Managers & Markets, Firms & Profits

1. Go Global !Go Global !
Managerial Economics :Managerial Economics :
Managers, Profits &
Markets
By
Stephen OngStephen Ong
Visiting Fellow, Birmingham City UniversityVisiting Fellow, Birmingham City University
Visiting Professor, College of Management,Visiting Professor, College of Management,
Shenzhen UniversityShenzhen University
April 2013April 2013

2. AgendaAgenda
1.1. Managers & MarketsManagers & Markets
2.2. The Firm & ProfitThe Firm & Profit
MaximisationMaximisation
3.3. Economic ProfitEconomic Profit

3. Learning ObjectivesLearning Objectives
To understand the role ofTo understand the role of
managers in decision makingmanagers in decision making
To understand basic concepts ofTo understand basic concepts of
the market and its structurethe market and its structure
To understand the rationale ofTo understand the rationale of
firms and the firm’s economicfirms and the firm’s economic
goalsgoals
To distinguish betweenTo distinguish between
economic profit and accountingeconomic profit and accounting
profitprofit

4. 11
Managers & MarketsManagers & Markets

5. EconomicsEconomics
MicroeconomicsMicroeconomics
Branch of economics thatBranch of economics that
deals with the behaviour ofdeals with the behaviour of
individual economic units—individual economic units—
consumers,consumers,
firms,firms,
workers, andworkers, and
 investors—investors—
as well as the marketsas well as the markets
that these units comprise.that these units comprise.
MacroeconomicsMacroeconomics
Branch of economics thatBranch of economics that
deals with aggregatedeals with aggregate
economic variables, sucheconomic variables, such
asas
the level and growth ratethe level and growth rate
of national output,of national output,
interest rates,interest rates,
unemployment, andunemployment, and
 inflation.inflation.

6. Why should managers studyWhy should managers study
economics?economics?
 To develop the economic insightTo develop the economic insight
necessary to identify your business’necessary to identify your business’
competitive advantage.competitive advantage.
 To identify how the ups and downs inTo identify how the ups and downs in
economy-wide economic activity willeconomy-wide economic activity will
impact your business.impact your business.
 To improve your business’To improve your business’
profitability.profitability.

7. Microeconomic InfluencesMicroeconomic Influences
on Managerson Managers
 How consumer behaviour affects theirHow consumer behaviour affects their
revenue.revenue.
 How production technology and inputHow production technology and input
prices affect their costs.prices affect their costs.
 How the market and regulatoryHow the market and regulatory
environment in which managersenvironment in which managers
operate influences their ability to setoperate influences their ability to set
prices and to respond to theprices and to respond to the
strategies of their competitors.strategies of their competitors.

8. Market DemandMarket Demand
DemandDemand is the number ofis the number of
units of a good or service thatunits of a good or service that
buyers are willing and able tobuyers are willing and able to
buy at various pricesbuy at various prices,,
when other factors, like,when other factors, like,
buyers incomes, tastes andbuyers incomes, tastes and
preferencespreferences and the prices ofand the prices of
goods related in consumptiongoods related in consumption
are held constant.are held constant.

9. Market SupplyMarket Supply
Market supplyMarket supply is theis the
number of units of a good ornumber of units of a good or
service that businesses areservice that businesses are
willing and able towilling and able to produceproduce
at various pricesat various prices, when, when
other factors, like,other factors, like, resourceresource
prices, productionprices, production
technologytechnology and prices ofand prices of
goods related in productiongoods related in production
are held constant.are held constant.

10. Market EquilibriumMarket Equilibrium
In efficient markets with flexibleIn efficient markets with flexible
prices, the market priceprices, the market price
fluctuates to eliminatefluctuates to eliminate
shortages (an excess of quantityshortages (an excess of quantity
demanded over quantitydemanded over quantity
supplied) and surpluses (ansupplied) and surpluses (an
excess of quantity supplied overexcess of quantity supplied over
quantity demanded).quantity demanded).

11. CONSUMERSCONSUMERS
Consumers have limited incomes, which can beConsumers have limited incomes, which can be
• spent on a wide variety of goods and services, orspent on a wide variety of goods and services, or
• saved for the future.saved for the future.
WORKERSWORKERS
Workers also face constraints and make trade-offs.Workers also face constraints and make trade-offs.
1.1. must decide whether and when to enter the workforce.must decide whether and when to enter the workforce.
2.2. face trade-offs in their choice of employment.face trade-offs in their choice of employment.
3.3. decide how many hours per week they wish to work,decide how many hours per week they wish to work,
thereby trading off labour for leisure.thereby trading off labour for leisure.
FIRMSFIRMS
Firms also face limits in terms ofFirms also face limits in terms of
• the kinds of products that they can produce, andthe kinds of products that they can produce, and
• the resources available to produce them.the resources available to produce them.
The Themes of MicroeconomicsThe Themes of Microeconomics
Trade-Offs

12. Prices and MarketsPrices and Markets
• Microeconomics describes howMicroeconomics describes how pricesprices
are determined.are determined.
• In a centrally planned economy, pricesIn a centrally planned economy, prices
are set by theare set by the government.government.
• In a market economy, prices areIn a market economy, prices are
determined by the interactions ofdetermined by the interactions of
consumers, workers, and firms. Theseconsumers, workers, and firms. These
interactions occur ininteractions occur in marketsmarkets——
collections of buyers and sellers thatcollections of buyers and sellers that
together determine the price of a goodtogether determine the price of a good.

13. Theories and ModelsTheories and Models
 In economics, explanation andIn economics, explanation and
prediction are based onprediction are based on
theoriestheories. Theories are developed. Theories are developed
to explain observed phenomenato explain observed phenomena
in terms of a set of basic rulesin terms of a set of basic rules
and assumptions.and assumptions.
AA modelmodel is a mathematicalis a mathematical
representation, based onrepresentation, based on
economic theory, of a firm, aeconomic theory, of a firm, a
market, or some other entity.market, or some other entity.

14. What Is a Market?What Is a Market?
MARKET :MARKET : Collection of buyers and
sellers that, through their actual or potential
interactions, determine the price of a product or
set of products.
 Market definition : Determination of
the buyers, sellers, and range of products that
should be included in a particular market.
 Arbitrage :Arbitrage : Practice of buying at a lowlow
price at one location and selling at a higherhigher
price in another.

15. Competitive versusCompetitive versus
Noncompetitive MarketsNoncompetitive Markets
Perfectly Competitive marketPerfectly Competitive market
Market with many buyers and sellers, so that noMarket with many buyers and sellers, so that no
single buyer or seller has a significant impact onsingle buyer or seller has a significant impact on
priceprice..
Many other markets are competitive enough to beMany other markets are competitive enough to be
treated as if they were perfectly competitive.treated as if they were perfectly competitive.
Other markets containing a small number ofOther markets containing a small number of
producers may still be treated as competitive forproducers may still be treated as competitive for
purposes of analysis.purposes of analysis.
Finally, some markets contain many producers butFinally, some markets contain many producers but
areare noncompetitivenoncompetitive; that is, individual firms; that is, individual firms
can jointlycan jointly affect the priceaffect the price..

16. Market PriceMarket Price
Price prevailing in a competitive marketPrice prevailing in a competitive market
In markets that are not perfectly competitive,In markets that are not perfectly competitive,
different firms might charge different prices for thedifferent firms might charge different prices for the
same product. This might happen because one firmsame product. This might happen because one firm
is trying to win customers from its competitors, oris trying to win customers from its competitors, or
because customers have brand loyalties that allowbecause customers have brand loyalties that allow
some firms to chargesome firms to charge higher priceshigher prices thanthan
others.others.
The market prices of most goods will fluctuateThe market prices of most goods will fluctuate
over time, and for many goods theover time, and for many goods the
fluctuationsfluctuations can be rapid. This iscan be rapid. This is
particularly true for goods sold in competitiveparticularly true for goods sold in competitive
markets.markets.

17. The Extent of a MarketThe Extent of a Market
 Boundaries of a market, both geographicalBoundaries of a market, both geographical
and in terms of range of products producedand in terms of range of products produced
and sold within it.and sold within it.
 For some goods, it makes sense to talkFor some goods, it makes sense to talk
about a market only in terms of veryabout a market only in terms of very
restrictive geographic boundaries.restrictive geographic boundaries.
 We must also think carefully about theWe must also think carefully about the
range of products to include in a market.range of products to include in a market.
 Market definition is important for twoMarket definition is important for two
reasons:reasons:
 AA companycompany must understand who its actual andmust understand who its actual and
potential competitors are for the various products that itpotential competitors are for the various products that it
sells or might sell in the future.sells or might sell in the future.
 Market definition can be important for public policyMarket definition can be important for public policy
decisions.decisions.

19. WHAT IS SWEETER?WHAT IS SWEETER?

20. THE MARKET FOR SWEETENERSTHE MARKET FOR SWEETENERS In 1990, the Archer-Daniels-In 1990, the Archer-Daniels-
Midland Company (ADM)Midland Company (ADM)
acquired the Clinton Cornacquired the Clinton Corn
Processing Company (CCP).Processing Company (CCP).
 The U.S. Department ofThe U.S. Department of
Justice (DOJ) challenged theJustice (DOJ) challenged the
acquisition on the groundsacquisition on the grounds
that it would lead to athat it would lead to a
dominant producer of corndominant producer of corn
syrup with the power to pushsyrup with the power to push
prices above competitiveprices above competitive
levels.levels.
 ADM fought the DOJADM fought the DOJ
decision, and the case went todecision, and the case went to
court. The basic issue wascourt. The basic issue was
whether corn syrupwhether corn syrup
represented a distinctrepresented a distinct
market.market.
 ADM argued that sugar andADM argued that sugar and
corn syrup should becorn syrup should be
considered part of the sameconsidered part of the same
market because they are usedmarket because they are used
interchangeably to sweeten ainterchangeably to sweeten a
vast array of food products.vast array of food products.

21. Diabetics, Sugar, HFCSDiabetics, Sugar, HFCS

22. Sweet CokeSweet Coke

23. Wholesale Sugar Market (1982-2010)Wholesale Sugar Market (1982-2010)

24. Corn & Ethanol Markets (1980– 2010)Corn & Ethanol Markets (1980– 2010)

25. The Price of SweetThe Price of Sweet

27. REALITY DOES SUCKREALITY DOES SUCK

28. TABLE
MARKETS FOR BICYCLESMARKETS FOR BICYCLES
TYPE OF BICYCLETYPE OF BICYCLE COMPANIES AND PRICESCOMPANIES AND PRICES
(2011)(2011)
Mass Market Bicycles:Mass Market Bicycles:
Sold by mass merchandisers
such as Target, Wal-Mart,
Kmart, and Sears.
Huffy: $90—$140Huffy: $90—$140
Schwinn: $140—$240Schwinn: $140—$240
Mantis: $129—$140Mantis: $129—$140
Mongoose: $120—$280Mongoose: $120—$280
Dealer Bicycles:Dealer Bicycles:
Sold by bicycle dealers –
stores that sell only(or mostly)
bicycles and bicycle
equipment.
Trek: $400—$2500Trek: $400—$2500
Cannondale: $500—$2000Cannondale: $500—$2000
Giant: $500—$2500Giant: $500—$2500
Gary Fisher: $600—$2000Gary Fisher: $600—$2000
Mongoose: $700—$2000Mongoose: $700—$2000
Ridley: $1300—$2500Ridley: $1300—$2500
Scott: $1000—$3000Scott: $1000—$3000
Ibis: $2000 and upIbis: $2000 and up
There are actually two different markets forThere are actually two different markets for
bicycles, markets that can be identified by thebicycles, markets that can be identified by the
type of store in which the bicycle is sold.type of store in which the bicycle is sold.
A BICYCLE IS A BICYCLE. OR IS IT?A BICYCLE IS A BICYCLE. OR IS IT?

29. Casestudy Presentation :Casestudy Presentation :
The Global Pharmaceutical industryThe Global Pharmaceutical industry
1.1. Read and prepare theRead and prepare the
Casestudy on The GlobalCasestudy on The Global
Pharmaceutical IndustryPharmaceutical Industry
(Johnson, Whittington &(Johnson, Whittington &
Scholes (2011)) forScholes (2011)) for
discussion anddiscussion and
presentation next week.presentation next week.
2.2. Identify and evaluate theIdentify and evaluate the
challenges facing globalchallenges facing global
pharmaceutical firms thepharmaceutical firms the
External Environment andExternal Environment and
Industry analysis –Industry analysis –
PESTEL and Five Forces.PESTEL and Five Forces.

30. Market StructureMarket Structure
Large Number of FirmsLarge Number of Firms
PerfectPerfect
CompetitionCompetition
MonopolisticMonopolistic
CompetitionCompetition OligopolyOligopoly MonopolyMonopoly
Single FirmSingle Firm

31. PerfectPerfect
CompetitionCompetition
 Large number of firmsLarge number of firms
 Each firm produces anEach firm produces an
identical good oridentical good or
serviceservice
 Easy for new firms toEasy for new firms to
enter the marketenter the market
 Complete information toComplete information to
all buyers and sellers inall buyers and sellers in
the marketthe market

32. Monopolistic CompetitionMonopolistic Competition
 Large number ofLarge number of
firmsfirms
 Each firm produces aEach firm produces a
good or service that,good or service that,
in some significantin some significant
way, is differentway, is different
 Relatively easy forRelatively easy for
new firms to enternew firms to enter
the marketthe market
 ImperfectImperfect
informationinformation

33. OligopolyOligopoly
 Few large,Few large,
mutuallymutually
interdependent,interdependent,
firmsfirms
 Firms may produceFirms may produce
similar or highlysimilar or highly
differentiateddifferentiated
productsproducts
 Significant barriersSignificant barriers
to new entryto new entry
 ImperfectImperfect
informationinformation

34. MonopolyMonopoly
One firmOne firm
producing aproducing a
good or servicegood or service
with no goodwith no good
substitutessubstitutes
New entry isNew entry is
blockadedblockaded
ImperfectImperfect
informationinformation

35. Real versus Nominal PricesReal versus Nominal Prices
 Nominal priceNominal price
 Absolute price of a good, unadjusted for inflation.Absolute price of a good, unadjusted for inflation.
 Real priceReal price
 Price of a good relative to an aggregate measurePrice of a good relative to an aggregate measure
of prices; price adjusted for inflation.of prices; price adjusted for inflation.
Consumer Price IndexConsumer Price Index
 Measure of the aggregate price level.Measure of the aggregate price level.
Producer Price IndexProducer Price Index
 Measure of the aggregate price level forMeasure of the aggregate price level for
intermediate products and wholesale goods.intermediate products and wholesale goods.

36. Egg Farmer or College Teacher?Egg Farmer or College Teacher?

37. THE REAL PRICETHE REAL PRICE OF EGGS vs EDUCATIONOF EGGS vs EDUCATION
TABLE 2 THE REAL PRICES OF EGGS AND OF A COLLEGE EDUCATION
1970 1980 1990 2000 2010
Consumer PriceConsumer Price
IndexIndex
38.838.8 82.482.4 130.7130.7 172.2172.2 218.1218.1
NoNominaminal Pricesl Prices
Grade A LargeGrade A Large
EggsEggs
$0.61$0.61 $0.84$0.84 $1.01$1.01 $0.91$0.91 $1.54$1.54
College EducationCollege Education $2,112$2,112 $3,502$3,502 $7,619$7,619 $12,976$12,976 $21,550$21,550
Real Prices ($1970)Real Prices ($1970)
Grade A LargeGrade A Large
EggsEggs
$0.61$0.61 $0.40$0.40 $0.30$0.30 $0.21$0.21 $0.27$0.27
College EducationCollege Education $2,112$2,112 $1,649$1,649 $2,262$2,262 $2,924$2,924 $3,835$3,835

38. TheThe realreal prices of eggs inprices of eggs in 1970 dollars1970 dollars is calculated as follows:is calculated as follows:
While theWhile the nominalnominal price ofprice of
eggs roseeggs rose during these years, theduring these years, the
realreal price of eggs actuallyprice of eggs actually
fell.fell.
THE REAL PRICE OF EGGSTHE REAL PRICE OF EGGS

39. TABLE 2TABLE 2 THE REAL PRICES OF EGGS AND OF A COLLEGE EDUCATIONTHE REAL PRICES OF EGGS AND OF A COLLEGE EDUCATION
19701970 1980 19901990 2000 20102010
Consumer Price Index 38.838.8 82.4 130.7130.7 172.2 218.1218.1
Nominal Prices
Grade A Large Eggs $0.61$0.61 $0.84 $1.01$1.01 $0.91 $1.54$1.54
College Education $2,112$2,112 $3,502 $7,619$7,619 $12,976 $21,550$21,550
Real Prices ($1970)
Grade A Large Eggs $0.61$0.61 $0.40 $0.30$0.30 $0.21 $0.27$0.27
College Education $2,112$2,112 $1,649 $2,262$2,262 $2,924 $3,835$3,835
The real prices of eggs inThe real prices of eggs in 1990 dollars1990 dollars is calculated as follows:is calculated as follows:

40. TABLE 2TABLE 2 THE REAL PRICES OF EGGS AND OF A COLLEGE EDUCATIONTHE REAL PRICES OF EGGS AND OF A COLLEGE EDUCATION
1970 1980 1990 2000 2010
Consumer Price Index 38.8 82.4 130.7 172.2 218.1
Nominal Prices
Grade A Large Eggs $0.61 $0.84 $1.01 $0.91 $1.54
College Education $2,112 $3,502 $7,619 $12,976 $21,550
Real Prices ($1970)
Grade A Large Eggs $0.61 $0.40 $0.30 $0.21 $0.27
College Education $2,112 $1,649 $2,262 $2,924 $3,835
The percentage change in real price is calculated as follows (inThe percentage change in real price is calculated as follows (in
1990 dollars):1990 dollars):

41. In nominal terms, the minimum wage hasIn nominal terms, the minimum wage has
increased steadily over the past 70 years.increased steadily over the past 70 years.
However, in real terms its expected 2010However, in real terms its expected 2010
level islevel is below that of the 1970s.below that of the 1970s.
THE MINIMUMTHE MINIMUM
WAGEWAGE

42. I’m lovin’ it

43. Meanwhile, Oil PricesMeanwhile, Oil Prices ……

45. Race to the Bottom:Race to the Bottom:
KaroshiKaroshi

46. Corporate Decision Making: The Toyota PriusCorporate Decision Making: The Toyota Prius
 Hybrid cars are more energy efficient than cars with just aHybrid cars are more energy efficient than cars with just a
gasoline engine; the Prius, for example, can get 45 to 55gasoline engine; the Prius, for example, can get 45 to 55
miles per gallon. The Prius was a big success, and within amiles per gallon. The Prius was a big success, and within a
few years other manufacturers began introducing hybridfew years other manufacturers began introducing hybrid
versions of some of their cars.versions of some of their cars.
 The design and efficient production of the Prius involvedThe design and efficient production of the Prius involved
not only some impressive engineering, but a lot ofnot only some impressive engineering, but a lot of
economics as well.economics as well.
1.1. Toyota had to think carefully about how theToyota had to think carefully about how the publicpublic wouldwould
react to the design and performance of this new product.react to the design and performance of this new product.
2.2. Toyota had to be concerned withToyota had to be concerned with the cost ofthe cost of
manufacturingmanufacturing these cars.these cars.
3.3. Toyota had to think about its relationship to the governmentToyota had to think about its relationship to the government
and the effects of regulatory policies.and the effects of regulatory policies.

47. FuelFuel
EfficiencyEfficiency
RaceRace

48. Public Policy Design:Public Policy Design: FuelFuel
Efficiency Standards for the 21Efficiency Standards for the 21stst
CenturyCentury
In 1975, the U.S. government imposed regulations designedIn 1975, the U.S. government imposed regulations designed
to improve the average fuel economy of domestically-soldto improve the average fuel economy of domestically-sold
cars and light trucks. Thecars and light trucks. The CAFE (Corporate Average FuelCAFE (Corporate Average Fuel
Economy)Economy) standards have become increasingly stringentstandards have become increasingly stringent
over the years. Designing a fuel efficiency program involvesover the years. Designing a fuel efficiency program involves
economics :economics :
1.1. Government must evaluate the monetary impact of theGovernment must evaluate the monetary impact of the
programme onprogramme on consumersconsumers..
2.2. To estimate the likely impact of CAFE standards on theTo estimate the likely impact of CAFE standards on the
cost of producingcost of producing cars and light trucks.cars and light trucks.
3.3. To ask why problems related to oil consumption are notTo ask why problems related to oil consumption are not
solved by oursolved by our market-orientedmarket-oriented economy.economy.

49. 22
The FirmThe Firm
&&
Profit MaximisationProfit Maximisation

50. The FirmThe Firm
A firm is a collection of resourcesA firm is a collection of resources
that is transformed into productsthat is transformed into products
demanded by consumersdemanded by consumers
ProfitProfit is the difference betweenis the difference between
revenue received and costsrevenue received and costs
incurredincurred

51. The FirmThe Firm
Transaction costsTransaction costs areare
incurred when entering into aincurred when entering into a
contractcontract
types of transaction coststypes of transaction costs
investigationinvestigation
negotiationnegotiation
enforcing contractsenforcing contracts

52. The FirmThe Firm
Transaction costsTransaction costs areare
incurred when entering into aincurred when entering into a
contractcontract
influencesinfluences
uncertaintyuncertainty
frequency of recurrencefrequency of recurrence
asset specificityasset specificity

53. The FirmThe Firm
“Any customer
can have a car
painted any
colour that he
wants so long as
it is black.”
Henry Ford

54. The FirmThe Firm
Limits to firm sizeLimits to firm size
tradeofftradeoff betweenbetween
external transactionsexternal transactions
and the cost ofand the cost of
internal operationsinternal operations
company chooses tocompany chooses to
allocate resources soallocate resources so
total cost is minimumtotal cost is minimum
outsourcingoutsourcing ofof
peripheral, non-coreperipheral, non-core
activitiesactivities

55. Toyota Car Factories WorldwideToyota Car Factories Worldwide

56. Economic goal of the firmEconomic goal of the firm
Profit maximizationProfit maximization hypothesis:hypothesis:
the primary objective of the firm (tothe primary objective of the firm (to
economists) is to maximize profitseconomists) is to maximize profits
Other goals include market share,Other goals include market share,
revenue growth, and shareholderrevenue growth, and shareholder
valuevalue
Optimal decision is the one thatOptimal decision is the one that
brings the firm closest to its goalbrings the firm closest to its goal

57. Economic goal of the firmEconomic goal of the firm
Short-runShort-run versusversus Long-runLong-run
nothing to do directly with calendarnothing to do directly with calendar
timetime
short-run: firm canshort-run: firm can vary amount ofvary amount of
some resourcessome resources but not othersbut not others
long-run: firm can vary amount oflong-run: firm can vary amount of allall
resourcesresources
at times short-run profitability willat times short-run profitability will
be sacrificed for long-run purposesbe sacrificed for long-run purposes

58. Goals other than profitGoals other than profit
Economic goalsEconomic goals
market share, growth ratemarket share, growth rate
profit marginprofit margin
return on investment, Return onreturn on investment, Return on
assetsassets
technological advancementtechnological advancement
customer satisfactioncustomer satisfaction
shareholder valueshareholder value

59. ““Quality is our lifeline.”Quality is our lifeline.”
Akio Toyoda

60. Goals other than profitGoals other than profit
Non-economic objectives
good work environment
quality products and
services
corporate citizenship,
social responsibility
Environment,
Sustainability &
Governance

61. Do companies maximize profit?Do companies maximize profit?
Criticism: companies do not maximizeCriticism: companies do not maximize
profits but instead merely aim toprofits but instead merely aim to
satisfice, which means to achieve asatisfice, which means to achieve a
satisfactory goal, one that may notsatisfactory goal, one that may not
require the firm to ‘do its best’require the firm to ‘do its best’
two forces affect satisficing:two forces affect satisficing:
position and power ofposition and power of
stockholdersstockholders
position and power ofposition and power of
managementmanagement

62. Position and power ofPosition and power of
managementmanagement
high-level managers may ownhigh-level managers may own
very little of the firm’s stockvery little of the firm’s stock
managers tend to be moremanagers tend to be more
conservative because jobs willconservative because jobs will
likely be safe if performance islikely be safe if performance is
steady, not spectacularsteady, not spectacular
Do companies maximize profit?Do companies maximize profit?

63. Do companies maximize profit?Do companies maximize profit?
Position and power of managementPosition and power of management
managers may be more interested inmanagers may be more interested in
maximizing own income andmaximizing own income and
perksperks
management incentives may bemanagement incentives may be
misaligned (eg. revenue not profits)misaligned (eg. revenue not profits)
 divergence of objectives is known asdivergence of objectives is known as
‘principal-agent’‘principal-agent’ problemproblem

64. Do companies maximize profit?Do companies maximize profit?
 Counter-arguments which support theCounter-arguments which support the
profit maximization hypothesisprofit maximization hypothesis
large stockholdings held by institutionslarge stockholdings held by institutions
(mutual funds, banks, etc.)(mutual funds, banks, etc.)
 scrutiny by professionalscrutiny by professional analystsanalysts
stockmarket disciplinestockmarket discipline
 if managers do not seek to maximizeif managers do not seek to maximize
profits, firms faceprofits, firms face threat ofthreat of
takeovertakeover
incentive effectincentive effect
 the compensation of many executivesthe compensation of many executives
is tied tois tied to stock pricestock price

65. Maximizing the wealthMaximizing the wealth
of stockholdersof stockholders
 Views the firm from the perspective of aViews the firm from the perspective of a
stream of profitsstream of profits (cash flows) over(cash flows) over
timetime
 the value of the stream depends on whenthe value of the stream depends on when
cash flows occurcash flows occur
 Requires the concept of theRequires the concept of the time valuetime value
of money: says a dollar earned in the futureof money: says a dollar earned in the future
is worth less than a dollar earned todayis worth less than a dollar earned today

66. Managerial Decision MakingManagerial Decision Making
Question : Finding the Best HotelQuestion : Finding the Best Hotel
 Assume there are only Three Hotels. (Assume there are only Three Hotels. (BestBest,,
Medium, Worst)Medium, Worst)
 Traveller can visit and compare but cannotTraveller can visit and compare but cannot
go back.go back.
 What is your strategy to maximise yourWhat is your strategy to maximise your
chances of achieving your goal (chances of achieving your goal (BestBest Hotel)?Hotel)?
BB BB M M W WM M W W
M WM W BB WW BB MM
W M WW M W BB MM BB

67. Managerial Decision MakingManagerial Decision Making
Strategy SolutionStrategy Solution
Strategy:Strategy:
Size up the 1stSize up the 1st
Hotel butHotel but
bypass it.bypass it.
Stop at theStop at the
2nd Hotel only2nd Hotel only
if its better thanif its better than
the 1st.the 1st.
Simulation:Simulation:
Traveller
finds BEST
Hotel 50% of
the time!
B B M M W WB B M M W W
M W B W B MM W B W B M
W M W B M BW M W B M B

68. 33
Economic ProfitEconomic Profit

69. Economic profitsEconomic profits
Economic profits and accounting
profits are typically different
 accountants measureaccountants measure explicitexplicit
incurred costsincurred costs, as allowed by, as allowed by
GAAPGAAP
 accountants useaccountants use historical costhistorical cost
of machinesof machines

70. Economic profitsEconomic profits
Economists are concerned withEconomists are concerned with
implicit costs, called opportunityimplicit costs, called opportunity
costscosts
Accordingly, economists useAccordingly, economists use
replacement cost of machinesreplacement cost of machines
 economic costs includeeconomic costs include
historical and explicithistorical and explicit
(accounting) costs(accounting) costs as well asas well as
replacement and implicitreplacement and implicit
(economic) costs(economic) costs
 economic profit is totaleconomic profit is total
revenue minus allrevenue minus all
economic costseconomic costs

71. ProfitProfit
• Accounting profitAccounting profit
• Total revenue less explicitTotal revenue less explicit
costcost
• Normal profitNormal profit
• Equal to implicit costEqual to implicit cost
• Economic or pure profitEconomic or pure profit
• Total revenue less economicTotal revenue less economic
costcost

72. Profits ComparedProfits Compared
EconomicEconomic
ProfitProfit
AccountingAccounting
Costs (ExplicitCosts (Explicit
Costs Only)Costs Only)
AccountingAccounting
ProfitProfit
ExplicitExplicit
CostsCosts
Implicit CostsImplicit Costs
(Including a(Including a
Normal Profit)Normal Profit)
EconomicEconomic
(Opportunity)(Opportunity)
CostsCosts
TotalRevenueTotalRevenue
EconomicEconomic AccountingAccounting

73. ConclusionConclusion
“Death from too much work is soDeath from too much work is so
commonplace incommonplace in JapanJapan that therethat there
is a word for it --is a word for it -- karoshikaroshi..”..”
The Washington Post, 13 July 2008The Washington Post, 13 July 2008

74. Casestudy : TESCOCasestudy : TESCO
1.1. Read and prepare theRead and prepare the
Casestudy on TESCOCasestudy on TESCO
(Johnson, Whittington &(Johnson, Whittington &
Scholes (2011)) forScholes (2011)) for
discussion and presentationdiscussion and presentation
next week.next week.
2.2. Identify and evaluate theIdentify and evaluate the
challenges facing TESCO’schallenges facing TESCO’s
global expansion byglobal expansion by
conducting Externalconducting External
Environment analysisEnvironment analysis
(PESTEL);and Industry(PESTEL);and Industry
(5+1 Forces) analysis.(5+1 Forces) analysis.

75. Core ReadingCore Reading
• Keat, Paul G. and Young, Philip KY (2009)
Managerial Economics, 6th
edition, Pearson
• Samuelson, William F. and Marks, Stephen G.
(2010) Managerial Economics, 6th
edition, John
Wiley
• Pindyck, Robert S. and Rubinfeld, Daniel L.(2013)
Microeconomics, 8th
edition, Pearson
• Samuelson, P.A. and Nordhaus, W. D.Samuelson, P.A. and Nordhaus, W. D.
(2010)(2010)“Economics”“Economics” Irwin/McGraw-Hill, 19Irwin/McGraw-Hill, 19thth
EditionEdition
• Porter, Michael E. (2004)Porter, Michael E. (2004)“Competitive Strategy –“Competitive Strategy –
Techniques for Analyzing Industries and Competitors”Techniques for Analyzing Industries and Competitors”
Free PressFree Press

76. Questions?Questions?