CHAPTER 1

Accounting Profit – amount of money taken from sales (total revenue) minus the dollar cost of
producing goods or service.

- Sales – COGS

Economic Profit – difference between total revenue and total opportunity cost

Opportunity Cost – the explicit cost of a resource plus the implicit cost of giving up its best
alternative.

Example:

a. AP = (8,000 * 25 paintings) – 30,000 = 170,000

b. EP = (8,000 * 25 paintings) – 30,000 – 110,000 = 60,000

* 80,000 is not chosen as the opportunity cost because 110,000 is

the best alternative that was turned down.

Managers use present value analysis to properly account:

1. PV of a single FV:

a. the amount that would have to be invested today at the prevailing interest rate to generate the
given future value:

b. PV reflects the difference between the FV and opportunity cost of waiting:

2. PV of a stream of FV: or

Example:

Net Present Value – the present value of the income generated by a project minus the current cost
of the project:

Example:
Present Value of Indefinitely Lived Assets – Present value of this perpetual income stream when the
same cash flow is generated (CF1 = CF2 = … = CF):

Example:

Profit Maximization – maximizing profits means maximizing the value of the firm, which is the
present value of current and future profits.

a. The value of a firm with current profits ( π 0), with no dividends paid out and expected, constant
profit growth rate of g (assuming g < i) is:

b. When dividends are immediately paid out of current profits, the present value of the firm is (at ex-
dividend date):

Example:

 If the growth rate in profits is less than the interest rate and both are constant, maximizing
current (short-term) profits is the same as maximizing long-term profits.

Marginal Analysis

 Given a control variable, Q, of a managerial objective, denote the

o Total benefits as B(Q) ; total cost as C(Q)
 Manager’s objective is to maximize net benefits: N(Q) = B(Q) – C(Q)

Marginal Cost: MC(Q) – the change in the total costs arising from a change in the control variable, Q.
Marginal net benefits: MNB (Q) = MB (Q) – MC (Q)

Marginal Principle – to maximize net benefits, the manager should increase the managerial control
variable up to the point where marginal benefits equal marginal costs (MB = MC). This level of the
managerial control variable corresponds to the level at which marginal net benefits are zero; nothing
more can be gained by further changes in that variable.

Example:

a. substitute
b. substitute
c. Maximizes total benefit is always equal to zero so MB(Q) = 20 – 4Q = 0 -> solve by algebra
d. sub
e. sub
f. The level of Q which minimizes total cost is always 0.
g. Maximize net benefits: MB(Q) = MC(Q) -> 20Q – 2(Q^2) = 4 + 2(Q^2) -> solve by algebra

 MB(Q) is pababa kasi

Incremental Decisions

Incremental revenues (MB) – additional revenues from a yes-or-no decision.

Incremental costs (MC) – additional costs from a yes-or-no decision.

CHAPTER 2 Market Forces: Demand and Supply

Demand

 Market Demand Curve – illustrates the relationship between the total quantity and price per
unit of a good all consumers are willing and able to purchase, holding other variables constant.
 Law of demand – the quantity of a good consumers are willing and able to purchase increases
(decreases) as the price falls (rises). ^Price = vQuantity ; vPrice = ^Quantity
- Price and quantity demanded are inversely related.

Shift in Quantity Demanded vs a Shift in Demand

 Changing only price leads to changes in quantity demanded

o This type of change is graphically represented by a movement along a given demand
curve, holding other factors that impact demand constant.
 Changing factors other than price lead to `changes in demand.
o These types of changes are graphically represented by a shift of the entire demand
curve.

Demand Shifters

1. Income

 Normal Good – food staples, clothing, appliances

 Inferior Good – public transport

2. Prices of related goods

 Substitute goods
 Complement goods

3. Advertising and consumer tastes

 Informative advertising
 Persuasive advertising

4. Population

5. Consumer expectations

6. Other factors

Linear Demand Function – simple but useful representation of a demand function:

Demand Function – for good X is a mathematical representation describing how many units will be
purchased at different prices for X, the price of a related good Y, income and other factors that affect
the demand for good X.

Example:

Inverse Demand Function – transposition of price and quantity demanded. This function is used to
construct a market demand curve.

Example:

Consumer Surplus

Marketing strategies – like value pricing and price discrimination – rely on understanding consumer
value for products.

 Total consumer value – sum of the maximum amount of a consumer is willing to pay at different
quantities.
 Total expenditure – the per-unit market price times the number of units consumed.
 Consumer surplus – the extra value that consumes derive from a good but do not pay extra for.

Example:
 At price of $2 consumer will buy 3 liters. Revenue = 2 x 3 = 6
 Consumer surplus = ½ base x height = ½(3) * (5-2) = $4.5

Market Supply Curve – a curve indicating the total quantity of a good that all producers in a
competitive market would produce at each price, holding input prices, technology, and other
variables affecting supply constant.

Law of supply – as the price of a good rises (falls), the quantity supplied of the good rises (falls),
holding other factors affecting supply constant.

Changes in Quantity supplied vs Changes in Supply

 Changing only price leads to changes in quantity supplied

o This type of change is graphically represented by a movement along a given supply
curve, holding other factors that impact supply constant.
 Changing factors other than price lead to changes in supply.
o These types of changes are graphically represented by a shift of the entire supply curve.

Supply Shifters

1. Input prices
2. Technology or government regulation
3. Number of firms
* Entry & Exit
4. Taxes
* Excise Tax – a tax on each unit of output sold, where tax revenue is collected from the supplier. (10
pesos per box ; the higher the units = the higher the tax)
* Ad valorem tax – percentage tax value (10 pesos if p=1000) 3% percentage tax = the higher the
price = the higher the tax
5. Producer expectations

Linear Supply Function – simple but useful representation of a supply function.

Example:

Qxs = 2,000 + 3(400) – 4(100) – 1(2,000)

= = 800 television sets
Inverse Supply Function - transposition of Quantity to Price. This function is used to construct a
market supply curve.

Producer Surplus – the amount producers receive in excess of the amount necessary to induce them
to product the good.

Example:

The supply curve for product X is given. QXs

1. What is the inverse of the supply function? P = 26 + ½Q

2. What is the surplus if the Qx = 400? When Qx = 1,000?

If Qx = 400

Surplus = ½ base * height = ½ (400) * (46-26) = 4,000

If Qx = 1,200

Surplus = ½ base * height = ½ (1,200) * (86-26) = 36,000

Competitive Market Equilibrium

 Determined by the intersection of the market demand and market supply curves.
 A price and quantity such that there is no shortage or surplus in the market.
 Forces that drive market demand and market supply are balanced, and there is no pressure in
prices or quantities to change.
 The equilibrium price is the price that equates quantity demanded with quantity supplied.

Equilibrium

 In a competitive market equilibrium, quantity freely adjust to the forces of demand and supply.
 Sometimes government restricts how prices are permitted to rise or fall.
o Price ceiling – maximum price to obtain
o Price floor – minimum price to obtain
Comparative static analysis – the study of the movement from one equilibrium to another

Chapter 3 – Quantitative Demand Analysis

Elasticity – a measure of the responsiveness of one variable to changes in another variable; the
percentage change in one variable that arises due to a given percentage change in another variable.

Important aspects of the elasticity

 Sign of the relationship:

o Positive (direct): If G increases, then S also increases.
o Negative (inverse): If G decreases, then S also decreases.
 Absolute value of elasticity magnitude relative to unity:
o |Eg,s| > 1 is highly responsive to changes in S.
o |Eg,s| < 1 is slightly responsive to change in S.

Own price elasticity of demand – measures the responsiveness of a percentage change in the
quantity demanded of good X to a percentage change in its price.

o Sign – negative by law of demand

o Magnitude of absolute value relative to unity:
 If |EQxd,Px| > 1 = Elastic
 If |EQxd,Px| < 1 = Inelastic
 If |EQxd,Px| = 1 = Unitary elastic -> Marginal Cost =
Marginal Revenue