Richard B. McKenzie

Microeconomics for MBAs: Principles of rational behavior in society and business

We are not ready to suspect any person of being defective in selfishness. Adam Smith The combined assumptions of maximizing behavior, market equilibrium, and stable preferences, used relentlessly and unflinchingly, form the heart of the economic approach. Gary S. Becker Our purpose in this chapter is to lay out in clear (if not stark) terms exactly how economists think about peoples decision making and behavior. We fully recognize that the economic way of thinking is not the only way people think about business and life more generally (through methods used in the hard sciences, psychology, the arts, etc.). Most people operate on several different intellectual plains, probably often more or less simultaneously. At other times they shift from intellectual plain to intellectual plain and remain there for a time with concentrated focus on given disciplinary methods of thinking. Here, we ask you to shift to the microeconomic intellectual plain and to remain there for at least the remainder of the course. However, be forewarned, with enough work on the economics plain, we expect many students will come to recognize the benefits of remaining there, or shifting back to the economics plain more often than you might now expect. We have frequently told our students that “economics is as much a ‘discipline’ as it is a disease. Once you catch it, it can be terminal, pervading with ease much of your thinking.” At the same time, we understand many students will want to resist the economic way of thinking every step of the way – until they have come to see the full method of thinking and have experienced its varied applicability to so many dimensions of behavior. We focus on the core founding assumptions in microeconomics, for two reasons: • First, this is a course in economics – not psychology or literature. We need to use your time and textbook space at our disposal economically, which means we need to stay focused on one disciplinary approach. • Second, we might wish we could fully integrate thinking methods and findings of other disciplines, but that is a tough order, primarily because economists have encountered difficulty doing that without undermining analytical progress through loss of precision, if not confusion, on students’ parts.

Microeconomics for MBAs: Consumer choice and demand in traditional and network markets

It is not the province of economics to determine the value of life in “hedonic units” or any other units, but to work out, on the basis of the general principles of conduct and the fundamental facts of social situations, the laws which determine prices of commodities and the direction of the social economic process. It is therefore not quantities, not even intensities, of satisfaction with which we are concerned … or any other absolute magnitude whatever, but the purely relative judgment of comparative significance of alternatives open to choice. Frank H. Knight People adjust to changes in some economic conditions with a reasonable degree of predictability. When department stores announce lower prices, customers will pour through the doors. The lower the prices go, the larger the crowd will be. When the price of gasoline goes up, drivers will make fewer and shorter trips. If the price stays up, drivers will buy smaller, more economical cars. Even defense departments around the world will reduce their planned purchases of tanks and bombers when their prices rise. Behavior that is not measured in dollars and cents is also predictable in some respects. Students who stray from the sidewalks to dirt paths on sunny days stick to concrete on rainy days. Professors who raise their course requirements and grading standards often find their classes shrinking in size. Small children shy away from doing things for which they have recently been punished. When lines for movie tickets become long, some people go elsewhere for entertainment. On an intuitive level, you very likely find these examples of behavior reasonable. Going one step beyond intuition, the economist would say that such responses are governed by the law of demand , a concept we first introduced in Chapter 3 and now take up in greater detail, with greater precision, and with more varied applications. In this chapter, we show how our understanding of a firms strategy can be enhanced by simply classifying various goods into such categories as “normal” and “inferior” goods, “substitute” and “complementary” goods, and “network” and “lagged-demand” goods, with the nature of the goods affecting their demands. We will also introduce formally the concepts of “elastic” and “inelastic” demands, all of which suggests that the development of profit-maximizing pricing strategies requires that MBAs know more about goods than merely that their demands slope downward.

Microeconomics for MBAs: Competitive product markets and firm decisions

Competition, if not prevented, tends to bring about a state of affairs in which: first, everything will be produced which somebody knows how to produce and which he can sell profitably at a price at which buyers will prefer it to the available alternatives; second, everything that is produced is produced by persons who can do so at least as cheaply as anybody else who in fact is not producing it; and third, that everything will be sold at prices lower than, or at least as low as, those at which it could be sold by anybody who in fact does not do so. Friedrich A. Hayek In the heart of New York City, Fred Liebermans small grocery is dwarfed by the tall buildings that surround it. Yet it is remarkable for what it accomplishes. Liebermans carries thousands of items, most of which are not produced locally, and some of which come from other parts of this country or the world, thousands of miles away. A man of modest means, with little knowledge of production processes, Fred Lieberman has nevertheless been able to stock his store with many if not most of the foods and toiletries his customers need and want. Occasionally Liebermans runs out of certain items, but most of the time the stock is ample. Its supply is so dependable that customers tend to take it for granted, forgetting that Liebermans is one small strand in an extremely complex economic network. How does Fred Lieberman get the goods he sells, and how does he know which ones to sell and at what price? The simplest answer is that the goods he offers and the prices at which they sell are determined through the market process – the interaction of many buyers and sellers trading what they have (their labor or other resources) for what they want. Lieberman stocks his store by appealing to the private interests of suppliers – by paying them competitive prices. His customers pay him extra for the convenience of purchasing goods in their neighborhood grocery – appealing to his private interests in the process.

The market economy, overview and application

Chapters 1–4 of Microeconomics for MBAs, which constitute Book I, develop the broad outlines of The Economic Way of Thinking for Managers. We explore in Chapters 1 and 2 what economists mean by markets and “rational behavior” and show how rationality-based thinking can illuminate many (hardly all) public and management policies. In Chapter 3 we will focus on how markets can be analyzed through the forces of supply and demand, developed with graphical analysis, in spite of serious limitations regarding the complete realism of having just two lines on a graph (supply and demand) to represent market forces. However, we show how supply and demand curves can be used to illuminate how and why competitive markets can work efficiently (to one degree or another) and under what conditions competitive markets can fail to work efficiently. In Book II, Chapters 5–6, supply and demand curve analysis is used to explore the market consequences of an array of governmental and organizational policies. Throughout Chapters 1–6, we will consider how management policies can affect the forces of supply and demand and how market forces can affect management policies. Our goal in Book I and II is to provide a broad overview of the market economy. In Book III, Chapters 7–9, and Book IV, Chapters 9–13, we will examine many of the theoretical details underpinning supply and demand. In these later chapters, we will develop a theory of firms and explain how firms can be pressed to minimize their production costs in markets with different levels of competitiveness and in markets dominated by firms with differing levels of monopoly power. Cambridge University Press 978-1-107-13948-0 Microeconomics for MBAs: The Economic Way of Thinking for Managers Richard B. McKenzie and Dwight R. Lee Excerpt More information