Introduction
Warren E. Buffett, the celebrated 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. As both a manager and an investor, Buffett is renowned for focusing on the economics of businesses.
Berkshire's collection of operating businesses, including the GEICO Insurance Company, International Dairy Queen, Inc., the Nebraska Furniture Mart, and See's Candies, commonly earn 30 percent to 50 percent per year on invested capital. This is astonishingly good performance in light of the 10 percent to 12 percent 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 The Washington Post Company, among others. As both manager and investor, Buffett looks for "wonderful businesses" with outstanding economic characteristics: high rates of return on invested capital, substantial profit margins on sales, and consistent earnings growth. Complicated businesses that face fierce competition or require large capital investment are shunned.1
Buffett's success is powerful testimony to the practical usefulness of managerial economics. Managerial economics answers fundamental questions. When is the market for a product so attractive that entry or expansion becomes appealing? When is exit preferable to continued operation? Why do some professions pay well, while others offer only meager pay? Successful managers make good decisions, and one of their most useful tools is the methodology of managerial economics.
1 Information about Warren Buffett's investment philosophy and Berkshire Hathaway, Inc., can be found on the Internet (http://www.berkshirehathaway.com).
HOW IS MANAGERIAL ECONOMICS USEFUL?
managerial economics
Applies economic tools and techniques to business and administrative decision making
Managerial economics applies economic theory and methods to business and administrative decision making. Managerial economics prescribes rules for improving managerial decisions. Managerial economics also helps managers recognize how economic forces affect organizations and describes the economic consequences of managerial behavior. It links economic concepts with quantitative methods to develop vital tools for managerial decision making. This process is illustrated in Figure 1.1.
Evaluating Choice Alternatives
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. Similarly, managerial economics provides production and marketing rules that permit the company to maximize net profits once it has achieved growth or market share objectives.
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