Managerial Economics

Managerial Economics Exam at EMBA program at Cotrugli Business School Belgrade Prepared by: Enor Cerimagic Date: January 2013 Managerial Economics Prepared by: Enor Cerimagic CONTENT SECTION A: Question 1 Provide a specific example of a poor decision that cost your company money. Identify the key decision-maker, and explain what happened. Did that person have the right incentives? Did they have sufficient knowledge?

Explain how an improvement in incentives mechanisms and/or knowledge systems could prevent similar mistakes being made in future. SECTION B: Question 4 In response to the global financial crisis central banks across the world have cut interest rates. Why? What are the main arguments against rate cuts? SECTION C: Question 5 Many economic commentators believe that the dollar is weak at the moment. Why is this? What are the key drivers of foreign exchange markets? What do you think will happen to the dollar in future? /8 Managerial Economics Prepared by: Enor Cerimagic SECTION A: Question 1 Provide a specific example of a poor decision that cost your company money. Identify the key decision-maker, and explain what happened. Did that person have the right incentives? Did they have sufficient knowledge? Explain how an improvement in incentives mechanisms and/or knowledge systems could prevent similar mistakes being made in future. For almost twelve years I have been working for international pharmaceutical companies.

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During this period of time with different companies’ philosophies, I have been able to realize that most of business or business related projects, which have been generated and led from regional offices or headquarters, without market specific modifications and inputs were usually, at least, more expensive. Sometimes, it can lead to project failure or project poor results. Local apples or a foreign strawberry… does not matter, if result will come, if business opportunities will be recognised, if strategy will be improved and revenue/profit will grow.

Although, nice apple and strawberry salad should be able to satisfy both – taste and flavour or result and cost. Decision by our Regional manager (RM) has been made to engage consulting agency from Hungary to lead the project of Profiling, Segmenting and Targeting (PST) physicians and pharmacies in Adriatic Region, which includes Bosnia and Herzegovina. Main purpose of project was to determinate clients who will be segmented, related to current strategy, and targeted based on their potential and their adaption stage.

Pareto principle (after Vilfredo Pareto, Italian scientists, 1848-1923), which states that 80% of our revenue/profit comes from 20% of our clients, was undisputed project goal for recognition. We have intended to cover 90% of total universe of doctors and pharmacies in country, and to profile them based on their potential and loyalty. In the project, further analysis included also our internal capacity, internal sales results (national and in territories) and market segments value and volume shares (national and in bricks). 00 90 80 70 80/20 RULE SALES 60 50 40 30 20 10 0 0 10 20 30 40 50 60 70 80 90 100 20% CLIENTS 80% RESULTS CLIENTS 3/8 Managerial Economics Prepared by: Enor Cerimagic In preparation stage we have alarmed RM that in B&H IMS data (traditional market data in pharmaceutical industry) does not exist with recommendation and suggestion that local agency should be engaged for project execution, what would give us an opportunity to hire the agent based on references (adverse selection) and to monitor further actions.

Also, local agencies are operating with valuable market data on daily basis. So, our intention was to decentralise project, but RM insisted on Hungarian agency for entire region. Result – project realisation lasted for five months, instead of three, with additional costs for market data from different sources and additional costs of Hungarian agency for analytics and deliverables. Finally, we had to engage local agency for additional consultancies in project.

Project itself was finished with costs 25% higher than in the bid, and 56% higher than the local agency’s offer for entire project. Project also included additional work of sales persons with additional, locally adopted, incentive mechanism for motivation. Conclusion – RM made the decision although his knowledge about market specifics was not sufficient. Right incentive was questionable, as well. Project described that project costs are unpredictable in case of centralized project with lack of information.

This case shows that project decentralisation, with right incentive program for local agency, and adequate (in this case – local) KPI (key performance indicators) would decrease costs in both terms – money and time. 4/8 Managerial Economics Prepared by: Enor Cerimagic SECTION B: Question 4 In response to the global financial crisis central banks across the world have cut interest rates. Why? What are the main arguments against rate cuts? Central Bank look after monetary policy through manages money supply. In theory central bank is using three main tools of monetary policies.

First is that central bank has power to create interest rate for lending money to commercial banks, second is to define reserve requirement on bank’s deposit and third is market operations through purchasing or selling assets. With regard to mentioned activities, central bank is able to monitor credit potential of commercial banks in country, to manage financial stability and liquidity in country, to oversee operations of the banking system in country and to be the fiscal agent of government (take care of servicing foreign and domestic obligations).

In a time of global crisis and threatened economy growth (decline in economic activity, investment, rising unemployment and general illiquidity), central bank with its instruments of regulation and stimulation of cash flow in country has an obligation and responsibility to influence the policy of commercial banks. The main goal of creating monetary policy of central bank in the current financial crisis is to increase the mass of money in circulation in commercial banks that will serve to increase their loan potential.

By increasing the money supply, central bank indirectly intends to generate more investment to the industry as well as to the consumers, what allows faster economical growth and stabilizes liquidity in country. As mentioned, one of significant stimulative monetary policy instrument used by central bank is interest rate policy. Due to decline in economic activity and consequently reduction in investment and consumption, commercial banks are showing more prominent caution in extending credits, what leads to high quantity of money in commercial banks, and less money in circulation.

Commercial banks are increasing the mass of deposits held at central bank, which could be higher than the deposit obligation (prescribed by legal regulations). On such deposited funds, commercial banks get a certain interest rate. To indirectly increase the economic growth, central bank is reducing its benchmark interest rate on funds deposited, and stimulating banks to release higher level of money in circulation through loans. Through mentioned activities commercial banks should realize higher interests through earns from the basis of the referral interest rate.

In addition to the benchmark interest rate, central bank can influence determination of interbank interest rate. Central bank can lend money to commercial banks, as well. This means that central bank can indirectly affect change in interbank interest rate. Namely, the interest rate at which the central bank lends money to commercial bank is discount rate. Lower central bank discount rate indirectly affects decrease of prime rate. 5/8 Managerial Economics Prepared by: Enor Cerimagic

Low discount rate increases the interest of commercial banks to borrow money from central bank, what affects the increasing level of money in circulation and, on the other side, lowers its price (cheaper money) for crediting the economy, population, etc. This means that it will generate lower nominal interest rate to consumer and investment loans. With these activities, mainly with focus on short-term interest rate, central bank is indirectly influencing money supply with intention to boost economy growth and investments, decreasing unemployment and increasing government public works.

Most powerful central banks in the world firstly began to apply this type of monetary stimulus. In the second half of 2008 the Fed and the Bank of England began to decrease interest rates dramatically, and these banks ended 2012 with rates of 0. 00% (Fed) and 0. 50% (Bank Engl. ). This type of monetary stimulus was accompanied by many other central banks of the world. However, simulative monetary policy pursued by the central bank through interest rates, as a monetary instrument, if not controlled, can cause negative effects.

If there is an increased amount of money in circulation, and on the other hand there is no economic progress, growth in production of goods and services, prices will begin to rise, and lead to significant inflationary disorders. If this stagnation further lead to the lack of major investment in new technology and projects, the entire economy, or the economy of country will become ineffective. Manufacture costs (inputs) start to grow, products’ prices and working costs start to increase, and that all contributes to inflation and multiply inflationary growth. Consequently, money depreciates which can lead to a general financial instability.

To keep process in control and do any necessary adjustments in monetary policy or to interest rate, central banks’ committees meet plenty of time a year to review the nation’s economy through essential economic targets and the global financial trends. For instance, the FOMC (Federal Open Market Committee), the branch of Fed, meets eight times a year for reviewing process. 6/8 Managerial Economics Prepared by: Enor Cerimagic SECTION C: Question 5 Many economic commentators believe that the dollar is weak at the moment. Why is this? What are the key drivers of foreign exchange markets?

What do you think will happen to the dollar in future? I will start with key drivers of foreign exchange markets. First of all, it is important to emphasize main factors which determinate the foreign exchange markets – country’s economic and political situation and Forex market philosophy. Economic situation is assessed with real GDP (nominal GDP adjusted with inflation rate), labor market (unemployment rate, incomes), purchasing power and consumer price index, human potential (described through HDI – human development index / index is conglomerate of human education, expectation, incomes… , foreign trade exchange (trade balance report – relations between export and import / directly influence GDP level ), index of industrial production, retail sales (measure the sales of retail goods over a time period), public finance policy (fiscal policy, direct and indirect taxis), value of foreign debt and country credit potential. Political stability or instability can generally create positive or negative impacts on economic situation and developments. Stabile government, with vision and responsible activities can influence in stronger investments from abroad or by domestic investors.

Elections can be reason for fiscal policy changes, or influence the demands and costs of a certain currency. Marketplace philosophy is simple – Foreign currency market is driven by demand and supply! However, some drivers are constantly presented like: Central Banks’ activities- explained in section B Crude oil price – some currencies are oil dependant (US, Japan), and if oil price decreases, the import value will decrease what will have a positive impact on countries currency value and its strengths.

Price of gold – for currencies of countries which are leaders in gold production and trade, for countries that have gold as a standard for monetary exchange. Additionaly, as current key drivers of foreign exchange markets, I would recognize: Greece situation and threats in Spain, Italy, Portugal Arabic political instability and its implications Further development of BRIC markets 7/8 Managerial Economics Prepared by: Enor Cerimagic The intentional weakening of dollar was logical direction for rescuing the U.

S. economy. It was direction for healing serious impairments, like: recession, debt crisis (mostly mortgages / which reduced the amount of money in circulation), rising unemployment and increasing government expenditure on social and health care programs. That is why dollar is cheap, for almost two years. The Fed’s monetary policy has significantly increased the amount of money by reducing the interest rate, which was a sure way to weaken the dollar.

Main reasons for weakening dollar were: Decline in general economic activity, especially in the most important branches of the economy real sector – manufacturing, especially car and construction industry, with the highest number of employees, Fear of worsening investor mortgage crisis which has hit most commercial banks and America, A more vulnerable population standard, High state deficit, mostly due to the growing needs of social funds, Ineffective fiscal policy – tax incentives from the Bush era (rates of tax benefits were not progressive, ie, dependent on the amount of annual income) and so on.

The effects of a falling dollar have affected the growth of U. S. exports due to decrease of prices of US goods on world markets, and the launch of additional production capacities, which resulted in a reduction in unemployment rate from 10% to 7. 8% (December, 2012). However, the weakening dollar has caused the falling confidence in the stability of the U. S. currency on the world market. The U. S. olitical scene is currently looking “promising”, as well, due to positive trend of monetary and fiscal changes. Support came through “fiscal package” (adopted in January 2013. ) which, certainly, helped to avoid the “fiscal cliff”, for the time being. Whether these measures will require some new monetary stimulus package to strengthen the dollar and, what is more important for world stock markets, restore confidence in the U. S. currency, it remains to be seen.

There is an ABBA song “Money, money, money must be funny in the rich men’s world”, and we are speaking about US which hold almost 25% of world economy, its currency which is the most famous Money, which “believe in God”, which determinate measures for suitcases productions… etc. Yes, I believe in dollar, as well! Predictions of the world’s stock exchanges and markets are that the dollar will appreciate, over the next 3, 6 and 9 months primarily in relation to the Euro, Japanese Yen and Chinese Yuan. Why? Primarily because the U. S. conomy is showing significant level of vitality. The economy growth rate in 2012 was 2. 5%. Number of employees increased, so the unemployment rate dropped from 10% at the beginning of 2012 to 7. 8% in December. Furthermore, the U. S. Congress has done and additional move to reduce the deficit. The newly adopted fiscal stimulus package (Jan. 2013 – taxing Americans with annual income over $ 400,000) will reduce the deficit. According to analysts, USA will ensure the level economic growth and stability of the dollar, trough these fiscal measures, for the next few months.

The Fed entered into a program of new monetary measures – timeless-unlimited purchases of long-term government bonds or repurchase banks active assets. With these measures, the Fed “relaxed” conditions on financial markets and enables banks to invest with less cautions at low rates. Measures should expand investment and consumption and result should be further economic growth, reduction of unemployment, rise of confidence and strengthening of dollar. 8/8