Graham - Managerial Economics For Dummies

Page 319

Chapter 17: Principal–Agent Issues and Adverse Selection: Can Everyone Agree? ✓ Principals frequently don’t directly observe the agent’s actions. ✓ The agent’s actions aren’t the sole determinant of the ultimate outcome. When a company loses a million dollars, was it because of poor managers, or did good managers keep the company from losing two million dollars? Simply looking at the firm’s profit doesn’t provide enough information to tell whether the management is good or bad just like looking at a coach’s record in a given season doesn’t indicate whether the individual is a good or bad coach. Winning half the games with less talented players may indicate great coaching while winning half the games with extremely talented players may indicate bad coaching. Shareholders in a large corporation, the principals, want to maximize their wealth — the return on their investment. Agents, in this case the firm’s managers, may pursue some combination of other goals, including less effort, higher income, greater job security, lower risk of failure, and better reputation. It’s a difficult challenge to coordinate these various objectives and make them consistent with maximizing the firm’s return on investment. As principals try to get all employees to work toward maximizing the company’s return on investment or profit, they must determine whether to use sticks or carrots. Sticks focus on supervision and negative consequences such as an employee being fired. The advantage of using sticks is they’re inexpensive to implement. On the other hand, sticks only motivate individuals to a point. That point is the minimum effort necessary to avoid the stick. On the other hand, carrots focus on rewards. Employees are rewarded for good effort, such as with a profit-sharing plan. The advantage of carrots is employees have an incentive or reward, such as a bonus, for continued hard work past the minimum effort necessary to keep their job. The disadvantage is carrots are expensive.

Behaving badly with a flat salary As an absentee owner, you realize your firm’s profit increases as your manager’s efforts increase. You decide to pay your manager a flat salary. Regardless of the manager’s effort, the salary doesn’t change. On the other hand, extra effort is bad for the manager — it’s hard work. Instead of working hard, the manager would rather talk with employees, surf the web, or play solitaire on the company’s computers. These activities give pleasure or utility, while managerial effort is hard and thus gives disutility. The resulting “compensation” for the manager equals the utility that comes from the flat salary minus the disutility associated with extra effort. Figure 17-1 describes the relationship between managerial effort — measured on the horizontal axis — and the principal’s goal (profit) and manager’s

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Producing too little with positive externalities: Honey

3min
pages 319-320

Regulating for efficiency

1min
page 323

Producing too much with negative externalities: Pollution

2min
page 318

Chapter 18: Rules, Rules Everywhere: Government and Managerial Decision-Making

0
page 315

Dealing with Adverse Selection

1min
page 310

Increasing Insurance Costs with Adverse Selection

1min
page 309

Keeping managers in line

1min
page 305

Behaving better with profit sharing

1min
page 303

Behaving badly with a flat salary

3min
pages 301-302

Principal–Agent Problem #1: When Managers and Owners Disagree

1min
page 300

Behaving better with stock options

1min
page 304

Chapter 17: Principal–Agent Issues and Adverse Selection: Can Everyone Agree?

1min
page 299

Calculating the internal rate of return

4min
pages 296-298

Indexing profitability

1min
page 295

Estimating Cash Flows in an Uncertain Environment

1min
page 288

Selecting among Alternative Investments

3min
pages 286-287

Sealing the deal: The sealed-bid auction

0
page 284

Bidding first wins: The Dutch auction

1min
page 283

Calculating the expected value Changing the Odds by Using New Information to

2min
pages 269-270

Using the expected utility criterion

1min
pages 280-281

Recalculating expected values

9min
pages 273-277

Making the best worst-case by using the mini-max regret rule

2min
pages 267-268

Considering Factors In and Out of Your Control

1min
page 265

Predatory pricing: Get out

6min
pages 259-262

Chapter 15: Risk Analysis: Walking Through the Fog

2min
page 263

Limit pricing: Keep out

1min
page 258

Allowing mixed bundling

3min
pages 255-256

Determining third-degree price discrimination with calculus (if you’re interested

2min
pages 246-248

Applying third-degree price discrimination

1min
page 245

Pricing coupons

3min
pages 249-250

Using second-degree price discrimination

3min
pages 243-244

Breakeven analysis

1min
page 239

Simplifying Price Determination by Using the Price Elasticity of Demand

1min
page 236

Wishing for first-degree price discrimination

1min
page 242

Chapter 14: Increasing Revenue with Advanced Pricing Strategies

1min
page 235

Determining the Ideal Amount of Advertising

7min
pages 231-234

Adjusting to the Long-Run Tendency of Profit Elimination

2min
page 230

Relying on calculus in monopolistic competition

3min
pages 228-229

Chapter 13: Monopolistic Competition: Competitors, Competitors Everywhere

2min
page 223

Testing commitment

5min
pages 220-222

Working together through collusion

0
page 219

Infinitely repeated games

3min
pages 214-216

Sequential-move, one-shot games

3min
pages 212-213

Profiting from the Long Run

2min
page 202

Working together by using cartels and collusion

5min
pages 198-201

Leading the pack: Another view of price leadership

5min
pages 194-197

Competing for customers through the Bertrand model

2min
pages 192-193

Reacting to rivals in the Cournot model

3min
pages 186-188

Leading your rivals with the Stackelberg model

2min
pages 189-191

Chapter 11: Oligopoly: I Need You

2min
page 181

Calculating the best allocation with calculus

3min
pages 178-180

Minimizing losses to make the best of a bad situation

1min
page 174

Enjoying the long run

1min
page 176

Calculating economic profit and the profit-per-unit fallacy

1min
pages 172-173

Maximizing profit with calculus

1min
page 171

Maximizing profit with total revenue and total cost

0
page 166

Deriving maximum profit with derivatives

3min
pages 167-168

Price, and Revenue

1min
pages 163-164

Standing Alone: Identifying the Sources of Monopoly Power Unable to Charge as Much as You Want: Relating Demand,

2min
page 162

Giving up and shutting down

3min
pages 153-154

Chapter 10: Monopoly: Decision-Making Without Rivals

1min
page 161

Making the best of a bad situation by minimizing losses

3min
pages 150-152

Calculating economic profit

0
page 149

Using calculus to find marginal revenue equals marginal cost

2min
pages 147-148

Maximizing profit as a marginal decision

2min
pages 145-146

Maximizing total profit with calculus

1min
page 144

Maximizing profit with total revenue and total cost

0
page 143

Identifying the Characteristics of Perfect Competition

2min
page 140

Chapter 9: Limited Decision-Making in Perfect Competition

1min
page 139

Recognizing that Two Can Be Less Than One with Economies of Scope

4min
pages 135-138

Going as far as you can with economies of scale

1min
page 133

Marginal cost

1min
page 125

Chapter 8: Production Costs: Where Less Is More

0
page 121

Hoping for less by minimizing per-unit costs

3min
pages 130-131

Watching developments by modeling diffusion

1min
pages 119-120

Developing parallel efforts: Where two is less than one

2min
pages 114-115

Time is money

1min
pages 116-117

Working harder: Calculating total factor productivity

1min
page 112

Working hard: Measuring labor productivity

1min
page 111

Chapter 7: Innovation and Technological Change: The Future Is Now

0
page 109

Long-Run Returns to Scale

1min
page 106

Minimizing Cost with Calculus (If You Want Recognizing That More Isn’t Always Better with

2min
pages 104-105

Defining isocost curves: All input combinations cost the same

2min
pages 100-101

Distinguishing between average product and marginal product

4min
pages 95-96

Examining production isoquants: All input combinations are equal

2min
pages 98-99

Starting with Basics by Using Single Input Production Functions

1min
page 94

Producing Hats: Identifying the Types of Inputs and Timely Production

1min
page 92

Chapter 6: Production Magic: Pulling a Rabbit Out of the Hat

1min
page 91

Issuing coupons

4min
pages 88-90

Selling gift cards

1min
page 87

Deciding what makes you happiest

1min
page 81

Doing the Best You Can Given Consumer Constraints Maximizing Pleasure through Consumer Choice and

1min
page 76

Consuming within limits

2min
page 80

Getting less from more: The law of diminishing marginal utility

1min
page 75

Adding happiness — at a price

0
page 74

Calculating Elasticity with Calculus (If You Must

3min
pages 70-72

Finishing Up with the Advertising Elasticity of Demand

1min
page 69

Identifying substitutes and complements

1min
page 68

Identifying necessities and luxuries

1min
page 66

Influencing the price elasticity of demand Identifying the bottom line, almost: The price elasticity

1min
page 61

Recognizing degrees of flexibility with inelastic or elastic

1min
page 60

Determining the price elasticity of demand: Formulas are your friend

1min
page 59

Knowing the Price Elasticity of Demand: The Fundamental Trade-Off

1min
page 58

Discovering the secret code: The Lagrangian Multiplier

4min
pages 52-56

Joining Derivatives and Optimization: An Ideal Partnership

1min
page 49

Changing equilibrium: Shift happens

8min
pages 34-38

Producing too much: Stuff lying everywhere

2min
page 32

Foolish Assumptions

2min
page 4

Rules, rules everywhere

7min
pages 42-46

Holding most, but not all, things constant by using partial derivatives

2min
pages 47-48

Producing not enough: The cupboard is bare

1min
page 33

Chapter 2: Supply and Demand: You Have What Consumers Want

1min
page 23

Chapter 3: Calculus, Optimization, and You

1min
page 39
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