SECTION REFERENCE: Six Steps to Decision Making
DIFFICULTY LEVEL: Easy
- One of the major steps in decision-making is to explore the alternatives. Do most managerial decisions have a few, limited number of options? Explain. Illustrate your answer with an appropriate example.
ANSWER: Most decisions have several (often many) competing options. Even when the choices are limited, there are often more alternatives than first meet the eye. For example, suppose Disney is deciding whether to build a new theme park. It must choose the location, and the scale of operation, and when its opening should be scheduled. In addition, subsequent decisions will involve advertising and pricing strategies. Many managerial decisions involve more than a once-for-all choice from a set of options. Instead, managers face a sequence of decisions. For instance, whether a firm should attempt to develop a new product and if all goes well, when and how should it launch and promote the product. The firm will also have to decide how it should price the product and gear up capacity to supply the expected sales at its chosen price.
SECTION REFERENCE: Six Steps to Decision Making
DIFFICULTY LEVEL: Easy
- Carefully define the term "model" and explain how models are used in managerial economics.
ANSWER: A model is a simplified description of a process, relationship, or other phenomenon. The two main types of models are deterministic and probabilistic. Models select key features for analysis (and, therefore, they deliberately ignore less important features). Models are useful to managers because they show how the various options that a manager faces translate into outcomes. Models usually help in explaining past outcomes or in predicting future outcomes.
SECTION REFERENCE: Six Steps to Decision Making
DIFFICULTY LEVEL: Easy
- Carefully define probabilistic and deterministic models, and explain how they differ.
ANSWER: Deterministic models are predictive models in which the outcome of a decision is certain (or close enough that it doesn’t matter). In probabilistic models, there is no one certain outcome but, rather, many possible outcomes with a probability attached to each.
SECTION REFERENCE: Six Steps to Decision Making
DIFFICULTY LEVEL: Easy
- Value maximization is the main objective of top management. Briefly describe the alternative objectives.
ANSWER: The three most important alternatives are: satisficing behavior, sales maximization, and pursuing the firm’s social responsibilities to all stakeholders. Satisficing behavior posits that firms will sometimes strive for second-best, or an acceptable level of performance as against the highest level of maximization. Sales targets may closely be linked to managers’ compensation and so firms may also strive to maximize sales subject to a certain level of profit. Firms that pursue social responsibility as their objective would aim to satisfy not only customers and investors but also society, the environment, and other stakeholders. All these objectives may be pursued at the expense of profits.
SECTION REFERENCE: Private and Public Decisions: An Economic View
DIFFICULTY LEVEL: Medium
- Ecotopia is a developing country that is facing a growing need for energy to power its industries and fuel its development. The Ecotopian government's proposal to set up a nuclear energy plant has drawn widespread protests from environmental activists across the country. Since this is an issue that affects a large number of people, how would one weight the benefits and costs to make a decision that is best for the society as a whole?
ANSWER: Setting up a nuclear plant in order to satisfy civilian energy needs affects the welfare of the society in general. In such a situation, since there are gains and losses for different groups of people, benefit-cost analysis should be used. Benefit-cost analysis weighs the total benefits and total costs of a decision (irrespective of who these benefits and losses accrue to). When setting up a nuclear plant, the benefits and costs need to be assigned a monetary value. If the value of the benefits is higher than the value of the costs, then the project should be undertaken. One of the possible benefits from nuclear energy is that Ecotopia can reduce its dependence on fossil fuels. Nuclear energy generation also does not emit greenhouse gases. Relevant costs include the high investment sum to build the plant, its ongoing operating costs, and safety-related costs including disposing of nuclear fuel. All these benefits and costs should be converted into a common measurable unit, usually dollars, and then compared.