Managerial Economics & Business Strategy

1. Managerial Economics & Business Strategy Chapter 1 The Fundamentals of Managerial Economics

2. 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.

3. 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???

4. 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

5. Entry • Entry Costs • Speed of Adjustment • Sunk Costs • Economies of Scale • Network Effects • Reputation • Switching Costs • Government Restraints Sustainable Industry Profits • Power of • Input Suppliers • Supplier Concentration • Price/Productivity of Alternative Inputs • Relationship-Specific Investments • Supplier Switching Costs • Government Restraints • Power of • Buyers • Buyer Concentration • Price/Value of Substitute Products or Services • Relationship-Specific Investments • Customer Switching Costs • Government Restraints Industry Rivalry Substitutes & Complements • Concentration • Price, Quantity, Quality, or Service Competition • Degree of Differentiation • Price/Value of Surrogate Products or Services • Price/Value of Complementary Products or Services • Network Effects • Government Restraints • Switching Costs • Timing of Decisions • Information • Government Restraints The Five Forces Framework

6. 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

7. 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??

8. 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”: • Example: • Lotto winner choosing between a single lump-sum payout of $104 million or $198 million over 25 years.

9. How much do I have to invest then??

10. So… • Present Value is the difference between the Future Value and the Opportunity Cost of waiting • PV = FV – OCW i PV OCW

11. 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: