Source: Exam 1 Objectives (Sections 1A, 1B) | Varghese, Texas A&M
Tags: microeconomics, managerial economics, intermediate micro, firm objectives, profit maximisation, CPR, corporate personal responsibility, behavioural economics, value of the firm, linear equations, slope, inverse demand, derivatives, three-step rule, marginal analysis math
This section covers two foundations you need before the applied chapters: (1) what microeconomics and managerial economics each deal with, why firms might not maximise profit, and how behavioural economics complicates the standard model; and (2) the core maths toolkit of lines, slopes, derivatives, and optimisation that underpins every problem on the exam.
Microeconomics
The study of how individual agents (consumers, firms, workers) make decisions and how those decisions interact in markets.
Managerial economics
The application of microeconomic theory to business decision-making, with a focus on pricing, output, and strategy from the firm's perspective.
Private decisions
Choices made by individual agents (consumers or firms) acting in their own interest.
Public decisions
Choices made by governments or public bodies, often to correct market failures or redistribute resources.
Value of the firm
The present value of all expected future profits. Distinguished from current-period profit by the time dimension: a firm that sacrifices profit today to invest may still maximise its value over time.
Profit maximisation
The standard assumption that firms choose output and price to make total profit as large as possible. In practice, firms may pursue other objectives.
Corporate personal responsibility (CPR)
A firm objective beyond pure profit, reflecting social or ethical commitments. One of several reasons a firm's behaviour may deviate from strict profit maximisation.
Behavioural economics
A field that integrates insights from psychology into economic models, showing that decision-makers often deviate from the perfectly rational choices standard theory assumes. Relevant because it challenges the assumption that managers always optimise correctly.
Slope
The rate at which one variable changes per unit change in another. For a line, it is constant (rise over run). For a curve, it is the slope of the tangent line at a given point.
Inverse demand function
The demand relationship rewritten with price as a function of quantity (P as a function of Q), rather than quantity as a function of price. The slope of the inverse demand function is the reciprocal of the slope of the demand function.
Three-step rule (derivative shortcut)
The method used in this course to find the slope of a curve or to optimise a function: take the derivative, set it equal to zero, and solve. For polynomials, bring the exponent down as a coefficient and reduce the exponent by one.
Microeconomics is the broader discipline; managerial economics is its applied branch, focused on the decisions managers face.
You should be able to classify a new example as a private or public decision when given one, even though you do not need to memorise specific examples.
Managers may pursue other objectives: growth, market share, personal compensation, or CPR.
The distinction between profit and firm value matters here. A firm might accept lower short-run profits to increase long-run value (e.g., investing in R&D).
For the exam, know the time-dimension difference between profit and value of the firm. Skip the other listed reasons for divergence.
Standard theory assumes rational, optimising agents. Behavioural economics shows systematic biases (overconfidence, loss aversion, anchoring) that cause real decisions to deviate.
This matters for managerial economics because it means we cannot always assume that observed firm behaviour is optimal.
Every linear relationship can be written in y = mx + b form, where m is the slope and b is the y-intercept.
To find the demand function from a general equation, isolate Q on one side.
To find the inverse demand function, isolate P on one side.
Worked example from objectives:
Starting equation: 3Q_d + 2P = 5
Demand function: Q_d = 5/3 − (2/3)P
Slope interpretation: as price rises by $1, quantity demanded falls by 2/3 of a unit.
Inverse demand function: P = −(3/2)Q_d + 5/2
Slope of the inverse demand function: −3/2 (the reciprocal of the demand function slope, −2/3).
Key point: the slope of the inverse demand function is always 1 divided by the slope of the demand function.
A line has a single, constant slope everywhere.
A curve has a different slope at every point, measured by the tangent line at that point.
If a line intersects a curve at a point, you cannot determine which is steeper without more information (the line might be steeper, the curve might be, or they could be tangent).
The derivative gives the slope of a function at any point.
For this course, you only need derivatives of polynomials.
Rule: if f(x) = ax^n, then f′(x) = n·a·x^(n−1).
To find the maximum of a function: set the derivative equal to zero, solve for the variable.
Positive slope: the curve rises as you move right.
Negative slope: the curve falls as you move right.
Increasing slope: the curve gets steeper as you move right.
Decreasing slope: the curve gets flatter as you move right.
You should be able to eyeball a graph and describe the slope's sign and whether it is increasing or decreasing.
Slope of a line: m = (y₂ − y₁) / (x₂ − x₁) = rise / run = Δy / Δx
Equation of a line: y = mx + b
Demand function from general form: Given aQ + bP = c → Q = c/a − (b/a)P
Inverse demand function: Given aQ + bP = c → P = c/b − (a/b)Q
Derivative of a polynomial term: d/dx [ax^n] = n·a·x^(n−1)
Optimisation condition: Set f′(x) = 0 and solve for x.
⚠️ The slope of the inverse demand function is 1 / (slope of the demand function). This reciprocal relationship is commonly tested.
⚠️ When transforming a line, be careful about which variable you solve for. Q on its own gives the demand function; P on its own gives the inverse demand function. Mixing these up is one of the most common errors.
⚠️ If a line intersects a curve at a point, you cannot conclude anything about which slope is steeper. The answer is "cannot be determined."
⚠️ Know the distinction between the value of the firm (present value of all future profits) and current-period profit. The exam tests the time-dimension difference specifically.
⚠️ You do not need to know: utility functions, production functions, how to check whether a critical point is a max or min, derivatives beyond polynomials, actual numerical consumer/producer surplus, or the supply curve and choke price.
Q: In the line 6P + 5Q = 10, with P on the y-axis and Q on the x-axis, what is the slope and y-intercept?
A: Rearrange to P = mx + b form (with Q on the x-axis): P = −(5/6)Q + 10/6. Slope is −5/6, y-intercept is 5/3. Answer: (a).
Q: The slope of a line is (a) rise over run, (b) change in y over change in x, (c) change in y per unit change in x, (d) the "m" in y = mx + b, (e) all of the above?
A: All of the above. Each is a correct description of slope. Answer: (e).
Q: If a line intersects a curve at a certain point, what can you say about their slopes?
A: You cannot tell which is steeper without more information. Answer: (d).
Q: Differentiate between the value of the firm and profits of the firm.
A: Profits refer to a single period's revenue minus costs. The value of the firm is the present value of the entire stream of expected future profits. A firm maximising value may accept lower profits today for higher profits later.
Q: Why might a manager not maximise the value of the firm?
A: The manager may pursue other objectives: personal compensation, market share, corporate personal responsibility, or may be subject to behavioural biases that lead to suboptimal decisions.
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