2 Discussions – 1 Problem set Discussions – 2 Problem Set – 1 Required Details attached. Discussion 2 Org. Leader and Decision Making After comp -

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Discussion 2 Org. Leader and Decision Making

After completing the reading this week, please review table 1.2 in the text and review the distinction between leadership and management. Then think about this in regard to how senior leaders versus senior managers lead change in an organization (especially when it comes to technical change in an organization).
This week please reflect on these concepts and answer the following questions:
1) When implementing change in an organization, there are always culture issues that are faced, such as not accepting change, determine how differently this would be handled thinking about the management versus leadership constructs?
2) When dealing with performing work, how is this implemented differently within the management versus leadership constructs?
Please be sure to answer all of the questions above in the initial post.
At least one scholarly (peer-reviewed) resource should be used in the initial discussion thread. Please ensure to use information from your readings and other sources from the UC Library. Use APA references and in-text citations.
Reference:
Title: Organizational Leadership
ISBN: 9781529715460
Authors: John Bratton
Publisher: SAGE

Publication Date: 2020-02-10
Edition: 1st ED. Problem set #1 Managerial Economics

Chapter 2 : The One Lesson of Business

Chapter 3: Benefits, Costs and Decisions

Describe a decision that you or your company made that involved opportunity costs that should have been considered. Why did your company make the decision? What should it have done? Compute the profit consequences of the change.

The assignment is to answer the question provided above in essay form. This is to be in narrative form. Bullet points should not to be used. The paper should be at least 1.5 – 2 pages in length, Times New Roman 12-pt font, double-spaced, 1 inch margins and utilizing at least one outside scholarly or professional source related to organizational behavior. This does not mean blogs or websites. This source should be a published article in a scholarly journal. This source should provide substance and not just be mentioned briefly to fulfill this criteria. The textbook should also be utilized. Do not use quotes. Do not insert excess line spacing. APA formatting and citation should be used. Discussion Managerial Economics

Chapter 2 : The One Lesson of Business

Chapter 3: Benefits, Costs and Decisions

Reflect on the assigned readings for the week. Identify what you thought was the most important concept(s), method(s), term(s), and/or any other thing that you felt was worthy of your understanding.
Also, provide a graduate-level response to each of the following questions:
1) According Interland (2009) the art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists of tracing the consequences of that policy not merely for one group but for all groups. Discuss

Source: Jeneen Interlandi, Not Just Urban Leg- end, Newsweek, January, 19, 2009

[Your initial post should be at least 450+ words and in APA format (including Times New Roman with font size 12 and double spaced). Post the actual body of your paper in the discussion thread then attach a Word version of the paper for APA review]. Benefits, Costs, and Decisions
3

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. Kamira/Shutterstock Images
CHAPTER

Costs are associated with decisions, not activities.
The opportunity cost of an alternative is the profit you give up to pursue it.
In computing costs and benefits, consider all costs and benefits that vary with the consequences of a decision and only those costs and benefits that vary with the consequences of the decision. These are the relevant costs and benefits of a decision.
Fixed costs do not vary with the amount of output. Variable costs change as output changes. Decisions that change output will change only variable costs.
2

Accounting profit does not necessarily correspond to real or economic profit.
The fixed-cost fallacy or sunk-cost fallacy means that you consider irrelevant costs. A common fixed-cost fallacy is to let overhead or depreciation costs influence short-run decisions.
The hidden-cost fallacy occurs when you ignore relevant costs. A common hidden-cost fallacy is to ignore the opportunity cost of capital when making investment or shutdown decisions.
3
continued

EVA is a measure of financial performance that makes visible the hidden cost of capital.
Rewarding managers for increasing economic profit increases profitability, but evidence suggests that economic performance plans work no better than traditional incentive compensation schemes based on accounting measures.
4
continued

Big Coal Power Company
Big Coal Power Co. switched to a 8400 coal when the price fell 5% below the price of 8800 coal
8400 coal generates 5% less power than 8800
The manager was compensated based on the average cost of electricity, and expected this move to save money
Instead company profit reduced
Why? What happened?
Discussion: Diagnose the problem.
Discussion: Come up with a proposal to fix it.
5

Big Coal Solution
Use our three questions for analysis
Who is making the bad decision?
The plant manager made the switch to the lower-priced
8400 coal.
Did he have enough information to make a good decision?
Yes, presumably he knew that this would reduce his output.
Did he have the incentive to make a good decision?
No, because he was evaluated based on the average cost of electricity produced at his plant.
6

Lesson From Coal Problem
The plant manager should have considered all the costs of switching to the lower Btu coal
Namely, the lost electricity
Average costs can be a poor measure of plant performance
Need to align incentives of a business unit with the goals of the parent company
7

Background: Types of Costs
Definition: Fixed costs do not vary with the amount of output.
Definition: Variable costs change as output changes.
8

FIGURE 3.1 Cost Curves

Example: A Candy Factory
The cost of the factory is fixed.
Employee pay and cost of ingredients are variable costs.
9

TABLE 3.1 Candy Factory Costs

Your Turn
Are these costs fixed or variable?
Payments to your accountants to prepare your
tax returns.
Electricity to run the candy making machines.
Fees to design the packaging of your candy bar.
Costs of material for packaging.
10

Real Example: Cadbury (Bombay)
Beginning in 1978, Cadbury offered managers free housing in company owned flats to offset the high cost of living.
In 1991, Cadbury added low-interest housing loans to its benefits package. Managers moved out of the company housing and purchased houses. The empty company flats remained on Cadburys balance sheet for 6 years.
In 1997, Cadbury adopted Economic Value Added (EVA)
Charges each division within a firm for the amount of capital it uses
Provides an incentive for management to reduce capital expenditures if they do not cover costs
Senior managers then decided to sell the unused apartments after seeing the implicit cost of capital.
11

Accounting Costs for Cadbury
12

TABLE 3.2 Cadbury Income Statement

Cadbury Accounting Profit
Accounting profit recognizes only explicit costs
Typical income statements include explicit costs:
Costs paid to its suppliers for product inputs
General operating expenses, like salaries to factory managers and marketing expenses
Depreciation expenses related to investments in buildings and equipment
Interest payments on borrowed funds

Cadbury Accounting Profit vs. Economic Profit
Whats missing from Cadburys statements are implicit costs:
Payments to other capital suppliers (stockholders)
Stockholders expect a certain return on their money (they could have invested elsewhere)
Profit should recognize whether firm is generating a return beyond shareholders expected return
Economic profit recognizes these implicit costs; accounting profit recognizes only explicit costs

Opportunity Costs & Decisions
Definition: the opportunity cost of an action is what you give up (forgone profit) to pursue it.
Costs imply decision-making rules and vice-versa
The goal is to make decisions that increase profit
If the profit of an action is greater than the alternative, pursue it.
15

Identifying Costs
Whenever you get confused by costs, step back and ask, What decision am I trying to make?
If you start with costs, you will always get confused
If you start with a decision, you will never get confused
Apply it to Cadbury:
The cost of the company of holding onto the apartments was the forgone opportunity to invest capital in the companys organization to earn a higher return.
16

Cadburys Costs
Holding on to the flats cost the company 600,000 each year.
Unless the benefits to the company of holding onto the apartments were at least 600,000, the capital was not employed in its highest-valued use.
The cost of the company of holding onto the apartments was the forgone opportunity to invest capital in the companys organization to earn a higher return.
By selling the flats, the company moved the capital to a higher-valued use.
17

Relevant Costs and Benefits
When making decisions, you should consider all costs and benefits that vary with the consequence of a decision and only costs and benefits that vary with the decision.
These are the relevant costs and relevant benefits of a decision.
You can make only two mistakes
You can consider irrelevant costs
You can ignore relevant ones
Definition: The fixed-cost/sunk-cost fallacy means you make decisions using irrelevant costs and benefits
18

Fixed-Cost/Sunk-Cost Fallacy Examples
Football game:
You pay $20 for a ticket. At halftime, youre team is losing by 56 points.
You say youll stay to get your moneys worth, but you cant get your moneys worth!
The ticket price does not vary whether you stay or leave its a sunk cost and irrelevant.
Launching a new product:
You are in a new products division and will be able to distribute a new product through your existing sales force
You will be forced to pay for a portion of the sales force
If you believe this overhead is big enough to deter an otherwise profitable product launch, then youve committed the sunk-cost fallacy

Hidden-Cost Fallacy
Definition: ignoring relevant costs (costs that vary with the consequences of your decision) when making a decision
Example: Football game (again)
You buy a ticket for $20
Scalpers are selling tickets for $50 because your team is playing cross-state rivals
You go to the game, saying, These tickets cost me only $20. WRONG
The tickets really cost you $50 because you give up the opportunity to scalp them by going
Unless you value them at $50, you are sitting on an unconsummated wealth-creating transaction
20

Example: Should You Fire an Employee?
The revenue he provides to the company is $2,500 per month
His wages are $1,900 per month
His office could be rented out $800 per month
YES, you are only making $600 a month from this employee but could make $800 a month from renting his office
21

Subprime Mortgages
The subprime mortgage crisis of 2008 is a good example
of the hidden-cost fallacy.
Credit-rating agencies failed to recognize the higher costs
of loans made by dubious lenders.
Example: Long Beach Financial
Gave loans out to homeowners with bad credit, asked for no proof of income, deferred interest payments as long as possible.
Credit ratings didnt reflect the hidden costs of risky loans
As a result, many Wall Street investors purchased packaged risky loans and eventually went bankrupt when the debtors defaulted.
22

Hidden cost of capital
Recall that accounting profit does not necessarily correspond to economic profit.
Discussion: Economic Value Added
EVA= net operating profit after taxes minus the cost of capital times the amount of capital utilized
Makes visible the hidden cost of capital
The major benefit of EVA is identifying costs.
If you cannot measure something, you cannot control it.
Those who control costs should be responsible for them.
23

Incentives and EVA
Goal alignment: By taking all capital costs into account, including the cost of equity, EVA shows the dollar amount of wealth a business has created or destroyed in each reporting period.
EVA is profit the way shareholders define it.
Discussion: can you make mistakes using EVA?
Does it help avoid the hidden cost fallacy?
Does it help avoid the fixed cost fallacy?
24

Does EVA work?
Adopting companies of EPPs (+ four years)
ROA from 3.5 to 4.7%
operating income/assets from 15.8 to 16.7%
Indistinguishable from non-adopters
Bonuses increase 39.1% for EVA firms
But 37.4% for control group
Interpretations
Selection bias?
NO, cheaper to use existing plans
Goal alignment, YES.
EVA is no better or worse
Rival EPPs
Bonus plans
Discussion: WHY?
25

Psychological Biases
Not enough information or bad incentives are not the only causes for business mistakes. Often psychological biases get in the way of rational decision making.
Definition: the endowment effect means that taking ownership of item causes owner to increase value she places on the item.
Definition: loss aversion individuals would pay more to avoid loss than to realize gains.
Definition: confirmation bias a tendency to gather information that confirms your prior beliefs, and to ignore information that contradicts them.
Definition: anchoring bias relates the effects of how information is presented or framed
Definition: overconfidence bias the tendency to place too much confidence in the accuracy of your analysis
26

In class problem (1)
You won a free ticket to see an Eric Clapton concert (which has no resale value). Bob Dylan is performing on the same night and is your next-best alternative activity. Tickets to see Dylan cost $40. On any given day, you would be willing to pay up to $50 to see Dylan. Assume there are no other costs of seeing either performer. Based on this information, what is the opportunity cost of seeing Eric Clapton?
A. $0 B. $10 C. $40 D. $50

In class problem (2)
You won a free ticket to see an Eric Clapton concert (which has no resale value). Bob Dylan is performing on the same night and is your next-best alternative activity. Tickets to see Dylan cost $40. On any given day, you would be willing to pay up to $50 to see Dylan. Assume there are no other costs of seeing either performer. Based on this information, what is the minimum amount (in dollars) you would have to value seeing Eric Clapton for you to choose his concert?
A. $0 B. $10 C. $40 D. $50

Alternate intro anecdote
Coca-Cola in the 1980s had very little debt, preferring to raise equity capital from its stockholders
The company had a diversified product line, including products like aquaculture and wine. These other businesses generated positive profits, earning a ten percent return on capital invested.
The company, however, decided to sell off these under-performing businesses
Why?
At the time, soft drink division was earning 16 percent return on capital
The opportunity cost of investing in aquaculture and wine is the foregone profit that could have been earned by investing in soft drinks
A dollar invested in aquaculture and wine is a dollar that was not invested in soft drinks
Divisions sold off and proceeds invested in core soft drink business
29

Voluntary transactions create wealth by moving assets from lower- to higher-valued uses.
Anything that impedes the movement of assets to higher-valued uses, like taxes, subsidies, or price controls, destroys wealth.
Economic analysis is useful to business for identifying assets in lower-valued uses.
The art of business consists of identifying assets in low-valued uses and devising ways to profitably move them to higher-valued ones.
A company can be thought of as a series of transactions.
A well-designed organization rewards employees who identify and consummate profitable transactions or who stop unprofitable ones.
2

Kidney Transplants
Two prominent hospitals recently refused patients for kidney transplants because the organs were from directed donations.
The kidneys were meant for specific people
Demand for organs is high far exceeding supply and many never receive them.
Despite high demand and low supply, buying and selling organs is illegal.
Why?
3

Apartments
Suppose you want to move from Detroit to Nashville
First, you would try a two-way trade
Failing that, youd try a three-way
connection with another city
Need to find correct trades with
correct timing = difficult!
Like with kidney transplants, compatibility problems lead to inefficiency

4
Detroit Nashville
Detroit Nashville
Los Angeles

Capitalism 101
To identify money-making opportunities,
you must first understand how wealth is created
(and sometimes destroyed).
Key note: Wealth is created when assets are moved from lower to higher-valued uses
Definition: Value = willingness to pay
Desire + Income = You want something + you can pay for it
Key note: Voluntary transactions, between individuals or firms, create wealth.
Meaning, people create wealth by pursuing self-interest.
5

Housing Example
A house is for sale:
The buyer values the house at $130,000
This is the buyers top dollar willingness to pay
The seller values the house at $120,000
This is the sellers bottom line wont accept less
The buyer and seller must agree to a price that splits surplus between buyer and seller. Here, $128,000.
6

Surplus
The buyer and seller both benefit from this transaction:
Buyer surplus = buyers value minus the price
$130,000 – $128,000 = $2,000 buyer surplus
Seller surplus = the price minus the sellers value
$128,000 – $120,000 = $8,000 seller surplus
Total surplus = buyer + seller surplus = difference in values
$2,000 + $8,000 = $10,000 $130,000 – $120,000 = $10,000
$10,000 are the gains from trade
7

Wealth-Creating Transactions
Which assets do these transactions move to higher-valued uses?
Factory Owners Corporate Raiders
Real Estate Agents Insurance Salesman
Investment Bankers
Discussion: How does eBay create wealth?
Discussion: Which individual has created the most wealth during your lifetime?
Discussion: How do you create wealth?
8

Do Mergers Create Wealth?
Do mergers follow the wealth-creating engine of capitalism? Do they move assets to a higher-valued use?
Our largest and most valuable assets are corporations.
Ex: Dell-Alienware merger:
In 2006, Dell purchased Alienware, a manufacturer of high-end gaming computers.
Dell left design, marketing, sales and support in Alienwares hands.
Dell took over manufacturing though, using its expertise
to build Alienwares computers at a much lower cost.
9

Do Mergers Create Wealth?
However, many mergers and acquisitions do not create value
If they do, value creation is rarely so clear
To create value, the assets of the acquired firm must be more valuable to the buyer than to the seller
10

Does Government Create Wealth?
Discussion: Whats the governments role is wealth creation?
Enforcing property rights and contracts legal tools that facilitate wealth creating transactions
Ensures that buyers and sellers keep gains from trade
Discussion: Why are some countries so poor?
No property rights
No rule of law
Discussion: Much of the justification for government intervention comes from the assertion that markets have failed. One money manager scoffed at this idea. The markets are working fine, but theyre giving people answers that they dont like, so people cry market failure.
11

The One Lesson of Economics
Definition: An economy is efficient if all assets are employed in their highest-valued assets.
This is an unattainable, but useful benchmark
The One Lesson of Economics: The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.
Must look at the intended and unintended effects of policies to understand their efficiency
The economists solution to inefficient outcomes is to argue for a change in public policy.
Business persons solution is to try to make money on the inefficiency
12

The One Lesson of Business
Definition: Inefficiency implies the existence of unconsummated, wealth-creating transactions
The One Lesson of Business: The art of business consists of identifying assets in lower valued uses and devising ways to profitably moving them to higher valued uses.
In other words, make money by identifying unconsummated

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