distinguishes between three factors:

See also

International Trade and Trade Barriers

 

In economics the Labour Force is the group of people who have a potential for being employed.

Normally, the labor force consists of everyone of working age (typically above a certain age (around 14 to 16) and below retirement (around 65) who are participating workers, that is people actively employed or seeking employment. People not counted include students, retired people, stay-at-home parents, people in prisons or similar institutions, as well as discouraged workers who simply do not want work.

The ratio between the labor force and the overall size of their cohort (national population of the same age range) is known as the labor force participation rate. In the West during the latter half of the 20th century, the labor force participation rate increased significantly, largely due to the increasing number of women entering the workplace.

The fraction of the labor force that cannot find work determines the unemployment rate.

See also

Median Earnings and Tax Paid by Level of Education 2003

Labour Economics seeks to understand the functioning of the market and dynamics for labour. Labour markets function through the interaction of workers and employers. Labour economics looks at the suppliers of labour services (workers), the demanders of labour services (employers), and attempts to understand the resulting pattern of wages, employment, and income.

It is an important subject because unemployment is a problem that affects the public most directly and severely. Full employment (or reduced unemployment) is a goal of many modern governments.

In economics, a person who is able and willing to work at a prevailing wage rate yet is unable to find a paying job is considered to be Unemployed. The unemployment rate is the number of unemployed workers divided by the total civilian labor force, which includes both the unemployed and those with jobs (all those willing and able to work for pay). In practice, measuring the number of unemployed workers actually seeking work is notoriously difficult, particularly those whose unemployment benefits have expired before finding work. There are several different methods for measuring the number of unemployed workers, each with its own biases, making comparisons between methods difficult.

Unemployment, NAIRU and the Phillips Curve - Mind Map

Larger Map

The history of unemployment is the history of industrialization. It was not considered an issue in rural areas, despite the "disguised unemployment" of rural laborers having little to do, especially in conditions of overpopulation.

The terms unemployment and unemployed are sometimes used to refer to other inputs to production that are not being fully used — for example, unemployed capital goods.

Activity

Macro-Economics - Aggregate Demand, Inflation, Unemployment and Growth

Aggregate Supply (AS)

The model shows the economy in an equilibrium position with inflation currently standing at 2.9% and output at Yo. This output level is consistent with a current rate of unemployment of 5%. We can now use changes in the AS and AD curves to analyse what happens to the whole economy. The problem is that we need to make some judgements about the extent to which the factors we have highlighted in the 'News' section above will affect these curves. This is why economists use the famous 'ceteris paribus' phrase - 'other things remaining equal' it allows us to identify what the effect of the change in one factor might be whilst recognising that in reality all these other things do not remain constant!

 

The Distribution of Income

Income and Wealth Distribution - Mind Map

Larger Map

Income distribution has always been a central concern of economic theory and economic policy. Classical economists such as Adam Smith, Thomas Malthus and David Ricardo were mainly concerned with factor income distribution, that is, the distribution of income between the main factors of production, land, labour and capital.

Modern economists have also addressed this issue, but have been more concerned with the distribution of income across individuals and households. Important theoretical and policy concerns include the relationship between income inequality and economic growth.

The distribution of income within a community may be represented by the Lorenz curve. The Lorenz curve is closely associated with measures of income inequality, such as the Gini coefficient.

 Family Income Distribution

See also

 

Applying Economic Reasoning to Policy

Tutorials

Readings

Market Failures and Government Policy

Government Intervention in Markets - Mind Map

Larger Map

Government Failure Map

Larger Map

Market Failure is a situation in which markets do not efficiently organize production or allocate goods and services to consumers. To economists, the term would normally be applied to situations where the inefficiency is particularly dramatic, or when it is suggested that non-market institutions (such as public policing and firefighting) would be more efficient and wealth-producing than their private alternatives.

On the other hand, many market failures are situations where market forces do not serve the perceived public interest. Here, the focus is on the economists' theories of market failure. Economists use model-like theorems to explain or understand such cases. The two main reasons that markets fail are:

The word "failure" here is not intended to mean an economic collapse, or a breakdown in market relations. Market failure is a claim that the market is failing to create maximum efficiency. It doesn't mean that the market has broken down or ceased to exist.

To understand the concept of market failure, it is first necessary to understand this key term:

In terms of market failure, due to nonrivalry and nonexcludability, private firms cannot profitably produce a public good. If, then, society still demands the good, it is the responsibility of the government to provide it---of course, the government can provide it only when funded by taxes.

 

Macroeconomic Policies

In economics, Inflation is a fall in the market value or purchasing power of money. This is equivalent to a sustained increase in the general level of prices. Inflation is the opposite of deflation. The term is applied to a given economic region in which a currency is used, however it may apply to smaller or larger regions also.

In some contexts the term inflation is used to refer to an increase in the money supply, although this concept is also often referred to as monetary expansion. There is some dispute between different economic schools of thought as to which of these is "real" inflation, for prices of goods and services in the currency in question to rise, or for the money supply to increase. These differing definitions (see polysemes) of inflation relate to whether it is viewed as a certain economic process, or if it merely is used to refer to a particular set of economic symptoms that result from underlying processes. Both forms of usage of the term are reasonably common.

Activity

Example of the type of vessels McBrides will be dismantling.

Related Web sites for research

 

International Policy Issues

Tutorials

Readings

External Shocks to the Global Economy - Mind Map

Larger Map

 

International Trade is the exchange of goods and services across international boundaries or territories. In most countries, it represents a significant share of GDP. While international trade has been present throughout much of history (see Silk Road, Amber Road), its economic, social, and political importance has been on the rise in recent centuries. Industrialization, advanced transportation, globalization, multinational corporations, and outsourcing are all having a major impact. Increasing international trade is the usually primary meaning of "globalization".

International trade is also a branch of economics, which, together with international finance, forms the larger branch of international economics.

International Relations Council Journal

International Relations Council Journal
Spring 2005, Volume 2
(Download PDF File (3.8MB)

International Economics - Mind Map

Larger Map

 

Most active regional blocs in the world.

A Trade Bloc is a large free trade area or free trade area formed by one or more tax, tariff and trade agreements. Typically trade pacts that define such a bloc specify formal adjudication bodies, e.g. NAFTA trade panels. This may include even a more democratic and participative system, as the EU and its parliament.

Particularly since the demise of most of the world's empires, a number of international—generally regionally based—economic blocs have been developed to promote trade between member states.

Several blocs also have stated or implicit political goals—notably the EU. Varieties of economic blocs include free trade areas, customs unions, single markets, and economic and monetary unions.

One of the first economic blocs was the German Customs Union (Zollverein) initiated in 1834, formed on the basis of the German Confederation and subsequently German Empire from 1871.

A trade bloc is established through a trade pact (or pacts) covering different issues of the economic integration.

The European Union 1 - Mind Map

Larger Map

 

International Finance is the branch of economics that studies the dynamics of exchange rates, foreign investment, and how these affect international trade. What Is the International Monetary Fund?

Fixed or Floting

In finance, the Exchange Rate (also known as the foreign-exchange rate, forex rate or FX rate) between two currencies specifies how much one currency is worth in terms of the other. For example an exchange rate of 120 Japanese yen (JPY, ¥) to the United States dollar (USD, $) means that JPY 120 is worth the same as USD 1. The foreign exchange market is one of the largest markets in the world. By some estimates, about 2 trillion USD worth of currency changes hands every day.

Exchange Rate Modeling

The spot exchange rate refers to the current exchange rate. The forward exchange rate refers to an exchange rate that is quoted and traded today but for delivery and payment on a specific future date.

 

Latest news and statistics on China's economy and business climate. Foreign Direct Investment (FDI) is defined as a long term investment by a foreign direct investor in an enterprise resident in an economy other than that in which the foreign direct investor is based. The FDI relationship, consists of a parent enterprise and a foreign affiliate which together form a Transnational Corporation (TNC). In order to qualify as FDI the investment must afford the parent enterprise control over its foreign affiliate. The UN defines control in this case as owning 10% or more of the ordinary shares or voting power of an incorporated firm or its equivalent for an unincorporated firm.

In the years after the Second World War global FDI was dominated by the United States, as much of the world recovered from the destruction wrought by the conflict. The U.S. accounted for around three-quarters of new FDI (including reinvested profits) between 1945 and 1960. Since that time FDI has spread to become a truly global phenomenon, no longer the exclusive preserve of OECD countries. FDI has grown in importance in the global economy with FDI stocks now constituting over 20% of global GDP. In the last few years, the emerging market countries such as China and India have become the most favoured destinations for FDI and investor confidence in these countries has soared. As per the FDI Confidence Index compiled by A.T. Kearney for 2005, China and India hold the first and second position respectively, whereas United States has slipped to the third position.

 

Monetary Policy is the government or central bank process of managing money supply to achieve specific goals—such as constraining inflation, maintaining an exchange rate, achieving full employment or economic growth. Monetary policy can involve changing certain interest rates, either directly or indirectly through open market operations, setting reserve requirements, or trading in foreign exchange markets. [1]

How monetary policy works?

Monetary policy is generally referred to as either being an expansionary policy, or a contractionary policy, where an expansionary policy increases the total supply of money in the economy, and a contractionary policy decreases the total money supply. Expansionary policy is traditionally used to combat unemployment in a recession by lowering interest rates, while contractionary policy has the goal of raising interest rates to combat inflation.

The great thrift shift

China plans prudent monetary policy for 2006

 

Fiscal Policy is the economic term which describes the actions of a government in setting the level of public expenditure and how that expenditure is funded.

It contrasts with monetary policy, which describes the policies about the supply of money to the economy.

 Fiscal Policy
Interactions between Monetary & Fiscal Policy

Activities

Dollars

Image: The falling dollar may mean a rise in tourism to the US but the effect might be mitigated by the increased security measures being introduced by US authorities.
Source: Jake Levin, stock xchng

 

EU Logo

 

Oil prices per barrel in US dollars, 1970-2005

Data source: Energy Information Administration

 

Dominican Girl

Image: Will opening up of markets to free trade lead to an improvement in the standard of living of those in the developing world? This little girl lives in the Dominican Republic, a country where the GDP per capita is $6,000 and where the inequality in the distribution of income is very high with the richest 10% of the population owning 40% of the wealth of the country. Copyright: Natalia Anna Kozlowska, stock.xchng

 

Recommended Texts

Managerial Economics

Managerial Economics, 9/e

Christopher Thomas

ISBN: 0073402818
Copyright year: 2008

Check the availability and buy your books from our Bookshop.
Microeconomics

Microeconomics, 5/e

David C Colander, Middlebury College

ISBN: 007254936x
Copyright year: 2004

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Macroeconomics

Macroeconomics, 5/e

David C Colander, Middlebury College

ISBN: 0072551194
Copyright year: 2004

Check the availability and buy your books from our Bookshop.

 

Resources

 

 

Country Briefings - China

Country Briefings - Egypt

Country Briefings - Hong Kong

Country Briefings - USA

Econweb Introduction

Case Studies

Exxon Mobil

Exxon Mobil Corporation or ExxonMobil (NYSE: XOM) is the largest publicly traded integrated oil and gas company in the world, formed on November 30, 1999, by the merger of Exxon and Mobil. It is the sixth-largest company in the world as ranked by the Forbes Global 2000 and the largest company in the world (by revenue) as ranked by the Fortune Global 500. It is the largest of the four oil "supermajors", which also includes BP (formerly British Petroleum), Shell and Total. It has the highest market value of any publicly traded company in the world, and in 2005 was the most profitable.

China Mobile

China Mobile Communications Corporation (中国移动通信 Zhongguo Yidong Tongxin) SEHK: 0941NYSE: CHL）, also known as China Mobile or CMCC, is the People's Republic of China's largest mobile phone operator. It is the world's largest mobile phone operator ranked by number of subscribers, with over 200 million customers. By turnover it is second to Vodafone. A state-owned enterprise, it was spun off from former monopoly China Telecom in 2000, and now has a 37.4% share of the highly competitive Chinese mobile market.

See also

 

Microsoft Windows

Microsoft Windows is a family of operating systems by Microsoft for use on personal computers, although versions of Windows designed for servers, embedded devices, and other platforms also exist. Microsoft first introduced an operating environment named Windows in November 1985 as an add-on to MS-DOS in response to the growing trend of graphical user interfaces popularized by the Apple Macintosh. Microsoft Windows eventually came to dominate the world's personal computer market. At the 2004 IDC Directions conference, IDC Vice President Avneesh Saxena stated that Windows had approximately 90% of the client operating system market.[1]

Wall-Mart

Wal-Mart Stores, Inc. (NYSE: WMT) is an American public corporation, founded by Sam Walton in 1962 and first incorporated on October 31, 1969, and listed on the New York Stock Exchange in 1972. It is the largest retailer in the world and the second largest corporation in the world based on revenue as of 2006.[1] For the fiscal year ending January 31, 2006, Wal-Mart reported net income of $11.2 billion on $316 billion of sales revenue (3.5% profit margin).[2] It is the largest private employer in the United States, Mexico and Canada.[2]

In the United States, Wal-Mart holds an 8.9% retail store market share.[2] It is also the largest grocery retailer in the United States, with an estimated 20% of the retail grocery and consumables business,[3] and is also the largest toy seller in the United States, with an estimated 22 percent of the retail toy business, having surpassed Toys 'R' Us in the late-1990s.[4]

Internationally, Wal-Mart operates in Mexico as Walmex, in the United Kingdom as ASDA and in Japan as The Seiyu Co., Ltd.. In 2006, Wal-Mart's international operations accounted for approximately 20.1% of total sales.[5] Wholly-owned operations are located in Argentina, Brazil, Canada, South Korea, Puerto Rico, and the United Kingdom. Wal-Mart's investments outside of North America have produced mixed results. Recently Wal-Mart sold its retail operations in some countries including South Korea and Germany.

Wal-Mart has been widely criticized for its policies and business practices by community groups, grassroots organizations, labor unions,[6] religious organizations,[7][8] and environmental groups. Specific concerns include the corporation's extensive foreign product sourcing, treatment of employees and product suppliers, environmental practices, the use of public subsidies, and the impact of stores on the local economies of towns in which they operate.[9][10][11]