ECO5000 Economics for Managers and Negotiation in Business

Q1

The rational actor paradigm is a framework that looks at each economic agent as ‘rational’. (Renn, Jaeger, Rosa, & Webler) This rationality is expressed through self interest- each agent works for self interest. The goal is to maximise this self interest, which can be in terms of sales, profits or utility. Every decision is taken by rationalising the options available, in terms of costs and benefits with an overall objective of maximising net benefits.   

This implies that to change decisions we must change the cost and benefits associated with it. The incentives built into every cost and benefit  must be changed to bring about a change in the decision.  

One criticism of this is that humans can be guided by non personal interests as well, especially when it comes to social service. This paradigm ignores such incentives. A second criticism is that the real world is too complex. Often the actions /decisions of one person impact on decisions of the other person. This kind of interdependence of incentives is not explained in rational actor logic.

Q2

NPV and break even analysis ate two ways to look at any investment and its viability.

NPV is more complicated mathematically. It also requires more information than the break even method. It needs information on life of project, the discount rate as well as projected annual inflow.  (Net Present value) All these stretch into the future and are fraught with uncertainty. It is sensitive to the initial investment value used.  The good part is that it allows clear decision in terms of rejection or acceptance of a project.

The break even analysis is easy in mathematical terms to compute.  (Guitierrez & Dalsted)It has less requirements- it does not need any discount rate or projected inflows. It deals more with the present and is useful for projects with short life. It is easily shown graphically also. A possible problem is that it needs a clear classification of fixed and variable cost. This may not be possible at all times. It does not give any clear direction on whether to continue a project or not. It simply gives the lowest output level to sustain a business without losses.

Q3

For example, if I have to decide whether to buy the 3^rd pair of shoes or not. I must look only at the cost of the third pair and compare with the benefits of this pair. What I bought as the 1^st or 2^nd pair has no relevance here in my decision making. Whatever money I spent on these pairs is like sunk now. I cannot get the money I spent on them even if I am unable to wear them due to poor fitting. I must not buy the 3^rd pair because the first two are now useless for me.   The decision to buy the 3^rd pair must consider the benefits and costs of this pair only.

In the same way every firm must decide to produce the next unit after looking at marginal cost and marginal revenues only- the costs incurred in the past have no relevance.    Such costs are irretrievable, and must not be part of decision making. SUNK costs refer to costs that are irretrievable; once made they cannot be recovered. For example the cost of the mould used for making special toys for kids is a sunk cost. This is because it cannot be used for any other purpose except these special toys. It won’t be resold as no one will buy it- resale is zero. Such equipment which is exclusive or specially designed for particular production often involves sunk costs.      

1. In this case the sunk costs = costs for custom machinery as it is not usable elsewhere. This is because it cant be relocated  = $1,00,000

The land cost of $200,000 is not sunk as the land can be used for other purposes also. The factory can be razed and a new one built.

to decide on optimum level we use the marginal cost- marginal revenue rule. ( MR-MC rule). Marginal revenue refers to the revenue generated from last unit, while marginal cost refers to the additional cost of the last unit of production.  (perfect competition)This rule dictates that at the optimum point MR must equal MC. Since the ice cream sells at $2.50/litre, the MR equals 2.5. to get MC we need the following equation

MC of n^th icecream= ( TC of n^th icecream – TC of n-1^th ice cream)

Using the above formula we get the table shown above.

For a volume of 400000, MC will be ( 5500000-350000)/100000 = 2

Now we compare MC with MR of 2.5.

Clearly this firm will not produce 600000units as MC > MR.  (MR=MC rule)

The optimum level is therefore 500000, where MC < MR.  The MC remains same at 300000 and 400000 units. Also but a firm will always maximise the amount it produces if MC is ame. So optimum is 500000 units.

1. Profits= revenues – costs

TC for 500000 units = 750000

TR for 500000 units = 2.5 *500000 = 1250000

So profits = 1250000-750000 = 50000

References

Examples of negotiataions in business: Sunk costs. (n.d.). Retrieved August 2, 2017, from Pon.harvard.edu: https://www.pon.harvard.edu/daily/business-negotiations/beware-the-pressure-of-sunk-costs/

Microeconomics. (n.d.). Retrieved June 2, 2017, from CSun.edu: https://www.csun.edu/sites/default/files/micro3.pdf

MR=MC rule. (n.d.). Retrieved August 2, 2017, from Courseera.org: https://www.coursera.org/learn/principles-of-microeconomics/lecture/zKD8R/pricing-and-production-rules-p-mr-mc-the-shutdown-rule

perfect competition. (n.d.). Retrieved August 2, 2017, from Staffwww.fullcoll.edu: https://staffwww.fullcoll.edu/fchan/Micro/4perfect_competition.htm

O, R., Jaeger, C., Rosa, E., Webler, T., & Renn, O. (n.d.). The Rational Actor Paradigm. Retrieved August 2, 2107, from KEnt.ac.uk: https://www.kent.ac.uk/scarr/events/finalpapers/renn.pdf

Guitierrez, P. H., & Dalsted, N. L. (n.d.). Break even method. Retrieved August 2, 2017, from extension.colorado.edu: https://extension.colostate.edu/topic-areas/agriculture/break-even-method-of-investment-analysis-3-759-2/

Net Present value. (n.d.). Retrieved August 1, 2017, from Tutor2u.net: https://www.tutor2u.net/business/reference/net-present-value-npv

Guitierrez, P. H., & Dalsted, N. L. (n.d.). Break even method. Retrieved August 2, 2017, from extension.colorado.edu: https://extension.colostate.edu/topic-areas/agriculture/break-even-method-of-investment-analysis-3-759-2/