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1 ECON2135 Business and Managerial Economics Module Handbook revision: June 20132 Contents Staff details 3 Module aims 4 Learning outcomes 4 Teaching ...
Teaching Managerial Economics
by Zoltan J. Acs and Daniel A. Gerlowski
Merrick School of Business University of Baltimore 1420 N. Charles St. Baltimore, MD 21201 Tel.: (410) 837-5012 Fax.: (410) 837-5027 E-mail: [email protected]
Abstract Managerial economics courses in most business schools is a blend of microeconomics and the decision sciences. In this approach the focus is on the firms role as a production and decision unit. As societies become more complex the transaction and coordinating costs of economic activity become more important. Managerial economics courses should move away from their exclusive focus on the firm as a production unit to a transacting and coordinating unit. This movement has been made possible by the development of new teaching material during the 1990s. In this article we describe one such effort at the University of Baltimore.
JEL Classification: A20, A23, C1.
According to a recent article in The Region (Salemi, 1998) there is widespread economic illiteracy. An important cause of economic illiteracy is that economics is too seldom part of the K-12 curriculum and , when taught, is too often taught by teachers with little training in economics. At the college-level introductory classes are often designed as if every student in the class is going to be an economics major, and every economics major will earn a Ph.D, and every Ph.D will pursue an academic career. College level texts have remained unchanged since Paul Samuelson published his Economics 50 years ago (Witz, 1998).1 In order to combat economic illiteracy The National Council on Economic Education has developed new standards for economic education (The Region, 1998). At professional business schools things are not much better. According to a recent survey (Gregorowicz and Hegji, 1998) over 700 institutions offer MBA programs, enroll in excess of 200,000 students, granting over 90,000 degrees in 1993-1994.
MBA student takes 1.48 economics courses. However, economics at the MBA level remains relatively unpopular with 54% of students responding that economics was unpopular or very unpopular. The primary reason for economics’ unpopularity was that students felt it was too theoretical a subject. The survey also suggested that economics was the most misunderstood component of many business programs, included only to be part of business decision making. In the mid 1980s American Association of Collegiate Schools of Busienss (AACSB) suggested that all member business schools require 9 credit hours of economics courses as a part their Bachelor’s Degree programs. Most students in Collegiate Schools of Business took separate microeconomic and macroeconomic principles courses. At both 1
The most recent attempt to break out of the traditional mold is Mankiw (1998)
the graduate and undergraduate level Managerial Economics or a course very similar followed these principles courses. Managerial Economics applies economic theory and methods to business and administrative decision making. Because it used the tools and techniques of economic analysis to solve managerial problems, managerial economics links traditional neo-classical economics with the decision sciences to develop vital tools for managerial decision making. 2 In most of these courses the primary focus is on the firm. Traditional, neo-classical theory focuses on the firms role as a production unit. However, appropriate this emphasis may have been when firms engaged in one, or few, activities and served only limited markets, it is no longer the case today. As society becomes more complex, the transaction and coordinating costs of economic activity become more important, these include both the increasing costs of acquiring information to measure the multiple dimensions of what is being exchanged, and those associated with enforcing contracts and making credible commitments across time and space, necessary to realize the potential of technological and organizational advances. In order to make the theory more relevant, Managerial Economics courses should (are) move away from their exclusive focus on the firm as a production unit, to a transacting and coordinating unit. This would require abandoning the close relationship between economics and the decision sciences in most business courses and forging a much closer and more collaborative effort with management, including but not limited to,
As of 1998, AACSB no longer formally requires nine credits of economics by undergraduates; however a perusal of undergraduate program catalogues and University web-sites reveals that, in the majority of cases, most business students still face nine credit hours of economics as part of their undergraduate set of core courses. Our own experience points to a situation being faced at institutions across the country: what economics should undergraduate students be expected to know beyond micro- and macro- principles?
strategy, innovation and technology management, human resource management, and managerial finance. New developments in the economics of organization are available to bring this approach into the classroom. Four new text books blending different aspects of managerial economics with the organizational approach have appeared during the 1990s: Milgrom and Roberts (1992), Brickley, Smith, and Zimmerman (1997), Acs and Gerlowski (1996), and Besanko, Dranove and Shanley (1997). In this paper, we describe our efforts to create a new course, replacing traditional Managerial Economics at The University of Baltimore. In the first section we present the standard approach to the teaching of Managerial Economics and suggest why this approach should be abandoned.
In the second section we explain our approach to teaching
Managerial Economics at the University of Baltimore. The third section discusses some of the teaching methods that we have used in order to overcome the shortage of materials for this approach, including using the web. Finally, we present some reasons why the traditional approach to teaching Managerial Economics continues to be popular. I. Economics Beyond Principles The standard approach in most business schools is to teach a third course with a content that can be broken into two components, one theory driven and the other mechanics driven.
On the theory side, coverage usually extends to competitive market
forces, optimal firm behavior including demand and cost considerations, market structure, and sometimes game theory. On the mechanics side coverage usually extends to some treatment of calculus, regression methods, and linear programming.
Over the years
professors have become very adept at blending these tools and theoretical constructs into a
very cohesive package. Table 1 provides some idea of the content of the traditional Managerial Economics courses.3
TABLE ONE ABOUT HERE
This body of material fills a need in undergraduate and graduate business education as a rigorous set of materials improving students’ quantitative abilities in the context of traditional, neo-classical economics. While this interpretation of managerial economics is narrow, perhaps even a “straw man” it is what has been in the textbooks. All of the texts shown in Exhibit 1 are classics in the sense that many of them are in high editions and all of them are extraordinarily well done in terms of writing and the use of examples. There are at least three reasons why this traditional approach focusing on the firm as a production unit should be abandoned. First, the teaching of basic statistics is being revolutionized due to the advent of spreadsheet based instruction. The standard statistics courses taken by undergraduates now typically cover many regression applications. Management Departments very often offer a course based on production, the content of which differs markedly from the Economists’ emphasis of diminishing marginal productivity.
Business policy courses
frequently explore topics associated with monopoly power. In other courses there is a witnessed movement away from quantitative topics as part of the instructional paradigm; instead the quantitative elements of business education are being assigned to specialists. 3
Managerial Economics In a Global Economy, Second Edition, Dominick Salvatore, McGraw-Hill, Inc., 1993. Hirschey, Mark and James L. Papas, fundamentals of Managerial Economics, Fifth Edition, The Dryden Press, Harcourt Brace College Publishers, 1995. Douglas, Evan J., Managerial Economics Analysis
Second, the traditional, neo-classical theory of the firm, focusing on the firms role as a production unit, rather than on a transacting and coordinating unit is limited in an era when all types of economic activity in moving in the direction of globalization. However, appropriate this emphasis may have been when firms engaged in one, or a few activities, and served only limited markets, it is no longer the case today.
As Douglas North4 has
shown, as society becomes more complex, the transaction and coordinating costs of economic activity become more important, these include both the increasing costs of acquiring information to measure the multiple dimensions of what is being exchanged, and those associated with enforcing contracts and making credible commitments across time and space, necessary to realize the potential of technological and organizational advances. Indeed as the reality of changes in the business world entered the classroom the traditional neoclassical explanations were unable to explain what was happening in corporations. Questions of downsizing, make or buy decisions, human resource issues, governance, takeovers were often beyond the scope of the traditional analysis. It did not make a lot of sense to use the neoclassical model as a framework for this analysis. What was needed were the tools to look inside the black box. Students needed from economics a set of principles with which to understand what differentiated one company from another. Third, while for years new developments in the economics of organization were unavailable to students, all this changed with the publication of two important books. The Pioneering spirit in this endeavor was embodies in Sharon Oster’s Modern Competitive Analysis, which fist appeared in 1989. Here in one book were most of the topics that were
and Strategy, Fourth Edition, Prentice Hall, Englewood Cliffs, NJ, 1992.Samuelson, William F. and Stephen G. Marks, Managerial Economics, The Dryden Press, Harcourt Brace College Publishers, 1992. 4 North, D., Institutions, International Change and Economic Performance, Cambridge: Cambridge University Press, 1990.
important for linking managerial economics with the economics of organization. Oster’s did not however cover all the topics that were necessary for this transition and the economic content was not rigorous. The first comprehensive treatment of the subject was the Economics, Organization, and Management by Paul Milgrom and John Roberts (1992). Although it represents a remarkable achievement, the book is written well above the level of most undergraduate and graduate students. Moreover, certain themes that warrant expansion in order to make the subject applicable in a global economy are missing including innovation and technological change, and the global economy. Three new text books blending different aspects of managerial economics with the organizational approach have appeared recently:
Managerial Economics and
Organizational Architecture, by Brickley, Smith, and Zimmerman (1997); Managerial Economics and Organization, by Acs and Gerlowski (1996); and The Economics of Strategy by David Besanko, David Dranove and Mark Shanley (1997). Exhibit 2 provides the content of managerial economics and organization textbooks. Exhibit 2 follows the outline of Exhibit 1 with the exception the quantitative tools section has been replaced with a section on the economics of organization. As is evident the main difference between these texts and traditional managerial texts is that none of these texts have any quantitative tool topics. While coverage varies between the four texts they uniformly cover contracting, transaction costs and agency theory.
TABLE 2 ABOUT HERE II. Teaching Goals For Managerial Economics The University of Baltimore is an upper divisional and graduate educational institution located in Baltimore, Maryland. Its mission is to provide education in the fields of Liberal Arts, Law, and Business to a largely non-traditional student base. The Robert G. Merrick School of Business offers degrees accredited by AACSB at the undergraduate and graduate level. Our purpose in writing Managerial Economics and Organization was to create a text that replaces the traditional focus of Managerial Economics on calculus, statistics and decision sciences and create a Managerial Economics text that has closer ties to organization and strategy. We maintain that undergraduate students’ exposure to economics beyond micro- and maco- principles should meet five broadly defined and interdependent goals: •
Economics of Organization
Relation to Other Business Disciplines
A Groundwork Feeding Into Business Strategy
Economic activity is really about exchange; this is what economists do. From their principles courses, students understand supply and demand interaction in competitive markets. However, many exchanges, or transactions, occur outside the protective realm of competitive markets. In terms of a firm’s role in the economy students must be made to
understand that one central question is whether or not a particular exchange best occurs within, or outside of, the firm. The external environment is critically important to both firms and consumers. The traditional managerial economics courses based on the books listed in Exhibit 1 explain the external environment very well to students. A firm understanding of competitive market forces, demand and elasticities, costs and productivities, and market structure is viewed as necessary. Each of these topics puts another tool in the students’ toolbox that can be used well beyond the classroom. Issues relating to the economics of organization also provide powerful tools to students. This term refers to a broad, diverse line of scholarly inquiry within Economics, we highlight here those elements beneficial to students grouping them into two levels. The first level deals with organizational issues that arise within very micro-level exchanges. The environment of exchange is explored and explained along the lines of informational asymmetries, specificities, bounded rationality, and opportunistic behavior. Also to be introduced at this point are the concepts of efficiency, the relation of efficiency to the standard competitive supply and demand model, a statement of the Coase Theorem, and the application of the Coase Theorem to the problems of externalities and public goods. Students benefit from an exploration of transaction costs and how they represent frictions preventing the smooth and efficient functioning of the price system. A body of literature, drawn heavily from the Journal of Law and Economics, can also be introduced to describe relational contracting in terms of reaching agreement in a less than perfect exchange situation.
The contracting issues can be arranged so as to highlight both the existence of transaction costs and attempts to mitigate their influence. A sound exposure to ex ante issues such as strategic misrepresentation and adverse selection and to ex post issues such as agency problems and specificities round out the students’ exposure to the first level topical coverage drawn from the economics of organization. The second level of material drawn from the economics of organization relate the transaction costs and contracting problems concepts to issues surrounding internal organization. In our own courses we have addressed this through three topics: the degree of vertical integration, the firm’s relationship to its employees, and the firm’s relationship with the providers of capital. Vertical integration is viewed largely as the decision whether or not to use outside suppliers. The cost of using outside suppliers include, of course, transaction costs. The benefits of using outside suppliers are described as including Adam Smith’s benefits of specialization. To this basic framework many more complex issues can be added. In dealing with its employees, a firm needs to recognize that agency issues cannot be ignored when dealing with employees; however an overly onerous reliance on rules and regulations is not productive either. Agency issues also provide the groundwork for the relationship between a firm and its providers of capital. We have found a number of interesting articles in the academic and popular press that address directly these issues related to corporate governance. Taking the teaching perspective, we now turn our attention to the fit of the third three credit economics course into the business curriculum. The content of economics beyond micro- and macro- principles should have a comfortable and logical relation to
other business disciplines. This can be accomplished with a content drawn appropriately from an understanding of exchange, an appreciation for the external environment of firms, and a comprehension of certain elements of the economics of organization. In many Organizational Behavior Courses (typically the first or second general management course) students are exposed to topics like corporate culture and the idea of firm stakeholders. Without an understanding of how culture can evolve to overcome agency and measurement problems and what the efficiency enhancing aspects of culture are, students are denied a logical, economic explanation as to why firms’ internal organization may feature elements of corporate culture. Similarly, exposure to concepts of corporate governance provide a different view from that most frequently encountered in discussions of the stakeholders of the firm. An understanding of the agency problems behind many exchanges and contractual agreements can also have explanatory power for students when coupled with topics in corporate finance and human resource management. Furthermore the insights into agency problems, measurement issues, and aspects of ownership can provide meaningful insights into the difficulties inherent in forming well functioning teams. A course centered on transaction costs and the economics of organization, when coupled with a solid understanding of a firm’s external environment will also help in the student’s overall business education by providing a groundwork feeding into business strategy courses which often culminate an undergraduate business education. One of the central questions addressed in our course is the firm’s choice regarding the potential use of outside suppliers.
These changes in the content of Managerial Economics fits more neatly into the curriculum, is well liked by students, and serves as a base upon which a broader, evolutionary theory of business organization can rest. III. Teaching Methods and Materials An instructor choosing to teach managerial economics with a traditional content can fortunately draw from a large set of textbooks, cases, homeworks, and other teaching materials that has been developed over the decades. Each of the books listed in Exhibit 1 has associated with it, and freely available from its publisher, an instructor’s resource package.
This segment of the textbook market is by all indications “thick” and
competition drives publishers to provide as complete of a package as possible. This body of teaching materials may be drawn upon freely to teach that portion of the content of the course we propose. For those wishing to teach the new Managerial Economics the market for supporting material is thin. Even though several excellent textbooks have been developed in the 1990s, supporting material in the form of study guides, instructors manuals, computerized test banks, existing problems etc., are still scarce, making teaching the new material more challenging. However, there are also new opportunities. The invention of the web is changing traditional approaches to teaching (Bullwinkle, 1988).
instructors and students are discovering how textbooks and web sites can be used together to support the learning of economics. We do not imply that the web cannot be integrated with traditional managerial economics courses. Instead, we suggest that when there does not exist an readily available body of supporting material, the web today provides an excellent resource to help develop these materials.
Perhaps the most important change in the class room supporting the web is the use of electronic presentations. The formal lecture, with chalk in hand, has been replaced by computer-based presentations.
Two dominant software packages have been used:
PowerPoint and FreeLance Graphics.
It is our understanding that numerous other
packages accomplish the same purpose, some allowing for true animation and the inclusion of sound and video clips. Even in those instances where a classroom based projection system has been unavailable, we have prepared presentations and simply printed them on traditional overhead transparencies. Our experience indicates that student retention is enhanced if students are given a set of presentation notes; the caveat being that these presentation notes must be less than complete in order to discourage shirking by students during the class lecture time. Therefore, there is an opportunity here to be innovative. This teaching approach is entirely consistent with the arguments made by Becker (1997) supporting alternative methods of instruction.5
We regularly use in our courses
learning with group activities, student driven presentations, and learning with individual activities. A sampling of the teaching materials we have used in the class are arranged by broad topic: WE NEED WED AND ELECTRONIC EXAMPLES HERE TO SUPPORT. Externalities Given that undergraduate students have a fairly well developed understanding of how markets function, they can build on this (somewhat ironically) by understanding how and why markets fail.
An excellent reason is the existence of
externalities in exchange. We rely on an excellent example taken from a study of the renting of retail space in large, urban malls capitalize on.6
Becker, William E., “Teaching Economics to Undergraduates,” The Journal of Economic Literature, September 1997, 1347-1373. 6 The most recent discussion we could find of this in a student accessible format is: “Why Some Shops Drop,” appearing in The Economist on March 1, 1997, page 78.
The Coase Theorem There are several fairly well-known examples of bargaining situations, our additions to them are highlighting some aspects of transaction costs and vertical integration in such a way so as to focus student thought on the economic problems of organization. The most widely read discussion appears in Coase (1960), The Problem of Social Cost.7 Coases’s example describing the coexistence of the railroad and the farmer’s field makes excellent reading for students. Governance One of the predominant features of our course is the amount of material that ties-in to related disciplines. We usually spend two weeks addressing the issue of corporate governance from the vantage point offered by the economics of organization. Many examples exist of large mass producing and conglomerate firms that were broken up in the early 1990s. We require students to read the paper on corporate governance by Jensen, (1993) and use it with pieces in the popular press to discuss governance issues.8 We have had great success showing the movie Other People’s Money in our course. Students find the story interesting and the story provides a rich framework within which to provide an introduction to the agency problems that may exist between the owners and managers within a firm. Specificities and the hold-up While the topic of specificities has gathered a lot of attention in the professional level academic literature within the economics of organization,
A full citation is Ronald Coase, “The Problem of Social Cost,” Journal of Law and Economics, 3, 1960, pages 1-45. 8
Jensen, Michael C., “The Modern Industrial Revolution, Exit, and the Failure of Internal Control Systems,” The Journal of Finance, 48, No. 3, 1993, pp. 831-880.
there are fewer ready-made examples available for instructional purposes. Our approach is to adopt a modified version of an example found in Rubin (1990).9 IV. Responses to Teaching the New Managerial Economics At the University of Baltimore we no longer teach managerial economics as a pure theory and quantitative analysis course. The managerial economics course aims to teach students the basics of microeconomic analysis, along with the economics of organization, transactions cost economics, and agency theory. We aim in this course to give students the tools with which to understand
the boundaries of the firm how firms operate and
how firms evolve in the modern economy. We also give them the tools to understand how economics relates to different disciplines, including finance, human resource management, innovation and technological change, and globalization. We have sought out two separate types of feedback on our course: from our colleagues in other departments, and from our students. Professors in other fields have congratulated us on two fronts: first, bringing new evolving material into the economics classroom; and second, introducing a different perspective on topics that they traditionally teach. Working with MBA instructors from marketing, human resources, finance, and accounting, we modified our course content slightly to magnify the inter-disciplinary nature of our course. This was accomplished easily and the end result was the sharing of two Harvard Business School cases with other courses based in other disciplines. The human resources faculty member especially liked how we laid a theoretical groundwork for both short- and long-term employment relationships. The finance faculty member was grateful for our discussions related to relational contracting, agency problems, 9
Rubin, Paul H., 1990, Managing Business Transactions, The Free Press, New York, New York, pp. 4-10.
and corporate governance. The marketing professor built upon our discussion of market demand in his own material on marketing. However, our attempts, and similar attempts nationally and internationally, have had mixed results. There are at least four reasons. First, as mentioned above, the teaching material has not been developed in sufficient quantity to support this effort. Second, it is difficult to find faculty that are willing to change even if they think changes should be made. Third, it is difficult to find faculty that are familiar with the new material. Almost all business school faculty are familiar with the content of the traditional managerial economics. Very few are familiar with the new approach, and even if they are, they may have attempted to teach it in the classroom. Using part times was even more difficult because they were not willing to (and why should they) make the investment to teach the new material. Fourth, the traditional approach to managerial economics works well, and students respond favorably, according to Gregorowicz and Hegji (1998), when economics is used to support finance and international business. The traditional approach does not work well when the program is oriented towards management of technology, and information systems, with traditional management and marketing somewhere in the middle. Therefore, the orientation of the program may help determine the type of managerial course that would work best. No matter what the reason, across the country, the traditional approach to teaching Managerial Economics, continues to be popular, at least with professors.
Table 1: Content of Traditional Managerial Economics Textbooks
Hirschey and Pappas (1995)
Samuelson and Marks (1992)
Theory Topics in Chapters Demand Theory Incl. Elasticities
Demand and Supply Production Cost Theory Cost Curves Market Structure
4 6 6,7 6
Regulation Marginal Optimization
4 4 7 8 8
3 6 7 7
10,11,12 13 2
9,10,11 12 2
3 8 (appendix) 5 6 6 8,9,10 2
Quantitative Tool Topics in Chapters Basic Statistics Incl. Exp. Value and risk Regression Forecasting Linear Programming Calculus Instruction Applied Calculus
5,8 5,8 6 appendix A optional
3 4,8 9 Optional
4,6,7 5 8 2 optional
4 4 7 2 (appendix) suggested
Table 2: Content of Managerial Economics and Organization Textbooks
Acs (FitzRoy) Gerlowski (1996)
Milgrom Roberts (1992)
Brickley Smith Zimmerman (1997) Theory Topics in Chapters
Besanko Branove Shanley (1996)
Demand Theory Incl. Elasticities
Demand and Supply Production Cost Theory Cost Curves Market Structure Incl. Game theory
Regulation Contracting Transaction Costs Agency Theory Property Rights Efficiency Finance / Investment Innovation and Technological Change Firm Boundaries and Strategy Vertical Integration Outsourcing Human Resource Management Compensation and Motivation
2 2 3 3 3 4 x 7-8 6 7-8 5
4 2-4 5 5 5 6 x x Economics of Organization in Chapters 5-7 7 2, 8 2 6 16 3, 9 3
Primer Primer Primer Primer, 13 Primer 7-8, 11 X 16 3 16
15 1-6 2-4
References Acs, Zoltan J. and Daniel Gerlowski, 1996, Managerial Economics and Organization, Upper Saddle River, New Jersey, Prentice Hall. FitzRoy, Felix, Zoltan J. Acs and Daniel Gerlowski, 1998, Management and Economics and Economics of Organization, London, Prentice Hall Europe. Brickley, James A., Clifford W. Smith Jr., and Jerold L. Zimmerman, 1997, Managerial Economics and Organizational Architecture, Chicago, Irwin. Besanko, David, David Dranove, and Mark Shanley, 1996, Economics of Strategy, new York, N. Y., John Wiley & Sons, Inc. Milgrom, Paul and John Roberts, Economics, Organization and Management, 1992, Upper Saddle River, New Jersey, Prentice Hall. Mankiw, Gregory, N., Principles of Economics, New York, N. Y., The Dryden Press.