Journal Chapter One- Managerial Economics Summary and Perspectives Chapter one offers an introduction into managerial economics and introduces tools that managers can use when making decisions, such as using economic method versus accounting method and Porter’s Five Forces to examine profits. It also shows how goals, constraints, incentives, market rivalry, present value analysis and marginal analysis affect economic decisions managers have to make.
The difference between the economic and accounting view of profits and Porter’s Five Forces were the most interesting to me. Accounting’s view of profits is what most people think of when they hear the word “profit”. It is simply the total amount of money generated from sales minus the dollar cost that goes into producing these goods or services. Economic profits go further by not only taking into account the explicit cost, but also factoring the implicit cost of giving up the best alternative use of the resource, or opportunity cost.
This is important to me because as I pursue my education, I incur opportunity cost along the way. I have turned down job offers which would have conflicted with class scheduling, I sacrifice time I could be spending with my family or just having fun to study or attend class, and I am using funds that I could put towards retirement or a big screen TV. Understanding choices involve a sacrifice of alternatives is an important skill for managers.
Porter’s Five Forces provide a framework to build strategies off of to earn and sustain profits. Understanding the ability of new competitors to enter into your market lets managers plan to build up a loyal customer base, raise cost of consumers switching to new entrants, or to aggressively fight new comers. Understanding industry concentration and rivals helps managers plan strategies involving prices, quantities, capacity, quality, and service.
Understanding how power is spread through your supply chain from input suppliers down to buyers helps managers understand their ability to influence the supply chain as well as profits. This aspect was the most important in my professional career in the mortgage industry as we had many suppliers who offered similar products and increased our negotiating power. We also understood our customers could get similar products for other sources so we needed to differentiate ourselves.
In addition, managers must be willing to look outside the industry to substitute and complementary products and understand how they can affect profits in their company and industry. Who, What, When, Where, Why, and How: Who this information is useful for would be any company from a small startup to a major Fortune 500 company as profits are always important. Knowing how to view profit in economic and accounting terms as well as how to use Porter’s Five Forces will help managers understand their ability to not only earn profit, but to sustain it.
The differing view of profits in economic and accounting terms has more wide spread use as we all make decisions that usually involve forgoing alternatives. What is the benefit to understanding these topics? Understanding the opportunity cost when deciding to go back to school, build a new plant, or making personal or corporate financing choices should lead to better decision making. Porter’s Five Forces analysis give managers a better understanding of the power their company holds and their ability to earn, sustain, and grow profits.
When would these tools be used? Whenever decisions need to be made, it is important to understand the implicit and explicit costs. Porter’s Five Forces can be used whenever business strategies are being developed or when examining the effectiveness of these strategies. Where would these tools be used? Any person or organization making decisions should weigh the opportunity costs, and any organization concerned with making and sustaining profit should utilize Porter’s Five Forces. Why would these tools be used?
Understanding the opportunity cost can help individuals and businesses avoid making decisions which when comparing just revenue and expenses seem profitable, but may not be the best choice because forgoing alternatives would carry to high an opportunity cost. Porter’s Five Forces can help businesses develop strategies to make, sustain, and grow profit. How would these tools be used? Managers can use sources within the company to gather data about implicit costs, or act like individuals must and gather there own data. Porter’s Five Forces can be consulted to help plan and evaluate strategies for the company.