Lecture 1

NATURE AND SCOPE OF MANAGERIAL ECONOMICS

QUESTIONS & ANSWERS

Q1.1 Is it appropriate to view firms primarily as economic entities?

Q1.1 ANSWER

Yes. Firms represent a combination of people, physical assets, and information (financial, technical, marketing, and so on). People directly involved include stockholders, managers, workers, suppliers, and customers. Businesses use scarce resources that would otherwise be available for other purposes, pay income and other taxes, provide employment opportunities, and are responsible for much of the material well-being of our society. Thus, all of society is indirectly involved in the firm's operation. Firms exist because they are useful in the process of allocating resources -- producing and distributing goods and services. As such, they are basically economic entities.

Q1.2 Explain how the valuation model given in Equation 1.2 could be used to describe the integrated nature of managerial decision making across the functional areas of business.

Q1.2 ANSWER

As seen in the text, Equation 1.2 can be written:
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where TR is total revenue, TC is total cost, i is an appropriate (risk-adjusted) interest rate, and t indicates the relevant time period. Thus, the value of the firm is the discounted present value of the stream of expected future profits. Each of the functional areas of business plays an important role in managerial decision making since each area provides vital input into the value maximization process. The marketing department of a firm has a major responsibility for sales, the production department a major responsibility for costs, and the finance department has a major responsibility for acquiring the capital necessary to support the firm's investment activities. There are many important overlaps among these functional areas--the