Chapter Review

CHAPTER REVIEW

Managerial economics is the application of economic theory and quantitative methods (mathematics and statistics) to the managerial decisionmaking process.In general,economic theory is the study of how individuals and societies choose to utilize scarce productive resources (land,labor, capital,and entrepreneurial ability) to satisfy virtually unlimited wants. Quantitative methods refer to the tools and techniques of analysis,which include optimization analysis,statistical methods,forecasting,game theory, linear programming,and capital budgeting.

Economic theory is concerned with how society answers the basic economic questions of what goods and services should be produced,and in what amounts, how these goods and services should be produced (i.e., the choice of the appropriate production technology),and for whom these goods and services should be produced.In market economies, what goods and services are produced by society is determined not by the producer, but rather by the consumer.Profit-maximizing firms produce only the goods and services their customers demand.How goods and services are produced refers to the technology of production,and this is determined by the firm’s management.Profit maximization implies cost minimization.In competitive markets,firms that do not combine productive inputs in the most efficient (least costly) manner possible will quickly be driven out of business. The for whom part of the question designates the individuals who are willing,and able,to pay for the goods and services produced.

The study of economics is divided into two broad subcategories: macroeconomics and microeconomics.Macroeconomics is the study of entire economies and economic systems and specifically considers such broad economic aggregates as gross domestic product,economic growth,national income,employment,unemployment,inflation,and international trade. In general,the topics covered in macroeconomics are concerned with the economic environment within which firm managers operate.For the most part,macroeconomics focuses on variables over which the managerial decision maker has little or no control,although they may be of considerable importance when economic decisions are mode at the micro level of the individual,firm,or industry.Macroeconomics also examines the role of government in influencing these economic aggregates to achieve socially desirable objectives through the use of monetary and fiscal policies.

Microeconomics,on the other hand,is the study of the behavior and interaction of individual economic agents.These economic agents represent individual firms,consumers,and governments.Microeconomics deals with such topics as profit maximization,utility maximization,revenue or sales maximization, product pricing, input utilization, production efficiency, market structure,capital budgeting,environmental protection,and governmental regulation.Microeconomics is the study of the behavior of individ-

ual economic agents,such as individual consumers and firms,and the interactions between them.

Unlike macroeconomics,microeconomics is concerned with factors that are directly or indirectly under the control of management,such as product quantity,quality,pricing,input utilization,and advertising expenditures. Managerial economics also explicitly recognizes that a firm’s organizational objective,usually profit maximization,is subject to one or more operating constraints (size of firm’s operating budget,shareholders’ expected rate of return on investment,etc.).

The dominant organizational objective of firms in free-market economies is profit maximization.Other important organizational objectives,which may be inconsistent with the goal of profit maximization, include a variety of noneconomic objectives, satisficing behavior,and wealth maximization.

The assumption of profit maximization has come under repeated criticism.Many economists have argued that this behavioral assertion is too simplistic to describe the complexity of the modern large corporation and the managerial thought processes required.Other theories emphasize different aspects of the operations of the modern,large corporation.Despite these attempts,no other theory of firm behavior has been able to provide a satisfactory alternative to the broader assumption of profit maximization.

Profit maximization (loss minimization) involves maximizing the positive difference (minimizing the negative difference) between total revenue and total economic cost,that is, total economic profit.Total revenue is defined as the price of a product times the number of units sold.Total economic cost includes all relevant costs associated with producing a given amount of output.These costs include both explicit,“out-of-pocket” expenses and implicit costs.

Economic profit is distinguished from accounting profit,which is the difference between total revenue and total explicit costs.Total economic profit considers all relevant economic costs associated with the production of a good or a service.Another important concept is normal profit,which refers to the minimum payment necessary to keep the firm’s factors of production from being transferred to some other activity.In other words,normal profit refers to the profit that could be earned by a firm in its next best alternative activity.Economic profit refers to profit in excess of these normal returns.

Noneconomic organizational objectives tend to emphasize such intangibles as good citizenship,product quality,and employee goodwill.The achievement of other organizational objectives,such as earning an “adequate”rate of return on investment,or attaining some minimum acceptable rate of sales,profit,market share,or asset growth,is the result of satisficing behavior on the part of senior management.Satisficing behavior is predicated on the belief that it is not possible for senior management to know when profits are maximized because of the complexities and uncertainties