Figure

Value Maximization Is a Complex Process

Value maximization is a complex process that involves an ongoing sequence of successful management decisions.

Business and Social Environment

Technology

• Production Capacity

• Worker Knowledge

• Communications Capability

• Research and Development

Market Environment

• Customer Demand

• Level of Competition

• Supplier Capability

Legal Environment

• Regulatory Policy

• Trade Policy

Competitive Strategy

• Product Choice

• Pricing Strategy

• Promotion Strategy

Competitive Strategy

• Product Choice

• Pricing Strategy

• Promotion Strategy

Organization Design

• Assignment of Decision Rights

• Match Worker Incentives with Manageriai Motives

• Decision Management and Control

Pay for Performance

• Worker Pay for Performance

• Divisional Pay for Performance

• Management Pay for Performance

Shareholder Value Maximization directions that society desires. Similar considerations should also be taken into account before applying political pressure or regulations to constrain firm operations. For example, from the consumer's standpoint it is desirable to pay low rates for gas, electricity, and telecom services. If public pressures drive rates down too low, however, utility profits could fall below the level necessary to provide an adequate return to investors. In that event, capital would flow out of regulated industries, innovation would cease, and service would deteriorate. When such issues are considered, the economic model of the firm provides useful insight. This model emphasizes the close relation between the firm and society, and indicates the importance of business participation in the development and achievement of social objectives.

Objectives

This text should help you accomplish the following objectives:

• Develop a clear understanding of the economic method in managerial decision making;

• Acquire a framework for understanding the nature of the firm as an integrated whole as opposed to a loosely connected set of functional departments; and

• Recognize the relation between the firm and society and the role of business as a tool for social betterment.

Throughout the text, the emphasis is on the practical application of economic analysis to managerial decision problems.

Development of Topics

The value maximization framework is useful for characterizing actual managerial decisions and for developing rules that can be used to improve those decisions. The basic test of the value maximization model, or any model, is its ability to explain real-world behavior. This text highlights the complementary relation between theory and practice. Theory is used to improve managerial decision making, and practical experience leads to the development of better theory.

Chapter 2, "Basic Economic Relations," begins by examining the important role that marginal analysis plays in the optimization process. The balancing of marginal revenues and marginal costs to determine the profit-maximizing output level is explored, as are other fundamental economic relations that help organizations efficiently employ scarce resources. All of these economic relations are considered based on the simplifying assumption that cost and revenue relations are known with certainty. Later in the book, this assumption is relaxed, and the more realistic circumstance of decision making under conditions of uncertainty is examined. This material shows how optimization concepts can be effectively employed in situations when managers have extensive information about the chance or probability of certain outcomes, but the end result of managerial decisions cannot be forecast precisely. Given the challenges posed by a rapidly changing global environment, a careful statistical analysis of economic relations is often conducted to provide the information necessary for effective decision making. Tools used by managers in the statistical analysis of economic relations are the subject of Chapter 3, "Statistical Analysis of Economic Relations."

The concepts of demand and supply are basic to understanding the effective use of economic resources. The general overview of demand and supply in Chapter 4 provides a framework for the more detailed inquiry that follows. In Chapter 5, "Demand Analysis and Estimation," attention is turned to the study and calculation of demand relations. The successful management of any organization requires understanding the demand for its products. The demand function relates the sales of a product to such important factors as the price of the product itself, prices of other goods, income, advertising, and even weather. The role of demand elasticities, which measure the strength of the relations expressed in the demand function, is also emphasized. Issues addressed in the prediction of demand and cost conditions are explored more fully in Chapter 6, "Forecasting." Material in this chapter provides a useful framework for the estimation of demand and cost relations.

Chapters 7, 8, and 9 examine production and cost concepts. The economics of resource employment in the manufacture and distribution of goods and services is the focus of this material. These chapters present economic analysis as a context for understanding the logic of managerial decisions and as a means for developing improved practices. Chapter 7, "Production Analysis and Compensation Policy," develops rules for optimal employment and demonstrates how labor and other resources can be used in a profit-maximizing manner. Chapter 8, "Cost Analysis and Estimation," focuses on the identification of cost-output relations so that appropriate decisions regarding product pricing, plant size and location, and so on can be made. Chapter 9, "Linear Programming," introduces a tool from the decision sciences that can be used to solve a variety of optimization problems. This technique offers managers input for short-run operating decisions and information helpful in the long-run planning process.

The remainder of the book builds on the foundation provided in Chapters 1 through 9 to examine a variety of topics in the theory and practice of managerial economics. Chapters 10 and 11 explore market structures and their implications for the development and implementation of effective competitive strategy. Demand and supply relations are integrated to examine the dynamics of economic markets. Chapter 10, "Perfect Competition and Monopoly," offers perspective on how product differentiation, barriers to entry, and the availability of information interact to determine the vigor of competition. Chapter 11, "Monopolistic Competition and Oligopoly," considers "competition among the few" for industries in which interactions among competitors are normal. Chapter 12, "Pricing Practices," shows how the forces of supply and demand interact under a variety of market settings to signal appropriate pricing policies. Importantly, this chapter analyzes pricing practices commonly observed in business and shows how they reflect the predictions of economic theory.

Chapter 13, "Regulation of the Market Economy," focuses on the role of government by considering how the external economic environment affects the managerial decision-making process. This chapter investigates how interactions among business, government, and the public result in antitrust and regulatory policies with direct implications for the efficiency and fairness of the economic system. Chapter 14, "Risk Analysis," illustrates how the predictions of economic theory can be applied in the real-world setting of uncertainty. Chapter 15, "Capital Budgeting," examines the key elements necessary for an effective planning framework for managerial decision making. It investigates the capital budgeting process and how firms combine demand, production, cost, and risk analyses to effectively make strategic long-run investment decisions. Finally, Chapter 16, "Public Management," studies how the tools and techniques of managerial economics can be used to analyze decisions in the public and not-for-profit sectors and how that decision-making process can be improved.

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