question archive ©2018 Cengage Learning
©2018 Cengage Learning
Subject:BusinessPrice: Bought3
©2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password -protected website for classroom use. ©K ami ra/ S hut t ers t oc k I mages CHAPTER Introduction:
What This Book is About 1 ©2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password -protected website for classroom use. ©K ami ra/ S hut t ers t oc k I mages Summary Of Main Points ? Problem solving requires two steps:
1) figure out what’s causing the problem 2) figure out how to fix it ? For both steps, predict how people behave ? Rational -actor paradigm: assumes that people act rationally, optimally, and self -interestedly ? Simply put, people respond to incentives ©2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password -protected website for classroom use. ©K ami ra/ S hut t ers t oc k I mages Summary Of Main Points, cont. ? Good incentives come from rewarding good performance • Ex: commission on sales ? A well -designed organization aligns employee incentives with organizational goals ? Specifically, employees have enough information to make good decisions, and the incentive to do so ©2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password -protected website for classroom use. ©K ami ra/ S hut t ers t oc k I mages Summary Of Main Points, cont. ? Three questions to find the source of the problem:
1) Who is making the bad decision? 2) Does the decision maker have enough information to make a good decision? 3) Does the decision maker have the incentive to make a good decision? ? Answers to these questions will suggest solutions:
1) Letting someone with better information or incentives make the decision 2) Giving the decision maker more information 3) Changing the decision maker’s incentives ©2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password -protected website for classroom use. ©K ami ra/ S hut t ers t oc k I mages Problem: Over -bidding OVI G as T ract ? A young geologist was preparing a bid recommendation for an oil tract in the Gulf of Mexico ? The geologist knew the productivity of nearby tracts also owned by the company ? Knowing this, he recommended a bid of $5 million ? Senior management bid $20 million – far over the next highest bid of $ 750,000 ? What, if anything, is wrong? ©2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password -protected website for classroom use. ©K ami ra/ S hut t ers t oc k I mages Problem Solving ? The goal of this text is to provide tools to help identify and solve problems like this ? Two distinct steps:
1) Figure out what’s wrong • i.e., why overbidding occurred 2) Figure out how to fix it ©2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password -protected website for classroom use. ©K ami ra/ S hut t ers t oc k I mages Model of Behavior ? Both steps require a model of behavior • Why are people making mistakes? • What can we do to make them change? ? Economists use the rational -actor paradigm to model behavior ? The rational actor paradigm states:
• People act rationally, optimally, self -interestedly • Meaning, they respond to incentives – to change behavior you must change incentives ©2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password -protected website for classroom use. ©K ami ra/ S hut t ers t oc k I mages Answer to Overbidding Problem ? Answer the three questions:
1) Senior management made the bad decision to overbid 2) They had enough information to make the right decision 3) They didn’t have the incentive to do so ? A bonus system created incentives to over -bid. • Senior managers were rewarded for acquiring reserves regardless of their profitability • They had the young geologist “do what he could” to increase the size of estimated reserves • Bonuses also created an incentive to manipulate the reserve estimate ©2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password -protected website for classroom use. ©K ami ra/ S hut t ers t oc k I mages Solution to Overbidding Problem Now that we know what is wrong, how do we fix it?
? Let someone else decide? NO ? Change information flow? NO ? Change incentives? YES • Change performance evaluation metric • Ex: Increased profitability as measurement of success instead of increased acquired reserves • Reward scheme • Ex: Make bonuses tied to profitability, not acquired reserves ©2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password -protected website for classroom use. ©K ami ra/ S hut t ers t oc k I mages NAR Problem ? In 2006, a TV reporter was sent into a National Auto Repair (NAR) shop with a perfectly good car ? The reporter came out with a new muffler and transmission – and a bill for over $8,000 ? The news story badly hurt NAR’s profits ? How do you solve this problem? ©2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password -protected website for classroom use. ©K ami ra/ S hut t ers t oc k I mages Problem -Solving Algorithm 1) Who is making the bad decision?
• The mechanic recommended unnecessary repairs 2) Does the decision maker have enough information to make a good decision?
• Yes, in fact, the mechanic is the only one with enough information to know whether repairs are necessary ©2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password -protected website for classroom use. ©K ami ra/ S hut t ers t oc k I mages Problem -Solving Algorithm, cont. 3) Does the decision maker have the incentive to make a good decision?
• No, the mechanic is evaluated based on the amount of repair work he does, and receives bonuses or commissions tied to the amount of repair work ©2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password -protected website for classroom use. ©K ami ra/ S hut t ers t oc k I mages NAR Solution ? There was an incentive issue ? NAR tried two solutions 1) reorganized into two division – led to colluding 2) adopted flat pay – led to less incentive to work hard ? Suggested resolution: add an additional performance evaluation metric to original commission scheme • Ex: Sporadically send in “secret shoppers” like the news reporter ? This shows the trade -offs you face when creating solutions ©2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password -protected website for classroom use. ©K ami ra/ S hut t ers t oc k I mages Ethics and Economics ? The rational -actor paradigm can make students uncomfortable • It seems to disregard personal ethics that guide behavior of most people ? You have to understand why unethical behavior occurs to fix it though • Be able to anticipate opportunistic behavior to know how to avoid it ©2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password -protected website for classroom use. ©K ami ra/ S hut t ers t oc k I mages Value System ? Debates about ethics and economics really are about different value systems ? Deontologists : actions are good or ethical if they conform to a set of principles (ex: The Golden Rule) ? Consequentialists : actions are judged based on whether they lead to a good consequence ? Economics is more consequentialist • Uses analysis to understand the consequences of different solutions ©2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password -protected website for classroom use. ©K ami ra/ S hut t ers t oc k I mages Reference Froeb, L. M., McCann, B. T., Shor, M., & Ward, M. R. (2018 ). Managerial economics: a p roblem solving approach (5 th ed.). Boston, MA: Cengage Learning.
