Transcript Lecture 1: Basics of Math and Economics

Lecture 3:
Introductory Spreadsheet Modeling
AGEC 352
Spring 2011 – January 24
R. Keeney
Material to Date

Review of mathematics and economics
and introduced optimization

Relating the algebra and calculus we have
seen in previous courses to the economic
principles from previous courses
◦ This is a general pattern for this course
factoring in that most of the math we do
shows up in spreadsheet formulae
Spreadsheet Modeling



Ways to think of it…
Miniature, reduced, simplified version of an
economic problem
A firm plans…
◦
◦
◦
◦
◦
◦
Production schedule
Purchase and sale activities (inputs and outputs)
Cost and inventory management
Transfers within company
Marketing and promotion
Managerial and labor assignments
Basics

Identification of the management problem
◦ Must be clearly specified
◦ Goal of modeling is not to ‘solve’ the problem—
rather to guide decision making

Given the management problem
◦ Identify the management objective
◦ Identify the choice(s) under management control
◦ Identify other variables not under management’s
control
 Other steps as we advance in class
Price setting example (1/19)
What price to charge to earn highest
profit?
 Under the firm’s control: Price
 Firm’s objective: Maximum Profits
 Not under the firm’s control

◦ Everything else…
Map the Problem Out
Maximum Profits
What comes in between?
Price Charged by Firm
Map the Problem Out
Maximum Profits
Costs
Revenue
Price charged affects revenue
(P x Q)
Does price charged affect
costs?
C = ???
Price Charged by Firm
Map the Problem Out
Maximum Profits
Revenue
Quantity
Costs
minus
multiply Price
Fixed Costs
plus
Variable Costs
Price Charged by Firm
Map the Problem Out
Maximum Profits
Revenue
Q = a + bP
Costs
minus
multiply Price
Fixed Costs
plus
VC = Q x U
Price Charged by Firm
Map the Problem Out
Maximum Profits
Revenue
Q = a + bP
Costs
minus
multiply Price
Fixed Costs
plus
VC = U x (a + bP)
Price Charged by Firm
Summary
Firm sets a price to influence profits
 The price chosen influences

◦ Quantity sold as determined by demand
curve
◦ Revenue due to price and the quantity sold
◦ Costs through variable costs and the quantity
sold

Not of the firm’s control:
◦ Demand curve numbers ( a and b)
◦ Cost curve numbers (Fixed costs, U)
Classification

Free/choice variable: price
◦ Firm can set any value it wants

Consequence variable: quantity, variable
costs, profits
◦ The value depends on the choice of the firm and
some values not under its control

Parameter (exogenous variable): demand
curve intercept and slope, fixed costs, unit
cost of production
◦ These values are given and do not change when
the firm changes its choices
Building a spreadsheet model

Labeling
◦ Every value entered into a spreadsheet needs an
accompanying label
 Easy to find
 Clearly identifies what the cell entry is

Formula linkages
◦ Every calculation in a spreadsheet needs to be
attached to the simplest accurate formula
 E.g. quantity instead of the full demand calculation

Parameter specification
◦ Every parameter (fixed number value) that is part
of a formula needs to be entered into its own cell
Model Results:
What is different about each section?
Consequence Variables
Profits ($)
Revenue ($)
Costs ($)
Quantity (units)
-15
0
15
10
-5
9
14
9
3
16
13
8
9
21
12
7
13
24
11
6
15
25
10
5
15
24
9
4
13
21
8
3
9
16
7
2
3
9
6
1
-5
0
5
0
Parameters
Demand Intercept
Demand Slope
Fixed Costs ($)
Variable Cost per Unit
10
-1
5
1
10
-1
5
1
10
-1
5
1
10
-1
5
1
10
-1
5
1
10
-1
5
1
10
-1
5
1
10
-1
5
1
10
-1
5
1
10
-1
5
1
10
-1
5
1
0
1
2
3
4
5
6
7
8
9
10
Choice Variables
Price ($)
Graphical Analysis
Dollars
(revenue, cost)
30
25
20
15
10
5
0
0
2
4
6
Price Charged by Firm
Revenue ($)
Costs ($)
8
10
Modeling to help decisions

We said a model is a simplification of a
management/economic problem

What do we do with it?
◦ We’ve seen how it guides price setting

What else?
◦ Management/planning questions
Model as a lab

Another way to think of an economic
model is as a laboratory for doing
experiments or scenarios
◦ (some textbooks call this ‘what if’ analysis)

Unlike physical sciences, it is rare to see
experimental trials in economics
◦ Agents like to earn on resources, not
randomize decisions to see which one
emerges as best…
Model utility
Just like in lab experiment settings, models
of economic situations are only as useful
as their proximity to actual conditions
 Difficulties

◦ Many interconnected decisions and
relationships at work
◦ Rely on historical data to express
relationships in the future
Lab tomorrow
Handout will be posted on class website
by 12PM.
 We’ll use Blackboard Discussion

◦ 1) Discussion forum is linked from the
blackboard page for this class
◦ 2) Sign in by replying to the sign-in topic
◦ 3) Instructor questions will be posted
between 12:50 and 1:00. If I am calling on you,
your name will be in the subject line…