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chap01 - CHAPTER 1 The Nature and Scope of Managerial...

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2 C H A P T E R 1 The Nature and Scope of Managerial Economics W arren E. Buffett, the renowned chairman and chief executive officer of Omaha, Nebraska-based Berkshire Hathaway, Inc., started an investment partnership with $100 in 1956 and has gone on to accumulate a personal net worth in excess of $30 billion. It is intriguing that Buffett credits his success to a basic understanding of managerial economics. Berkshire’s collection of operating businesses includes the GEICO Insurance Com- pany, Buffalo News newspaper, See’s Candies, and the Nebraska Furniture Mart. They commonly earn 30%–50% per year on invested capital. This is astonishingly good performance in light of the 10%–12% return typical of industry in general. A second and equally important contributor to Berkshire’s outstanding performance is a handful of substantial holdings in publicly traded common stocks such as The American Express Company, The Coca-Cola Company, and Wells Fargo & Com- pany. As both manager and investor, Buffett looks for ‘‘wonderful businesses’’ with outstanding economic characteristics: high rates of return on invested capital, sub- stantial profit margins on sales, and consistent earnings growth. Complicated busi- nesses that face fierce competition or require large capital investment and ongoing innovation are shunned. 1 Buffett’s success is powerful testimony to the practical usefulness of managerial economics. Managerial economics answers fundamental questions. When are the characteristics of a market so attractive that entry becomes appealing? When is exit preferable to continued operation? Why do some professions pay well, whereas others offer meager pay? Successful managers make good decisions, and one of their most useful tools is the methodology of managerial economics. T HE M ANAGERIAL D ECISION -M AKING P ROCESS Managerial economics applies economic theory and methods to business and ad- ministrative decision making. Managerial economics prescribes rules for improving managerial decisions. Managerial economics also helps managers recognize how eco- nomic forces affect organizations and describes the economic consequences of man- agerial behavior. It links traditional economics with the decision sciences to develop vital tools for managerial decision making. This process is illustrated in Figure 1.1. Managerial economics identifies ways to efficiently achieve goals. For example, suppose a small business seeks rapid growth to reach a size that permits efficient use of national media advertising. Managerial economics can be used to identify pricing and production strategies to help meet this short-run objective quickly and effectively. 1 See James P. Miller, ‘‘Buffett Bash Is Set to Burst Over Omaha,’’ The Wall Street Journal, May 3, 1999, C1.
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