Managerial Economics and Quantitative Methods [615383]

Managerial Economics and Quantitative Methods
Final Examination
Anthony J. Evans, [anonimizat]
Student: [anonimizat]:
Question 1
Present a way in which your company could identify opp ortunity costs that
currently go unnoticed. For example, some firms charge rent for the office
space and equipment that each business unit uses. This gives managers an
incentive to relocate to less valuable locations, and provides a signal to other
manager s about where real estate is at a premium. Other companies use
transfer pricing so that resources that move between department are
“bought” and “sold” at market rates. How might your organisation “bring
the market inside”?
My company is working in automoti ve business . The division to which is
belonging the factory I’m working for is making filter elements for diesel and
gasoline engines . Location from my city is considered as advantageous cost location,
and the development of the factory was fast and consis tent reaching 15000 sqm (last
5000 sqm are closed to be finalised and ready for production) and is projected a
development to double the size in the next 2 years to prepare the increase in volumes
we have seen and estimated when we prepare the budget and th e strategy in 2016.
Actually we are close to sign the agreement with a building constructor for the
expansion, but we have some last moment information about the trend in automotive
market, which change our company strategy.
Facts are on one side t hat we can see in the future years a decrease in volumes
requested for our products (they are suitable only for diesel and gasoline engines, not
for electrical engines, which is seems that are developing faster than initially
estimated due to higher invest ment in this area in studies ).
On the other side, the company would like to prepare itself for this important
market trend change – combustion engine to electrical engine, and to allocate more
development and design resources to launch innovative products for electrical cars,
and to allocate fewer resources to develop actual products which we estimate will
have significant drop in sales over the next 10 years.
The local management have to reconsider the strategy for the next years ,
because with the actual p remises the next years budgets will turn from green numbers,
with positive profit results to red numbers.

After a deep analysis on our crossfunctional teams we identified some
opportunity costs to go back close to initial assumption in our budget ex ercise:
1. Building and amortization costs
a. The almost ready building, considering the drop in sales with impact
on future lines size will be occupied in longer period than expected,
some remaining available space being visible in the next 2 years. As
action was decided that the unused space which is having anyway
some costs associated (part of amortisation, heating ) will be used to
relocate the goods from an external warehouse into the factory. The
gain is about 100kE /year.
b. The remaining building extension wi ll be split in 3 modules, w hich
will be built in the next 4 years instead of next year, which will reduce
the depreciation cost with 400kE /year.
2. People costs
a. Part of the operators will have no work due to reduced volumes will
take over the external quality control comp any for new proj ects.
Internal hourly rate is 15 % cheaper than external company rate. This
action will have double effect by utilising with work available direct
resources and having lower cost per hour for quality control operation.
The rest of excess res ources will be recovered by natural operator
turnover (4% per month) in next 6 months. Here based on the scenario,
we will have 0 loss/0 gains (we will have for part of the year in
parallel external controlling company and our extra people being in
trainin g for quality control), but we didn’t have to make any people
firing, which can have a negative impact in people stability and
performance medium term.
b. Design cost – local small design team will be increased to make all the
design job from new project loca lly instead to be done together with
our colleagues from Germany. This will increase the people cost by 2
new local hires, but will absorb also 2 engineers from actual structure
who will not be loaded anymore due to decrease of the volumes, and
will decrea se actual develop/design rate which is a mix between
Romanian hourly rate and German hourly rate in this moment. Total
gain estimated: 200kE/ year
c. Indirect headco unt remained available, based on our estimation, will be
organized in a new department – Contin uous improvement department.
For that department we will indicate some KPI’s to be tracked and
improved. All the KPI’s will be translated in money and will be posted
on the factory board to be visible and to see the clear impact in P&L.
Example:
i. Overtime c ost actual average 10 % of the total labour cost.
Target for improvement – decrease with 5%. Estimated gain:
240kE by year

ii. OEE (overall equipment efficiency) to be improved by 6% . 1%
of OEE is equivalent with 50kE/year. Total gain estimate:
300kE.
iii. Scrap co st, actual 400kE/year. Target to reduce with 20%,
which mean 80kE /year.
iv. Waste recovery – actually the plastic scrap is not segregated by
type of plastic, which make us to receive a lower price by kg
from the recycling company. By segregating we will have a
higher price/kg with 0.1E. Total amount of estimated
earnings/year here is 5kE.
In that way, part of the people costs will be absorbed by doing other
activities which generate important gaines.
This gives us a total gain of 1325kE which will offset the effect in the next 3 years of
reduced sales. Every year on the budget exercise will be re -evaluated the sales in
alignment with automotive market and electrical cars shares. Also will be assessed the
new innovative products the company will generate with application in electrical car
market, to compensate sales decrease.

Section B:
Question 4
Provide an example of a central bank that has adopted quantitative easing
(QE). Briefly define QE, and explain the arguments in favour . What are the
downside risks ? Did it work? Should central banks continue to use QE?
Quantitative E asing (QE) represent a size increase , of the balance sheet of a
central bank through an consequent increase on it ’s monetary liabilities (base
money) keepi ng constant the composition of the assets. Asset composition
represe nt the proportional shares of different f inancial instruments of a central
bank in the total value of its assets. Anot her def. is that QE represent increase
in the size of the balance sheet , of a central bank through an increase in its
monetary liabilities t hat keeps constant the liquidity and riskiness of its asset
portfolio.
As an example, let’ s took the FED case, which enacts QE by creating money
and with the money buying bonds or other financial assets from banks. The bank s
will have extra money available to lend. A higher loan growth, in turn, will make it
easier to finance new projects – example, the construction of a new building for
offices . These kind of pr ojects give people jobs , and are helping the economy to grow.
Another additional effect , the Fed’s purchases help increase the prices of b onds by
reducing their supply, which causes a fall in their yields . Lower yields, in turn,
provide additional fuel fo r economic expan sion, by decreasing borrowers’ costs.
This is how the theory is saying , at least. But in practice banks don’t have to
loan their excess c ash. If the banks are lacking in confidence – as was happening in
the years after the financial crisis of 2008 – the higher money supply is possible to not
represent the engine of growth as Fed had estimated .

FED was taken four rounds of Quantitative E asing from November 2008
until February 2014.
QE 1 & QE 2
In the interva l from November 2 5, 2008 until March 2010, slow growth and
high unemployment that followed in the wake of the 2007 -2008 financial meltdown,
prompted the Fed to stimulate the economy th rough a policy of QE. The program had
small impact initially, so it was announced an expansion of this program from an
initial value of $600 billion to $1.25 trillion , on March 18, 2009.
Quick after the first QE program concluded, some troubl e appeared in the form of
slower growth, the rise of the European debt crisis and renewed instability in the
financial markets. The Fed start a second round of QE, which became known as
“QE2” and in response, the Fed purchased in addition other $600 billion in short –
term bonds. This program, which Chairman Ben Bernanke first hinted at on August
27, 2010 – ran from November 2010 through June 2011. QE2 improve seriously the
dynamic of the financial markets but did not s o much to stimulate sustainable
economic growth.
QE3 launched in September 2012.
Additionall y, the Fed representatives announced – for the first time – that it would
keep short -term rates low , through 2 015. These moves indicates the Fed's view that
the economy still not reach the point of self -sustaining growt h (means the ability to
continue growing without any stimulu s). Accordingly, the Fed imp lemented what
some others have called "QE Infinity," a n amb itious plan to purchase $85 billion of
fixed – income securities per month, $40 billion of mortgage – backed securities , and
$45 billi on of U.S. Treasuries.
Unlike QE1 and QE2, this 3rd program had no set end date. But, the early consen sus
was that the Fed would start to wind down the size of its purc hases prior 2013 w as
ended, with the target of closing this program by 2015 .
QE4 was th e 4th round of QE established by t he FED . Through QE4, the Fed
bought long – term US. treasury notes , using credit it simply created. It used its
Trading De sk at the NY Federal Reserve Bank buying $85 billion in Treasuries from
member banks every month and a lmost all banks are members of the FED system.
This program starts in January 2013.
On June 19, 2013 the FO MC announced it would start reducing purchases by the end
of tha t year if the economic growth, unemployment and inflation will be on track to
the Fed's established targets.
Quantitative Easing 4 Is u nprecedented , because this fourth round signalled a
consistent change in FED policy. First, Ex Fed Chairman Ben Bernanke announced
that the QE4 would continue until e ither one of two things will happen :
1. Unemployment dropped below 6.5%.
2. The core inflation rate rose above 2.5%.
This was the first time the FED targeted the unemployment rate. It meant the Fed was
just as concerned with stimulating the economic growth as it was with keep inflation
under control . Historically the Fed had prioritized inflation – fighting more than job
creation.

Because they were so specific i n this target, the F ed almost guaranteed that QE
would continue through 2013, due t o unemployment of 7.7%, and inflation below 2% ,
when this program was started . This target oriented approach gave Congress and the
President more time to negotiate and find an adequate solution to the fiscal cliff .
Second thing , Bernanke announced the Fed funds rate remained at its actual 0% level
until 2015.
So, in conclusion, a mong the arguments against QE are:
 QE helps banks more than the economy, since they can opt to strengthen their
balance sheets by “keeping” the money rather than using it to increase their
loan a ctivity.
 By creating money, the Fede ral Reserve makes the U.S. $ less competitive
against foreign curren cies. (Consid erng supply and demand: a bigger supp ly of
dollars, rel ated with same demand, would co nduct to falling prices; in above
case, the ‘amount ’ of foreign currency a $ can buy).
 Increasing the money supply may create inflation . Because there is a delay
between the Fed policy implementation and its economic impact, inflat ion
could quickly increase to levels that cannot be contained.
 QE can create ‘bubbles ’ in asset prices.
As personal opinion, I consider a huge financial effort done by FED, with
expectations reached later and in smaller amount than forecasted. Quantitative Easing
measures should be combined with strong additional economic messages which
should increase confidence among participants on the economic environment.

Section C:
Question 6
Provide 3 examples of behavioural anomalies that have been demonstrated by
people within your organisation. Make sure you label them correctly and
suggest ways you can ensure that they are less likely to happen in future .
1. Excessive optimism – the tendency to see reality better than it is and to
don’t consider, or diminish the risks may occur .
In the organization there are few persons which can be integrated to this category. In
my opin ion, most dangerous for the organization is when those kinds of persons are
working in the planning activities , equal if is s about production planning, project
management or budgetary exercise.
No matter the place of work, all our out-put in term of organization al planning
should be standardised and to include a risk assessment exercise, to be held in teams,
as a brainstorming, and back -up actions to be formalised to mitigate all identified
risks. If we have those commo n exercise s a better perception of reality would be
considered in our planting. Actually in my opinion a moderate optimism is
necessary, can be a catalysts for to team it self and for the team thinking.

2. Ownership bias
This bias occurs when we overvalue a good that we own, regardless of its
objective market value (Kahneman, Knetsch, & Thaler, 1 991).
This is an interesting bias, and I would like to address it from two perspectives,
one intracompany and the other intercompany (but belonging to the same corporation) .
The intracompany part we should lo ok for example on the ideas, projects which
are not delivering expected results. If for example is a project, the owner of that project,
who usually is driving all the team and guide them through milestones can be inelastic
on some environmental ch anges which can affect the project as output or timing, or
financial benefits. To keep this under control, if we discuss about projects for example,
we have to set a number of KPI which are defining the project from all perspectives
(financial, timing , resources, etc). Besides KPI, should be set also the margin of each
KPI and a reviewing cycle. If at any review some of the KPI are beyond the margin set
(in negative direction), the project team and the superior should debate and find new
plan to go bac k on track. Here important for the person with this behavioural anomaly is
to have common meetings, come with arguments, being positive and encourage him on
one side, but explaining very clear that the final result is important, as project and team
result, not necessarily the initial path design by him in our example.
The intercompany ownership bias is more interesting and more difficult to be
addressed , and I ’m looking at this note from the personal (people) perspective , but fr om
the organizational one.
Along the time, some of the business cond ition might change. Romania was a
cost advantageous country from labo ur perspective , but some of the last years salary
increases makes not so much attractive with some other countries from the region
(Serbia, Ukraine), even are outside of EU.
Some of the business were moved from Germany to my plant were based on some
calculation related with a certain labour cost. This gives to my plant labour intensive
projects, which are much cheaper to b e realized in Romania than Germany. Now , when
we start having plants in countries more cost advantageous than Romania, some of the
business we are “owning ” we realize that can have better profitability on those plants.
But sending those businesses outside and not receiving in compensation new business,
will decrease our profitability as location. So, we as owner we fight to keep the business
and have good location profitability but larger interest is maybe to move them. I put this
example here because is very interesting and is not yet defined in the organization:
should we deliberately tell and ask the organization to move above kind of business in
more advantageous location, or we should k eep and figh t for them, and not make to o
much disturbance when we observe that our margin/profit is reducing due to some
market changes. I personally would go with first option, but I was hit in the past by a
similar decision, when th e plant I was working in was shut down and the business
moved in more cost advantageous countries.

3. Overconfidence bias – overestimating our own abilities/ ideas
This in my opinion is having sim ilar effects like excessive op timism .
Being in an automotive factory, where we have tight and serious timing plans,
independently if we are speaking about goods delivery for mass production or samples to
be delivered for new projects of cars we have a clear absolute must – no delays in any

action which can have impact on customer (one hour of breakdown of the car
manufacturer line due to missing components can have major financial implication on a
medium company, one day can mean even bankruptcy…).
In that respect, all the activit ies we are performing, by our people we have to set right
KPI to catch all possible bias or behavioural anomalies, independently if are related with
production, quality, controlling, etc and can affect the activity . More than that, we as a
factory are involved in regular coaching pro grams, which starts with an individual
evaluation and after actions customised to each person (one coaching program just
started in December 2016 and will continue until April 2017) .
Also, we are using PDCA cycle (plan, do, chec k, act) as continuous improvement
concept, where we identify any deviation, and we use root cause analysis tools like
Ishikawa diagram, 5 why ’s, brainstorming, to identify the real root causes and to
improve the activity, no matter if related to a good, s ervice or person.