Managerial Economics
Module 2
Obj ecti ves
Explore the relationship of economic concepts and analysis to
business decision-making and strategies
1 Explain the roles of Microeconomics and Industrial
Organization to Managerial Economics
Engage ourselves to individual segments of economy and
analyze how they are affected by recent crisis
Understand the principal-agent problem and why it occurs
Maximizing the Value of the Firm
Value of a firm
▪ the price for which the firm can be sold, which equals the present
value of future profits
Risk Premium
▪ an increase in the discount rate to compensate investors for
uncertainty about the future
Principle:
The value of a firm is the price for which it can be sold, and the
price is equal to the present value of the expected future profits
of the firm. The larger (smaller) the risk associated with future
profits, the higher (lower) the risk adjusted discount rate used to
compute the value of the firm, and the lower (higher) will be the
value of the firm.
For Present Value and Future Value computations, you may
refer to the link below and open slides 4-12
https://www.slideserve.com/zamora/the-basic-tools-of-finance
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Principle:
If cost and revenue conditions in any period are independent of
decisions made in other time periods, a manager will maximize the
value of a firm (the present value of the firm) by making decisions
that maximize profit in every single time period.
Separation of Ownership
and Control of the Firm
Principal-Agent Relationship
▪ relationship formed when a business owner (the principal)
enters an agreement with an executive manager (the agent)
whose job is to formulate and implement tactical and strategic
business decisions that will further the objectives of the
business owner (the principal)
The Principal-Agent Problem
▪ a manager takes an action or makes a decision that advances
the interests of the manager but reduces the value of the firm
A principle-agent problem arises between a firm’s
owner and manager when two conditions are met:
▪ the objectives of the owner and manager are not aligned
▪ the owner finds it either too costly or impossible in the case of moral hazard to
perfectly monitor the manage to block all management decisions that might be
harmful to the owner of the business
Complete contract
▪ an employment contract that protects owners from every possible
deviation by managers from value maximizing decisions
Hidden actions
▪ actions or decisions taken by managers that cannot be observed by
owners for any feasible amount of monitoring
Moral hazard
▪ a situation in which managers take hidden actions that harm the
owners of the firm but further the interests of the managers
Market Structure
and Managerial Decision
Price Taker
▪ a firm that cannot set the price of the product it sells, since
price is determined strictly the market forces of demand and supply
Price Setting Firm
▪ a firm that can raise its price without losing all of its sales
Market Power
▪ a firm’s ability to raise price without losing all sales
What is a market?
A market is any arrangement through which buyers and
sellers exchange final goods or services, resources
used for production, or, in general, anything of value.
Market Structure
A market structure is a set of market characteristics
that determines the economic environment in which
a firm operates
Economic Characteristics that describe a market:
▪ The number and size of the firms operating in the market
▪ The degree of product differentiation among competing
producers
▪ The likelihood of new firms entering a market when
incumbent firms are earning economic profits
Market Structures
Perfect Monopoly Monopolistic Oligopoly
Competition Market Competition
Globalization of Markets
the process of integrating markets located in nations
around the world
provides managers with an opportunity to sell more
goods and services to foreign buyers and to find new
and cheaper sources of labor, capital, and raw materials
there is a threat of intensified competition by foreign
businesses
R eference
Thomas, C. R., & Maurice, S. (2015). Managerial Economics: Foundations
of Business Analysis and Strategy. New York, NY: McGraw-Hill Education.
