Managerial Economics, 14th Edition
By Mark Hirschey and Eric Bentzen
By Mark Hirschey and Eric Bentzen
Contents
1 H Part i: Overview of Managerial Economics i
Chapter i: Nature and Scope of Managerial Chapter 2: Economic Optimization 23
Economics 3 Economic Optimization Process 23
How is Managerial Economics Useful? 3 Optimal Decisions, 23 9 Maximizing the Value
Evaluating Choice Alternatives, 3 8 Making the of the Firm, 24
Best Decision, 5 Revenue Relations 25
Managerial Application 1.1 Business Ethics 5 Demand and Total Revenue, 25 • Marginal
Theory of the Firm 6 Revenue, 28 * Revenue Maximization Example, 29
Expected Value Maximization 6 • Constraints Managerial Application 2.1 Ethical Aspects
and the Theory of the Firm 7 • Limitations of the of Corporate Governance 25
Theory of the Firm, 8 Managerial Application 2.2 Do Firms
Managerial Application 1.2 The World is Really Optimize? 30
Turning to Capitalism and Democracy 9 Cost Relations 30
Profit Measurement 9 Total Cost, 30 • Marginal and Average Cost, 32
Business Versus Economic Profit 9 9 Variability 9 Average Cost Minimization Example, 33
of Business Profits, 10 Profit Relations 34
Why do Profits Vary Among Firms? 12 Total and Marginal Profit, 34 9 Profit Maximization
Disequilibrium Profit Theories, 12 Example, 35
• Compensatory Profit Theories, 12 9 Role Incremental Concept in Economic Analysis 37
of Profits in the Economy, 13
Marginal Versus Incremental Concept, 37
Managerial Application 1.3 Google on Social
• Incremental Profits, 38 • Incremental Concept
Responsibility Example, 39
Role of Business in Society 14 Managerial Application 2.3 Behavioral
Why Firms Exist, 14 * Social Responsibility of Economics 38
Business, 15 Summary 41
Managerial Application 1.4 The IKEA way 16 Questions 42
Structure of this Text 16 Self-Test Problems and Solutions 42
Objectives, 16 * Development of Topics, 16 Problems 47
Summary 18 Case Study: Spreadsheet Analysis of the
Questions 19 EOQ at the Neighborhood Pharmacy, Inc. 52
Case Study: Is Coca-Cola the ‘Perfect’ Business? 19 Selected References 53
Selected References 22 Appendix 2A: Math Analysis for Managers 54
Properties of Real Numbers 54
Transitive Property, 54 * Commutative Properties,
54 • Associative Properties, 55 • Distributive
Properties, 55 • Inverse Properties, 55 • Exponents
and Radicals, 55
Equations 56
Equivalent Operations, 56 • Linear Equations, 57
• Quadratic Equations, 57 • Multiplicative
Equations, 57 • Exponential Functions, 57
• Logarithmic Functions, 58
Concept of a Marginal 59
Rules for Differentiating a Function 61
Constants, 61 • Powers, 62 • Sums and
Differences, 62 • Products, 63 • Quotients, 64
• Logarithmic Functions, 64 9 Function of a
Function (Chain Rule), 65
Appendix 2B: Multivariate Optimization and
the Lagrangian Technique 67
Partial Derivative Concept, 67 e Maximizing
Multivariate Functions, 68
Constrained Optimization 69
Role of Constraints, 70 • Lagrangian Multipliers, 71
Problem 75
Chapter 3: Demand and Supply 77
Basis for Demand 77
Direct Demand, 77 • Derived Demand, 78
Managerial Application 3.1: How the Internet
Affects Demand and Supply 79
Market Demand Function 79
Determinants of Demand, 79 • Industry Demand Versus
Firm Demand, 80
Demand Curve 81
Demand Curve Determination, 81 • Relation
Between the Demand Curve and Demand
Function, 82
Basis for Supply
How Output Prices Affect Supply, 84 • Other
Factors that Influence Supply, 85
Market Supply Function 85
Determinants of Supply, 85 • Industry Supply
Versus Firm Supply, 87
Supply Curve 87
Supply Curve Determination, 87 • Relation
Between Supply Curve and Supply Function, 89
Market Equilibrium 91
Surplus and Shortage, 91 • Comparative Statics:
Changing Demand, 93 • Comparative Statics:
Changing Supply, 95 • Comparative Statics:
Changing Demand and Supply, 96
Summary 97
Questions 97
Self-Test Problems and Solutions 98
Problems 101
Case Study: Spreadsheet Analysis of Demand
and Supply for Sunbest Orange Juice 105
Selected Reference 107
Part 2: Demand Analysis and Estimation
Chapter 4: Demand Analysis 111
Utility Theory 111
Basic Assumptions, 111 • Utility Functions, 112
• Marginal Utility, 113 • Law of Diminishing
Marginal Utility, 114
Managerial Application 4.1: Odd-Number
Pricing Riddle 116
Indifference Curves 116
Basic Characteristics, 116 • Perfect Substitutes
and Perfect Complements, 118
Budget Constraints 118
Characteristics of Budget Constraints, 118 • Effects
of Changing Income and Changing Prices, 121
• Income and Substitution Effects, 122
Individual Demand 122
Price-Consumption Curve, 122 • Income-
Consumption Curve, 125 • Engle Curves, 125
Managerial Application 4.2: Relationship
Marketing
Optimal Consumption
Marginal Utility and Consumer Choice, 128
• Marginal Rate of Substitution, 129 • Utility
Maximization, 131
Demand Sensitivity Analysis: Elasticity
Elasticity Concept, 132 • Point Elasticity, 132
• Arc Elasticity, 133
Price Elasticity of Demand
Price Elasticity Formula, 133 • Price Elasticity
and Total Revenue, 135
Price Elasticity And Marginal Revenue
Elasticity Varies Along a Linear Demand Curve, 137
• Price Elasticity and Price Changes, 138
Managerial Application 4.3: Haggling
in the Car Business 141
Price Elasticity and Optimal Pricing Policy 141
Optimal Price Formula, 141 • Optimal Pricing
Policy Example, 142
Cross-Price Elasticity of Demand 143
Cross-Price Elasticity Formula, 143 • Substitutes
and Complements, 144
Income Elasticity of Demand 144
• Income Elasticity Formula, 144 • Normal Versus
Inferior Goods, 145
Managerial Application 4.4: What’s in a Name? 146
Summary 146
Questions 147
Self-Test Problems and Solutions 148
Problems 153
Case Study: Optimal Level of Advertising 156
Selected References 157
Chapter 5: Demand Estimation 159
Interview and Experimental Methods 159
Consumer Interviews, 159 • Market
Experiments, 160
Simple Demand Curve Estimation 160
• Simple Linear Demand Curves, 160
• Using Simple Linear Demand Curves, 162
Managerial Application 5.1: Sampling
Technology for TV Advertising
Simple Market Demand Curve Estimation
Graphing the Market Demand Curve, 163
• Evaluating Market Demand, 164
Identification Problem
Changing Nature of Demand Relations, 166
• Interplay of Demand and Supply, 166 • Shifts
in Demand and Supply, 167 • Simultaneous
Relations, 169
Regression Analysis 169
What is a Statistical Relation?, 169 • Specifying the
Regression Model, 172 * Least Squares Method, 173
Managerial Application 5.2: Market Experiments
on the Web 170
Measures of Regression Model Significance 175
161
163
166
Standard Error of the Estimate, 175 • Goodness
of Fit, 176 * F Statistic, 178
Judging Variable Significance 179
Two-Tail t Tests, 179 • One-Tail t Tests, 181
Summary 182
Questions 183
Self-Test Problems and Solutions 183
Problems 188
Case Study: Demand Estimation for
Mrs Smyth’s Pies 192
Selected Reference 194
Chapter 6: Forecasting 195
Forecasting Applications 195
Macroeconomic Applications, 195 ” Microeconomic
Applications, 196 • Forecast Techniques, 196
Managerial Application 6.1: Economic
Forecasting: The Art and the Science 197
Qualitative Analysis 198
Expert Opinion, 198 • Survey Techniques, 198
Trend Analysis and Projection 199
Trends in Economic Data, 199 • Linear Trend
Analysis, 199 • Growth Trend Analysis, 202
• Linear and Growth Trend Comparison, 204
Managerial Application 6.2: Prediction Markets 204
Business Cycle 205
What is the Business Cycle?, 205 • Economic
Indicators, 207 • Economic Recessions, 208
• Sources of Forecast Information, 210
Managerial Application 6.3: The Stock Market
and the Business Cycle 211
Exponential Smoothing 212
Exponential Smoothing Concept, 212
• One-Parameter (Simple) Exponential
Smoothing, 212 • Two-Parameter (Holt)
Exponential Smoothing, 213 ” Three-Parameter
(Winters) Exponential Smoothing, 214 • Practical
Use of Exponential Smoothing, 214
Econometric Forecasting 215
Advantages of Econometric Methods. 215
1 Single-Equation Models, 217 • Multiple-Equation
Systems, 218
Managerial Application 6.4: How Good is Your
Forecasting Ability? 216
Judging Forecast Reliability 220
Tests of Predictive Capability, 220 * Correlation
Analysis, 220 • Sample Mean Forecast Error
Analysis, 220
Choosing the Best Forecast Technique
Data Requirements, 227 • Time Horizon
Considerations, 221 • Role of Judgment, 223
Summary
221
223
Questions 224
Self-Test Problems and Solutions 225
Case Study: Forecasting Global Performance
for a Mickey Mouse Organization 233
Selected Reference 236
Part 3: Production and Competitive Markets
Chapter 7: Production Analysis
and Compensation Policy 239
Production Functions 239
Properties of Production Functions, 239 • Returns to
Scale and Returns to a Factor, 240
Total, Marginal, and Average Product 240
• Total Product, 241 * Marginal and Average
Product, 242
Law of Diminishing Returns to a Factor 245
Illustration of Diminishing Returns to a Factor, 247
Managerial Application 7.1: Efficiency Wages 246
Input Combination Choice 248
Production Isoquants, 248 • Input Factor
Substitution, 248 • Marginal Rate of Technical
Substitution, 251 • Rational Limits of Input
Substitution, 251
Marginal Revenue Product and Optimal
Employment 252
Marginal Revenue Product, 252 • Optimal
Level of a Single Input, 253 • Illustration of
Optimal Employment, 254
Managerial Application 7.2: National minimum
wages in the EU 253
Optimal Combination of Multiple Inputs 255
Budget Lines, 255 • Expansion Path, 257
• Illustration of Optimal Input Proportions, 258
Managerial Application 7.3: The Future of
Manufacturing in Europe 2015-2020 259
Optimal Levels of Multiple Inputs 259
Optimal Employment and Profit Maximization, 259
• Illustration of Optimal Levels of Multiple
Inputs, 260
Returns to Scale 260
• Output Elasticity and Returns to
Scale, 260 12 Returns to Scale Estimation, 261
Productivity Measurement 262
Economic Productivity, 263 • Productivity and
Investment in Computer Technology (ICT), 264
Managerial Application 7.4: Labor productivity
growth in selected countries 2009-2012. 263
Summary 265
Questions 266
Self-Test Problems and Solutions 266
Problems 269
Case Study: Worker Productivity Among
Giant US Corporations 274
Selected References 276
Appendix 7A: A Constrained Optimization
Approach to Developing the Optimal Input
Combination Relationships 277
Constrained Production Maximization 277
Constrained Cost Minimization 279
Problem 280
Chapter 8: Cost Analysis and Estimation 281
Economic and Accounting Costs 281
Historical Versus Current Costs, 281
• Opportunity Costs, 282
Role of Time in Cost Analysis 283
Incremental Versus Sunk Cost, 283 6 How is
the Operating Period Defined?, 284
Managerial Application 8.1: GE’s ’20-70-10′ Plan 284
Short-Run Cost Curves 285
Short-Run Cost Categories, 285 • Short-Run
Cost Relations, 286
Managerial Application 8.2: GAAP and IRES 288
Long-Run Cost Curves 288
Long-Run Total Costs, 288″ Economies ofScale, 290
• Cost Elasticities and Economies of Scale, 290
• Long-Run Average Costs, 291
Managerial Application 8.3: Cost Stickiness 293
Minimum Efficient Scale 293
Competitive Implications ofMinimum Efficient
Scale, 293 • Transportation Costs and MES, 293
Firm Size and Plant Size 295
Multiplant Economies and Diseconomies of
Scale, 295 * Economics of Multiplant
Operation: an Example, 296 • Plant Size and
Flexibility, 298
Learning Curves 300
Learning Curve Concept, 300 s Learning Curve
Example, 302 • Strategic Implications of the
Learning Curve Concept, 303
Managerial Application 8.4: Bigger isn’t
Always Better 301
Economies of Scope 304
Economies of Scope Concept, 304 ® Exploiting
Scope Economies, 305
Cost-Volume-Profit Analysis 305
• Cost-Volume-Profit Charts, 305 • Degree
of Operating Leverage, 307
Summary 309
Questions 310
Self-Test Problems and Solutions 311
Problems 313
Case Study: Estimating Hospitalization Costs
for Regional Hospitals 317
Selected References 320
Chapter 9: Linear Programming 321
Basic Assumptions 321
Inequality Constraints, 327 • Linearity
Assumption, 322
Managerial Application 9.1: Karmarkar’s LP
Breakthrough 322
Production Planning for a Single Product 323
Production Processes, 323 • Production
Isoquants, 324 • Least-Cost Input Combinations, 326
• Optimal Input Combinations with Limited
Resources, 327
Managerial Application 9.2: LP: More than a
Visual Approach 330
Production Planning for Multiple Products 330
Objective Function Specification, 330 • Constraint
Equation Specification, 331 • Non-negativity
Requirement, 331
Graphic Specification and Solution 332
Analytic Expression, 332 • Graphing the
Feasible Space, 332 • Graphing the Objective
Function, 334 • Graphic Solution, 335
Algebraic Specification and Solution 336
Algebraic Specification, 336 • Algebraic
Solution, 338
Managerial Application 9.3: LP on the PC! 341
Dual in Linear Programming 342
Duality Concept, 342 • Shadow Prices, 342
Dual Specification 343
Dual Objective Function, 343 • Dual
Constraints, 343 9 Dual Slack Variables, 344
Solving the Dual Problem 345
Dual Solution, 345 • Using the Dual Solution
to Solve the Primal, 346
Summary 348
Questions 349
Self-Test Problems and Solutions 349
Problems 357
Case Study: A LP Pension Funding Model 362
Appendix 9A: Rules for Forming the Dual Linear
Programming Problem 365
Primal Problem 365
Dual Problem 366
Selected References 367
Chapter 10: Competitive Markets 369
Competitive Environment 369
What is Market Structure?, 369 • Vital Role
of Potential Entrants, 370
Factors that Shape the Competitive Environment 370
Product Differentiation, 370 • Production
Methods, 372 • Entry and Exit Conditions, 372
Managerial Application 10.1: Benefits From
Free Trade 371
Competitive Market Characteristics 373
Basic Features, 373 • Examples of Competitive
Markets, 373 • Profit Maximization Imperative, 375
• Role of Marginal Analysis, 375
Managerial Application 10.2: Seasonality
on Stock Markets? 374
Marginal Cost and Firm Supply 379
Short-Run Firm Supply Curve, 379 • Long-Run
Firm Supply Curve, 381
Managerial Application 10.3: Dot.com 382
Competitive Market Supply Curve 382
Market Supply with a Fixed Number of
Competitors, 382 • Market Supply with Entry
and Exit, 384
Competitive Market Equilibrium 385
Balance of Supply and Demand, 386 • Normal
Profit Equilibrium, 387
Managerial Application 10.4: The Enron
Debacle 388
Summary 388
Questions 389
Self-Test Problems and Solutions 390
Problems 395
Case Study: Profitability Effects of Firm
Size for DJIA Companies 399
Selected References 401
Chapter n: Performance and Strategy
in Competitive Markets 403
Competitive Market Efficiency 403
Why is it Called Perfect Competition?, 403
• Deadweight Loss Problem, 404 • Deadweight
Loss Illustration, 406
Managerial Application 11.1: The Wal-Mart
Phenomenon 407
Market Failure 408
Structural Problems, 408 * Incentive Problems, 409
411
411
414
Role for Government 410
How Government Influences Competitive
Markets, 410 • Broad Social Considerations, 411
Managerial Application 11.2: Corn Growers
Discover Oil!
Subsidy and Tax Policy
Anti-Subsidy Rules, 412 • Deadweight Loss
from Taxes, 412
Tax Incidence and Burden
Role of Elasticity, 414 • Tax Cost-Sharing
Example, 415
Managerial Application 11.3: Measuring
Economic Profits 418
Price Controls 418
Price Floors, 418 * Price Ceilings, 420
Business Profit Rates 422
Return on Stockholders’ Equity, 422 • Typical
Profit Rates, 423
Market Structure and Profit Rates 425
Profit Rates in Competitive Markets, 425
• Mean Reversion in Profit Rates, 426
Competitive Market Strategy 426
Short-Run Firm Performance, 427
Long-Run Firm Performance 428
Summary 428
Questions 430
Self-Test Problems and Solutions 431
Problems 437
Case Study: The Most Profitable S&P 500
Companies 441
Selected References 444
Part 4: Imperfect Competition 445
Chapter 12: Monopoly and Monopsony 447
Monopoly Market Characteristics 447
Basic Features, 447 • Examples of Monopoly, 448
Managerial Application 12.1: The EU
Commission fines parking heaters producer
€68 million in cartel settlement 449
Profit Maximization Under Monopoly 449
Price-Output Decisions, 449 • Role of Marginal
Analysis, 451
Social Costs of Monopoly 453
Monopoly Underproduction, 453 • Deadweight Loss
from Monopoly, 453
Social Benefits of Monopoly 457
Economies of Scale, 457 • Invention and Innovation, 457
Monopoly Regulation 458
Dilemma of Natural Monopoly, 458 • Utility Price
and Profit Regulation, 460 • Utility Price and Profit
Regulation Example, 462 • Problems with Utility Price
and Profit Regulation, 464
Managerial Application 12.2: Is Ticketmaster
a Monopoly? 459
Monopsony 464
Buyer Power, 464 • Bilateral Monopoly
Illustration, 465
Managerial Application 12.3: is this why
they Call it ‘Hardball’? 468
Antitrust Policy 468
Overview of Antitrust Law, 468
Managerial Application 12.4: Price Fixing
by the Insurance Cartel 469
Competitive Strategy in Monopoly Markets 469
Market Niches, 469 • Information Barriers to
Competitive Strategy, 470
Summary 472
Questions 473
Self-Test Problems and Solutions 473
Problems 480
Case Study: Effect of R&D on Tobin’s q 484
Selected References 487
Chapter 13: Monopolistic Competition
and Oligopoly 489
Contrast Between Monopolistic Competition
and Oligopoly 489
Monopolistic Competition, 489 • Oligopoly, 490
• Dynamic Nature of Competition, 491
Monopolistic Competition 491
Monopolistic Competition Characteristics, 491
• Monopolistic Competition Price-Output
Decisions, 493
Managerial Application 13.1: Dell’s Price
War with Dell 492
Managerial Application 13.2: Intel: Running
Fast to Stay in Place 495
Monopolistic Competition Process 495
Short-Run Monopoly Equilibrium, 495
• Long-Run High-Price/Low-Output
Equilibrium, 496 • Long-Run Low-Price/
High-Output Equilibrium, 498
Oligopoly 498
Oligopoly Market Characteristics, 499
• Examples of Oligopoly, 499
Cartels and Collusion 500
Overt and Covert Agreements, 500
Enforcement Problems, 501
Oligopoly Output-Setting Models 501
Cournot Oligopoly, 501 • Stackelberg
Oligopoly, 504
Oligopoly Price-Setting Models 507
Bertrand Oligopoly: Identical Products, 507
• Bertrand Oligopoly: Differentiated Products,
508 • Sweezy Oligopoly, 511 • Oligopoly Model
Comparison, 512
Managerial Application 13.3: Contestable
Airline Passenger Service Markets 513
Market Structure Measurement 513
Economic Census, 513 • NAICS System, 514
Census Measures of Market Concentration 516
Concentration Ratios, 516 * Herfindahl-
Hirschmann Index, 518 • Limitations of
Census Information, 518
Managerial Application 13.4: Horizontal
Merger Guidelines 519
Summary 522
Questions 524
Self-Test Problems and Solutions 524
Problems 528
Case Study: Market Structure Analysis
at Columbia Drugstores, Inc. 533
Selected References 535
Chapter 14: Game Theory and Competitive
Strategy 537
Game Theory Basics 537
Types of Games, 537 • Role of Interdependence,
538 • Strategic Considerations, 539
Managerial Application 14.1: Asymmetric
Information 539
Prisoner’s Dilemma 540
Classic Riddle, 540 • Business Application,
541 • Broad Implications, 542
Nash Equilibrium 543
Nash Equilibrium Concept, 543 e Nash
Bargaining, 544
Infinitely Repeated Games 545
Role of Reputation, 545 • Product Quality
Games, 546
Managerial Application 14.2: The Market
for Lemons
Finitely Repeated Games
Uncertain Final Period, 547 • End-of-Came
Problem, 548
Game Theory and Auction Strategy
First-Mover Advantages, 549 9 Auction Types, 549
• Public Policy Applications, 550
Managerial Application 14.3: Wrigley’s Success
Formula
Competitive Strategy
Competitive Advantage, 551 9 When Large Size
is a Disadvantage, 553
Pricing Strategies
Limit Pricing, 553 9 Network Externalities, 555
• Market Penetration Pricing, 555
Managerial Application 14.4: Network
Switching Costs 556
Nonprice Competition 556
Advantages of Nonprice Competition, 556
• Optimal Level of Advertising, 557
• Optimal Advertising Example, 559
Summary 561
Questions 562
Self-Test Problems and Solutions 562
Problems 565
Case Study: Time Warner, Inc., is Playing
Games with Stockholders 570
Selected References 572
Chapter 15: Pricing Practices 573
Pricing Rules-of-Thumb 573
Competitive Markets, 573 • Imperfectly
Competitive Markets, 574
Managerial Application 15.1: Mark-Up Pricing
Technology 575
Mark-Up Pricing and Profit Maximization 575
Optimal Mark-Up on Cost, 575 9 Optimal
Mark-Up on Price, 576 9 Why Do Optimal
Mark-Ups Vary?, 577
Price Discrimination 578
Profit-Making Criteria, 578 • Degrees of Price
Discrimination, 579
Price Discrimination Example 580
Price-Output Determination Case I, 581
• One-Price Alternative, 583 9 Price-Output
Determination Case II, 585
Managerial Application 15.2: Do Colleges
Price Discriminate? 581
Two-Part Pricing 586
One-Price Policy and Consumer Surplus, 586
• Capturing Consumer Surplus with Two-Part
Pricing, 588 • Consumer Surplus and Bundle
Pricing, 588
Multiple-Product Pricing 589
Demand Interrelations, 589 • Production
Interrelations, 590
Joint Products 591
joint Products in Variable Proportions, 591
• Joint Products in Fixed Proportions, 591
Joint Product Pricing Example 593
joint Products without Excess By-Product, 593
• Joint Production with Excess By-Product
(Dumping), 596
Managerial Application 15.3: lOc for a Gallon
of Gas in Dayton, Ohio
Managerial Application 15.4: Why Some
Price Wars Never End
Summary
Questions and Answers
Self-Test Problems and Solutions
Problems
Case Study: Pricing Practices in the Denver,
Colorado, Newspaper Market
Selected References
Appendix 15A: Transfer Pricing
Transfer Pricing Problem
Divisional Relationships, 609 • Products without
External Markets, 610 • Products with Competitive
External Markets, 610 • Products with Imperfectly
Competitive External Markets, 611
Global Transfer Pricing Example 611
Profit Maximization for an Integrated Firm, 611
• Transfer Pricing with No External Market. 612
• Competitive External Market with Excess Internal
Demand, 613 9 Competitive External Market with
Excess Internal Supply, 614
Problem 615
Part 5: Long-Term Investment Decisions
Chapter 16: Risk Analysis 619
Concepts of Risk and Uncertainty 619
Economic Risk and Uncertainty, 619 * General
Risk Categories, 620 • Special Risks of Global
Operations, 621
Probability Concepts 621
• Probability Distribution, 622 • Expected
Value, 623 • Absolute Risk Measurement, 625
• Relative Risk Measurement, 627 • Other Risk
Measures, 627
Managerial Application 16.1: Behavioral Finance 622
Standard Normal Concept 628
Normal Distribution, 628 • Standardized
Variables, 629 • Use of the Standard Normal
Concept: an Example, 629
Managerial Application 16.2: Why are
Lotteries Popular? 630
Utility Theory and Risk Analysis 630
Possible Risk Attitudes, 631 • Relation
Between Money and its Utility, 631
Adjusting the Valuation Model for Risk 632
Basic Valuation Model, 632 • Certainty
Equivalent Adjustments, 633 • Certainty
Equivalent Adjustment Example, 635
• Risk-Adjusted Discount Rates, 636,
• Risk-Adjusted Discount Rate Example, 637
Managerial Application 16.3: Stock Option
Backdating Scandal 633
Decision Trees and Computer Simulation 638
Decision Trees, 638 • Computer Simulation, 639
• Computer Simulation Example, 640
Managerial Application 16.4: Internet Fraud 642
Summary 643
Questions 644
Self-Test Problems and Solutions 645
Problems 649
Case Study: Stock-Price Beta Estimation
for Google, Inc. 653
Selected References 657
Chapter 17: Capital Budgeting 659
Capital Budgeting Process 659
What is Capital Budgeting?, 659 • Project
Classification Types, 660
Steps in Capital Budgeting 660
Sequence of Project Valuation, 660 • Cash
Flow Estimation, 661 • Incremental Cash
Flow Evaluation, 661
Managerial Application 17.1: Market-Based
Capital Budgeting 662
Cash Flow Estimation Example 662
Project Description, 662 • Cash Flow
Estimation and Analysis, 663
Capital Budgeting Decision Rules 665
Net Present-Value Analysis, 665 • Profitability
Index or Benefit/Cost Ratio Analysis, 668
Internal Rate of Return Analysis, 668
• Payback Period Analysis, 669
Project Selection 670
Decision Rule Conflict Problem, 670
Managerial Application 17.2: Is the Sun
Setting on Japan’s Vaunted MOF? 671
Reasons for Decision Rule Conflict, 672
• Ranking Reversal Problem, 672 • Making
the Correct Investment Decision, 675
Cost of Capital 675
Component Cost of Debt Financing, 675
• Component Cost of Equity Financing, 676
• Weighted-Average Cost of Capital, 679
Managerial Application 17.3: Federal Government
Support for R&D 676
Managerial Application 17.4; Capital Allocation
at Berkshire Hathaway, Inc. 681
Optimal Capital Budget 681
Investment Opportunity Schedule, 681
• Marginal Cost of Capital, 683 • Postaudit, 683
Summary 684
Questions 684
Self-Test Problems and Solutions 685
Problems 689
Case Study: Sophisticated NPV Analysis at
Level 3 Communications, Inc. 694
Selected References 698
Chapter 18: Organization Structure and
Corporate Governance 701
Organization Structure 701
What is Organization Structure?, 701 • Optimal
Design is Dynamic, 702
Transaction Cost Theory of the Firm 703
Nature of Firms, 703 • Coase Theorem’ 704
The Firm’s Agency Problem 704
Sources of Conflict within Firms, 704 • Risk
Management Problems, 705 • Investment Horizon
Problems, 707 • Information Asymmetry
Problems, 707
Managerial Application 18.1: Organization
Design at GE 705
Organization Design 708
Resolving Unproductive Conflict within
Firms, 708 • Centralization Versus
Decentralization, 709
Decision Management and Control 710
Assigning Decision Rights, 710 ‘ Decision
Process, 711
Corporate Governance 712
Role Played by Boards of Directors, 712
Managerial Application 18.2: Company
Information on the Internet 713
Corporate Governance Inside the Firm, 714
Managerial Application 18.3: Sarbanes-Oxley 715
Ownership Structure as a Corporate
Governance Mechanism 715
Dimensions of Ownership Structure, 715
• Is Ownership Structure Endogenous?, 719
Managerial Application 18.4: Institutional
Investors are Corporate Activists 720
Agreements and Alliances Among Firms 720
Franchising, 720 • Strategic Alliances, 721
Legal and Ethical Environment 722
Sarbanes-Oxley Act, 722 • Business Ethics, 723
Summary 723
Questions 725
Self-Test Problems and Solutions 726
Problems 728
Case Study: Do Boards of Directors Make
Good Corporate Watchdogs? 731
Selected References 734
Chapter 19: Government in the Market
Economy 735
Externalities 735
Negative Externalities, 735 • Positive
Externalities, 736
Managerial Application 19.1: ‘Tobacco’Ethics 738
Solving Externalities 738
Government Solutions, 738 • Market
Solutions, 739
Public Goods 740
Rivalry and Exclusion, 740 • Free Riders and
Hidden Preferences, 741
Managerial Application 19.2: Political
Corruption
Optimal Allocation of Social Resources
Pareto Improvement, 744 • Marginal Social
Costs and Benefits, 744
Benefit-Cost Methodology
Benefit-Cost Concepts, 746 • Social Rate
of Discount, 747
Benefit-Cost Criteria
Social Net Present-Value, 748 • Benefit-Cost
Ratio, 750 9 Social Internal Rate of Return, 751
• Limitations of Benefit-Cost Analysis, 752
Additional Methods of Improving Public
Management
Cost-Effectiveness Analysis, 752 • Privatization, 753
Managerial Application 19.3: Free Trade Helps
Everyone
Regulatory Reform in the New Millennium
Promoting Competition in Electric Power
Generation, 755 • Fostering Competition in
Telecommunications, 755 w Reforming
Environmental Regulation, 756 9 Improving
Regulation of Health and Safety, 756
Managerial Application 19.4: Price Controls
for Pharmaceutical Drugs
Health Care Reform
Managed Competition, 757 • Outlook for
Health Care Reform, 759
Summary 760
Questions 761
Self-Test Problems and Solutions 762
Problems 767
Case Study: Oh, Lord, Won’t You Buy
Me a Mercedes-Benz (Factory)? 772
Selected References 774
Appendix A: Compounding and the
Time Value of Money 775
Appendix B; Interest Factor Tables 791
Appendix C: Statistical Tables 799
Selected Check Figures for End-of-Chapter
Problems 805
Index 811
Chapter i: Nature and Scope of Managerial Chapter 2: Economic Optimization 23
Economics 3 Economic Optimization Process 23
How is Managerial Economics Useful? 3 Optimal Decisions, 23 9 Maximizing the Value
Evaluating Choice Alternatives, 3 8 Making the of the Firm, 24
Best Decision, 5 Revenue Relations 25
Managerial Application 1.1 Business Ethics 5 Demand and Total Revenue, 25 • Marginal
Theory of the Firm 6 Revenue, 28 * Revenue Maximization Example, 29
Expected Value Maximization 6 • Constraints Managerial Application 2.1 Ethical Aspects
and the Theory of the Firm 7 • Limitations of the of Corporate Governance 25
Theory of the Firm, 8 Managerial Application 2.2 Do Firms
Managerial Application 1.2 The World is Really Optimize? 30
Turning to Capitalism and Democracy 9 Cost Relations 30
Profit Measurement 9 Total Cost, 30 • Marginal and Average Cost, 32
Business Versus Economic Profit 9 9 Variability 9 Average Cost Minimization Example, 33
of Business Profits, 10 Profit Relations 34
Why do Profits Vary Among Firms? 12 Total and Marginal Profit, 34 9 Profit Maximization
Disequilibrium Profit Theories, 12 Example, 35
• Compensatory Profit Theories, 12 9 Role Incremental Concept in Economic Analysis 37
of Profits in the Economy, 13
Marginal Versus Incremental Concept, 37
Managerial Application 1.3 Google on Social
• Incremental Profits, 38 • Incremental Concept
Responsibility Example, 39
Role of Business in Society 14 Managerial Application 2.3 Behavioral
Why Firms Exist, 14 * Social Responsibility of Economics 38
Business, 15 Summary 41
Managerial Application 1.4 The IKEA way 16 Questions 42
Structure of this Text 16 Self-Test Problems and Solutions 42
Objectives, 16 * Development of Topics, 16 Problems 47
Summary 18 Case Study: Spreadsheet Analysis of the
Questions 19 EOQ at the Neighborhood Pharmacy, Inc. 52
Case Study: Is Coca-Cola the ‘Perfect’ Business? 19 Selected References 53
Selected References 22 Appendix 2A: Math Analysis for Managers 54
Properties of Real Numbers 54
Transitive Property, 54 * Commutative Properties,
54 • Associative Properties, 55 • Distributive
Properties, 55 • Inverse Properties, 55 • Exponents
and Radicals, 55
Equations 56
Equivalent Operations, 56 • Linear Equations, 57
• Quadratic Equations, 57 • Multiplicative
Equations, 57 • Exponential Functions, 57
• Logarithmic Functions, 58
Concept of a Marginal 59
Rules for Differentiating a Function 61
Constants, 61 • Powers, 62 • Sums and
Differences, 62 • Products, 63 • Quotients, 64
• Logarithmic Functions, 64 9 Function of a
Function (Chain Rule), 65
Appendix 2B: Multivariate Optimization and
the Lagrangian Technique 67
Partial Derivative Concept, 67 e Maximizing
Multivariate Functions, 68
Constrained Optimization 69
Role of Constraints, 70 • Lagrangian Multipliers, 71
Problem 75
Chapter 3: Demand and Supply 77
Basis for Demand 77
Direct Demand, 77 • Derived Demand, 78
Managerial Application 3.1: How the Internet
Affects Demand and Supply 79
Market Demand Function 79
Determinants of Demand, 79 • Industry Demand Versus
Firm Demand, 80
Demand Curve 81
Demand Curve Determination, 81 • Relation
Between the Demand Curve and Demand
Function, 82
Basis for Supply
How Output Prices Affect Supply, 84 • Other
Factors that Influence Supply, 85
Market Supply Function 85
Determinants of Supply, 85 • Industry Supply
Versus Firm Supply, 87
Supply Curve 87
Supply Curve Determination, 87 • Relation
Between Supply Curve and Supply Function, 89
Market Equilibrium 91
Surplus and Shortage, 91 • Comparative Statics:
Changing Demand, 93 • Comparative Statics:
Changing Supply, 95 • Comparative Statics:
Changing Demand and Supply, 96
Summary 97
Questions 97
Self-Test Problems and Solutions 98
Problems 101
Case Study: Spreadsheet Analysis of Demand
and Supply for Sunbest Orange Juice 105
Selected Reference 107
Part 2: Demand Analysis and Estimation
Chapter 4: Demand Analysis 111
Utility Theory 111
Basic Assumptions, 111 • Utility Functions, 112
• Marginal Utility, 113 • Law of Diminishing
Marginal Utility, 114
Managerial Application 4.1: Odd-Number
Pricing Riddle 116
Indifference Curves 116
Basic Characteristics, 116 • Perfect Substitutes
and Perfect Complements, 118
Budget Constraints 118
Characteristics of Budget Constraints, 118 • Effects
of Changing Income and Changing Prices, 121
• Income and Substitution Effects, 122
Individual Demand 122
Price-Consumption Curve, 122 • Income-
Consumption Curve, 125 • Engle Curves, 125
Managerial Application 4.2: Relationship
Marketing
Optimal Consumption
Marginal Utility and Consumer Choice, 128
• Marginal Rate of Substitution, 129 • Utility
Maximization, 131
Demand Sensitivity Analysis: Elasticity
Elasticity Concept, 132 • Point Elasticity, 132
• Arc Elasticity, 133
Price Elasticity of Demand
Price Elasticity Formula, 133 • Price Elasticity
and Total Revenue, 135
Price Elasticity And Marginal Revenue
Elasticity Varies Along a Linear Demand Curve, 137
• Price Elasticity and Price Changes, 138
Managerial Application 4.3: Haggling
in the Car Business 141
Price Elasticity and Optimal Pricing Policy 141
Optimal Price Formula, 141 • Optimal Pricing
Policy Example, 142
Cross-Price Elasticity of Demand 143
Cross-Price Elasticity Formula, 143 • Substitutes
and Complements, 144
Income Elasticity of Demand 144
• Income Elasticity Formula, 144 • Normal Versus
Inferior Goods, 145
Managerial Application 4.4: What’s in a Name? 146
Summary 146
Questions 147
Self-Test Problems and Solutions 148
Problems 153
Case Study: Optimal Level of Advertising 156
Selected References 157
Chapter 5: Demand Estimation 159
Interview and Experimental Methods 159
Consumer Interviews, 159 • Market
Experiments, 160
Simple Demand Curve Estimation 160
• Simple Linear Demand Curves, 160
• Using Simple Linear Demand Curves, 162
Managerial Application 5.1: Sampling
Technology for TV Advertising
Simple Market Demand Curve Estimation
Graphing the Market Demand Curve, 163
• Evaluating Market Demand, 164
Identification Problem
Changing Nature of Demand Relations, 166
• Interplay of Demand and Supply, 166 • Shifts
in Demand and Supply, 167 • Simultaneous
Relations, 169
Regression Analysis 169
What is a Statistical Relation?, 169 • Specifying the
Regression Model, 172 * Least Squares Method, 173
Managerial Application 5.2: Market Experiments
on the Web 170
Measures of Regression Model Significance 175
161
163
166
Standard Error of the Estimate, 175 • Goodness
of Fit, 176 * F Statistic, 178
Judging Variable Significance 179
Two-Tail t Tests, 179 • One-Tail t Tests, 181
Summary 182
Questions 183
Self-Test Problems and Solutions 183
Problems 188
Case Study: Demand Estimation for
Mrs Smyth’s Pies 192
Selected Reference 194
Chapter 6: Forecasting 195
Forecasting Applications 195
Macroeconomic Applications, 195 ” Microeconomic
Applications, 196 • Forecast Techniques, 196
Managerial Application 6.1: Economic
Forecasting: The Art and the Science 197
Qualitative Analysis 198
Expert Opinion, 198 • Survey Techniques, 198
Trend Analysis and Projection 199
Trends in Economic Data, 199 • Linear Trend
Analysis, 199 • Growth Trend Analysis, 202
• Linear and Growth Trend Comparison, 204
Managerial Application 6.2: Prediction Markets 204
Business Cycle 205
What is the Business Cycle?, 205 • Economic
Indicators, 207 • Economic Recessions, 208
• Sources of Forecast Information, 210
Managerial Application 6.3: The Stock Market
and the Business Cycle 211
Exponential Smoothing 212
Exponential Smoothing Concept, 212
• One-Parameter (Simple) Exponential
Smoothing, 212 • Two-Parameter (Holt)
Exponential Smoothing, 213 ” Three-Parameter
(Winters) Exponential Smoothing, 214 • Practical
Use of Exponential Smoothing, 214
Econometric Forecasting 215
Advantages of Econometric Methods. 215
1 Single-Equation Models, 217 • Multiple-Equation
Systems, 218
Managerial Application 6.4: How Good is Your
Forecasting Ability? 216
Judging Forecast Reliability 220
Tests of Predictive Capability, 220 * Correlation
Analysis, 220 • Sample Mean Forecast Error
Analysis, 220
Choosing the Best Forecast Technique
Data Requirements, 227 • Time Horizon
Considerations, 221 • Role of Judgment, 223
Summary
221
223
Questions 224
Self-Test Problems and Solutions 225
Case Study: Forecasting Global Performance
for a Mickey Mouse Organization 233
Selected Reference 236
Part 3: Production and Competitive Markets
Chapter 7: Production Analysis
and Compensation Policy 239
Production Functions 239
Properties of Production Functions, 239 • Returns to
Scale and Returns to a Factor, 240
Total, Marginal, and Average Product 240
• Total Product, 241 * Marginal and Average
Product, 242
Law of Diminishing Returns to a Factor 245
Illustration of Diminishing Returns to a Factor, 247
Managerial Application 7.1: Efficiency Wages 246
Input Combination Choice 248
Production Isoquants, 248 • Input Factor
Substitution, 248 • Marginal Rate of Technical
Substitution, 251 • Rational Limits of Input
Substitution, 251
Marginal Revenue Product and Optimal
Employment 252
Marginal Revenue Product, 252 • Optimal
Level of a Single Input, 253 • Illustration of
Optimal Employment, 254
Managerial Application 7.2: National minimum
wages in the EU 253
Optimal Combination of Multiple Inputs 255
Budget Lines, 255 • Expansion Path, 257
• Illustration of Optimal Input Proportions, 258
Managerial Application 7.3: The Future of
Manufacturing in Europe 2015-2020 259
Optimal Levels of Multiple Inputs 259
Optimal Employment and Profit Maximization, 259
• Illustration of Optimal Levels of Multiple
Inputs, 260
Returns to Scale 260
• Output Elasticity and Returns to
Scale, 260 12 Returns to Scale Estimation, 261
Productivity Measurement 262
Economic Productivity, 263 • Productivity and
Investment in Computer Technology (ICT), 264
Managerial Application 7.4: Labor productivity
growth in selected countries 2009-2012. 263
Summary 265
Questions 266
Self-Test Problems and Solutions 266
Problems 269
Case Study: Worker Productivity Among
Giant US Corporations 274
Selected References 276
Appendix 7A: A Constrained Optimization
Approach to Developing the Optimal Input
Combination Relationships 277
Constrained Production Maximization 277
Constrained Cost Minimization 279
Problem 280
Chapter 8: Cost Analysis and Estimation 281
Economic and Accounting Costs 281
Historical Versus Current Costs, 281
• Opportunity Costs, 282
Role of Time in Cost Analysis 283
Incremental Versus Sunk Cost, 283 6 How is
the Operating Period Defined?, 284
Managerial Application 8.1: GE’s ’20-70-10′ Plan 284
Short-Run Cost Curves 285
Short-Run Cost Categories, 285 • Short-Run
Cost Relations, 286
Managerial Application 8.2: GAAP and IRES 288
Long-Run Cost Curves 288
Long-Run Total Costs, 288″ Economies ofScale, 290
• Cost Elasticities and Economies of Scale, 290
• Long-Run Average Costs, 291
Managerial Application 8.3: Cost Stickiness 293
Minimum Efficient Scale 293
Competitive Implications ofMinimum Efficient
Scale, 293 • Transportation Costs and MES, 293
Firm Size and Plant Size 295
Multiplant Economies and Diseconomies of
Scale, 295 * Economics of Multiplant
Operation: an Example, 296 • Plant Size and
Flexibility, 298
Learning Curves 300
Learning Curve Concept, 300 s Learning Curve
Example, 302 • Strategic Implications of the
Learning Curve Concept, 303
Managerial Application 8.4: Bigger isn’t
Always Better 301
Economies of Scope 304
Economies of Scope Concept, 304 ® Exploiting
Scope Economies, 305
Cost-Volume-Profit Analysis 305
• Cost-Volume-Profit Charts, 305 • Degree
of Operating Leverage, 307
Summary 309
Questions 310
Self-Test Problems and Solutions 311
Problems 313
Case Study: Estimating Hospitalization Costs
for Regional Hospitals 317
Selected References 320
Chapter 9: Linear Programming 321
Basic Assumptions 321
Inequality Constraints, 327 • Linearity
Assumption, 322
Managerial Application 9.1: Karmarkar’s LP
Breakthrough 322
Production Planning for a Single Product 323
Production Processes, 323 • Production
Isoquants, 324 • Least-Cost Input Combinations, 326
• Optimal Input Combinations with Limited
Resources, 327
Managerial Application 9.2: LP: More than a
Visual Approach 330
Production Planning for Multiple Products 330
Objective Function Specification, 330 • Constraint
Equation Specification, 331 • Non-negativity
Requirement, 331
Graphic Specification and Solution 332
Analytic Expression, 332 • Graphing the
Feasible Space, 332 • Graphing the Objective
Function, 334 • Graphic Solution, 335
Algebraic Specification and Solution 336
Algebraic Specification, 336 • Algebraic
Solution, 338
Managerial Application 9.3: LP on the PC! 341
Dual in Linear Programming 342
Duality Concept, 342 • Shadow Prices, 342
Dual Specification 343
Dual Objective Function, 343 • Dual
Constraints, 343 9 Dual Slack Variables, 344
Solving the Dual Problem 345
Dual Solution, 345 • Using the Dual Solution
to Solve the Primal, 346
Summary 348
Questions 349
Self-Test Problems and Solutions 349
Problems 357
Case Study: A LP Pension Funding Model 362
Appendix 9A: Rules for Forming the Dual Linear
Programming Problem 365
Primal Problem 365
Dual Problem 366
Selected References 367
Chapter 10: Competitive Markets 369
Competitive Environment 369
What is Market Structure?, 369 • Vital Role
of Potential Entrants, 370
Factors that Shape the Competitive Environment 370
Product Differentiation, 370 • Production
Methods, 372 • Entry and Exit Conditions, 372
Managerial Application 10.1: Benefits From
Free Trade 371
Competitive Market Characteristics 373
Basic Features, 373 • Examples of Competitive
Markets, 373 • Profit Maximization Imperative, 375
• Role of Marginal Analysis, 375
Managerial Application 10.2: Seasonality
on Stock Markets? 374
Marginal Cost and Firm Supply 379
Short-Run Firm Supply Curve, 379 • Long-Run
Firm Supply Curve, 381
Managerial Application 10.3: Dot.com 382
Competitive Market Supply Curve 382
Market Supply with a Fixed Number of
Competitors, 382 • Market Supply with Entry
and Exit, 384
Competitive Market Equilibrium 385
Balance of Supply and Demand, 386 • Normal
Profit Equilibrium, 387
Managerial Application 10.4: The Enron
Debacle 388
Summary 388
Questions 389
Self-Test Problems and Solutions 390
Problems 395
Case Study: Profitability Effects of Firm
Size for DJIA Companies 399
Selected References 401
Chapter n: Performance and Strategy
in Competitive Markets 403
Competitive Market Efficiency 403
Why is it Called Perfect Competition?, 403
• Deadweight Loss Problem, 404 • Deadweight
Loss Illustration, 406
Managerial Application 11.1: The Wal-Mart
Phenomenon 407
Market Failure 408
Structural Problems, 408 * Incentive Problems, 409
411
411
414
Role for Government 410
How Government Influences Competitive
Markets, 410 • Broad Social Considerations, 411
Managerial Application 11.2: Corn Growers
Discover Oil!
Subsidy and Tax Policy
Anti-Subsidy Rules, 412 • Deadweight Loss
from Taxes, 412
Tax Incidence and Burden
Role of Elasticity, 414 • Tax Cost-Sharing
Example, 415
Managerial Application 11.3: Measuring
Economic Profits 418
Price Controls 418
Price Floors, 418 * Price Ceilings, 420
Business Profit Rates 422
Return on Stockholders’ Equity, 422 • Typical
Profit Rates, 423
Market Structure and Profit Rates 425
Profit Rates in Competitive Markets, 425
• Mean Reversion in Profit Rates, 426
Competitive Market Strategy 426
Short-Run Firm Performance, 427
Long-Run Firm Performance 428
Summary 428
Questions 430
Self-Test Problems and Solutions 431
Problems 437
Case Study: The Most Profitable S&P 500
Companies 441
Selected References 444
Part 4: Imperfect Competition 445
Chapter 12: Monopoly and Monopsony 447
Monopoly Market Characteristics 447
Basic Features, 447 • Examples of Monopoly, 448
Managerial Application 12.1: The EU
Commission fines parking heaters producer
€68 million in cartel settlement 449
Profit Maximization Under Monopoly 449
Price-Output Decisions, 449 • Role of Marginal
Analysis, 451
Social Costs of Monopoly 453
Monopoly Underproduction, 453 • Deadweight Loss
from Monopoly, 453
Social Benefits of Monopoly 457
Economies of Scale, 457 • Invention and Innovation, 457
Monopoly Regulation 458
Dilemma of Natural Monopoly, 458 • Utility Price
and Profit Regulation, 460 • Utility Price and Profit
Regulation Example, 462 • Problems with Utility Price
and Profit Regulation, 464
Managerial Application 12.2: Is Ticketmaster
a Monopoly? 459
Monopsony 464
Buyer Power, 464 • Bilateral Monopoly
Illustration, 465
Managerial Application 12.3: is this why
they Call it ‘Hardball’? 468
Antitrust Policy 468
Overview of Antitrust Law, 468
Managerial Application 12.4: Price Fixing
by the Insurance Cartel 469
Competitive Strategy in Monopoly Markets 469
Market Niches, 469 • Information Barriers to
Competitive Strategy, 470
Summary 472
Questions 473
Self-Test Problems and Solutions 473
Problems 480
Case Study: Effect of R&D on Tobin’s q 484
Selected References 487
Chapter 13: Monopolistic Competition
and Oligopoly 489
Contrast Between Monopolistic Competition
and Oligopoly 489
Monopolistic Competition, 489 • Oligopoly, 490
• Dynamic Nature of Competition, 491
Monopolistic Competition 491
Monopolistic Competition Characteristics, 491
• Monopolistic Competition Price-Output
Decisions, 493
Managerial Application 13.1: Dell’s Price
War with Dell 492
Managerial Application 13.2: Intel: Running
Fast to Stay in Place 495
Monopolistic Competition Process 495
Short-Run Monopoly Equilibrium, 495
• Long-Run High-Price/Low-Output
Equilibrium, 496 • Long-Run Low-Price/
High-Output Equilibrium, 498
Oligopoly 498
Oligopoly Market Characteristics, 499
• Examples of Oligopoly, 499
Cartels and Collusion 500
Overt and Covert Agreements, 500
Enforcement Problems, 501
Oligopoly Output-Setting Models 501
Cournot Oligopoly, 501 • Stackelberg
Oligopoly, 504
Oligopoly Price-Setting Models 507
Bertrand Oligopoly: Identical Products, 507
• Bertrand Oligopoly: Differentiated Products,
508 • Sweezy Oligopoly, 511 • Oligopoly Model
Comparison, 512
Managerial Application 13.3: Contestable
Airline Passenger Service Markets 513
Market Structure Measurement 513
Economic Census, 513 • NAICS System, 514
Census Measures of Market Concentration 516
Concentration Ratios, 516 * Herfindahl-
Hirschmann Index, 518 • Limitations of
Census Information, 518
Managerial Application 13.4: Horizontal
Merger Guidelines 519
Summary 522
Questions 524
Self-Test Problems and Solutions 524
Problems 528
Case Study: Market Structure Analysis
at Columbia Drugstores, Inc. 533
Selected References 535
Chapter 14: Game Theory and Competitive
Strategy 537
Game Theory Basics 537
Types of Games, 537 • Role of Interdependence,
538 • Strategic Considerations, 539
Managerial Application 14.1: Asymmetric
Information 539
Prisoner’s Dilemma 540
Classic Riddle, 540 • Business Application,
541 • Broad Implications, 542
Nash Equilibrium 543
Nash Equilibrium Concept, 543 e Nash
Bargaining, 544
Infinitely Repeated Games 545
Role of Reputation, 545 • Product Quality
Games, 546
Managerial Application 14.2: The Market
for Lemons
Finitely Repeated Games
Uncertain Final Period, 547 • End-of-Came
Problem, 548
Game Theory and Auction Strategy
First-Mover Advantages, 549 9 Auction Types, 549
• Public Policy Applications, 550
Managerial Application 14.3: Wrigley’s Success
Formula
Competitive Strategy
Competitive Advantage, 551 9 When Large Size
is a Disadvantage, 553
Pricing Strategies
Limit Pricing, 553 9 Network Externalities, 555
• Market Penetration Pricing, 555
Managerial Application 14.4: Network
Switching Costs 556
Nonprice Competition 556
Advantages of Nonprice Competition, 556
• Optimal Level of Advertising, 557
• Optimal Advertising Example, 559
Summary 561
Questions 562
Self-Test Problems and Solutions 562
Problems 565
Case Study: Time Warner, Inc., is Playing
Games with Stockholders 570
Selected References 572
Chapter 15: Pricing Practices 573
Pricing Rules-of-Thumb 573
Competitive Markets, 573 • Imperfectly
Competitive Markets, 574
Managerial Application 15.1: Mark-Up Pricing
Technology 575
Mark-Up Pricing and Profit Maximization 575
Optimal Mark-Up on Cost, 575 9 Optimal
Mark-Up on Price, 576 9 Why Do Optimal
Mark-Ups Vary?, 577
Price Discrimination 578
Profit-Making Criteria, 578 • Degrees of Price
Discrimination, 579
Price Discrimination Example 580
Price-Output Determination Case I, 581
• One-Price Alternative, 583 9 Price-Output
Determination Case II, 585
Managerial Application 15.2: Do Colleges
Price Discriminate? 581
Two-Part Pricing 586
One-Price Policy and Consumer Surplus, 586
• Capturing Consumer Surplus with Two-Part
Pricing, 588 • Consumer Surplus and Bundle
Pricing, 588
Multiple-Product Pricing 589
Demand Interrelations, 589 • Production
Interrelations, 590
Joint Products 591
joint Products in Variable Proportions, 591
• Joint Products in Fixed Proportions, 591
Joint Product Pricing Example 593
joint Products without Excess By-Product, 593
• Joint Production with Excess By-Product
(Dumping), 596
Managerial Application 15.3: lOc for a Gallon
of Gas in Dayton, Ohio
Managerial Application 15.4: Why Some
Price Wars Never End
Summary
Questions and Answers
Self-Test Problems and Solutions
Problems
Case Study: Pricing Practices in the Denver,
Colorado, Newspaper Market
Selected References
Appendix 15A: Transfer Pricing
Transfer Pricing Problem
Divisional Relationships, 609 • Products without
External Markets, 610 • Products with Competitive
External Markets, 610 • Products with Imperfectly
Competitive External Markets, 611
Global Transfer Pricing Example 611
Profit Maximization for an Integrated Firm, 611
• Transfer Pricing with No External Market. 612
• Competitive External Market with Excess Internal
Demand, 613 9 Competitive External Market with
Excess Internal Supply, 614
Problem 615
Part 5: Long-Term Investment Decisions
Chapter 16: Risk Analysis 619
Concepts of Risk and Uncertainty 619
Economic Risk and Uncertainty, 619 * General
Risk Categories, 620 • Special Risks of Global
Operations, 621
Probability Concepts 621
• Probability Distribution, 622 • Expected
Value, 623 • Absolute Risk Measurement, 625
• Relative Risk Measurement, 627 • Other Risk
Measures, 627
Managerial Application 16.1: Behavioral Finance 622
Standard Normal Concept 628
Normal Distribution, 628 • Standardized
Variables, 629 • Use of the Standard Normal
Concept: an Example, 629
Managerial Application 16.2: Why are
Lotteries Popular? 630
Utility Theory and Risk Analysis 630
Possible Risk Attitudes, 631 • Relation
Between Money and its Utility, 631
Adjusting the Valuation Model for Risk 632
Basic Valuation Model, 632 • Certainty
Equivalent Adjustments, 633 • Certainty
Equivalent Adjustment Example, 635
• Risk-Adjusted Discount Rates, 636,
• Risk-Adjusted Discount Rate Example, 637
Managerial Application 16.3: Stock Option
Backdating Scandal 633
Decision Trees and Computer Simulation 638
Decision Trees, 638 • Computer Simulation, 639
• Computer Simulation Example, 640
Managerial Application 16.4: Internet Fraud 642
Summary 643
Questions 644
Self-Test Problems and Solutions 645
Problems 649
Case Study: Stock-Price Beta Estimation
for Google, Inc. 653
Selected References 657
Chapter 17: Capital Budgeting 659
Capital Budgeting Process 659
What is Capital Budgeting?, 659 • Project
Classification Types, 660
Steps in Capital Budgeting 660
Sequence of Project Valuation, 660 • Cash
Flow Estimation, 661 • Incremental Cash
Flow Evaluation, 661
Managerial Application 17.1: Market-Based
Capital Budgeting 662
Cash Flow Estimation Example 662
Project Description, 662 • Cash Flow
Estimation and Analysis, 663
Capital Budgeting Decision Rules 665
Net Present-Value Analysis, 665 • Profitability
Index or Benefit/Cost Ratio Analysis, 668
Internal Rate of Return Analysis, 668
• Payback Period Analysis, 669
Project Selection 670
Decision Rule Conflict Problem, 670
Managerial Application 17.2: Is the Sun
Setting on Japan’s Vaunted MOF? 671
Reasons for Decision Rule Conflict, 672
• Ranking Reversal Problem, 672 • Making
the Correct Investment Decision, 675
Cost of Capital 675
Component Cost of Debt Financing, 675
• Component Cost of Equity Financing, 676
• Weighted-Average Cost of Capital, 679
Managerial Application 17.3: Federal Government
Support for R&D 676
Managerial Application 17.4; Capital Allocation
at Berkshire Hathaway, Inc. 681
Optimal Capital Budget 681
Investment Opportunity Schedule, 681
• Marginal Cost of Capital, 683 • Postaudit, 683
Summary 684
Questions 684
Self-Test Problems and Solutions 685
Problems 689
Case Study: Sophisticated NPV Analysis at
Level 3 Communications, Inc. 694
Selected References 698
Chapter 18: Organization Structure and
Corporate Governance 701
Organization Structure 701
What is Organization Structure?, 701 • Optimal
Design is Dynamic, 702
Transaction Cost Theory of the Firm 703
Nature of Firms, 703 • Coase Theorem’ 704
The Firm’s Agency Problem 704
Sources of Conflict within Firms, 704 • Risk
Management Problems, 705 • Investment Horizon
Problems, 707 • Information Asymmetry
Problems, 707
Managerial Application 18.1: Organization
Design at GE 705
Organization Design 708
Resolving Unproductive Conflict within
Firms, 708 • Centralization Versus
Decentralization, 709
Decision Management and Control 710
Assigning Decision Rights, 710 ‘ Decision
Process, 711
Corporate Governance 712
Role Played by Boards of Directors, 712
Managerial Application 18.2: Company
Information on the Internet 713
Corporate Governance Inside the Firm, 714
Managerial Application 18.3: Sarbanes-Oxley 715
Ownership Structure as a Corporate
Governance Mechanism 715
Dimensions of Ownership Structure, 715
• Is Ownership Structure Endogenous?, 719
Managerial Application 18.4: Institutional
Investors are Corporate Activists 720
Agreements and Alliances Among Firms 720
Franchising, 720 • Strategic Alliances, 721
Legal and Ethical Environment 722
Sarbanes-Oxley Act, 722 • Business Ethics, 723
Summary 723
Questions 725
Self-Test Problems and Solutions 726
Problems 728
Case Study: Do Boards of Directors Make
Good Corporate Watchdogs? 731
Selected References 734
Chapter 19: Government in the Market
Economy 735
Externalities 735
Negative Externalities, 735 • Positive
Externalities, 736
Managerial Application 19.1: ‘Tobacco’Ethics 738
Solving Externalities 738
Government Solutions, 738 • Market
Solutions, 739
Public Goods 740
Rivalry and Exclusion, 740 • Free Riders and
Hidden Preferences, 741
Managerial Application 19.2: Political
Corruption
Optimal Allocation of Social Resources
Pareto Improvement, 744 • Marginal Social
Costs and Benefits, 744
Benefit-Cost Methodology
Benefit-Cost Concepts, 746 • Social Rate
of Discount, 747
Benefit-Cost Criteria
Social Net Present-Value, 748 • Benefit-Cost
Ratio, 750 9 Social Internal Rate of Return, 751
• Limitations of Benefit-Cost Analysis, 752
Additional Methods of Improving Public
Management
Cost-Effectiveness Analysis, 752 • Privatization, 753
Managerial Application 19.3: Free Trade Helps
Everyone
Regulatory Reform in the New Millennium
Promoting Competition in Electric Power
Generation, 755 • Fostering Competition in
Telecommunications, 755 w Reforming
Environmental Regulation, 756 9 Improving
Regulation of Health and Safety, 756
Managerial Application 19.4: Price Controls
for Pharmaceutical Drugs
Health Care Reform
Managed Competition, 757 • Outlook for
Health Care Reform, 759
Summary 760
Questions 761
Self-Test Problems and Solutions 762
Problems 767
Case Study: Oh, Lord, Won’t You Buy
Me a Mercedes-Benz (Factory)? 772
Selected References 774
Appendix A: Compounding and the
Time Value of Money 775
Appendix B; Interest Factor Tables 791
Appendix C: Statistical Tables 799
Selected Check Figures for End-of-Chapter
Problems 805
Index 811
where is william theory in this book at which page?