THE ETHICS OF GREED VERSUS SELF-

MANAGERIAL ECONOMICS INTEREST

 Because all costs are variable in the long run, long-run 05 INCENTIVES
 Managers make tough choices that involve benefits and Capitalismpeople is based on voluntary exchange
fixed costs always equal zero.  Rewarding according to the value created
costs. between self-interested parties.
 Long Run – period of complete flexibility with respect to for the organization.
 Spreadsheets were a pivotal innovation because they put  Market-based exchange is voluntary; both
input use.
the tools for insightful demand, cost, and profit analysis at TOTAL PROFIT
parties must perceive benefits, or profit, for
 Total Costs – fixed and variable expenses.
the finger tips of decision makers. market transactions to take place. If only one
 Fixed Costs – expenses that do not vary with output.  It is simply the difference between total revenue
 Effective managers must collect, organize, and process party were to benefit from a given transaction,
 Variable Costs – expenses that fluctuate with output. and total cost. Π = TR – TC
relevant operating information. However, efficient there would be no incentive for the other party to
information
MARGINAL ANDprocessing
AVERAGE COST requires more than electronic cooperate and no voluntary exchange would
MARGINAL PROFIT
computing capability; it requires a fundamental take place.
 Marginal
understanding Costof– basic change in total relations.
economic cost associated with a 1-  ItAisself-interested
the change in total profit due to aalso
1-unit change
capitalist must have in
unit change in output.
 “Effective managerial decision making is the process of inmind
output.
the interest of others. In contrast, a truly
 MC=∂TC/∂Q
arriving at the best solution to a problem.’’
“Marginal cost
 OPTIMAL DECISIONis the change
– Choice in total cost caused
alternative by a I-unit
that produces a “Marginalselfish individual
profit is the change is only concerned
in total with himself
profit caused by a 1-
change
result mostin the number with
consistent of units producedobjectives.
managerial (Q).” unit change in the number of units sold.” Mπ = ∂π / ∂Q of
or herself, without regard for the well-being
others.
 Average
 A challenge Costthat – total mustcostbedivided
met in by the
the decision-making
number of units
 Self-interested
MARGINAL PROFIT behavior leads to profits and
produced.
process is characterizing the desirability of decision success under capitalism; selfish behavior
 AC = TC/Q in terms of the objectives of the organization.
alternatives Marginal does
profit not.
can be thought of as the difference between
 Managerial the
 Whenever marginalalso
economics is less
provides than tools the foraverage, the
analyzing marginal revenue and marginal
 Precise information aboutcost. Mπ = of
the effect MRa– MC
change
average will fall. Whenever the marginal
and evaluating decision alternatives. Economic concepts is greater than the
in output on total
PROFIT MAXIMIZATION RULE revenue is given by the
average, the average
and methodology are will
used rise.to Ifselect
the marginal
the optimal is equal to the
course of marginal relation between revenue and output.
average, the average is at either
action in light of available options and objectives.a minimum or a maximum.
Profit is maximized
Total, average,when and Mπ =marginal
MR-MC =relations
0 or MR=MC, are
 If
 MC = AC,ofand
Principles average cost
economic analysisfalls withformanthe expansion
basis for in
assumingvery profit declines
useful with further expansion
in optimization in number
analysis. Whereas
output, then AC is at a maximum.
describing demand, cost, and profit relations. Most If MC = AC, and average
of unit sold.
the definitions of totals and averages are well
cost rises the
important, withtheoryan expansion
and process in output, then AC isgives
of optimization at a
known, the meaning of marginal relations needs
minimum.
practical insight concerning the value maximization theory MARGINAL VERSUS INCREMENTAL CONCEPT
some explanation.
of the firm. Optimization techniques are helpful because  A marginal
AVERAGE COST MINIMIZATION
they offer a realistic means for dealing with the MARGINAL CONCEPTrelation measuresis thethe change in the
effect associated
dependent
with unitary changesvariable
in output.caused by a 1-unit change in
– ancomplexities
activity level of goal-oriented
that generates the managerial
lowest average activities.cost. an independent variable.
 In managerial economics, the primary objective of  The marginal
Marginal revenueconcept
(MR)isis although
the change correct
in totalfor
 MC=AC
management is assumed to be maximization of the analyzing
revenue unitary
associatedchanges
with ina output,
1-unit ischange
too narrow
in
 The
value relationship
of the firm. between
This marginal cost and average
value maximization objectivecostis tooutput:
provide a general methodology for evaluating all
can be studied
expressed in Equation to determine the change in average cost
 alternative
MR = ∂TR/∂Q courses of action.
 that will occur EQUATION
MAXIMIZING with a 1-unitischange a complex in thetasknumber of units
that involves  “Marginal revenue is the change in total revenue
produced.
consideration of future revenues, costs, and discount rates. INCREMENTAL CONCEPT
caused by a 1-unit change in the number of
 With
 TOTAL average
REVENUES cost are minimization,
directly determined the lowest by thepossible
quantity
average  Itunits
is thesold (Q).”
generalization of the marginal concept. It
sold and cost is achieved.
the prices obtained
involves examining the impact of alternative
 Factors that affect
MARKET-BASED MANAGEMENTprices and the quantity sold include DO FIRMS REALLY OPTIMIZE?
managerial decisions of courses of action on
the choice of products made available for sale, marketing
strategies,
 Charles pricing and distribution policies, competition, and
Koch  revenues,
Economic costs, and profit.
theory is useful for one simple
the general state of the economy reason—it works.
INCREMENTAL CHANGE
Market-Based
 COST ANALYSIS Management includes (MBM) a detailed examination of the  Cost Functions – relations between cost and
 Itoutput.
is the change resulting from a given managerial
 It is a business philosophy input
prices and availability of various that factors,
fosters alternative
principled, Short-run Cost Functions – cost relations
 decision.
production schedules, production
entrepreneurial behavior among its employees. methods, and so on
when fixed costs are present; used for day-to-
 ‘’Effective
 “seeks to adaptproduction and pricing
the principles of adecisions
free society dependand upon
market a
INCREMENTAL PROFIT
day operating decisions.
careful
economy understanding
to of
improve revenue relations.’’
management practice in
 Spreadsheet  Long-run Cost Functions – cost relation when
organizations.”– table of electronically stored data.  It is the profit gain or loss associated with a given
all costs are variable; used for long-term
 Equation – analytical expression of functional relationships managerial decision.
FIVE DIMENSIONS
 Total Revenue –OF is aMBM
function of output. planning.
 The easiest way to examine basic economic concepts is to  Short Run Operating – period during which the
01 VISION
consider the functional relations incorporated in the basic availability of at least one input is fixed.
 Determining
valuation model. whenConsider
and howthe the relation
organization between can output,
create theQ.
greatest long-term value based upon competitive COST RELATION
and total revenue, TR.
 advantages.
The value of the dependent variable (total revenue) is Total costs are comprised of fixed and variable
02 VIRTUE AND TALENTS
determined by the independent variable (output). expenses.
 Helping ensure that
• Equation people
(2.2), TR with the right
= f(Q), doesvalues, skills, and
not indicate the
capabilities are hired, retained, and developed. In equation form, total cost can be expressed as
specific relation between output and total revenue;
03 KNOWLEDGE PROCESSES
it merely states that some relation exists.
 Creating, sharing, andTR applying relevant aknowledge to TC = FC+VC.
• Equation (2.3), = PQ, provides more precise
discoverexpression
how employees and practices
of this functional relation: can become more Fixed costs do not vary with output. These costs
profitable.
• When a linear demand curve is written as P = include interest expenses, rent on leased plant and
04 DECISION RIGHTS equipment, depreciation charges associated with the
 Ensuring the right people are in the right roles with the right
authority to make decisions and holding them accountable.