Mba Managerial Economics

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MBA Managerial Economics
Review Questions for the Final Exam (Illustrative Answers)


0.1-1 Introduction:Managerial Decision-Making and Market Processes

(a) How does operational effectiveness differ from organizational strategy?

Operational effectiveness is achieving excellence in individual activities while organizational strategy is about combining these activities to fit and reinforce one another and create competitive advantage and obtain superior profitability. OE refers to being “on” the production frontier, while OS refers to where the firm is on the frontier (cost leadership vs. high quality product)

(b) If cost leadership and differentiation (creation of customer value) are the two main strategies available to firms in your industry, what determines your own organization's best strategy?

The requirements for a firm in using cost leadership differ from those of a firm using differentiation. In order for a firm to successfully pursue a strategy of cost leadership, it must have skills and resources such as the ability to sustain capital investments (and access to capital), process engineering skills, intense supervision of labor, products designed for ease of manufacture, and the low-cost distribution system. It must also avoid product proliferation. In order for a firm to successfully pursue a strategy of differentiation, it must have skills and resources including core capabilities, such as marketing or innovation. It must have product, rather than process, engineering skills, and it must have strengths in basic research and brand equity in the form of a corporate reputation for quality or technological leadership. The firm must also have a long tradition in the industry for the ability to acquire skills from others. Strong cooperation from distribution and supply channels is also very important. Ultimately, whether a firm chooses cost leadership or differentiation as a strategy depends upon the skills and resources available to the firm.

(c) Explain why $1000 three years from now is not equal to $1000 today.

The purchasing power of $1000 today is greater that $1000 three years from now because one can always invest money today and get some return on the investment. For example, $1000 invested at rate of return of 6% for three years will be worth:

$1000(1.06)^3 = $1191.02

while the $1000 that you receive three years from now would be worth, well, $1000. Conversely, the present value of your $1000 gift in three years will be:

$1000(1/(1+0.06))^3 = $839.62

The inflation rate will also devalue the future value of the dollar. This could be modeled by subtracting the expected inflation rate from the rate of return, but generally the rate of return includes a component reflecting expected inflation.

(d) What are the most powerful incentives within your own organization? To what extent are decisions determined by their impacts on profitability?

The most powerful incentives within an organization as described by the theory of the firm, is to maximize its value (PV of expected future cash flows). This may include various attempts to maximize stock price and/or perceived shareholder value. However a couple of other issues that may arise include satisficing and the principal-agent problem. Satisficing is where a firm aims at a satisfactory rate of profit rather than attempt to maximize profit. The principal-agent problem occurs when managers pursue their own interests/objectives even though decreases the profit of the owners. To deal with these problems firms often establish contracts with their managers that give the latter incentives to achieve profit maximization.

(e) How do economic profits differ from accounting profits?

Economic profits take into account the opportunity costs (what labor and capital could have earned elsewhere) while accounting profits only look at actual accounting revenues and actual monetary outlays from...
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