UMGC
MBA 620: Financial

Decision Making

Project 2: Review and

Practice Guide

Project 2: Review and

Practice Guide

Managerial Economics

Contents
Topic 1: Economics Principles ……………………………………………………………………………………………………….. 3

How People Make Decisions ……………………………………………………………………………………………………… 3

Topic 2: Market Equilibrium………………………………………………………………………………………………………….. 4

Demand Curve ………………………………………………………………………………………………………………………… 4

Supply Curve …………………………………………………………………………………………………………………………… 4

Market Equilibrium ………………………………………………………………………………………………………………….. 5

What moves the Supply/Demand Curves ……………………………………………………………………………………. 5

Topic 3: Elasticity ………………………………………………………………………………………………………………………… 6

What is Price Elasticity ……………………………………………………………………………………………………………… 6

Elasticity of Demand: Inelastic …………………………………………………………………………………………………… 6

Elasticity of Demand: Unit Elastic ………………………………………………………………………………………………. 7

Elasticity of Demand: Elastic ……………………………………………………………………………………………………… 8

Topic 4: Market/Industry Structure ……………………………………………………………………………………………….. 9

Industry Structure Examples ……………………………………………………………………………………………………… 9

Market Structure Comparison …………………………………………………………………………………………………… 9

Perfect Competition ……………………………………………………………………………………………………………….. 10

Topic 5: How Companies Make Decisions …………………………………………………………………………………….. 11

Principle 3 …………………………………………………………………………………………………………………………….. 11

Maximizing Profit …………………………………………………………………………………………………………………… 11

Problems/Exercises ……………………………………………………………………………………………………………………. 12

What to do ……………………………………………………………………………………………………………………………. 12

Exercises ……………………………………………………………………………………………………………………………….. 12

…………………………………………………………………………………………………………………………… 12

…………………………………………………………………………………………………………………………… 12

…………………………………………………………………………………………………………………………… 12

References ……………………………………………………………………………………………………………………………. 12

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Topic 1: Economics Principles

How People Make Decisions
• Principle 1: People face trade-offs

• Principle 2: The cost of something is what you give up to get it (opportunity cost)

• Principle 3: Rational people thing at the margin (MR=MC)

• Principle 4: People respond to incentives

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Topic 2: Market Equilibrium

Demand Curve

The market demand curve: a downward-sloping curve.

It depicts a movement along a stationary demand curve.

Based on Webster (2015, p. 22)

Supply Curve

The market supply curve: an upward-sloping curve.

It depicts a movement along a stationary supply curve.

Based on Webster (2015, p. 32)

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Market Equilibrium

A market equilibrium: determination of market price and

output.

It depicts a market equilibrium where the quantity

demanded equals the quantity supplied.

Based on Webster (2015, p. 37)

What Moves the Supply/Demand Curves

Demand:

• Price

• Income

• Price of related goods

• Tastes

• Expectations

• Number of buyers

Supply:

• Price

• Input prices

• Technology

• Expectations

• Number of sellers

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Topic 3: Elasticity

What is Price Elasticity?
• Price elasticity—how sensitive demand or supply is to price changes

• Formula:

Absolute value of (% ℎ

% ℎ
)

% change = (new value – old value) / average of new and old values

• Three Types of Elasticity

1. Inelastic: elasticity < 1

2. Elastic: elasticity > 1

3. Unit Elastic: elasticity = 1

Based on information in Mankiw (1997)

Elasticity of Demand: Inelastic

Source: Mankiw (1997)

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Elasticity of Demand: Unit Elastic

Source: Mankiw (1997)

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Elasticity of Demand: Elastic

Source: Mankiw (1997)

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Topic 4: Market/Industry Structure

Industry Structure Examples

Source: Mankiw (1997)

Market Structure Comparison
Market Structure

Characteristic
Perfect Competition Monopolistic Competition Oligopoly Monopoly

Type of

competition
Perfect Imperfect Imperfect Imperfect

Number of firms Very many Many Few One

Type of product Homogeneous Differentiated. Many close
substitutes

Homogeneous
or

differentiated

Unique. No close
Substitutes

Market power None; firms are “price

takers”
Some; limited by availability

of close substitutes
Limited; pricing

decisions

characterized

by strategic

behavior

Considerable;

firms are “price

makers.”

Barriers to entry

and exit
Few to none; easy

entry and exit
Few; easy entry and exit Considerable Entry impossible

Non-price

competition
None Considerable,

advertising, brand-name

recognition, and trademarks

to promote customer loyalty

Considerable;

especially with

respect to

differentiated

products

None since there

is only one firm;

monopolies

frequently

advertise for

other reasons

Source: Webster (2015)

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Perfect Competition
• Theoretical benchmark of market structure, six assumptions (Mankiw, 1997):

1. All companies have an identical (homogeneous) product

2. All competitors are price takers (they cannot influence the market price of their

product)

3. Market share does not influence price

4. Buyers have complete (“perfect”) information at all times (past, present, future) about

the product and prices

5. Resources like labor are perfectly mobile

6. Companies can enter or exit the market without cost

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Topic 5: How Companies Make Decisions

Principle 3
Rational people thing at the margin—so do companies! (Mankiw, 2015)

Maximizing Profit
Profit

= TR – TC*

Marginal Revenue

MR = TR/Q; MC = TC/Q

Maximize () when the following is true:

Marginal Revenue = Marginal Cost or MR – MC = 0

(Example: An empty seat on a flight at takeoff is a lost profit opportunity, because

there is almost no variable cost.)

* MR – marginal revenue, MC – marginal cost, TR – total revenue, TC – total cost, Q – quantity,  —

change

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Problems/Exercises

What to do
You are encouraged to complete all the practice exercises listed below. They will help you gain the

knowledge and skills needed to fully participate in the group assignment in Step 3 and complete the

final Project 2 deliverable. The answers are provided, so you can check your own work.

Exercises
(in Webster, 2015)

• Solve exercises on pages 28, 31, 42, 45, 49

• Solve exercise on pages 57, 60, 68, 70, 71

• Solve exercises on pages 178, 181, 183, 184

References
Mankiw, N. G. (1997). Principles of Economics (1st ed.). Harcourt.

Webster, T. J. (2015). Managerial economics: tools for analyzing business. Lexington Books.

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Now that you have read this Review and Practice Guide and completed
the exercises, you are ready to participate in the group assignment in
Step 3.