Transcript CH.(1) AN INTRODUCTION TO MICROECONOMICS

COURSE SYLLABUS
Course Title
: Managerial Economics
Credit Hours
: 3 Hours
Prerequisites
: Microeconomics
Professor Name : Dr. Fakhry El-Fiky
Email Address : [email protected]
Text Book
: Paul G. Keat, And Philip K.Y. Young,
Managerial Economics :Economic Tools for Today’s Decision
Makers, Fifth Edition. Pearson Education International, 2006.
1
COURSE OBJECTIVES
The aim of this course is to present a clear
understanding of the principles of managerial
decision-making.which lays the foundation
for a comprehensive awareness of what is
going on a round us in the real business
world. To that end, the professor together
with the participants will review the basic
microeconomic concepts and theories that
are centered toward the consumer and firm
economic rational behavior.
2
TEACHING TOOLS
Lecture : Coverage of course material using power point slides
Home & Class Assignments: Four assignments. A gradual
development of the graduate student’s interactive learning skills and
Invest more time in deepening the participants understanding of the
course material .
Case Studies : Each chapter opens with a real-life mini-case
studies, that is developed through the chapter. Examples from all over
The world ,and the following mini-case studies are demonstrated and
discussed in depth .
Exams : mid-term, and a final exams.
3
COURSE EVALUATION & REQUIREMENTS
Evaluation System
Participation & Assignments :
Midterm Exam :
Final Exam :
Weight
20 %
20 %
60 %
Requirements
Attendance : Participants are advised to attend classes in timely
fashion .Attendance is an important element in the evaluation system.
Make up Policy : All assignments should be handed in on timely
manner. Make ups for some missing academic works may be granted
in exceptional circumstances.
Format of assignments: All assignment and take-home exams are to
Be typed , not hand written
4
COURSE OUTLINE:
1-The Market Demand & Supply (Ch. 3)
2- Elasticity of Demand & Supply (Ch. 4)
3- Demand Estimations & Forecasting (Ch. 5)
4- The theory & Estimation of production (Ch. 6)
5- The Theory & Estimation of Cost (Ch. 7)
6- Pricing & Output Decisions : Perfect Competition &
Monopoly. (Ch. 8)
7- he Game Theory (Ch. 11)
8- Capital Budgeting & Risk (Ch. 12)
5
PART (1) :MARKET SUPPLY AND DEMAND
CHAPTER (3) OUTLINE:
1-DEMAND &SUPPLY(D&S) CURVES
•
THE DEMAND CURVE &SHIFTS IN THE (D) CURVE
•
THE SUPPLY CURVE & SHIFTS IN THE (S) CURVE
2-EQUILIBRIUM PRICE (Pe) & QUNTITY (Qe)
3-ADJUSTMENT TO CHANGES IN(D)OR(S),ITS EFFECTS ON (Pe)&(Qe )
4-GOVERNMENT INTERVENTION IN MARKETS: PRICE CONTROL
RENT CONTROL : WHO BENEFITS , WHO LOSES
6
DEMAND & SUPPLY CURVES
A-DEMAND: Qs THAT CONSUMERS ARE WILLING & ABLE TO BUY AT A
CERTAIN (P) AND DURING A PERIOD OF TIME.
a-FACTORS AFFECTING(D) FOR (X) COMMODITY:
-
1-THE ( Px )
Q Dx
THE LAW OF(D):THERE IS AN OPPOSITE RELATIONSHIP B/W (Px) AND
(Q Dx) , IF WE HOLD OTHER FACTORS CONSTANT.
Px
2
4
6
8
10
Px
Qx/DY 500
400
300
200
100
10
D
8
6
4
D
2
Qx
0
100
200
300 400
500
7
A-DEMAND CONT,D – FACTORS AFFECTING (Dx)
2-INCOME (I):
- NORMAL GOODS:
(I)
+
Dx
-
- INFERIOR GOODS:
(I)
Dx
3-PRICE OF OTHER RELATED GOODS ( Py ):
- SUBSTITUTES
( Py )
Dx
+
- COMPLEMENTS
( Py )
Dx
4-TASTE : CONSUMER PREFERANCES WOULD BE AFFECTED BY
COMMERCIALS, SEASONALITY, TRADITION ,..etc.
+
5-NUMBER OF CONSUMERS (# Cs): # Cs
6-CONSUMER EXPECTATIONS(EXP):
(P) c exp
Dx
+
Dx
8
CHANGES IN THE DEMAND
Px
I, Py, T, #Cs, Pexp
A CHANG IN THE ABOVE FACTOR
ONLY WILL CAUSE A MOVEMENT
ALONG THE SAME (D) CURVE
Px
A CHANGE IN ONE OR ALL OF
THE ABOVE FACTORS ONLY WILL
CAUSE SHIFTS IN THE (D) CURV
Px
D
D1
D
++
A
D2
10
B
6
D1
-
D
Qx
0
100
300
D2
0
D
Qx
9
Demand & Algebra
• Demand
Algebra
QX = 500 – 2(PX )+ 0.5(PY) + 1.5(I) (Demand Function)
PX = 250 + 0.25(PY )+ 0.75(I) – 0.5(QX )(Inverse Demand
Function)
– Consumer Surplus
• Benefit buyers receive from paying prices less than they’d be
willing to pay
• Measured as area below Demand but above Price
10
Assignment (1) - Demand
Managerial Economics :
_________________________________________________________________________
Name
ID#
__________________________________________________________________________
1.
What happens to the demand for SONY television sets when each of the
following happens:
a.
the price of LG TVs rises
b.
the price of SONY TVs rises
c.
personal income falls
d.
dramatic price reductions occur for CD recorders
e.
gov’t imposes tariffs on Japanese TVs beginning next year
2.
Suppose the demand for a product (X) can be expressed as a function of its
price (PX), consumer monthly income (I), and the price of a related good R
(PR)
QX = 180 - 10 PX - 0.2 I + 10 PR
a.
Interpret the slope coefficient on Px
b.
Is good X a normal or inferior good? How do you know?
c.
Are goods X and R substitutes or complements? How do you know?
d.
Forgetting income and the price of a related good, how much
consumer surplus exists in this market if the price of X were $10?
11
DEMAND & SUPPLY CURVES CONT”D
B-SUPPLY: Qs THAT PRODUCERS ARE WILLING
& ABLE TO SELL
AT A CERTAIN( P) AND DURING A PERIOD OF TIME.
a-FACTORS AFFECTING (S) FOR X COMMODITY:
+
1-THE (Px) :
Q Sx
THE LAW OF (S): THERE IS A POSITIVE RELATIONSHIP B/W (Px)AND
THE (Q Sx),IF WE HOLD OTHER FACTORS CONSTANT
Px
Px
2
QSx 100
4
6
200 300
8
400
10
500
S
10
8
6
2-PRODUCTION COST (PROD.cost):
( PROD.cost )
Sx
3-TECHNOLOGY (TECH):
+
( BETTER TECH)
Sx
4
2
S
Qx
0
100
200
300
400
500
12
B-SUPPLY CONT’D – FACTORS AFFECTING (Sx)
4-FISCAL POLICY:GOV’T POLICIES REGARDING TAXEX &
SPENDING
HIGHER TAXES
MORE SUBSIDY
+
LESS Sx (VICE VESA)
MORE Sx (VICE VERSA
5- NUMBER OF PRODUCERS( # PRODx):
+
(# PRDs)
Sx
6- PRODUCER’S EXPECTATIONS (P prod exp) :
(P prod exp)
-
Sx
13
CHANGES IN THE SUPPLY
COST, Py, TECH., #Ps, Pexp, FISCAL POLICY
Px
A CHANGE IN ONE OR ALL OF
THE ABOVE FACTORS ONLY WILL
CAUSE SHIFTS IN THE (S) CURV
A CHANG IN THE ABOVE FACTOR
ONLY WILL CAUSE A MOVEMENT
ALONG THE SAME (S) CURVE
Px
Px
s2
S
-
S
S1
A
10
s1
B
6
+
S
0
S1
S
Qx
300
500
0
Qx
14
Supply & Algebra
• Supply
– Algebra
– QX = 500 + 2PX =
• Positive relationship between QS and Price
– PX = -250 + 0.5QX (Inverse Supply Function)
• This is graphed
– Producer Surplus
• Benefit sellers receive from receiving prices more than they’d
be willing to accept
• Measured as area above Supply but below Price
15
2-DETERMINATION OF THE EQUILIBRIUM (Pe)
AND (Qe)
EX:THE EQILIBRIUM
Pe = 6 AND Qx = 300
THIS BECAUSE:
1- Qs = Qd
Px
2
4
6
8
QDx 500 400 300 200
QSx 100 200 300 400
2- STABLE , B/C ANY ANY
DEVATION FROM THE (Pe)
WILL CREATE AUOTOMATIC
FORCES ( SHORTAGE OR
SURPLUS )THAT WILL BRING
THE PRICE BACK TO THE (Pe)
10
100
500
Px
D
S
10
8
Pe
6
4
2
D
S
Qx
0
100
200
300
Qe
400
500
16
3- ADJUSTMENT IN Dx & Sx AND ITS IMPACT ON
(Px) & (Qx)
A-CHANGES (+&-) IN (Dx) , NO CHANGE IN (Sx ):
- INCREASE IN (Dx):
- DECREASE IN (Dx)
Sx
PX
D
Px
D2
S
D
D1
8
6
6
4
D2
Sx
0
D
300 400
Pe & Qe INCREASE
D
S
Qx
O
D1
200
Qx
300
Pe & Qe DECREASE
17
3- ADJUSTMENT IN Dx & Sx AND ITS
IMPACT ON (Px) & (Qx) – Cont’d
B-CHANGES (+&-) IN (Sx) , NO CHANGE IN (Dx):
- INCREASE IN (Sx):
PX
- DECREASE IN (Sx )
S
S1
D
S2
PX
S
D
8
6
6
S2
4
S
D
S1
0
S
Qx
300
D
400
Pe DECREASE & Qe INCEASE
0
Qx
200
300
Pe INCREASE & Qe DECREASE
18
3- ADJUSTMENT IN Dx & Sx AND ITS
IMPACT ON (Px) & (Qx) – Cont’d
C- CHANGES (+&-) IN BOTH (Sx) &AND (Dx):
- INCREASE IN BOTH (Sx)& (Dx):
PX
D1
- DECREASE IN BOTH (Sx )&(Dx):
S
S1
D
S2
PX
S
D
D2
7
6
6
D1
S
D
S1
0
Qx
300
500
Pe INCREASE & Qe INCEASE
B/C + IN Dx > + Sx
0
S2
D
S
D2
Qx
200
300
Pe NO CHANGE & Qe DECREASE
B/C - IN Dx = - IN Ax
19
4- GOV’T. INTERVENTION IN MARKETS:
A-PRICE CEILING :
CAUSE SHORTAGE (AB)
B- PRICE FLOOR:
CAUSE SURPLUS(CD)
Px
Px
D
S
S
D
D
C
Pf 8
e
6
Pc 4
A
0
6
B
S
D
D
S
Qx
200 300 400
e
0
Qx
200 300 400
20
CASE STUDY DISCUSSION: RENT CONTROL IN
EGYPT
Market Pe = 800
Ceiling price (P)= 500
Black market (P) = 1000
SHORTAGE = 100,000 UNITS
Px
S
D
Black market price 1000
Market price
800
Ceiling price
500
e
D
S
Qx
0
100,000
200,000
300,000
21
Example: Demand ,Supply Equations &
Market Equilibrium
I-
Use the following generalized linear demand relation to
answer the following questions:
Qx = 680 - 9 Px + 0.006 I – 4 PY
1- where (I) is income and Py is the price of a related good,
y. From this relation it is apparent that the good is:
aan inferior good
ba substitute for good R
ca normal good
da complement for good R
eboth c and d
22
Example: Demand ,Supply Equations &
Market Equilibrium (Cont’d)
2. If (I) = $15,000 and Py = $20, the
demand function is
Qx = 680 - 9 Px + 0.006 (I) – 4 Py
a.
P  690  9Qd
b.
Qd  690  9 P
c.
d.
e.
Qd  680  9 P
P  680  9Qd
Qd  800  19 P
23
3.
If (I) = $15,000 and Py = $20 and the supply function
is Qx = 30 + 3 Px , equilibrium price and quantity are,
respectively,
a.
b.
c.
d.
e.
P = $55 and Q = 195.
P = $9 and Q = 609.
P = $12 and Q = 200.
P = $50 and Q = 170.
P = $40 and Q = 250.
24
4. If (I) = $15,000 and Py = $20 and the supply
function is Qs  30  3P , then, when the price of
the good is $40
a.
there is a shortage of 180 units of the good.
B.
C.
D.
there is equilibrium in the market.
there is a surplus of 180 units of the good.
the quantities demanded and supplied are
indeterminate.
25
5-If (I) = $15,000 and Py= $20 and the supply
function is Qs  30  3P , then, when the price of
the good is $60,
a.
b.
c.
d.
there is equilibrium in the market.
there is a shortage of 60 units of the good.
there is a surplus of 60 units of the good.
there is a shortage of 80 units of the good.
26
Assignment (2): Use the following demand and
supply functions to answer the next 3 questions:
Demand:
Supply:
Qd  50  4 P
Qs  20  2 P
1.Equilibrium price (Qe) and equilibrium quantity (Pe)
are
a.
P = $5 and Q = 30.
b.
P = $11 and Q = 30.
c.
P = $12 and Q = 44.
d.
P = $15 and Q = 50.
e.
none of the above
27
2.If the price is $10, there is a
a.
b.
c.
d.
e.
3.
surplus of 35 units.
shortage of 30 units.
surplus of 30 units.
shortage of 10 units.
none of the above
If the price is $2, there is a
a.
surplus of 10 units.
b.
shortage of 10 units.
c.
surplus of 30 units.
d.
shortage of 18 units.
e.
none of the above
28
(4) : Answer The Following Questions
- Assume that the equilibrium price of Nokia
mobile brand name (x) Pe =1000 and
equilibrium quantity Qe = 400 , show this
graphically. what will happen if the price of the
Samsung mobile brand name -Y increases and
the cost of producing the Nokia mobile
increased by the same percentage (Hint :Make
shift in D =shift in S)
29
Answer The Following Questions (cont’d)
5- The following function describes the demand for
a company making flags for the Egyptian
National Team :
Qx= 2,000 – 100 Px , answer the following:
a. How many flags could be sold at LE 12 ?
b. What should be the price in order for the
company to sell 1,000 flags?
c. At what price would flag sales equal zero?
30
6-Briefly list and elaborate on the factors that will
Be affecting the demand for the following
products In the next several years . Do you think
these factors will cause the demand to increase
or decrease.?
a.
b.
c.
d.
e.
Products purchased on the internet.
Fax machines
Film and cameras
Pay-per- view television programming
Airline local travel in Egypt
f.
Gasoline
31
7-Briefly list and elaborate on the factors that will
Be affecting the supply for the following
products In the next several years . Do you think
these factors will cause the supply to increase
or decrease.?
a.
b.
c.
d.
e.
f.
Crude oil
Beef
Computer memory chips
Hotel rooms
Laptop computers
Credit cards issued by financial institutions
32
Part (2)
Elasticity of Demand & Supply
• Elasticity
The degree of responsiveness (sensitivity) of the
quantity demanded (QDx) or quantity supplied (QSx) to
changes in another variable affecting each one of them
, such as (Px , I , Py, etc..)
Coefficient of elasticity= % ∆ in Qx/ % ∆ in any factor
• The absolute value is taken as a A good measure the
elasticity
33
I - DEMAND ELASTICITIES
1- PRICE ELSTICITY OF DEMAND (PED)
a- DEFINITION (PED):THE DEGREE OF RESPONSIVENESS (SESITIVITY) OF THE
Q Dx TO THE CHANGES IN THE Px.
b- MEASURING THE(PED):
- DISCRETE POINT ELASTICITY FORMULA
PED = % ∆ Qx / % ∆ Px
∆ Qx
PEDx =
x
∆ Px
∞ >PED > 1
ELASTIC
Px
THE SIGN IS NORMALLY ( - ) , IF :
Qx
PED=1
UNITE ELASTIC
EX :LUXTURIES (RECEREATION TRIPS)
0<PED< 1
INELASTIC
NECESSITIES (MEDICIN)
34
1 –PRICE ELASTICITY OF DEMAND (PED)
(CONT’D)
- ARC ELASTICITY FORMULA:
PED =
Qx
Q1 + Q2
Px
P1 + P2
2
THE SIGN NORMALLY( - )
2
- CONTINUES POINT PED = DQX/DPX . PX/QX
FACTORS DETERMINING PED:
1-TYPE OF THE COMMODITY: BASIC GOODS (BREAD) ARE LESS ELASTIC,
WHILE LUXURIES (TRIPS) ARE HIGHLY ELASTIC.
2-NUMBER & DEGREE OF SUBSTITUTES: LESS NUMBER OF
SUBSTITUTES(OIL)MEANS LESS PED , WHILE CLOSE SUBSTITUTES (DELL &
HP COMPUTER) MEANS HIGH PED.
3-PERCENTAGE OF INCOME SPENT ON THE COMMODITY: IF THE % IS
VERY LITTLE (SALT) , THE PED WILL BE LITTLE.
4-THE TIME NEEDED TO ADJUST: IF THE TIME AVAILABLE TO THE CONSUMER
IS NOT ENOUGH TO ADJUST TO THE CHANGES IN THE (P) OF A CERTAIN
GOOD,THEN THE PED IS LESS AND VICE VERSA .
35
1 – PRICE ELASTICITY OF DEMAND (PED)
(CONT’D)
-THE RELATIONSHIP B/W THE PED & TOTAL REVENUE (TR):
1-PED > 1 ,THEN, THERE IS A NEGATIVE RELATIONSHIP B/W
(P) AND (TR). THAT IS WHEN THE (P) , THEN (TR) AND VICE
VERSA.
2-PED< 1 , THEN, THERE IS A POSITIVE RELATIONSHIP B/W
(P) AND (TR) . THAT IS , WHEN THE (P) , THEN (TR) AND VICE
VERSA.
3-PED = 1, THEN, THERE NO CHANGE IN THE(TR) WHEN THE (P)
IS CHANGING
36
2- INCOME ELASTICITY OF DEMAND
Qx
IED =
Qx
THE SIGN COULD BE :
I
I
( + ) IF THE GOOD IS NORMAL
OR ( - ) IF THE GOOD IS INFERIOR
3- CROSS PRICE ELASTICITY OF DEMAND (CPED):
Qx
Qx
CPED =
THE SIGN COULD BE :
Py
Py
( - ) IF GOOD x COMPLEMENT GOOD y
( + ) IF GOOD x SUBSTITUTE GOOD y
37
II- THE PRICE ELSTICITY OF SUPPLY(PES)
Qsx
PES =
1-PES = 0
Px
Qsx
Px
THE VALUE COULD TAKE 5 CASES:
COMPLETELY INELASTIC
2-PES = ∞
COMPLETELY ELASTIC
3-PES < 1
INELASTIC
4-PES = 1
UNIT ELASTIC
5-PES > 1
ELASTIC
FACTORS AFFECTING PES
1-FLEXIBILTY IN USING FACTORS OF PRODUCTION
2-TIME NEEDED TO ADJUST PRODUCTION
38
Assignment (3)
1-When the Sony TV price decreases from LE 1000
to LE 800 , consumers increases their quantity
demand from 100,000 units/ month to 120,000 units
/month. calculate the price elasticity of demand
(PED). Also , While this is happening, the price LG
TV increases from le 500 to le 600, calculate the
cross-price elasticity.
39
Answer the Following Questions
2- Discuss the relative (PED) of the following products:
a. Mayonnaise
b. Chevrolet automobiles
c. Washing machines
d. Air travel (vacation)
e. Diamond rings
3- Would you expect the (CPED) coefficient b/w each
of the following pairs of products to be (+) or (-)
a. Personal computers and software.
b. Electricity and natural gas
c. Bread and CDs
40
Answer the Following Questions
4- Discuss the (IED) of the following consumer products:
a. Fine Jewelry
b. Studio apartments
c. Fool and Falafel sandwiches
d. Riding microbus
e. Salt
5- The equation for a demand curve has been estimated
to be : Qx = 100 – 10 Px + 0.5 (I). Assume Px = 7 and
(I) = 50 .
a. Interpret the equation.
b. At a Px = 7, what is the PED?
c. At an income of 50, what is IED?
d. Now assume (I) = 70,what is the PED at Px = 8 ?
41
Answer the Following Questions
6- Dr. El Fiky has the following demand eqution for a
certain product:
Q = 30 – 2 P
a. At a price of LE , What is the point elasticity?
b. Between prices of LE 5 and LE 6, what is the arc
PED?
c. If the market is made up 100 individuals with demand
curves identical to Dr El Fiky’s, what will be the point and
arc PED for the conditions specified in parts a and b?
42
Part (3) Demand Estimations
• Specify the Regression Equation & Obtaining the Data:
1- determine all the factors that might influence the demand based
on the economic policy of demand
2- availability of data and the cost of generating these
data.
3- data in regression analysis could be used in two ways :
a. Cross-section
b. Time-series
QX = a0 + a1 Pxt + a2 Py + a3 (I) + a4 Pxt+1 + a5 B
Where : Pxt+1 : Expected price of product x
B : Budget for marketing campaign
43
Estimating & interpreting the Regression
Analysis
El-Fiky Company uses the per capita income (in thousand LE) to
help forecast its demand for computer (brand x) units in million
LE . The firm collected the data in the following table (which is
presented on annual basis.
Year
2003
2004
2005
2006
2207
2008
2009
I
Dx
5.15 3.25
5.05 3.10
5.25 3.30
5.40 3.65
5.60 3.90
5.70 4.10
5.65 4.15
REGRESS : dependent variable (Demand for x
computer Using the income per head as
independent variable during the period
(2003 – 2009)
44
Variable
Coefficient
Std Err T-stat
CONST
(I)
-5.20679 0.616404 -8.44704
1.63750
0.114037 14.3594
No. of Observations = 7
R² = .9763 (adj)= .9716
Sum of Sq. Resid. = .260089E-01
Std. Error of Reg.= .721234E-01
Durbin-Watson = 2.0012
F ( 1, 5) = 206.191
Significance = .05
45
Statistical Evaluation of Regulation Results
1. t – test or statistics = b / SE (standard error) measure the statistical
significance of each estimated regression coefficient. If the absolute
value of a coefficient t – statistics is greater than 2, we can conclude that
the estimated coefficient is significant at the 0.05 level or we are 95 %
confident that the results obtained from the sample are representative of
the population.
2. Coefficient of Determination = R2 . This measure shows the % of the
variation in a dependent accounted for by variation in all the explanatory
variables in the regression equation, thus it ranges between 0 and 1.
The closer R2 is to (1) the greater the explanatory power of the
regression equation
3. F- test are used in conjunction with R2 . It measure the statistical
significance of the entire regression equation rather than of each
individual coefficient as in the case of t-test. In fact, the F-test is a
measure of the statistical significance of R2 . By comparing between the
estimated value of F-test and its value from the table with a degree of
freedom of (k),(n-k-1) { n = sample size – k = no. of the independent
variables} at the 0.05 significance level.
46
Review of Key Steps for Analyzing Regression
Results
Step 1: Check Signs and Magnitudes.
Step 2: Compute Elasticity Coefficients.
Step 3: Determine Statistical Significance.
47
Problems in The Use of Regression Analysis
1- The Identification Problem
2- Multicollinearity
3- Auto correlation
48
1-What is the equation of the estimated least
squares regression?
- Dx = -5.20679 + 1.63750 (I)
2-Test the hypothesis that there is no
relationship between the dependent and
independent variable (at the 95 percent
confidence level) in El Fiky Company
Regression. Your results indicate that
- you would reject the null hypothesis and
conclude that the two variables are related
49
3-The coefficient of determination for this El Fiky
Company regression indicates that
- 97.63 percent of the variation in Dx is explained by
variation in (I)
4-Suppose that per capta income 6,300 is expected in
2007. What would be the estimate of El
Fiky Company's demand for its coputer in year 2007 ?
a.
b.
c.
d.
$ 4.62 million
$ 4.95 million
$ 4.99 million
$ 5.11 million
50
2- An equation is estimated as:
QDx = 400 - 2.0 (Px) + 0.015 (I) - 0.17Py
(250)
(1.0)
(0.010)
(0.10)
Standard errors are in parentheses
1.The most statistically significant coefficient
a. Is the constant term.
b. The most significant coefficient is of Px .
c. The most significant coefficient is of I .
d. The most significant coefficient is of Py .
51
2-The statistic used to test whether the independent
variables taken as group statistically explain variation in
the dependent variable is the
a.
R-squared statistic.
b.
t-statistic.
c.
Durbin-Watson statistic.
d.
F-test statistic.
3- Serial correlation occurs when
a.
independent variables are correlated across
observations.
b.
dependent variables are correlated across
observations.
c.
error terms are correlated across
observations.
d.
R-squared is near one and the t-statistics are
near zero.
52
4-The statistic that tests an individual coefficient for
statistical significance is the
a.
R-squared statistic.
b.
t-statistic.
c.
Durbin-Watson statistic.
d.
F-test statistic.
5- Multiple regression differs from simple regression in
that
a.
there can be multiple dependent variables.
b.
the time periods over which observations are
taken are multiplied to increase explanatory
power.
c.
a simple regression is done multiple times to
increase explanatory power.
d.
there are multiple independent variables.
53
Part (4):Forecasting
• Forecast helps in two areas:
1- Setting cos. Objectives.
Revenue or profit Growth- return on investment
2- Constructing cos. business plans.
company planners in all areas; sales, HR, facilities,
manufacturing, finance ,will utilize an array of forecast in
constructing the various portions of the plan
• Subjects of Forecast:
1- Macroeconomic Level
2- Sector level
3- Industry level
4- Product level
54
Demand Estimate & Forecasting
• Prerequisite of a good forecast
1- Consistency with other parts of the business.
2- Adequate knowledge of the relevant past.
3- Take into consideration the econ. & political
environment.
4- Conducted in timely fashion
55
Forecasting Techniques
Classified into:
A- Qualitative Techs: Based on personal judgments
1- Expert Opinion.
2- Opinion Polls & Market research.
3- Surveys of spending plans.
B- Quantitative Techs: Utilize significant amount of
historical data as a basis for prediction.
1- Naïve
2 - Explanatory
4- Econ. Indicators.
5- Projections.
6- Econometric models.
56
1- Expert Opinion
• Various types of techs: Choosing the most
important.
1- The jury of executive opinion.
Forecast are generated by a group of of corporate
executives who may be setting around a table discussing
the subject to be forecasted
2- Soliciting the views of the sales staff in a co. to
forecast sales.
3- Delphi method.
It uses a panel of experts without the need to get together,
then by answering a sequence of questions using emailing
techniques
57
Opinion Polls & Market research.
Dealing with specific products and are often
conducted by individual firms.
A- Opinion Polls.
– Conducted on samples of population.
– Choice of the representative sample is of utmost
importance.
B- Market research. (very close to the opinion
polls)
Market forecast depends on answering questions such as who
the consumer is ,why the consumers is or is not buying , how
he is using the product ? What characteristic he thins are the
most important in the purchasing decision.
58
3- Surveys of spending plans.
• Quite similar to opinion poll & market
research, but it seeks information about
macro-type data relating to the economy.
• it includes:
1- Consumer intentions: It is related to changes
in consumer attitudes and their effect on consumers
spending
2- Inventories and sales expectations.
3- Capital expenditure surveys.
59
B-Quantitative Techs.
4- Econ. Indicators.
• Designed to alert business communities to
changes in general econ. Conditions.
• There are 3 major series of indicators:
- Leading, tells us where we are going, where
we are, and where we have been.
- Coincident, identifies peaks and troughs.
- Lagging, confers upturns and downturns in
econ. activities.
60
5- Projections.
• A quantitative technique ,naïve metod of forecasting.
- Past data are projected into the future without taking
into consideration reasons for the change, It is simply
assumed that the past trends will continue in the future.
- Classification:
1- Constant compound growth rate.
2- Visual time series projection.
3- Time series projection using the least squares
method
61
6- Econometrics models.
• Causal or explanatory models
1- Single equation model
a- Uni-variate : Dx = f(Px) ;
Dx = a + b1 Px
b- multi-variate ;
Dx = a + b1 (Px) + b2 (Py) + b3 (I)
2- multi-equation model.
Dx = a + b Px ------------------------------------ (1)
Sx = c + d Px -------------------------------------- (2)
Dx = Sx
----------------------------------- (3)
62
Time series regression model
• Single equation-multi-variete model
Ex. Demand for automobile:
∆ Rt = a0 + a1 ∆Y+ a2 ∆P/M + a3 ∆S + a4 ∆X +a5 ∆Rt-1
Where: R= retail sales, in millions of new cars.
Y= real disposable income.
P= real retail price of new cars.
M= average credit terms (no. of months of the average installment
contract)
S= Existing stock, in millions of cars.
X= Dummy variable.
63
Demand for computers
Log (yt /yt-1) = a0 + a1 log Pt – a2 log Yt-1
Where Yt = Stock of comps. In yr. t.
Yt-1 = Stock of comps. In yr. t-1.
P = real price of comps.
Forecast with smoothing techniques:
a- Moving average :
Et+1 =(x1 +x2 +x3 )/ n
b- Exponential smoothing forecasting
Et+1 = w xt + (1- w) Et
64
Managerial Economics: Trial Mid-Term
Exam (Questions & Problems)
Chapter (3)
Questions: 12,13
Problems: 3,5,9,11
Mid-Term
(pp.125,126)
(pp.126-129)
Q: 8
Pro. 6
Chapter (4)
Questions: 5,11,13,
Problems: 7, 13,15
(pp.162,163)
(pp.164,165)
-
4
8
(pp.238,239)
(pp.239-242)
- 4
- 6
pp.282,283)
(pp.284-287)
- 6
- 6
Chapter (5)
Questions: 3,5,7,8
Problems: 5,7
Chapter (6)
Questions: 5,13,18
Problems: 5,7,11,
65
Managerial Econ.Take-Home Exam
• Assume you are assigned as the head of El-Fiky Consulting
Firm (ECF), and you are invited to assess the market for one
of the mainstream product of three of the following
industries :
-
Pfizer products in Egypt
Tora cement company
The new economy dot-com firms; Amazon.com, Yahoo.com .
Soft drink industry
Health care Services
Hotel industry
Automobile industry
1- Suggest the kind of variables that are believed to affect the
demand for the underlying selected products from the above
industries. Be as specific as possible about how the
variables are going to be identified.
66
Managerial Econ.Take-Home Exam
2- How concerned should each of these companies be
about its own price policy and about its competitors price
policies.
3- Comment on the usefulness of the following statistics:
a- (t) , (F) , (R²) , (DW) tests
4- Comment on the case of what if the demand estimation
passes the F- test but fail the t-test for each of the
individual regression coefficients .What would you
recommend.?
5- What would you recommend to apply as the appropriate
forecasting techniques? Justify.
67
Part (5): The theory & Estimation of production
I- The Production Function:
Q = f ( X1 ,X 2,X 3,…..X n)
Where Q = Output = Total Product.
xs = Inputs = Factors of production = Econ. resources.
“The max. output that can be produced by a set of inputs within a given
period of time and with a given level of technology”.
For the purpose of analysis:
Q = f (L , K)
Where :
Q = Output = Total Product
L = Labor input
K = Capital input
1- Short-run production function: the period during which max .output
can be produced by varying certain inputs (variable inputs like labor)
other inputs remain unchanged ( fixed input like capital)
2- Long-run production function: the period during which max .output
can be produced by varying all inputs (all inputs are variable )
68
1- The Short-run Production Function
The short-run is e period during which max .output can be produced by
varying certain inputs (variable inputs like labor) other inputs remain
unchanged ( fixed input like capital)
QL = f (L , K)
-Total Product (Q) = The total sum of marginal product of
labor (L) or capital (K) .
Total Product (Q) of labor = Σ (MPL)
- Marginal Product (MP) of labor or capital = The change (∆) in TP due
to a change (∆) in the variable input (labor-L or capital-K) by one
unit.
Marginal Product of labor (MPL) of labor = ∆ TPL / ∆ L
- Average Product (MP) of labor or capital = The TP per unit of the
variable input (labor-L or capital-K) (APL) of labor
Average Product (APL) = TPL / L
69
1- Short-run Production Function (cont’d)
I- The Law of Diminishing Returns:
As additional homogenous units of a variable input (labor) is
combined with a fixed input (capital) at some points the additional
output (MPL)will diminish
TPL
K
1
1
1
1
1
1
1
L
0
1
2
3
4
5
6
TPL
2
6
12
20
30
36
MPL
2
4
6
8
10
6
APL
2
3
4
5
6
6
1
1
1
7
8
9
38
38
36
2
0
-2
5.40
4.75
4
Stage I
Stage II
Stage III
0
L
MP
AP
AP
0
6
70
MR
8
L
Derived Demand & The Optimal Level of Labor
K
1
1
1
1
1
1
1
1
1
1
L
0
1
2
3
4
5
6
7
8
9
TPL
0
2
6
12
20
30
36
38
38
36
MPL
0
2
4
6
8
10
6
2
0
-2
APL TRP MRP TLC
0
0
2
20
20 20
3
60
40 40
4
120
60 60
5
200
80 80
6
300
100 100
6
360
60 120
5.40 380
20 140
4.75 380
0 160
4
360
-20 180
MLC (TRP-TLC) (MRP-LC)
0
0
20
(0 )
0
20
(20 )
20
20
(60 )
40
20
(120)
60
20
(200)
80
20
(240)
40
20
(240)
0
20
(220)
-20
20
(180)
-40
MRP = MPL × PX TLC = L × W MLC=∆TLC /∆L
A profit maximizing firm operating in a perfectly competitive markets will
71
demand the number of labor at the point where : MRP = MLC (W)
PX = LE 10
wL = LE 20
2- The Long-run Production Function
(Return to Scale)
The Long-run is the period during which max .output can be produced by
varying all inputs (all inputs are variable)
K
L
1
2
4
5
6
1
2
3
4
5
6
7
8
9
7
8
9
3
TPL Return to scale: if a firm increase its scale
2
by a certain proportion result in an increase in
8
output by a greater proportion, the firm
16
experiences increasing return to scale (IRTS) ,
24
if output increases by the same proportion , the firm
30
36
40
42
45
experiences a constant return to scale (CRTS) , and if
output increases by less proportion , the firm
experiences a decreasing return to scale (DRTS)
72
Measuring Return to scale
1- Output Elasticity (EQ) = % ∆ in Output / % ∆ in all inputs
Q
If: (EQ) > 1 increasing return to scale (IRTS),
(EQ) = 1 Constant return to scale (CRTS) ,
IRTS
o
(EQ) < 1 Decreasing return to scale (DRTS)Q
2- hQ = f ( mL , mK)
If: h > m increasing return to scale (IRTS) , o
Q
h = m Constant return to scale (CRTS) ,
h < m decreasing return to scale (DRTS)
L,K
CRTS
L,k
DRTS
o
73
L,k
The Estimation of Production Function
1- The possible shape of production function.
• Q = f (L)k
( Short-run production function)
Q = a + bL + cL² - dL³
& Q = a + bL - cL²
Q=aL b
( power function)
log Q = log a + b log L
2- Cobb-Douglas production function.
b 1- b
Q=aL K
It assumes CRTS, (b +1-b =1)
b
c
However it could be rewritten as: Q = a L K
It assumes:
IRTS , If b + c >1 , CRTS , If b + c = 1 , and DRTS , If b +c < 1
1- MPL = b Q / L
2- MPK = c Q / K , Decreasing Marginal Product.
2- The function can be converted to linear function using logarithms.
74
We shall examine a generalized
third-order equation of a production
function with a single variable input, L,
assuming all other inputs constant,
Q = + 10L + 1.5L² + -0.05L³ ,
In this representation, the
power 3 in the third term
on the right side of this
function makes it a third-order
equation. The constant in
this equation is missing,
implicitly having a value
of zero, so that the graphic
depiction of the production
function passes through
the origin. The signs on the
coefficients of L2 and L3
indicate that as L increases from the origin, Q at first icreases at an in creasing
rate, Then eventually increases at a decreasing rate (the range of diminishing
returns) until Q reaches a maximum value, beyond which Q decreases. The
average and marginal functions to the Q function are displayed in the bottom 75
panel .
The firm's production function curves
may change either because wear or
weathering (i.e., depreciation) results
in capital consumption, or because the
management of the firm implements
changes in the technologies employed
in the firm's production processes.
Capital consumption may be expected
to shift the product curves downward
and to the right. If the technology changes
are output-increasing, they will shift the product curves
upward.
The management of an organization may gather output
data via its production and inventory accounting systems; its
research staff may perform regression analyses upon the data to
estimate the parameters of its production functions.
76
Part (5) Problems
A firm has the following short-run production
function:
Q = 50 L +6 L² – 0.5L³
a- when does the law of diminishing returns take effect?
b- Calculate the values for labor over which stages I , II , III occur.
c- Assume each worker is paid LE 10 per hour and works a 40hour week, How many workers should the firm hire if the price
of the output is LE 10 per unit ? Suppose the price of the output
falls to LE 7.50. What do you think would be the short run
impact on the firm’s production ? The long run impact?
77
2- Following are different algebraic expression
of the production function. Decide whether
each has constant, increasing, or decreasing
return to scale .
0.25 0.75
0.15 0.40 0.45
1- Q = 75 L K
2- Q = 75 L K C
0.70 0.60
3- Q = 75 L K
2
5- Q = 50 L + 50 K
4- Q = 100 + 50 L + 50 K
2
6- Q = 50 L + 50 K + 50 LK
78
3- The owner of a car wash is trying to decide on the number of
people to employ based on the following short production
function:
Q = 6 L – 0.5 L²
Where Q = No. of car washes per hour
L = No. of workers
a- Generate a schedule showing TP,AP,MP.,
then graph it.
b- Suppose the price for a basic car wash (no under coating ,no
wax treatments etc.) in his area of business is LE 5. How
many people should he hireif he pays each worker LE 6 / he.?
c- Suppose he consider hiring students on a part time basis for
LE 4 \ hr. . Do you think he should hire more students at this
lower rate ? Explain.
79
Part (6) :The Theory & Estimation of Cost
Why should firms incur costs? Why do
they exist?
The existence of costs of production is attributable directly to the
existence of scarcity.
1- Cost Concepts
a- Implicit Costs. We shall refer to nonpecuniary costs as
implicit costs , economists identify it as opportunity costs.
b- Explicit Costs. is pecuniary, accounting cost by virtue of
the fact that such money-denominated costs are visible, readily
monitored, and hence easily included by accountants
80
Accounting Costs
Subdivided into two categories:
- Disbursement Costs. Disbursement costs are those out of pocket
money payments from the enterprise to parties who provide
services or resources to the enterprise. such as the payroll,
payments for energy, the raw materials, etc.
- Non-disbursement cost: depreciation (capital consumption). is an
allowance for the decline in the value of the capital stock which is
attributable to the using-up of part of the enterprise's capital
equipment during the production (the accounting) period. An
allowance for depreciation is not paid out (disbursed) to any party
outside the enterprise; rather it is in a sense paid to the enterprise
itself for the use of the capital equipment owned by the enterprise.
81
Spill-Over Costs
Spill-Over Costs: A final example of costs which are irrelevant
to current decision making consists of social or spill-over costs. i.e.,
the negative aspects of production which descend upon members of
society other than the production decision maker? For example, air,
water, and noise pollution are the unfortunate by-products of
production processes which affect parties outside the enterprise.
These spill-over costs, however, are irrelevant to the
production decision context unless or until either the production
decision maker experiences a twinge of conscience, or the
authorities require the firm to prevent, clean-up,or compensate those
who have been harmed.We may say,then, that while such spill-over
costs currently are irrelevant to the production decision context, they
always have the potential for becoming relevant costs and
should not be ignored entirely by the production decision maker.
82
Variable and Fixed Costs
1- Variable costs (VC): are those which vary with the level
of productive output. Variable costs are always relevant
to the rate-of-production decision.
2- Fixed or overhead costs: are associated with the
existence of the manager, the plant, and the equipment.
Such as contractual salaries and insurance premiums.
They continue at the same levels or rates irrespective of
the rate of production, even if it is zero. Once the plant
has been put in place, these fixed or overhead costs are,
"sunk" costs, and sunk costs are not relevant to any
rate-of-production decisions
83
Accounting profit and economic profit
Accounting profit is the explicit, money-denominated
revenues realized by the enterprise during an accounting period,
less the explicit, money-denominated costs which are incurred in
that same period. Accounting profit does not include any implicit
costs, .the computation of an enterprise's accounting profit may
over- or understate its true (economic) profit and thereby lead to
erroneous decisions.
Economic profit is the result of the economist's effort to
recognize all benefits (implicit as well as money revenues) and costs
(opportunity costs as well as accounting costs) accruing to the
enterprise. Economic costs are all of the costs which are relevant
to decision making, whether or not money disbursements were
made and whether or not they are recognized in formal accounting
A critical distinction between a "good management" and "poor
management" may lie in the ability of the decision maker to
recognize the implicit costs and benefits of managerial decisions.
84
Cost Table & Curves in the Short-term
VI- COMPLETE THE FOLLOWING TABLE & graph it:
Q
FC
VC
TC
AFC
AVC
ATC
MC
0
1
2
3
4
5
6
7
8
9
10
100
100
0
100
180
240
280
340
420
520
640
780
940
100
200
280
340
380
440
520
620
740
880
1040
∞
100
50
33.3
25
20
16.7
14.3
12.5
11.1
10
100
90
80
70
68
70
74.3
80
86.7
94
∞
200
140
113..3
95
88
86.7
88.6
92.5
97.8
1004
0
100
80
60
40
60
80
100
120
140
160
= ∆ TC/ ∆Q
85
COSTS IN THE LONG-RUN
In the long run all enterprise's operations can be adjusted, so all costs are
variable .Any long run cost consists of a sequence of short runs. Costs in the
Long Run
The curve in the figure
which is tangent to
the sequence of short-term
SATC curves is a long run
average total cost
curve, LATC. It is
also referred
to as an "envelope"
curve because it
envelopes the
sequence of SATC curves
86
COSTS IN THE LONG-RUN (Cont’d)
Each of the SATC curves represents the cost conditions
for a plant of particular capacity which the enterprise
may construct. The LATC curve, however, represents no
single such entity, but rather is a sequence of points
each on a different SATC curve. Each of these points
represents the single optimal plant size, rate of
production, and cost level to meet a particular level of
demand.
The LATC curve may therefore be regarded as a longrun "planning horizon" concept which may assist the
production manager in selecting the appropriate plant
size, given the existing or anticipated level of demand for
the product.
87
COSTS IN THE LONG-RUN (Cont’d)
The following figures represent possible shapes of the
LATC curve.
Empirical data for a variety of
Industries suggests that some
of the other shapes may be
more common than the theoretical
U-shape. Shape (1) suggests
Possible early (small-plant) scale
economies, but after a rather small
least-cost plant size has been
reached, diseconomies of scale
if the company attempts to build
larger-scale plants.
These long-run cost conditions are
conducive to the development of a market
populated by a rather larger number of
smaller firms (or firms with a multiplicity
of small-capacity plants).
88
COSTS IN THE LONG-RUN (Cont’d)
Shape(2) depicts long-run cost conditions characterized by the
progressive, though gradual, exploitation of economies of scale which
never seem to reach exhaustion. A market characterized by these long
Run cost conditions will tend to be populated by a rather smaller number
of larger-sized firms, and perhaps ever fewer firms as time passes and
competition ensues. Economists classify such a market as oligopolistic.
The ultimate end of competitive evolution in such a market might be a
single, very large surviving firm, a so-called "natural monopoly." Shape(3)
may have involved a few minor scale economies as firms grew from very
small size at start-up, and could eventually reach a range of diseconomies
of large scale if existing firms Grow much larger. But the salient
characteristic of LATC curve is that it is flat-bottomed, i.e., there are no
significant scale economies to be exploited or diseconomies to be
suffered over a very wide range of plant sizes. .
89
Mathematical Specification and Empirical
Estimation of Cost Functions
TC = b0 + b1Q + b2Q2 + b3Q3,
from which may be derived
MC = dTC/dQ = b1 + 2 b2Q + 3 b3Q2
and
ATC = TC/Q = b0/Q + b1 + b2Q + b3Q2.
If b3 turns out not to be statistically significant but both b1 and b2
are significant, the model may be respecified as a quadratic of form
TC = b0 + b1Q + b2Q2,
from which may be derived
MC = dTC/dQ = b1 + 2 b2Q
and
ATC = TC/Q = b0/Q + b1 + b2Q.
if upon regression analysis of the quadratic form the coefficient b2
appears not to be statistically significant, the equation may be
respecified as a linear form,
TC = b0 + b1Q,
from which may be derived
MC = dTC/dQ = b1,
and
ATC = TC/Q = b0/Q + b1.
90
cost-function simulation model
The Management of Costs
Whether the management of the firm develops cost-function simulation
model or not, the cost related job involves many facets:
(1) in the long run, selecting the most efficient technology for producing the
selected products;
(2) with that technology, selecting the scale of plant with an output range
which is most compatible with current and expected future levels of
demand for the products;
(3) given the right scale of plant, selecting the appropriate output level to
meet the enterprise's goals (profit aximization, cost minimization, etc.);
(4) for the target level of output, selecting the appropriate internal allocation
of the enterprise's resources, i.e., the most efficient combination of
inputs, given the available input prices;
(5) operating efficiently and without waste, i.e., to operate at points on the
enterprise's production function surface (not below it) and on its
respective cost curve (not above it).
Furthermore, economists can argue that if the goal of the enterprise is to
maximize profits, and if it does so operate to maximize profits without
monopolizing its markets or exploiting its resources, it will also meet a
desirable social objective of efficiency in the allocation of resources .91
Perfect Competition
The descriptive characteristics:
(1) There is a large number of very small firms which operate within the same
product market.
(2) The single product which they produce and market is essentially homogeneous
across the member firms.
(3) The member firms have virtually identical managerial capacities; they use
essentially the same technologies; no one of them has or can acquire any
special expertise which is not available to all of the others.
(4) All participants in the market have access to the same information about
changing market conditions
Consequences and behavioral patterns for firms in the purely competitive market
:
92
Perfect Competition (Cont’d)
(
a) Entry into the market is easy; entry may be accomplished
quickly because of the ready availability of common
technology, and with very little capital investment.
(b) Exit from the market is likewise easy, i.e., the firm can
dispose of its capital assets quickly and with very little loss of
value.
(c) Once a decision has been made to enter the competitive
market there is likely be very little incentive or effort to
exercise further entrepreneurship, except the decision to exit
the market.
(d) The atomistic size and limited financial resources of the
competitive firm militate against its acquisition of any special
managerial or technical expertise; firms are unable
successfully to differentiate their products, and no firm can
attain any position of market dominance.
93
Perfect Competition (Cont’d)
(e) Because of the common knowledge of changing market conditions,
all participants in the market become aware of such changes
simultaneously, and all adjust at approximately the same rates.
(f) Because of the large number and atomistic size of sellers,
competition is essentially anonymous; no seller is aware of or
concerned about the identities of other sellers.
(g) A common price likely emerges in the market, and no market
participant finds incentive to try to charge any price higher or lower
than the market price.
(h) Due to the absence of successful product differentiation, there is
little or no point in advertising the firm's product characteristics or its
price.
(i) Supernormal and subnormal profits in the competitive market,
although they may occur, are fleeting; profits tend toward the
economically normal level of opportunity cost (what the firm can
realize in the next best alternative application of its resources).
94
A Firm in a Purely Competitive Industry
The general principle that
govern output decision
making when the goal is
to maximize profit is to:
P(MR) =MC
increase Q if MR > MC, but to
decrease Q if , MR < MC.
MR is easy to identify in the
purely competitive market
because it is equal to price,
and the MR curve is coincident
with the demand curve.
However, MC is not directly
observable. It can be computed
for any output level if the equation
of the TC or MC curve is known,
but knowing either of these equations
probably required a costly data
collection and model specification
and estimation process.
Incremental cost can be computed
more cheaply from data for two
different output levels, but it is only
an approximation to true
marginal cost
95
The Operate vs. Shut-Down Criterion in
the Short Run
It may be rational to shut-down operations in the short-run if
the revenue generated by selling the output cannot cover
even the operating costs (or variable costs) of producing
the output. Assuming cubic production and cost functions,
the shut-down criterion can be illustrated in the above
figure at any Qt for which
AR (P) < AVC, In these circumstances, the firm should not
operate because the revenue resulting from operation would
not cover all of the operating costs, and could make no
contribution at all to the overhead costs . In shut-down
mode, the firm minimizes its losses by incurring only the
fixed costs. The fixed costs, which continue in the short run
whether the firm operates or not, can be saved (or avoided)
only by exiting the industry..
96
Operate vs. Shut-Down Criterion in the
Short Run
I-You have given the following cost function:
TC = 100 + 600 Q – 3 Q² + 0.1 Q³
TC = 100 + 600 Q – 3 Q²
TC = 100 + 600 Q
1- compute the AVC,AC,and MC for each function. Plot them in
graph.
2- In each case , indicate the point at which diminishing returns
occur, also indicate the point of max. cost efficiency.
3- For each function, discuss the relationship b/w MC, AVC ,and
b/w MC and AC, and the relationship b/w AVC and AC.
II-The demand and cost function for a company are estimated to
be as follows:
p = 170 – 5Q
TC = 50 + 80Q – 10Q2 + 0.6Q3
97
Operate vs. Shut-Down Criterion in the
Short Run
a. What price should the company charge if it wishes to
maximize its profits in the short run.
b. What price should it charge if it wishes to maximize its
revenue in the short run?
c. suppose the company lacks confidence in the
accuracy of cost estimates expressed in a cubic
equation and simply wants to use a linear approximation.
Suggest a linear representation of this cubic equation.
What difference would it make on the recommended
profit maximizing and revenue maximizing prices?
98
Purely Competitive Adjustment in the Long-Run
We may recall that ATC is greater
than AVC by the average fixed cost at
each level of output. Under the
circumstances illustrated by P1 and TR1,
firms presently operating in the market
t can cover all of their variable and fixed
costs and enjoy a profit at the current
market price. When these profits are
perceived by outsiders, and if these profits
are greater than can be earned in other
markets, the outsiders may exercise
their entrepreneurship to enter the
market and try to share in the
supernormal profits. This entry into
the market will have the effect of
increasing market supply, shifting it to
the right to some position like S2 in panel (a) of the figure . As a result, market price will fall
toward P2, which will become the new locus of the demand and marginal revenue curves
as well. Correspondingly, the TR curve will rotate downward to its new position, TR2. As
consequence, the firm's profit-maximizing output level will change to q7, and the profit
earned by the firm will be smaller.
99
Purely Competitive Adjustment in the
Long-Run
driven by continuing entry into the market, could
continue until the price falls to P2 and the total revenue
curve rotates to position TR2; here, supernormal profits
are eliminated and the market price just covers the firm's
variable and fixed costs, allowing only a normal return to
the firm's ownership interest. The important point is that
with no effective way for firms to prevent entry into the
market, all super-normal profits will be competed away.
But no firm in the market will be suffering because each
will be paying or earning normal returns for all of the
resources under its employ. Capital and
entrepreneurship, having entered the market, will
continue in their present occupation until the prospect of
supernormal profits appears elsewhere.
100
Purely Competitive Adjustment in the
Long-Run
Managers who committed to plants like ATCm or ATC1
may find their firms realizing losses relative to firms
whose managers chose to build a least-cost plant. They
are stuck with plants which are too small or too large for
the duration of the lives of the plant and equipment.
Their short-run options are to continue to operate while
suffering losses if Pe happens to exceed their average
variable cost, or to shut-down if Pe is less than their
average variable cost. If price remains as low as Pe, the
firms which are realizing losses have the option of exiting
the market. Exit from the market will likely involve capital
losses if the plant and equipment cannot be
economically converted to other applications, or if they
must be sold at prices below their depreciated book
values.
101
2-Your are given the following LTC function:
TC = 160 Q- 20 Q² + 1.2 Q³
a- Calculate the LATC & the LMC . Graph these cost.
b- Describe the nature of of this function’s scale economies. Over what range of
output does economies of scale exist? Diseconomies of scale ? Show this in
the graph.
3- The demand and cost function for a company are estimated to be
as follows:
P = 100 – 8 Q
TC = 50 + 80 Q – 10 Q² + o.6 Q³
a- What quantity and price should the company charge if it wishes to maximize its
profit in the short-run ? Calculate the max. profit.
b- What quantity and price should it charge if wishes to maximize its revenue in the
short-run ?
c- Suppose the company lacks confidence in the accuracy of cost estimates
expressed in a cubic equation and simply wants to use a linear approximation .
Suggest a linear representation of the cubic equation. What difference would it
make on the recommended profit maximizing and revenue-maximizing prices
102
The following represents (D) & (D):in a perfectly competitive market.
D = 3000 – 10 P
S = - 1000 + 10 P
a- At what P would D = 0
b- At what P would S = 0 ,
c- Graph both D & S
d- What are the Qe & Pe ? Suppose the industry (S) consist of 100
identical firms, Determine The Q that should be produced by each
individual firm .
e- Suppose that the commodity is a normal good & average income
increased and moved D upward to the right, changing the D
equation to: D1 = 3500 - 10 P., what is the effect on Qe & Pe?
Determine The Q that should be produced by each individual firm .
f- Suppose another 50 new firms enter the market due to the increase
in D, so the new S is : S2 = -500 + 10 P, What are the new Qe & Pe
?
Determine The Q that should be produced by each individual firms.
g- Show these changes on the graph
103
Assume the following is the production function for each of the150
identical firms :
0.5 0.5
Q = 100 K L
104
Final Exam
I- Write Short Notes on 4/6
II- Three Problems 2/3
Slide 64 , 79 and 80 , 85
105