Transcript Managerial Economics & Business Strategy

Managerial Economics &
Business Strategy
Chapter 1
The Fundamentals of Managerial
Economics
Opportunity Cost
• Accounting Costs


The explicit costs of the resources needed to produce
produce goods or services.
Reported on the firm’s income statement.
• Opportunity Cost

The cost of the explicit and implicit resources that are
foregone when a decision is made.
• Economic Profits

Total revenue minus total opportunity cost.
Why use opportunity cost?
• Situation: You are able to open a pizza shop in a building
that you own. During the year Uncle Vinnie offers you a job
with his pizza shop (he wants to eliminate the competition)
which will pay $30,000 and Aunt Judy offers you $100,000
to rent the building for a year for her new hair salon. You
decide to continue with your pizza shop. At the end of the
year you calculate the following on your income statement.


Revenue = $100,000
Cost of Supplies = $20,000
• Did you make a good decision???
Did you???
• Accounting profit


100,000 - 20,000 = 80,000
Looks like you did!!!
• Economic profit


100,000 – 20,000 – 30,000 – 100,000 = -$50,000
You could have done better by taking them up on their offers
The Five Forces Framework
Entry Costs
Speed of Adjustment
Sunk Costs
Economies of Scale
Entry
Power of
Input Suppliers
Power of
Buyers
Supplier Concentration
Price/Productivity of
Alternative Inputs
Relationship-Specific
Investments
Supplier Switching Costs
Government Restraints
Sustainabl
e Industry
Profits
Industry Rivalry
Concentration
Price, Quantity, Quality, or
Service Competition
Degree of Differentiation
Network Effects
Reputation
Switching Costs
Government Restraints
Switching Costs
Timing of Decisions
Information
Government Restraints
Buyer Concentration
Price/Value of Substitute
Products or Services
Relationship-Specific
Investments
Customer Switching Costs
Government Restraints
Substitutes & Complements
Price/Value of Surrogate Products
or Services
Price/Value of Complementary
Products or Services
Network Effects
Government
Restraints
Market Interactions
• Consumer-Producer Rivalry

Consumers attempt to locate low prices, while producers attempt to
charge high prices.
• Consumer-Consumer Rivalry

Scarcity of goods reduces the negotiating power of consumers as
they compete for the right to those goods.
• Out-bid or under-bid
• Producer-Producer Rivalry

Scarcity of consumers causes producers to compete with one
another for the right to service customers.
• Better customer service, higher quality, perks…
• The Role of Government


Disciplines the market process.
Firms “tell on each other” to try to get the government to intervene
In order to make decisions in the
future you need to know what the
future holds….
Is a dollar today worth the same as a
dollar in three years??
The Time Value of Money
• How much do I have to invest today to have $1,000 in three
years if the interest rate is 10%??
• Present value (PV) of a lump-sum amount (FV) to be
received at the end of “n” periods when the per-period
interest rate is “i”:
PV 
• Example:

FV
1  i 
n
Lotto winner choosing between a single lump-sum payout of $104
million or $198 million over 25 years.
How much do I have to invest
then??
1000
PV 
 751.32
3
(1  .10)
So…
• Present Value is the difference between the Future
Value and the Opportunity Cost of waiting

PV = FV – OCW
i
OCW
PV
Present Value of a Series
• What if you are “promised” different amounts every
year??
• Present value of a stream of future amounts (FVt)
received at the end of each period for “n” periods:
PV 
FV1
1  i 
1

FV2
1  i 
2
 ...
FVn
1  i 
n