Managerial Economics

MBA 640 (Summer IS 2010) MANAGERIAL ECONOMICS EXAM #1 STUDENT NAME: Exam is open book and open material. 1. Explain the interaction of Managerial Economics with other business disciplines, giving specific examples. Managerial economics has been defined by conventional theorists as a science that “is all about how people make choices” After you’ve defined managerial economics and it’s relationship to its economic theory. Managerial economics will interact with each of these business’s disciplines at some point or another; demand, marketing, finance, accounting, management science and strategy. An example of one of the disciplines (demand or price elasticity): Ford and Honda cater to the subcompact segment (marketing segmentation) of the automobile market with their Focus and Civic models, respectively. Are Ford Focus buyers more or less price sensitive than buyers of Honda Civics? One way to answer this question is to estimate the change in quantity demanded with a $100 increase in the price of each make. But this does not compare like with like. A more consistent way of comparing the price sensitivity of Focus and Civic buyers is to use the own-price elasticity’s of the demands. The own-price elasticity’s of the demands for Focus and Civics have been estimated to be both 3. 4. This indicates that Focus and Civic buyers are equally sensitive to price. For a 1% increase in price, both groups would reduce sales purchases by 3. 4%. 2. Briefly describe the how the forces of supply and demand impact the allocation of resources in organizations. Once the supply and demand has been experienced, a resource allocation strategy should be developed to which a manager can choose (capacity or demand based model) and where to expend these resources. Regardless of the specific strategy, the allocation of resources to meet specific demands results in fewer resources available to meet others supply and demands. Choose cautiously…. 3. Compare and contrast Business Risk and Financial Risk, using specific examples. Business risk refers to the stability of a company’s assets if it uses no debt or preferred stock financing. Business risk stems from the unpredictable nature of doing business, i. e. , the unpredictability of consumer demand for products and services produced (classic case the Ford Edsiel). When a company uses debt or preferred stock financing, additional risk—financial risk—is placed on the company’s common shareholders. Thus creates a financial risk. They the (shareholders) demand a higher expected return for assuming this additional risk, which in turn, raises a company’s costs. 4. Compare and contrast the stockholder wealth measurement methods of Market Value Added and Economic Value Added. For many years, managers and shareholders have believed that growth in annual earnings per share and increases in return on equity were the best measures for maximizing shareholders wealth. However, in more recent years there has been a growing awareness that these conventional accounting measures are not reliably linked to increasing the value of the company’s shares. This occurs because earnings do not reflect changes in risk and inflation, nor do they take account of the cost of additional capital invested to finance growth. One way of viewing the “shareholder value” approach is to value the business using Economic Value Added as a valuation methodology. This can be achieved by taking the number of shares and multiplying by the share price and adding the book value of long and short-term loans net of any cash deposits. The market value at this point in time is equal to its total capital employed plus or minus the net present value of all future Economic Value Added. This present value of all future Economic Value Added is theoretically equal to Market value added. We are now able to validate economic profitability and use it as a performance measurement, which directly links strategy to value and is therefore the key to wealth creation. . Discuss the non-price determinates of supply and demand. Non-price determinants (sometimes called demand shifters) result in a change in demand. A change in demand means that the amount consumers are willing and able to buy changes at each and every price. This affects your supply demands. When demand is high the price becomes low and vice/versa. 6. Define market equilibrium and briefly explain how knowledge of this factor can facilitate the organizational decision making process. Market equilibrium occurs where quantity supplied equals quantity demanded. An increase of supply or overproduction will facilitate a price decrease and the number of quantity produced to rise. A decrease of supply affects the equilibrium price to rise and the quantity to fall. When supply increases and demand remains constant, price falls and quantity sold rises. A decrease in supply and the demand remains constant, causes price to rise and quantity sold to fall. This knowledge of equilibrium/disequilibrium can help an organization determine marketing decisions. Continue production, price change, or get rid of this market. . How does the impact of supply and demand influence the Pricing of goods and services? Because supply and demand plays a critical role in today’s economy, it’s important to understand how they both operate – and how you can use them to analyze decisions about the pricing of goods and services provided. My Father once told me a story and said;” I lost $40,000 dollars today”! I said,” You did? How”? He replied, “Someone wanted to buy 4,000 sheep for $10 dollars a piece and I didn’t have a single one” Funny I thought. Look at it this way suppose he had the sheep and the going price was $20 dollars apiece? He had the opportunity to sell at $10 or use some posture and demand to sell at the $20 dollar price. But the moral of my Father story was if a customer has a demand but you can’t supply your losing money. 8. Define Price Elasticity of Demand, and give an example of its application as it relates to Revenue. Definition of Price Elasticity is the extent to which demand changes with price are known as “price elasticity of demand. An example would be in 1991 Apple Computer Inc. drop prices of some of its Macintosh computers models by as much as 50% hoping to stimulate its demand quantity. The end results were phenomenal. Sales had increased as much as 85%. Cutting the price clearly benefited Apple Computer Inc revenue. 9. Explain how businesses can use Demand Estimation in Forecasting. Typically, companies use forecasting techniques based on statistical models to predict demand and use the resulting forecast to produce or order the amount they anticipate their customers will demand. But even with the most sophisticated forecasting models, forecasts are inaccurate. On the contrary companies can minimize forecast errors by creating a more responsive supply chain so that they can react to demand fluctuations even when they are not anticipated. 10. How is Estimation of Production used in the operational planning of an organization? It is used by organization’s operational plan to determining a firm’s level of output (i. e. , the production function) either short or long run function ability. Because this can fluctuate with various attributes it is usually hard to perform controlled laboratory experiments with respect to production. Instead, actual operating data is used with statistical procedures to derive these estimates. 11. How is Estimation of Cost used in the operational planning of an organization? Decision-making is imperative for operational planning. You must obtain at a minimum production and costs functions (accounting data). But this data creates problems because economic and accounting definitions of costs are different. By using Estimation of Cost will help or condition the manager to properly strategize and forecast sound operational goals via planning mode (before production starts). Productions goals based on time series analysis for short-run costs, cross-sectional regression technique has a better advantage with long-run cost estimations. 12. How would an organization use the theories of managerial economics to guide market research conducted with consumers? The term market research encompasses a number of activities that are designed to connect marketers to consumers through information gathering and evaluation. Market research provides businesses with information about their customers, their competitors, and their overall industry. Managerial Economics is a science dealing with effective use of scarce resources (market research). It guides managers in taking decisions relating to the firm’s customers, competitors, and suppliers as well as relating to the internal functioning of a firm. It also makes use of statistical and analytical tools (market research) to assess economic theories in solving practical business solutions.

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