**Managerial Economics, 14th Edition**

By Mark Hirschey and Eric Bentzen

**Contents**

1 H Part i: Overview of Managerial

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

**Economics**iChapter 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