Centre for Financial & Management Studies (CeFiMS) - University of London

Individual Professional Courses – IPC  

Managerial Economics [FM102]

Introduction

Managerial Economics aims to present the main ideas and analytical tools in microeconomics and in managerial economics. These ideas and tools are essential for a sound understanding of financial management. The course starts by discussing the methods of microeconomic analysis and of managerial economics and their relevance for financial economics and management. The theory of the consumer and the theory of the firm are then examined in detail. After examining the behaviour of individual firms, the course looks at the interactions among firms by analysing various types of market equilibrium: perfect competition, monopoly and oligopoly. The analysis of oligopoly is carried out by making use of game-theoretic tools to model the strategic interactions between the competing firms.

The course then presents some modern developments in managerial economics, which are based on the idea that firms and agents have only an imperfect knowledge of their competitors or of other agents. They must therefore behave or design contracts (e.g. wage contracts or financial contracts) in such a way that their own welfare is maximised, despite their being unable to perfectly observe the behaviour of the other partners to the contract (such as workers or managers of firms). Finally, the course looks at the classical and modern theories of investment and finance, and applies these theories to financial decisions and to corporate control issues.

Aims & Objectives

This course aims to familiarise students with the key microeconomic concepts and models necessary for understanding and dealing with the problems of financial management, to enable them to:

• carry out an appropriate microeconomic analysis of the actions of firms

• use game theory to analyse firms’ behaviour in a competitive market

• design coping strategies to compensate for the existence of uncertainty and risk.

Resources

Students receive a looseleaf binder containing eight ‘course units’; these texts are carefully structured to provide the main teaching and are equivalent to traditional course lectures, defining and exploring the main concepts and issues, locating these within current economics debate and introducing and linking the further assigned readings. Two obligatory assignments, which are marked by CeFiMS tutors, and a specimen examination paper are also included within the student pack, along with the following:

Textbooks:

Hugh Gravelle and Ray Rees, Microeconomics, Second Edition, 1992, Longmans, ISBN0582023866.

Paul Milgrom and John Roberts, Economics, Organization and Management, First Published 1992, Prentice Hall, ISBN0132246503.

Course Timetable:

This shows the linkage between the various components of the course and indicates the schedule for reading the texts, watching the video lectures, submitting assignments, etc.

Course Content

Unit 1 Introduction

This first unit introduces the main methods of microeconomics and managerial economics. It looks at how problems of optimisation under constraints can be formulated, which are central to this course. After explaining the language and the main concepts of microeconomics, the role of optimisation in economic analysis is studied. Some general methods for solving optimisation problems and for analysing the characteristics of the solutions are then examined. This unit lays the foundations for the analysis in the course.

Unit 2 The Theory of the Consumer

Unit 2 looks at the theory of the consumer. It sets out the objectives of consumers and describes the set of constraints under which their decisions are made. It introduces the notion of utility, and shows how rational consumers can maximise their welfare by optimal choice of their consumption bundle. Finally, the unit illustrates how the optimal choice of consumers depends on their preferences, and how their choice depends on the price of the commodities and on their income.

Unit 3 The Theory of the Firm

The theory of the firm is the focus of Unit 3. This unit discusses the nature and objectives of the firm, exploring the technological conditions under which the firm operates. It also examines how to define a production function. The structure of the costs of the firm, both in the short run and in the long run, are analysed in the context of how it can minimise its costs and maximise its profits.

Unit 4 Competitive and Monopolistic Markets

Unit 4 examines equilibrium in competitive and in monopolistic markets. Under competitive conditions, individual firms can only affect the market outcome in a negligible fashion, whereas under monopoly the industry coincides with the firm, and therefore the firm wields considerable market power. It is seen how to aggregate individual demand functions by consumers and individual supply functions by producers to obtain the industry demand and supply curves. For perfect competition, students will look at equilibrium in the short run (when productive capacity is fixed) and in the long run (where productive capacity is variable). For monopoly, the critical conditions for a profit-maximising monopolistic firm are analysed, and how equilibrium conditions must be modified if the monopolist is able to discriminate amongst its customers.

Unit 5 Strategic Behaviour and Oligopoly

In Unit 5, markets with few sellers, or oligopolistic markets, are studied. These types of markets are neither perfectly competitive, nor monopolistic. Instead, in making decisions, firms take into account the decisions of other firms in the market. Because the outcome of any decision depends not only on that decision itself but also on the decisions of the others, these types of interactions are referred to as games. The Unit introduces game theory and some of its more important solution concepts before applying them to the model. In the context of oligopoly, the outcome of quantity competition, sequential competition, and price competition are discussed. Finally, the relationships between these three models are discussed and important extensions are investigated.

Unit 6 Bargaining and Private Information

This unit addresses some of the issues relevant to the analysis of motivation in trade. First, a formal framework for one-to-one bargaining is examined, and ways of dividing welfare improving surplus between the negotiating parties. It is then shown that the existence of trade may be significantly affected by information asymmetries. Examples of how these asymmetries can cause adverse selection are discussed, which may lead to significant reduction of trade in some markets (and may sometimes even cause the total collapse of the market). It is shown how signalling and screening may be used to reduce the inefficiencies caused by adverse selection. Asymmetric information about behaviour after agreements have been made may cause problems of moral hazard. Finally, the unit considers how various incentive schemes may help in controlling these negative effects.

Unit 7 The Optimal Provision of Incentives

Unit 7 introduces the art and science of optimal provision of incentives. An optimal contract must strike a balance between eliciting a high level of effort, normally through providing incentives such as performance-related pay, and insuring workers against risk. The theory of decision under uncertainty is introduced, and it is shown how risk can be eliminated through pooling. Several principles for the design of optimal contracts are pointed out. Finally, it is shown how incentives may change where the relationship between the worker and the firm is long-term.

Unit 8 Financial Investment, Capital Structure and Corporate Control

This final unit describes the relationship between the firm and its providers of capital. Firms can either borrow or sell shares and stocks to raise the capital required to finance their investments. In Unit 8, the classical framework is developed, which allows analysis of the decisions of firms about which investment projects to undertake, and how to finance them. It is then asked what projects investors would be willing to finance through their holdings of various shares and stocks. The classical framework is dependent on the claim that financial markets are informationally efficient, and this raises questions about its universality.

The classical framework abstracts from issues of information asymmetries and incentives. This is the main reason why the predictions of the classical framework are not consistent with actual financial behaviour of firms and of investors. However, existing data can be explained by extending the classical framework to include managerial and stockholders’ incentives, and the possibility of asymmetric information about the firm’s performance.

Tuition & Assessment

The course is assessed by two assignments and a three-hour examination held in the autumn. Each assignment consists of compulsory questions or an essay topic, which should be answered, in total, in no more than 2500 words. Assignments count for 30% of the overall grade for this course, while the examination is worth 70% of the final assessment.