Managerial Economics - Review Articles - List

The book 'Managerial Economics' was authored and published by Joel Dean in 1951.

The purposed was stated as to show how economic analysis could be used in formulating business policies. The focus of the book is to give executives access to the practical contributions that economic thinking can make to top-management policies. It is also stated that the book deals only with those phases of enterprise economics that strike the author as particularly useful to he management of large industrial corporations.

The book highlights economic analysis for the concepts of profit, competition, demand, cost, price and applied areas like advertising and capital budgeting.


Review notes for the chapters of the book

1. Profits
2. Competition
3. Multiple Products
4. Demand analysis
5. Cost
6. Advertising
7. Basic Price
8. Product-line Pricing
9. Pricing Differentials
10.Capital Budgeting

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Economics of Advertising - Economics for the CEO

Advertising is a pure form of selling cost. This chapter illustrates the general approach of managerial economics to various kinds of marketing or selling outlays.

Nature of Advertising Costs

Advertising costs are designed to increase the demand for the firm's products. Advertising expenditures shift the demand curve to the right of where it would otherwise be.

Selling costs are incurred to the get the business. Production and distribution costs create the product and take it to the market.

Pure selling costs are designed to shift the demand schedule, i.e., to obtain sales that would not otherwise have been obtained at the same price. Selling expenses have no functional relationship to production output. They are a cause of sales or some part of sales. In the short run, sales and hence profit depend on the combinations of price, product improvement or specified functionality and quality, advertising outlay and other selling activities. These four influences are interactive. Advertising can shift the demand curve to the right and also can make demand less elastic.

Promotional Elasticity of Demand

Promotional elasticity of demand measures the responsiveness of sales to changes in the amount of advertising with constant price. Like other elasticity measures, it is the ratio of proportionate chagne in sales to the proportionate change in the advertising that causes the change.

Long-Run Aspect of Advertising

Advertising has long-run impacts apart from shifting the short term demand to the right. It helps a firm to attain strategic advantage in market position and gives it a security that contributes to the long-run profit maximization.

The further discussion in the chapter is focused on three issues.

1. The level of the total advertising expenditure over a period of years.
2. Fluctuations in the annual outlays over the course of a business cycle.
3. Measuring the effects of advertising for planning and control purposes.



1. The Level of Advertising Expenditure

The theory of monopolistic competition provides an opportunity to analyze advertising expenditure and its effect on profit for a monopolist.

Simple theory of behavior of advertising expenditure and its impact: Ad expenditure includes all pure selling costs in the theory. The marginal cost of advertising comes down initially and then it goes up in the short run. A firm can go on advertising till the marginal cost of advertising becomes equal to gross profit (gross profit assumed to be constant).


Methods for determining total advertising budget: While the theoretical rule of marginal cost is equal to gross profit on a unit is rational, firms use more simple thumb rules. They are further discussed in the chapter.

a. Percentage of sales approach
b. All-you-can-afford approach
c. Return on investment approach
d. Objective and task approach
e. Competitive parity approach

2. Cyclical Fluctuations

3. Measuring the effects of advertising for planning and control purposes.

One has to measure how much the firm's demand schedule has shifted as a result of a specified amount of advertising outlay. Historical data if available can be studied in two ways. (i) by comparing firms with different advertising outlays and (ii) by comparing a firm's performance over time with different advertising outlays.

While Joel Dean's book authored in 1951 has pointed out that economics of advertising is an important managerial economics issue for top management, it has not provided much content. One has to see the contribution of subsequent authors in this topic to get more useful direction.

Reference: Managerial Economics by Joel Dean

For a Recent Update on Economics of Advertising
The Economics of Advertising: Introduction - Kyle Bagwell - Prof - Columbia University
http://www.stanford.edu/~kbagwell/Bagwell_Web/advertisingintrofv2.pdf

Originally posted at
http://knol.google.com/k/narayana-rao/economics-of-advertising-economics-for/2utb2lsm2k7a/3134


Updated:2.1.2014
Published in the blog 11.12.2011

Managerial Economics of Basic Price - Joel Dean - Review Notes

Joel Dean stated that the firms activities can be viewed as three important ones.

1. Product development and improvement (innovation).
2. Sales promotion, and
3. Pricing

The objective of this chapter is to develop philosophy of price making and to explain how economic analysis and market research can be used to improve practical pricing.

The discussion focuses on manufacturers, who have some flexibility to set prices as their products are differentiated and also the setting is a multi-product firm.

Pricing objectives

While survival of the firm making the required return on capital is the broadest objective, on a more specific level various objectives can be rate of growth, market share, etc.

Pricing theory

Pricing theory indicated that concepts of demand and demand schedule, competitors actions, and cost of the product are relevant for pricing decisions.

Pricing research

Research needs to be done to information on the structure of competition, the behavior of the firm's costs, and the nature of demand.

Economic theory of monopoly pricing is discussed in the chapter.

In the case of new products pioneer pricing and maturity pricing are discussed.

Pricing of problems of oligopoly are discussed. The topic of cost-plus pricing is also covered in the chapter



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Updated 2 Jan 2-14

Managerial Economics of Profit - Economics for CEO - Review Notes

"A business firm is an organization designed to make profits and profits are the primary measure of its success." Joel Dean

Business organizations operate within the societies and societies expect quality of products, reliable supply in quantity and place etc. To make profits, firms have to satisfy the desires of the buyers and other stakeholders of the society. The firm can continue as profit system only by satisfying the stakeholders. But within the system of profits, profits are the acid test of the individual's firm's performance.

Joel Dean highlighted three issues regarding profit.

1. Profit measurement - Economic analysis of accounting data for policy making
2. Policy decisions on profit standards and profit goals
3. Use of profits for control purposes in complex business organizations.


Economic Analysis of Profits Measurement by Accoutants

"Economists are unhappy about conventional accounting methods for measuring business income."

Conceptual conflict

Economists look to the future and economic decisions taken today produce profits in the future. For decision making today past is irrelevant, excepting for its use in forecasting for the future.

Joel Dean discussed four issues specially.

1. The types of costs to be deducted from revenues to arrive at profit.
2. Depreciation
3. The treatment of capital gains and losses
4. Price level basis of valuation of assets.




Policy decisions on profit standards and profit goals

Reasons for Limiting Profits

it is an interesting topic and Joel Dean brought into explanation at the start of the topic.

1. To discourage potential competitors.
2. To woo the voting public and restrain the zeal of antitrusters.
3. To restrain wage demands of organized labor.
4. To maintain customer good will
5. To keep control undiluted.
6. To maintain pleasant working cnditions.

Joel Dean highlighted the need for restraining profits and gave some guidelines for determining reasonable profits.

Profits for Control

1. In divisional organization, where products are different:
2. In vertically integrated organization

There is complexity in this issue, and the conclusion is that profit standard for control must be set largely by managerial ukase, designed with discretion and wisdom.

Note:
Meaning of "ukase": edict of Tsarist Russian government,
From Russian Ukaz: ordinance, edict
to be understood as discretionary order


Originally posted at
http://knol.google.com/k/narayana-rao/managerial-economics-of-profit/2utb2lsm2k7a/3050

Economics of Competition - Economics for CEOs - Review Notes

CEOs need an understanding of the structure of competition in their industries as business decisions of their firms are to be oriented to competition in their industry.

Joel Dean included the article "The Nature of Competition" by Clair Wilcox in this chapters.

The types of competition discussed in the paper are:

Perfect competition
Pure competition
Imperfect competition
Monopolistic competition
Non-price competition
Oligopoly
Cutthroat or destructive competition
Predatory or discriminatory competition
Unfair competition
Fair competition
Potential competition
Effective or workable competition

Reference
Managerial Economics by Joel Dean

Originally posted at
http://knol.google.com/k/narayana-rao/economics-of-competition-economics-for/2utb2lsm2k7a/3052

Economics of Multiple Products - Economics for CEOs

Product policy, promotional policy and pricing policy are three important business policy decisions.

Microeconomic theory has been developed on the premise that each firm makes only one product.

Managerial decision problem of product coverage in the case of multi-product firm was discussed from an economic viewpoint by Joel Dean in chapter 3 of his book.


Why does a firm decide to produce multiple products?

Excess capacity of a firm in certain production facilites (or managerial facilties) [due to indivisibility of certain facilities]
Secular shifts[Demand for existing product has come down due change in tastes and hence excess capacity appears].
Vertical integration
Research [research finds certain technologies that reduce production times and thereby create excess capacity or it develops new products that make existing products obsolete and thus create excess capacity]


Policy on Adding New Products

Policy on Dropping Old Products

Why does the problem arise?
Product obsolescence caused by basic changes in consumer taste or by striking improvements in rivals' products forces firm to think of dropping existing products.


Reference
Managerial Economics by Joel Dean

Originally posted at
http://knol.google.com/k/narayana-rao/economics-of-multiple-products/2utb2lsm2k7a/3054

Managerial Economics of Demand - Economics for CEOs

"Demand analysis seeks to search out and measure the forces that determine sales." Joel Dean


The two main managerial purposes of demand analysis are:

1. Forecasting sales, and
2. Manipulating demand

To use demand studies to influence or manipulate demand in an active way, the management must recognize the degree to which sales are a result of external economic environment as well as the actions of the company itself. Sales volumes or the underlying demand will differ with money spent on advertising, price policy, product improvements, sales effort etc. Forecasting sales for policy of no change in the existing company controlled economic variables is to be used as a benchmark for estimating the consequences of other plans for adjusting those economic variables.

Concepts of Demand Theory Highlighted in the Chapter

Demand Schedule
Demand Function
Producers' Goods, Consumers' Goods
Durable Goods, Perishable Goods
Derived Demand, Autonomous Demand
Industry Demand, Compay Demand
Short-run Demand, Long-run Demand
Demand Fluctuation, Long-run Trend
Total Market, Market Segment
Elasticity of Demand,

Methods of Forecasting Demand

Forecasting Sales of Established Products

Forecasting the Demand for New Products

Criteria of a Good Forecasting Method

Price-Demand Relations

Income-Demand Relations

Multiple Variables - Demand Relations



Article of the series
Economics for CEOs - Managerial Economics by Joel Dean

Article originally published in
http://knol.google.com/k/narayana-rao/managerial-economics-of-demand/2utb2lsm2k7a/3058

Managerial Economics of Cost - Economics for CEO

There are many managerial decisions that use principles of economics as the standard framework. These economic rules of decision making require estimates cost and revenues. In other words economic analysis requires cost estimates. Cost estimates relevant for management decisions can be produced from orthodox accounting records. Statistical and engineering analysis are used to convert financial accounting figures into cost concepts useful for use in managerial decision problems. The decision model also guides the estimation procedure.


Determinants of Cost Behavior

Prices of input factors
Technology
Lot size
Efficiency
Other factors

Cost Concepts

Opportunity costs - Outlay costs
Past costs - Future costs
Short run costs - Long run costs
Variable costs - Constant costs
Traceable costs - Common costs
Out of pocket costs - Book costs
Incremental costs - Sunk costs
Escapable costs - Unavoidable costs
Controllable costs - Non-controllable costs
Replacement costs - Historical costs

Relation Between Cost and Other Variables

Cost and The Rate of Output

Short-run cost output functions
Determination of cost-output functions

Cost and Size of Plant

Cost of Multiple Products

Breakeven Analysis
(Cost - Volume - Profit analysis)

Article originally posted at
http://knol.google.com/k/narayana-rao/managerial-economics-of-cost-economics/2utb2lsm2k7a/3128

Product-Line Pricing - Managerial Economics

Product differentials are tied solely to the characteristics of the product and its use, size differentials, quality differentials etc.

Alternative policies (General)
1. Prices are proportional to full cost.

2. Prices are proportional to incremental costs

3. Profit margins are proportional to conversion costs

4. Prices that produce contribution margins that depend upon the elasticity fo demand fo different market segments of different products.

5. Prices that are systematically related to the stage of market and competitive development of individual members of the product line.

Demand characteristics peculiar to multiple-product lines like complementarity and substitutability may existing within a product line also. Products in a product line may be substitutes for each other as different models of television. They may be complementary. But the complementarity may be over a period of time. In a subtle way, it may enhance the reputation of the firm and make more products acceptable.

Specific Issues in Product Line Pricing

Pricing products that differ in size

Pricing products that differ in quality

Charm prices

Pricing special designs

"Load factor" price differentials

Pricing repair parts

Pricing leases and licenses

Reference: Managerial Economics by Joel Dean

Originally posted at
http://knol.google.com/k/narayana-rao/product-line-pricing-managerial/2utb2lsm2k7a/3150

Economics of Price Differentials - Joel Dean - Managerial Economics - Review Notes

Firms offer different prices based on a list price to tailor the price to the peculiarities of the purchase situations.

Dean identified the following situations as giving rise to price differentials.

1. The trade status of the buyer
2. Amount of purchase
3. The location of the purchaser
4. The promptness of payment
5. The time of purchase
6. The personal situation of the buyer or the firm.

Goals of Differential prices

1. Implementation of market strategy
2. Market segmentation
3. Market expansion
4. Competitive adaptation
5. Reduction of production cost

Economics of Capital Budgeting - Joel Dean - Managerial Economics - Review Notes

Joel Dean qualified his treatment of capital budgeting with the statement that the economic analysis of capital budgeting activity is offered tentatively, because capital budgeting has not received adequate attention from economists. The treatment of Joel Dean, focused on economic analytical issues of capital budgeting and procedures and organization of capital budgeting process is not covered in the chapter.

For economic analysis of capital budgeting activity, a capital expenditure should be defined in terms of economic behavior. Capital assets cost the company much above the amount they could be sold for at any point in time and therefore tie up capital inflexibly for long periods.

The capital budgeting problem consists of three questions:

1. How much money will be needed for expenditures in the coming period? Basically this is a demand schedule of the company for capital giving different rates of return?

2. How much money will be available? This is supply schedule at different rates of return demanded by the capital market.

3. How much money should be acquired by the company from the capital market and what projects are to be implemented? This is the allocation and rationing decision.

In this framework, capital budgeting is modeled in the traditional economic framework of demand and supply schedules.

Demand for Capital

The investment proposals from various operating units are invited periodically to determine the demand for capital.  The operation units or departments in production, marketing and service activities have to discover and create profitable opportunities for capital expenditures. The discovery and development of good investment proposals requires continuous and project based efforts. Certain departments specialize in this role. The research and development department creates opportunities in the new products, in improved products, and in improved technology. Industrial engineering department's efficiency and productivity improvement projects provide cost reduction investment projects. Equipment vendors keep developing new equipment and thereby create profitable investment opportunities. Opportunities arise in expansion of marketing channels and even advertising that expands potential market size for the company.

Principles for Measuring Capital Earnings

Capital investments are made because of productivity (rate of return).

1. Recognition of source of capital productivity is essential to correct estimation of it. Generally the most important sources are expected cost savings and growth in sales leading to increased profits.

2. Earnings must be estimated on an individual project basis for the project being proposed.

3. The relevant data of decision is making is future profit which is based on future sales volumes, future prices, future costs etc. The record of the past is useful as a guide or input to estimates of the future.

4. In any decision making situation, alternatives are present. The principle of opportunity cost emphasizes considering at least one alternative to compare with the proposal under consideration and if there are many alternatives, then, it is the best alternative among all other alternatives. The principle of opportunity cost emphasizes the comparison of these two alternatives for right decision making.

5. Effort has to be made for measuring capital productivity over the whole life of the asset, even though the view of the distant future is not very clear.

6. The stream of capital earnings have to be discounted to take account of the diminishing value of distant earnings to terms of today earnings.

7. The amount of capital investment committed to a project is the average capital tied up in the asset ove the period.

8. Estimates of earnings have to take into account the indirect effects of the proposed projects on the operation of existing facilities.

9. There will be tendency in the economic environment to destroy abnormal profit opportunities which are presently available and this risk of profit destruction in the long run should be examined in connection with each profitability estimate.

10. Estimates of future revenues and costs will differ in inherent riskiness and in the width of error margins. Some systematic method for allowing these differences in risk for comparing alternative investments is to be used.

11. Capital productivity measurement is to be emphasized for projects of borderline productivity.  For some projects, quantification may be impractical but  qualitative arguments can be convincing. In some other cases, the loss or revenue by lack of a machine etc. is so evident that estimates of return are more of a formality rather than aid to rational decision making.


Supply of Capital Funds

Supply of capital to a firm consists of internal sources and external sources. The chief internal sources are depreciation and retained earnings. External sources are sale of equity and long-term debt securities to institutions and public.

Capital Rationing

Rejection rates
Cost of capital
Criticism of alternatives to rate-of-return rationing.

Classification of Capital Expenditures

1. Based on source of earnings on capital
2. Based on competitive orientation
3. Based on form of capital asset - plant facility, product improvement, market position etc.
4. Related to technical change - Innovative product, improve product etc.
5. Strategy aspect - two important types of risk reducing and welfare-improving.