Chapter 1 The Fundamentals of managerial economics Flashcards
(34 cards)
General rule of thumb about money
1 dollar today is worth more than 1 received in the future
What is Elasticity?
Explain >1, =1, <1
Elasticity measures how sensitive demand is to price changes.
Elastic Demand (>1) → People change their buying habits a lot.
Non-Elastic Demand (<1) → People buy no matter the price.
Unit Elastic Demand (=1) → Demand changes in perfect proportion to price changes.
Elastic Demand (>1) explain what happens with price
means People are price-sensitive
🔹 If price goes up, demand drops a lot.
🔹 If price goes down, demand increases a lot.
🔹 People have choices and can switch to alternatives.
✅ Example: Energy gels – If prices double, many triathletes switch to bananas or another fuel.
Non-Elastic Demand (<1) explain what happens with price
means People buy anyway
🔹 If price goes up, demand barely changes.
🔹 If price goes down, demand doesn’t increase much.
🔹 People must buy it, no real substitutes.
✅ Example: Ironman registration fee – Even if the price rises, serious athletes still sign up.
Unit Elastic Demand (=1) explain what happens with demand
means Perfect Balance
🔹 If price goes up by 10%, demand drops by 10%.
🔹 Price and demand change at the same rate.
✅ Example: Race fuel – If the price of energy bars rises 10%, triathletes might buy 10% less.
Explain elasticity in all 3 different forms
Elastic (>1) → Stretchy, flexible demand (optional purchases).
Non-Elastic (<1) → Stiff, locked-in demand (must-have purchases).
Unit Elastic (=1) → Even trade-off (balanced reaction to price changes).
What is Present Value?
The present value of an amount received in the future is the amount that would have to be invested today at prevailing interest rates to generate the given future value.
Example Present Value + formula
If someone offers you $1.10 one year from today, its present value at a 10% interest rate is $1.00. Investing $1 today at 10% would yield $1.10 in a year, making $1 its present value.
Formula of Present Value
- Future value / (1 + i)^n
where i = interest rate, n = number of years.
What is Net Present Value? + formula
**Net Present Value (NPV) **
checks if an investment is profitable by adjusting future cash flows to today’s value and subtracting the initial cost.
Formula:
NPV = (Future Cash Flow ÷ (1 + Discount Rate)ⁿ) - Initial Cost
The discount rate is the percentage used to adjust future money to its value today. It accounts for inflation, risk, and the opportunity cost of investing elsewhere.
Example (10% discount rate):
Investment: $8,000
Future Earnings:
Year 1: $5,000 → $5,000 ÷ 1.1 = $4,545
Year 2: $13,000 → $13,000 ÷ (1.1²) = $10,744
Year 3: $21,000 → $21,000 ÷ (1.1³) = $15,817
Final Calculation:
NPV = ($4,545 + $10,744 + $15,817) - $8,000 = $23,106
If NPV > 0, it’s profitable. If NPV < 0, it’s a loss.
Marginal Analysis + example
Marginal Analysis is about comparing the extra benefits and extra costs of doing something a little more or a little less.
**Example: **A bakery sells 10 cakes a day. If making one more cake costs $5 but brings in $8 in sales, the extra benefit ($8) is greater than the extra cost ($5), so making more cakes is a good idea.
Managerial Control Variable (Q) + example
Quantity
(e.g., units produced or actions taken).
B(Q)
The total benefits obtained from a decision or action.
functions are commonly written in the form F(X) to indicate that the output (dependent variable) is determined by the input (independent variable).
C(Q)
The total costs incurred from a decision or action.
N(Q)
N = net benefits
The difference between total benefits and total costs.
MB(Q)
Marginal benefit MB
The extra benefit from one additional unit of Q.
MC(Q)
MC = marginal cost
The extra cost incurred from one additional unit of Q.
MNB(Q)
MNB = marginal net benefits
The extra gain from a decision after subtracting the extra cost (MB - MC).
d (as in dQ)
d = differential
Yes, when d is in dQ, it means a change in quantity (Q).
If you see something like dC/dQ, it means the change in cost (C) for a tiny change in quantity (Q)—this is how we get marginal cost.
Represents a tiny change in a variable (from calculus).
dB(Q)
Db = Differential benefits
A change in total benefits relative to the quantity
Aka the difference in benefits between 2 options
dC(Q)
dc = Differential Costs
A small (differential) increase in cost relative to quantity
A tiny change in total costs.
dN(Q)
DN = differential net benefits
Net benefits = are the total benefits minus the total costs of a decision, showing the overall gain or value.
A tiny change in net benefits (profit).
dQ
A tiny change in the quantity produced or sold.
Maximizing Net Benefits
Increase Q until Marginal Benefit (MB) equals Marginal Cost (MC).
Stop when MB = MC.
whether to stop increasing quantity when marginal benefit (MB) equals marginal cost (MC) depends on the context and objective. However, in basic economic theory, this rule is used because it represents the point where net benefits are maximized—meaning any further increase would reduce overall gains.
Net Benefits vs. Total Benefits
Total benefits (or total revenue) is just how much money or value is generated.
Net benefits (or profit) is what’s left after subtracting costs.
