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,Chapter 1
Introduction to managerial economics
LEARNING OBJECTIVES
● Appreciate the objective of managerial economics.
● Understand value added and economic profit.
● Apply total benefit and total cost to decide participation.
● Apply marginal benefit and marginal cost to decide extent.
● Appreciate the effect of bounded rationality on decision-making.
● Understand the vertical and horizontal boundaries of an organization.
● Distinguish competitive markets, market power, and imperfect markets.
KEY TAKEAWAYS
● Managerial economics is the science of cost-effective management of scarce
resources.
● Value added is the difference between buyer benefit and seller cost, and comprises
buyer surplus and seller economic profit.
● In decisions on participation, compare the total benefit and total cost.
● In decisions on extent, compare the marginal benefit and marginal cost.
● In decision-making, take care to avoid systematic biases, including the sunk-cost
fallacy, status quo bias, and anchoring.
● The vertical boundaries of an organization delineate activities closer to or further
from the end user.
● The horizontal boundaries of an organization are defined by the scale and scope of
operations.
● Businesses with market power must manage their costs, pricing, advertising, and
relations with competitors.
● Businesses in imperfect markets should act strategically to resolve the imperfection.
TIPS FOR INSTRUCTORS
Global flower market video: https://www.bbc.com/future/bespoke/made-on-earth/the-
new-roots-of-the-flower-trade/
, PROGRESS CHECKS AND ANSWERS
1A. Explain the relation among the following: buyer benefit, seller cost, value added,
buyer surplus, and economic profit.
1B. Suppose that the offer from the new firm is $25 per hour. Should Angela reject?
Answer
Angela should compare the marginal earnings and marginal cost in the new job, decide
how much she would work in the new job, and then compare the total earnings and
total costs in the current and new jobs.
1C. What is bounded rationality and what problems does it cause?
Answer
Bounded rationality is the idea that there are limits to rationality when individuals make
decisions. It can result in suboptimal decision-making: for instance, individuals may
erroneously count sunk costs, display a tendency to stick to the status quo, or rely
excessively on a specific piece of information when making decisions.
1D. Explain the difference between the vertical and horizontal boundaries of an
organization.
Answer
The vertical boundaries delineate activities closer to or further from the end user. By
contrast, the horizontal boundaries are defined by the organization's scale and scope of
operations.
1E. Distinguish the three branches of managerial economics.
Answer
The three branches are: (i) Competitive markets, (ii) Market power, and (iii) Imperfect
markets. Competitive markets have large numbers of buyers and sellers, none of which
can influence market conditions. By contrast, a buyer or seller with market power can
influence market conditions. A market is imperfect if one party directly conveys benefits
or costs to others, or if one party has better information than another.
REVIEW QUESTIONS AND ANSWERS
1. Explain the difference between value added and economic profit.
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