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Managerial economics, meaning the application of economic methods in the managerial decision-making process, is a fundamental part of any business or management course. This textbook covers all the main aspects of managerial economics: the theory of the firm; demand theory and estimation; production and cost theory and estimation; market structure and pricing; game theory; investment analysis and government policy. It includes numerous and extensive case studies, as well as review questions and problem-solving sections at the end of each chapter. Nick Wilkinson adopts a user-friendly problem-solving approach which takes the reader in gradual steps from simple problems through increasingly difficult material to complex case studies, providing an understanding of how the relevant principles can be applied to real-life situations involving managerial decision-making. This book will be invaluable to business and economics students at both undergraduate and graduate levels who have a basic training in calculus and quantitative methods.
To introduce the concept of production and explain its relevance to managerial decision-making.
To explain the meaning and significance of different time frames.
To describe the different factors of production and explain the concept of the production function.
To explain the different concepts of efficiency.
To explain the concept of an input-output table and its applications to different time frames and to isoquants.
To explain isoquant analysis and its applications in both short-run and long-run situations.
To explain how an optimal combination of inputs can be determined in both short-run and long-run situations.
To explain the parallels between production theory and consumer theory.
To describe different forms of production function and their implications.
To explain the concept of returns to scale and its relationship to production functions and empirical studies.
To describe and explain relationships between total, average and marginal product, and the different stages of production.
To enable students to apply the relevant concepts to solving managerial problems.
In the previous chapters we have seen how firms are usually profit-oriented in terms of their objectives and we have focused on the revenue side of the profit equation by examining demand. We now need to examine the other side of the profit equation by considering costs. However, just as we had to examine consumer theory in order to understand demand, we must now examine production theory before we can understand costs and cost relationships.
Part II (Chapters 3 and 4) examines the topic of demand. The demand for a firm's products determines its revenues and also enables the firm to plan its production; thus a thorough understanding of demand by managers is fundamental to a firm's profitability. Chapter 3 is concerned with the factors that determine demand, both those that are controllable by the firm and those that are uncontrollable, or environmental. The sensitivity of demand to these factors is examined, and also how knowledge of this sensitivity is useful to managers. Chapter 4 is concerned with the estimation of demand, examining techniques for estimating and interpreting demand relationships, and using such relationships for forecasting purposes. The use of statistical methods is explained in particular. Finally, important results from empirical studies are discussed.
To explain the concept of market structure and its significance.
To describe the characteristics of the different types of market.
To examine the relationships between structure, conduct and performance.
To explain the equilibrium conditions for different types of market in terms of price and output, both in graphical and algebraic terms.
To explain the types and significance of entry and exit barriers.
To give examples of different industries where different market conditions exist, explaining their prevalence.
To examine some welfare implications regarding different forms of market.
To emphasize the importance of oligopolistic markets, and examine the particular problems relating to their analysis.
In order to maximize profits or shareholder wealth, managers must use the information that they have relating to demand and costs in order to determine strategy regarding price and output, and other variables. However, managers must also be aware of the type of market structure in which they operate, since this has important implications for strategy; this applies both to short-run decision-making and to long-run decisions on changing capacity or entering new markets.
It is useful to start by explaining the characteristics of markets and different types of market structure, with a general examination of the relationships between structure, conduct and performance. The four main types of market structure are then discussed and analysed in terms of their strategic implications.
To explain the importance of cost estimation for managerial decision-making.
To explain the different methods of cost estimation and their relative advantages and disadvantages.
To describe the different types of empirical study which are used in cost estimation.
To explain the types of problem which are encountered in statistical cost estimation.
To explain how these problems apply in different ways to short-run and long-run situations.
To explain how these problems can be overcome.
To describe and interpret the different types of cost function in mathematical terms.
To explain the specification and estimation of the learning curve.
To examine and interpret the findings of various empirical studies.
After discussing the theory of demand in Chapter 3 we proceeded to examine the estimation of demand functions in the following chapter. Now that we have discussed the theoretical aspects of production and cost we need to examine the estimation of cost functions.
Importance of cost estimation for decision-making
We have already seen in the previous chapter why managers need to understand the nature and application of cost functions in various aspects of decision-making. Since these functions are not self-evident, they have to be estimated using an appropriate method. Managers cannot apply their knowledge of the firm's cost functions unless these have been estimated in the first place.
Part I (Chapters 1 and 2) examines the nature, scope and methods of managerial economics and the theory of the firm. Chapter 1 is therefore concerned with explaining why managerial economics is important and useful as an area of study, how it relates to other disciplines, what its core areas are, and the methods of analysis which it uses. Chapter 2 examines the basic profit-maximizing model of behaviour, and its underlying assumptions, and then proceeds to relax these assumptions to develop a more complex but realistic model of firms' behaviour. The focus is on the individual and the nature of transactions, with an emphasis on agency theory. These two chapters introduce the framework of parameters and analysis that are developed throughout the remainder of the text.
To explain the meaning and use of different concepts of cost.
To show how different concepts of cost are relevant for managerial decision-making.
To explain how production relationships underlie cost relationships.
To explain cost behaviour in the short run.
To explain cost behaviour in the long run.
To explain how cost relationships can be derived in mathematical terms.
To explain the purpose and principles of cost–volume–profit analysis.
To describe a problem-solving approach for applying cost–volume–profit analysis.
Importance of costs for decision-making
Demand analysis is fundamentally concerned with the revenue side of an organization's operation; cost analysis is also vital in managerial economics, and managers must have a good understanding of cost relationships if they are to maximize the value of the firm. Many costs are more controllable than are factors affecting revenue. While a firm can estimate what effect an increase in advertising expenditure will have on sales revenue, this effect is generally more uncertain than a decision to switch suppliers, or invest in new machinery, or close a plant.
Just as with production theory, the distinction between short run and long run is an important one. In the short run, managers are concerned with determining the optimal level of output to produce from a given plant size (or plant sizes, for a multiplant firm), and then planning production accordingly, in terms of the optimal input of the variable factor, scheduling and so on.
To explain the nature and significance of capital budgeting.
To describe and distinguish between different types of investment or capital expenditure.
To explain the process and principles of cash flow analysis.
To explain the different methods of evaluating investment projects.
To explain the concept and measurement of the cost of capital.
To explain the nature and significance of risk and uncertainty in investment appraisal.
To examine the measurement of risk.
To explain the different ways of incorporating risk into managerial decision-making in terms of investment analysis.
To explain the concept of the optimal capital budget and how it can be determined.
The nature and significance of capital budgeting
So far in the analysis of the previous chapters we have concentrated largely on the aspects of managerial decision-making that relate to making the most efficient use of existing resources. It is true that some aspects of decision-making in the long run have been considered, for example determining the most appropriate scale for producing a given output (Chapter 6), and the decision to expand capacity in a duopolistic market (Chapter 9), but many factors were taken as given in these situations. This chapter examines these long-run decisions in more detail, and explains the various factors that need to be considered in determining whether to replace or expand a firm's resources. As has been the case throughout the book, it will normally be assumed that the firm's objective is to maximize shareholder wealth, but certain aspects of public sector decision-making will also be considered, and these will be examined in further detail in the final chapter.
To explain why government policy is important for managerial decision-making.
To discuss the objectives of government policy.
To emphasize the distinction between positive and normative aspects of policy.
To explain the concept of market failure and its implications for both governments and businesses.
To explain the concept of externalities and their relevance to both governments and businesses.
To explain the concept of public goods and their relationship with externalities.
To discuss the importance of transaction costs and their implications.
To discuss certain social and ethical issues which are particularly relevant in business decision-making.
To explain why government intervention can be desirable in certain markets.
To explain the SCP model and its shortcomings.
To discuss the objectives of government policy in the areas of monopoly and competition policy.
To point out differences between objectives in the UK, the EU and the USA.
To discuss the various policy options in monopoly policy, explaining the relative advantages and disadvantages.
To discuss the various policy options in competition policy, explaining the relative advantages and disadvantages.
To describe the policies implemented by the UK, the EU and the USA, making comparisons.
Importance of government policy
The first fundamental question here is: why should government policy be important to managers? Government policy affects firms in a multitude of ways and managers need to know what these policy effects are likely to be so that they can anticipate both the policies and their effects.
To outline the types of issue which are addressed by managerial economics.
To explain the difference between positive and normative economics.
To explain the relationship between managerial economics, economic theory and the decision sciences.
To explain how managerial economics is related to other disciplines in business, such as marketing and finance.
To identify the main subject areas in managerial economics, explain how they are related to each other, and describe how they are organized and presented in the text.
To explain the methods used in the development of scientific theories and show their relevance to managerial economics.
To explain how economic theory is presented from a pedagogical viewpoint, and how this relates to the organization and presentation of the material in the text.
What is managerial economics about? What kind of issues does it deal with? How can it help us make better decisions, in business or elsewhere? These are fundamental questions which any student may ask when first approaching the subject. It is therefore a good idea to make a start by examining a situation that has become increasingly high on the economic and political agenda on a global basis over many years; yet it is not a situation where it might seem at first sight that managerial economics is particularly relevant. We shall see, to the contrary, that the methods studied and implemented in managerial economics are vital to identifying solutions to the problems raised.
To explain the significance of pricing, both in the economic system as a whole and from a management perspective.
To explain the context in which pricing decisions are and should be made.
To relate the concepts and analysis of the previous chapters to more complex and detailed pricing situations.
To explain the importance of the concept of competitive advantage.
To explain the concept of value creation and to show its significance in a purchasing model.
To explain the meaning of market positioning and its strategic implications.
To discuss market segmentation and targeting strategies.
To explain the meaning and uses of price discrimination.
To analyse pricing decisions for firms producing multiple products.
To analyse pricing decisions for firms producing joint products.
To explain the concept of transfer pricing and the issues involved.
To examine the dynamic aspects of pricing, by discussing pricing over the product life-cycle.
To consider other pricing strategies that firms tend to use in practice.
Pricing is often treated as being the core of managerial economics. There is certainly a fair element of truth in this, since pricing brings together the theories of demand and costs that traditionally represent the main topics within the overall subject area. However, as indicated in various parts of this text, this can lead to an over-narrow view of what managerial economics is about. This chapter will continue to examine pricing in a broader context, but first it is helpful to consider the role of pricing in the economic system.
Part IV (Chapters 8–12) examines the nature of strategic behaviour and various decision-making tools that managers can use in determining strategy. Chapter 8 considers market structure, which forms the environmental framework within which strategic behaviour takes place. Chapter 9 examines game theory in some detail, and discusses its implications in terms of decision-making. It is stressed that many of its conclusions are counter-intuitive, but are the only way of explaining many aspects of firms' behaviour that are empirically observed. Chapters 10 and 11 consider the detailed aspects of pricing and investment strategies respectively. Finally, Chapter 12 examines government policy insofar as it impacts on managerial decision-making.
To define and explain the significance of strategic behaviour.
To explain the characteristics of different types of games and show how differences in these characteristics affect the behaviour of firms.
To examine the various concepts of equilibrium in terms of strategies.
To examine the concepts of Cournot and Bertrand competition.
To explain the relationships between static and dynamic games.
To explain the solution of dynamic games using the backward induction method.
To explain the importance of strategic moves and commitment.
To discuss the concept of credibility and the factors which determine it.
To examine games with uncertain outcomes and explain different approaches to their solution.
To examine repeated games and how their nature leads to different solutions from one-shot games.
To examine a variety of different applications, in order to relate game theory concepts to much of the other material in the book.
To demonstrate how game theory explains much firm behaviour that cannot be explained by traditional analysis.
To stress that many of the conclusions of game theory are counter-intuitive.
In the previous chapter we have indicated that oligopoly is in practice the most common form of market structure. Most of the products that people consume, from cars to consumer electronics, cigarettes to cereals, domestic appliances to detergents, and national newspapers to athletic shoes, are supplied in oligopolistic markets. This also applies to many services, like supermarket retailing, travel agencies and, at least in the UK, commercial banking.
Part III (Chapters 5–7) is concerned with the analysis of production and cost relationships. A knowledge of these is fundamental to capacity planning in the long run, as well as scheduling and purchasing in the short run. Managers can then operate the firm efficiently, manipulating the use of inputs appropriately. Chapter 5 is concerned with the nature of production relationships between inputs and outputs, which in turn determine cost relationships with outputs. The latter are examined in detail in Chapter 6, with a particular emphasis on the use of cost–volume– profit analysis. Chapter 6 is concerned with the estimation of cost relationships, and again makes use of the statistical methods explained in Chapter 4, while describing the particular problems associated with measuring cost relationships. The results of empirical studies are also discussed.
Managerial economics, meaning the application of economic methods to the managerial decision-making process, is a fundamental part of any business or management course. It has been receiving more attention in business as managers become more aware of its potential as an aid to decision-making, and this potential is increasing all the time. This is happening for several reasons:
It is becoming more important for managers to make good decisions and to justify them, as their accountability either to senior management or to shareholders increases.
As the number and size of multinationals increases, the costs and benefits at stake in the decision-making process are also increasing.
In the age of plentiful data it is more imperative to use quantitative and rationally based methods, rather than ‘intuition’.
The pace of technological development is increasing with the impact of the ‘new economy’. Although the exact nature of this impact is controversial, there is no doubt that there is an increased need for economic analysis because of the greater uncertainty and the need to evaluate it.
Improved technology has also made it possible to develop more sophisticated methods of data analysis involving statistical techniques. Modern computers are adept at ‘number-crunching’, and this is a considerable aid to decision-making that was not available to most firms until recent years.
As managerial economics has increased in importance, so books on the subject have proliferated. Many of the more recent ones claim like this one to take a problem-solving approach.