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Managerial Economics: A Problem-solving Approach

Managerial Economics: A Problem-solving Approach . Why is teaching economics to MBA’s so difficult? . Students with varying backgrounds: English majors vs. Engineers; Econ. and Business majors; Executive MBA’s and non-degree Exec. Ed. Healthcare professionals etc

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Managerial Economics: A Problem-solving Approach

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  1. Managerial Economics:A Problem-solving Approach

  2. Why is teaching economics to MBA’s so difficult? • Students with varying backgrounds: • English majors vs. Engineers; • Econ. and Business majors; • Executive MBA’s and non-degree Exec. Ed. • Healthcare professionals • etc • Students want practical knowledge • Not abstract theory • Do MBA’s learn differently than we do?

  3. Solution • Use a problem-based pedagogy (instead of model-based) • Begin with a real business problem • Give students just enough analytical structure to understand the problem and find a solution • Teaches students to solve problems by • Identifying profitable decisions (benefit-cost analysis) • And implement them (principal-agent theory) • Links study of economics to other MBA disciplines • Accounting, finance, statistics, marketing, strategy, operations

  4. Example: Over-bidding OCS gas tract • A young geologist was preparing a bid recommendation for an gas tract in his exploration to oil • With knowledge of the productivity of neighboring tracts also owned by company, the geologist recommended a bid of BD5000000 • Senior management, though, bid BD21000000 - far over the next highest-bid of BD 750,000. • What, if anything, is wrong? • The goal of this text is to provide tools to help diagnose and solve problems like this.

  5. Analyze the over-bidding mistake • Another clue: • After winning the bid, the geologist increased the estimated reserves of the company. • But, after a “dry” well was drilled, the reserve estimates were decreased. • Senior Management stepped in and rejected the decrease in the estimate (kept it high) • Last clue: • Senior management resigned several months later.

  6. ANSWER: Manager bonuses for increasing reserves • The bonus system created incentives to over-bid. • Senior managers were rewarded for acquiring reserves regardless of their profitability • Bonuses also created incentive to manipulate the reserve estimate.

  7. Problem solving • Two distinct steps: • Figure out what’s wrong, i.e., why the bad decision was made • Figure out how to fix it • Both steps require a model of behavior • Why are people making mistakes? • What can we do to make them change? • Economists use the rational actor paradigm to model behavior. The rational actor paradigm states: • People act rationally, optimally, self-interestedly • i.e., they respond to incentives – to change behavior you must change incentives.

  8. Keep the ultimate goal in mind Align the incentives of employees with the profitability goals of the company. • How do we make sure employees have the information necessary to make good decisions? • And the incentive to do so?

  9. what is wrong • Under the rational actor paradigm, mistakes are made for one of two reasons: • lack of information or • bad incentives. • To diagnose a problem, ask 3 questions: 1. Who is making bad decision? 2. Do they have enough info to make a good decision? 3. Do they have the incentive to do so?

  10. How to fix it • The answers will suggest one or more solutions: 1. Let someone else make the decision, someone with better information or incentives. 2. Change the information flow. 3. Change incentives • Change performance evaluation methods within your firm • Change reward scheme • Use benefit-cost analysis to choose the best (most profitable?) solution …….. Mohammed Give them information about Break Even here

  11. Coverage • Traditional coverage (see TOC) • Changes to second edition • Examples from the financial crisis • Additional material • Insights from behavioral econ (psychological pricing, barriers to rational decision making) • Iceland: Trade, Foreign Exchange, Bubbles • Chapters cut into smaller pieces • Uncertainty & Auctions • Long-run equilibrium & Strategy

  12. 1. Introduction: What this book is about • 2. The one lesson of business • Benefits, costs and decisions • 4. Extent (how much) decisions • 5. Investment decisions: Look ahead and reason back • 6. Simple pricing • Economies of scale and scope • 8. Understanding markets and industry changes • 9. Relationships between industries: The forces moving us towards long-run equilibrium • 10. Strategy, the quest to slow profit erosion • 11. Using supply and demand: Trade, bubbles, market making • 12. More realistic and complex pricing • 13. Direct price discrimination • 14. Indirect price discrimination • 15. Strategic games • 16. Bargaining • 17. Making decisions with uncertainty • The problem of adverse selection • The problem of moral hazard • 21. Getting employees to work in the best interests of the firm • 22. Getting divisions to work in the best interests of the firm • 23. Managing vertical relationships • 24. You be the consultant • EPILOG: Can those who teach, do? Managerial Economics - Table of contents

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