Exam 1 Eco for Strategic Decisions

Measuring and Maximizing Economic Profit

(Economic) Profit = Revenues-(Economic) Costs

Economic Forces that promote long-run profitability

-few close substitutes -strong entry barriers -weak rivalry within market -low market power of input suppliers -low market power of consumers -abundant complementary products -limited harmful government intervention

What is a Market

-A market is any arrangement through which buyers & sellers exchange anything of value. Markets reduce transaction costs: - Costs of making a transaction happen, other than the price of the good or service itself.

Globalization of Markets

-Economic integration of markets located in nations around the world -Provides opportunity to sell more goods & services to foreign buyers -Presents threat of increased competition from foreign produces

Economic Profit vs. Accounting Profit

-Economic profit = total revenue - total economic costs or =total revenue - explicit costs-implicit costs -Accounting profit = Total revenue - explicit costs

Oligopoly

-Few firms produce all or most of the market output -Profits are interdependent -Goldilocks principle: most realistic

Monopolistic Competition

-Large number of relatively small firms -Differentiated products -Price setters -No barriers to entry

Perfect Competition

-Larger number of relatively small firms -Undifferentiated product -Price takers with no market power -No barriers to entry **any economic profit earned will vanish as new firms enter

Managerial Economics & Theory

-Managerial economics applies microeconomic theory to business problems. -Economic theory helps managers understand real world business problems.

Common Mistakes managers Make

-Never increase output simply to reduce average costs -Pursuit of market share usually reduces profit -Focusing on profit margin won't maximize total profit -Maximizing total revenue reduces profit -Cost-plus pricing formulas don't produce profit-maximizing prices

Types of Implicit Costs

-Opportunity cost of cash provided by owners (Equity capital (money provided to businesses by the owners)) -Opportunity cost of using land or capital owned by the firm. -Opportunity cost of owner's time spent managing or working for the firm

Economic Cost of Resources

-Opportunity cost: what a firm must give up to use resources to produce goods and services. -Market-supplied resources: Owned by others and hired, rented, or leased. -Owner-supplied resources: Owned and used by the firm.

Separation of Ownership and Control

-Principal-agent problem: a manager takes an action or makes a decision that advances the interests of the manager but reduces the value of the firm. -Complete contract: an employment contract that protects owners from every possible deviation by managers form value-maximizing decisions. -Hidden actions: actions or decisions taken by managers that cannot be observed by owners for any feasible amount of monitoring effort. -Moral Hazard: a situation in which managers take hidden actions that harm the owners of the firm but further the interests of the managers.

Principal-Agent Relationship

-Relationship formed when a business owner (the principal) enters an agreement with an executive manager (the agent) whose job is to formulate and implement tactical and strategic business decisions that will further the objectives of the business owner (the principal).

Monopoly

-Single firm -Produces product with no close substitutes Protect by a barrier to entry **Allows the monopolist to raise its price without concern that economic profits will attract new firms.

Total Economic Cost

-Total economic cost: Sum of opportunity costs of both market-supplied resources and owner-supplied resources. -Explicit Costs: Monetary opportunity costs of using market-supplied resources. -Implicit Costs: Nonmonetary opportunity costs of using owner-supplied resources.

Maximizing the Value of a Firm

-Value of a firm: a price for which is can be sold. Equal to the present value of expected future profits. -Risk premium: an increase in the discount rate to compensate investors for uncertainty about future profits. The larger the risk, the higher the risk premium, and the lower the firm's value. -Maximizing firm's value by maximizing profit in each time period: cost & revenue conditions must be independent across time periods.

Strategic Decisions

-business actions taken to alter market conditions and behavior of rivals in ways that increase and/or protect the strategic firm's profit -While common business practices are necessary for the goal of profit-maximization, strategic decisions are generally optimal actions managers can take as circumstances permit. *Strategic decisions do NOT take competition as given/fixed.

Microeconomics

-is the study of individual consumers, business firms and markets. -Business practices or tactics: are business decisions managers must make to ear the greatest profit. -Industrial Organization: Specialized branch of Microeconomic focusing on behavior and structure of firms and industries. It helps provide a foundation for understanding strategic decisions through application of game theory. Sometimes called the "economics of imperfect competition."

Corporate Control Mechanisms

Internal control mechanisms: -require managers to hold stipulated amount of firm's equity -Increase percentage of outsiders serving on board of directors -Finance corporate investments with debt instead of equity External mechanism -Corporate takeovers

Market Structures

Market characteristics that determine the economic environment in which a firm operates: -Number and size of firms in market -Degree of product differentiation among competing firms -Likelihood of new firms entering market when incumbent firms are earning economic profits

Price-Takers vs. Price-Setters

Price-taking firm: -Cannot set price of its product -Price is determined strictly by market forces or demand & supply Price-setting firm: -Can set price of its product -Has a degree of market power, which is the ability to raise price without losing all sales