Managerial Economics, 3rd Edition Class Notes

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11. INTRODUCTION: WHAT THIS BOOK IS ABOUTProblem SolvingEthics and EconomicsEconomics in Job InterviewsMain PointsProblem solving requires two steps: First, figure out why mistakes are being made; and thenfigure out how to make them stop.Therational-actor paradigmassumes that people act rationally, optimally, and self-interestedly.To change behavior, you have to change incentives.Good incentives are created by rewarding good performance.A well-designed organization is one in which employee incentives are aligned with organizationalgoals. By this we mean that employees have enough information to make good decisions, and theincentive to do so.It follows that you can analyze problems by asking three questions: (1) Who is making the baddecision?; (2) Does the decision maker have enough information to make a good decision?; and(3) the incentive to do so?Answers to these questions will suggest solutions centered on (1) letting someone else make thedecision, someone with better information or incentives; (2) giving the decision maker moreinformation; or (3) changing the decision maker’s incentives.Teaching NoteIt is useful toopen with a business problem, like the over-bidding in the introduction, the Kidder-Peabodyanecdote, or any of the anecdotes in the concluding chapter “you be the consultant.” Then ask the studentsto assume that they are a consultant brought in to the company to figure out what is wrong.Play 20questions, and make them ask questions that have “yes” or “no” answers until they figure out what iswrong.Students will invariably use the rational actor paradigm to do this.Point this out to them.Tellthem that this class is trying to show them how to use this paradigm more formally.At the beginning of each of my lectures,students’problem solving skillscan be reinforcedby askingthem to solve a specific problem.The trick is to dribble out the information, bit by bit, to engage thestudents and keep them guessing what the problem is.Note that some students will typically define the problem as the lack of a particular solution.When thishappens, use the opportunity to point out how this approach locks you into aparticular solution.Showthem how not to do this.Only thenformally introducethem tothe rational actor paradigm and show how it can be used to bothidentify why problems occur and what can be done to change behavior.I tell them that the key step insolving problems is to bring it down to an individual decision level.First, find out who made a baddecision. Under the rational actor paradigm there are only two reasons for making mistakes: not enoughinformation or bad incentives.Find out which it is.Bottom line is that problems can be identified byasking three questions:1. Who made the bad decision?2. Did they have enough information to make a good decision?3. Did they have the incentive to make a good decision?

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