Source: Lecture 1A, Managerial Economics Textbook Ch. 1
Tags: microeconomics, managerial economics, private decisions, public decisions, value of the firm, profit maximisation, satisficing, corporate social responsibility, CSR, behavioral economics, homo economicus, drug prices Africa, arbitrage, intermediate micro, Texas A&M
Intermediate microeconomics applies economic reasoning to real-world decision-making in firms and government. The course distinguishes between private decisions (firms choosing prices, quantities, inputs) and public decisions (governments weighing social costs and benefits). A recurring theme is the tension between these two, and the fact that firms may pursue objectives beyond simple profit maximisation.
Managerial economics
The application of microeconomic theory to business decision-making. The course textbook is titled "Managerial Economics" because the focus is on decisions within companies, even though the course is called Intermediate Microeconomics.
Private decisions
Choices made by firms or individuals acting in their own interest, such as setting prices, choosing output levels, or allocating production across plants.
Public decisions
Choices made by governments or public bodies, typically based on social costs and benefits rather than profit. Examples include whether to build a bridge or how to regulate pollution.
Value of the firm
The long-run measure of a firm's worth, accounting for time, risk, and strategic pricing. Maximising value is the manager's core objective, and it differs from short-run profit.
Profit of the firm
A short-run measure of revenue minus costs. Profit maximisation alone may not align with maximising the firm's long-run value.
Satisficing behaviour
A firm or manager sets a target level of profit (say, "good enough") and stops optimising once that threshold is reached, rather than pushing for the absolute maximum.
Corporate social responsibility (CSR)
The idea that firms should maximise welfare for employees, customers, and society, not only shareholders. In 2019, major business leaders formally endorsed this broader view. CSR also builds reputational capital.
Homo economicus
The traditional economic model of a perfectly rational agent who weighs benefits against costs without emotion. Behavioral economics challenges this by introducing factors like regret and jealousy.
Behavioral economics
A field that incorporates psychology into economic models, recognising that people do not always behave as perfectly rational agents. Emotions such as regret and jealousy affect decisions by both firms and consumers.
Arbitrage
The practice of buying a good at a low price in one market and reselling it at a higher price in another. In the Africa drug-pricing case, drug companies feared that discounted medicines sold in developing countries would be resold in developed markets.
Firms face decisions about what to produce, how much, and at what price.
Chrysler example: the firm must decide the price and quantity of minivans in both the US and Italy. Prices and quantities will differ across markets. If Chrysler has plants in both countries, it must also decide how to allocate production across plants to minimise costs.
Uber example (2009 market entry): private decisions around entering a regulated market, dealing with taxi-driver opposition, and navigating local regulations.
Public decisions are framed around costs and benefits to society, not profit.
Bridge example: building a bridge connecting suburbs costs $100 million. Revenue comes from tolls. Trucks pay higher tolls because tolls are assessed by weight (heavier vehicles cause more road damage). The decision rests on whether social benefits justify the cost, not on whether the project turns a profit.
Environmental regulation is a clear case. Reducing global warming is a public goal, but regulations impose costs on businesses. Policymakers must balance social objectives with the impact on private enterprise.
Time
Profit is a short-run goal. Value is a long-run goal. A decision that sacrifices short-term profit may increase long-term firm value.
Risk
Firms face greater risk in the short run. Over longer periods, insurance and risk-spreading tools become cheaper and more accessible (the life-insurance analogy: a longer time horizon reduces per-period risk costs).
Pricing
In the short run, a firm looks for the optimal price and quantity. In the long run, more strategies become available, including pricing below cost to deter new entrants from the market.
Managers tend to focus on short-term performance and their own incentive structures (bonuses, promotions).
Managers may lack complete information about market conditions.
Managers simply make mistakes, setting the wrong price or quantity.
The core problem: managers and shareholders often have different motivations.
Satisficing: set a profit target and stop there.
Maximise total sales or revenue: car companies, for instance, may chase volume even at the expense of per-unit profit.
Corporate social responsibility (CSR): broaden the objective to include employees, customers, and society. Also builds reputational capital.
Behavioral economics insights: real people (and managers) are influenced by regret, jealousy, and other emotions. Marketing strategies can account for these.
This case illustrates the tension between private profit motives and public health needs.
Drug companies initially resisted lowering prices in Africa because they needed to recoup heavy R&D spending. Much of that R&D was directed at diseases prevalent in developed countries, not developing ones.
Three forces pushed companies to change course:
Threats from developing countries themselves
National governments threatening to revoke patents
Pressure from organisations like Doctors Without Borders
The compromise: companies would lower prices for developing countries in exchange for patent protections. A key concern was arbitrage, where cheap drugs sold in Africa could be resold in developed markets, undercutting the higher prices there.
This compromise was described as "a drop in the bucket." Developing countries still need broader aid, more resources, and internal reforms.
⚠️ Know the difference between value of the firm (long run) and profit of the firm (short run), and be able to explain it across time, risk, and pricing dimensions.
⚠️ Be ready to classify a new scenario as a private or public decision and explain why. The exam may present unfamiliar examples.
⚠️ Understand the three reasons a manager may fail to maximise firm value: short-term focus, information gaps, and mistakes.
⚠️ The Africa drug-pricing case is specifically flagged as a key example of private-vs-public tension. Know the forces that changed the companies' minds and the arbitrage concern.
⚠️ Be able to list and briefly explain the four alternatives to value maximisation: satisficing, revenue maximisation, CSR, and behavioral economics.
Q: What is the difference between maximising the value of the firm and maximising profit?
A: Profit is a short-run measure, while value is a long-run concept. They differ across three dimensions: time horizon (short vs. long run), risk (higher in the short run, more manageable over time), and pricing strategy (short-run optimal pricing vs. long-run strategies like deterrent pricing below cost).
Q: Give three reasons why a manager might not maximise the value of the firm.
A: Managers may focus on short-term results tied to their personal incentives, they may lack full information about markets and costs, and they may simply make errors in setting prices or quantities.
Q: In the Africa drug-pricing case, why were drug companies initially reluctant to lower prices?
A: They needed to recoup large R&D investments. They also feared arbitrage, where discounted drugs sold in developing countries would be resold in developed markets at lower prices.
Q: What pressures ultimately caused drug companies to lower prices in Africa?
A: Threats from developing countries, national governments threatening to revoke patents, and pressure from organisations such as Doctors Without Borders.
Q: What is satisficing behaviour?
A: A firm or manager sets a target level of profit and considers that "good enough," rather than continuing to optimise for the absolute maximum.
Q: How does behavioral economics challenge the traditional model of decision-making?
A: Traditional economics assumes a perfectly rational agent (homo economicus) who weighs benefits against costs without emotion. Behavioral economics shows that emotions like regret and jealousy also shape decisions, for both firms and consumers.
intermediate microeconomics, managerial economics, private vs public decisions, firm value, profit maximisation, satisficing, corporate social responsibility, CSR, behavioral economics, homo economicus, arbitrage, drug pricing, Doctors Without Borders, principal-agent problem, short run vs long run, pricing strategy, deterrent pricing, Texas A&M ECON