## Managerial Economics: Foundations of Business Analysis and Strategy, Twelfth Edition

By Christopher R. Thomas and S. Charles Maurice

**Contents:**

CHAPTER 1 Managers, Profits, and Markets 1

1.1 The Economic Way of Thinking about Business Practices and Strategy 2

Economic Theory Simplifies Complexity 3

The Roles of Microeconomics and Industrial Organization 3

1.2 Measuring and Maximizing Economic Profit 7

Economic Cost of Using Resources 7

Economic Profit versus Accounting Profit 11

Maximizing the Value of the Firm 14

The Equivalence of Value Maximization and Profit Maximization 16

Some Common Mistakes Managers Make 16

1.3 Separation of Ownership and Control of the Firm 21

The Principal–Agent Problem 21

Corporate Control Mechanisms 24

1.4 Market Structure and Managerial Decision Making 25

What Is a Market? 26

Different Market Structures 27

Globalization of Markets 29

1.5 Summary 30

Key Terms 32

Technical Problems 32

Applied Problems 33

Mathematical Appendix: Review of Present Value Calculations 35

Mathematical Exercises 37

CHAPTER 2 Demand, Supply, and Market Equilibrium 38

2.1 Demand 39

The General Demand Function: Qd 5 f (P, M, PR, 7, PE, N ) 40

Direct Demand Functions: Qd 5 f (P) 44

Inverse Demand Functions: P 5 f (Qd ) 46

Movements along Demand 47

Shifts in Demand 48

2.2 Supply 52

The General Supply Function: Qs 5 f (P, PI , Pr , T, Pe , F ) 53

Direct Supply Functions: Qs 5 f (P ) 55

Inverse Supply Functions: P 5 f (Qs) 56

Shifts in Supply 57

2.3 Market Equilibrium 61

2.4 Measuring the Value of Market Exchange 64

Consumer Surplus 65

Producer Surplus 67

Social Surplus 67

2.5 Changes in Market Equilibrium 68

Changes in Demand (Supply Constant) 68

Changes in Supply (Demand Constant) 69

Simultaneous Shifts in Both Demand and Supply 70

Predicting the Direction of Change in Airfares: A

Qualitative Analysis 74

Advertising and the Price of Milk: A Quantitative Analysis 75

2.6 Ceiling and Floor Prices 76

2.7 Summary 78

Key Terms 79

Technical Problems 79

Applied Problems 84

CHAPTER 3 Marginal Analysis for

Optimal Decisions 88

3.1 Concepts and Terminology 89

3.2 Unconstrained Maximization 91

The Optimal Level of Activity (A*) 91

**Marginal Benefit** and Marginal Cost 95

Finding Optimal Activity Levels with Marginal Analysis 97

Maximization with Discrete Choice Variables 99

Sunk Costs, Fixed Costs, and Average Costs Are Irrelevant 101

3.3 Constrained Optimization 103

Marginal Benefit per Dollar Spent on an Activity 103

Constrained Maximization 104

Optimal Advertising Expenditures: An Example of

Constrained Maximization 106

Constrained Minimization 107

3.4 Summary 109

Key Terms 110

Technical Problems 110

Applied Problems 114

Mathematical Appendix: A Brief Presentation of

Optimization Theory 117

Mathematical Exercises 120

CHAPTER 4 Basic Estimation

Techniques 121

4.1 The Simple Linear Regression Model 122

A Hypothetical Regression Model 123

The Random Error Term 123

4.2 Fitting a Regression Line 125

4.3 Testing for Statistical Significance 129

The Relative Frequency Distribution for ˆ

b 130

The Concept of a t-Ratio 131

Performing a t-Test for Statistical Significance 132

Using p-Values to Determine Statistical

Significance 134

4.4 Evaluation of the Regression Equation 135

The Coefficient of Determination (R 2) 136

The F-Statistic 137

Controlling Product Quality at SLM: A Regression

Example 138

4.5 Multiple Regression 141

The Multiple Regression Model 141

4.6 Nonlinear Regression Analysis 141

Quadratic Regression Models 142

Log-Linear Regression Models 146

4.7 Summary 149

Key Terms 150

Technical Problems 150

Applied Problems 154

Statistical Appendix: Problems Encountered in

Regression Analysis 157

CHAPTER 5 Theory of Consumer

Behavior 159

5.1 Basic Assumptions of Consumer Theory 160

The Consumer’s Optimization Problem 160

Properties of Consumer Preferences 160

The Utility Function 162

5.2 Indifference Curves 163

Marginal Rate of Substitution 164

Indifference Maps 166

A Marginal Utility Interpretation of MRS 166

5.3 The Consumer’s Budget Constraint 169

Budget Lines 169

Shifting the Budget Line 172

5.4 Utility Maximization 173

Maximizing Utility Subject to a Limited Income 173

Marginal Utility Interpretation of Consumer

Optimization 176

Finding the Optimal Bundle of Hot Dogs and

Cokes 179

5.5 Individual Demand and Market Demand Curves 180

An Individual Consumer’s Demand Curve 180

Market Demand and Marginal Benefit 181

5.6 Corner Solutions 184

5.7 Summary 185

Key Terms 186

Technical Problems 186

Applied Problems 193

Mathematical Appendix: A Brief Presentation of Consumer Theory 194

Mathematical Exercises 196

Online Appendix 1: Substitution and Income

Effects of a Price Change

CHAPTER 6 Elasticity and Demand 197

6.1 The Price Elasticity of Demand 199

Predicting the Percentage Change in Quantity

Demanded 200

Predicting the Percentage Change in Price 200

6.2 Price Elasticity and Total Revenue 201

Price Elasticity and Changes in Total Revenue 201

Changing Price at Borderline Video Emporium: A

Numerical Example 203

6.3 Factors Affecting Price Elasticity of Demand 205

Availability of Substitutes 205

Percentage of Consumer’s Budget 206

Time Period of Adjustment 206

6.4 Calculating Price Elasticity of Demand 207

Computation of Elasticity over an Interval 207

Computation of Elasticity at a Point 208

Elasticity (Generally) Varies along a Demand

Curve 212

6.5 Marginal Revenue, Demand, and Price

Elasticity 214

Marginal Revenue and Demand 214

Marginal Revenue and Price Elasticity 218

6.6 Other Demand Elasticities 219

Income Elasticity (EM) 220

Cross-Price Elasticity (EXR) 221

6.7 Summary 225

Key Terms 226

Technical Problems 226

Applied Problems 232

Mathematical Appendix: Demand Elasticity 233

Mathematical Exercises 235

CHAPTER 7 Demand Estimation and

**Forecasting** 236

7.1 Direct Methods of Demand Estimation 238

Consumer Interviews 238

Market Studies and Experiments 241

7.2 Specification of the Empirical Demand Function 242

A General Empirical Demand Specification 242

A Linear Empirical Demand Specification 243

A Nonlinear Empirical Demand Specification 244

Choosing a Demand Specification 244

7.3 Estimating Demand for a Price-Setting Firm 246

Estimating the Demand for a Pizza Firm: An

Example 247

7.4 Time-Series Forecasts of Sales and Price 251

Linear Trend Forecasting 252

A Sales Forecast for Terminator Pest Control 253

A Price Forecast for Georgia Lumber Products 254

7.5 Seasonal (or Cyclical) Variation 255

Correcting for Seasonal Variation by Using Dummy

Variables 256

The Dummy-Variable Technique: An Example 258

7.6 Some Final Warnings 265

7.7 Summary 266

Key Terms 267

Technical Problems 268

Applied Problems 271

Mathematical Appendix Empirical Elasticities 272

Data Appendix: Data for Checkers Pizza 273

Online Appendix 2: Estimating and Forecasting

Industry Demand for

Price-Taking Firms

CHAPTER 8 Production and Cost in the

Short Run 274

8.1 Some General Concepts in Production and Cost 275

Production Functions 276

Technical and Economic Efficiency 277

Inputs in Production 278

Short-Run and Long-Run Production Periods 279

Sunk Costs versus Avoidable Costs 280

8.2 Production in the Short Run 282

Total Product 282

Average and Marginal Products 284

Law of Diminishing Marginal Product 286

Changes in Fixed Inputs 287

8.3 Short-Run Costs of Production 291

Short-Run Total Costs 291

Average and Marginal Costs 294

General Short-Run Average and Marginal Cost

Curves 295

8.4 Relations Between Short-Run Costs and

Production 297

Total Costs and the Short-Run Production

Function 297

Average Variable Cost and Average Product 298

Marginal Cost and Marginal Product 299

The Graphical Relation between AVC, SMC, AP,

and MP 300

8.5 Summary 302

Key Terms 303

Technical Problems 303

Applied Problems 307

Mathematical Appendix: Short-Run Production and

Cost Relations 309

Mathematical Exercises 310

CHAPTER 9 Production and Cost in the

Long Run 311

9.1 Production Isoquants 313

Characteristics of Isoquants 313

Marginal Rate of Technical Substitution 314

Relation of MRTS to Marginal Products 315

9.2 Isocost Curves 316

Characteristics of Isocost Curves 316

Shifts in Isocost Curves 317

9.3 Finding the Optimal Combination of Inputs 318

Production of a Given Output at Minimum Cost 319

The Marginal Product Approach to Cost

Minimization 321

Production of Maximum Output with a Given Level

of Cost 322

9.4 Optimization and Cost 324

An Expansion Path 325

The Expansion Path and the Structure of Cost 326

9.5 Long-Run Costs 327

Derivation of Cost Schedules from a Production

Function 327

9.6 Forces Affecting Long-Run Costs 332

Economies and Diseconomies of Scale 332

Economies of Scope in Multiproduct Firms 338

Purchasing Economies of Scale 344

Learning or Experience Economies 345

9.7 Relations Between Short-Run and Long-Run Costs 347

Long-Run Average Cost as the Planning Horizon 347

Restructuring Short-Run Costs 349

9.8 Summary 351

Key Terms 352

Technical Problems 352

Applied Problems 357

Mathematical Appendix: Production and Cost

Relations with Two Variable Inputs 360

Mathematical Exercises 362

CHAPTER 10 Production and Cost

Estimation 364

10.1 Specification of the Short-Run Production

Function 365

10.2 Estimation of a Short-Run Production Function 367

10.3 Short-Run Cost Estimation: Some Problems with

Measuring Cost 371

Correcting Data for the Effects of Inflation 371

Problems Measuring Economic Cost 372

10.4 Estimation of a Short-Run Cost Function 373

Estimation of Typical Short-Run Costs 374

Estimation of Short-Run Costs at Rockford

Enterprises: An Example 376

10.5 Summary 379

Key Terms 380

Technical Problems 380

Applied Problems 381

Mathematical Appendix: Empirical Production and

Cost Relations 383

Mathematical Exercises 389

Online Appendix 3: Linear Programming

CHAPTER 11 Managerial Decisions in

Competitive Markets 390

11.1 Characteristics of Perfect Competition 392

11.2 Demand Facing a Price-Taking Firm 393

11.3 Profit Maximization in the Short Run 395

The Output Decision: Earning Positive Economic

Profit 396

The Output Decision: Operating at a Loss or Shutting

Down 401

The Irrelevance of Sunk Costs, Fixed Costs, and

Average Costs 405

Short-Run Supply for the Firm and Industry 407

Producer Surplus and Profit in Short-Run

Competitive Equilibrium 408

11.4 Profit Maximization in the Long Run 410

Profit-Maximizing Equilibrium for the Firm in the

Long Run 410

Long-Run Competitive Equilibrium for the

Industry 411

Long-Run Supply for a Perfectly Competitive

Industry 413

Economic Rent and Producer Surplus in Long-Run

Equilibrium 418

11.5 Profit-Maximizing Input Usage 421

Marginal Revenue Product and the Hiring

Decision 421

Average Revenue Product and the Shutdown

Decision 424

11.6 Implementing the Profit-Maximizing Output

Decision 425

General Rules for Implementation 425

Profit Maximization at Beau Apparel: An

Illustration 427

11.7 Summary 433

Key Terms 434

Technical Problems 434

Applied Problems 440

Mathematical Appendix: Profit Maximization for

Price-Taking Firms 444

CHAPTER 12 Managerial Decisions for Firms

with Market Power 446

12.1 Measurement of Market Power 448

Market Definition 449

Elasticity of Demand 450

The Lerner Index 450

Cross-Price Elasticity of Demand 451

12.2 Barriers to Entry 451

Barriers Created by Government 455

Economies of Scale 457

Essential Input Barriers 457

Brand Loyalties 458

Consumer Lock-In 458

Network Externalities (or Network Effects) 459

Sunk Costs as a General Barrier to Entry 460

12.3 Profit Maximization Under Monopoly:

Output and Pricing Decisions 462

Demand and Marginal Revenue for a Monopolist 463

Maximizing Profit at Southwest Leather Designs:

An Example 464

Short-Run Equilibrium: Profit Maximization or Loss

Minimization 466

Long-Run Equilibrium 471

12.4 Profit-Maximizing Input Usage 472

12.5 Monopolistic Competition 476

Short-Run Equilibrium 477

Long-Run Equilibrium 478

12.6 Implementing the Profit–Maximizing Output

and Pricing Decision 480

General Rules for Implementation 480

Maximizing Profit at Aztec Electronics: An

Example 484

12.7 Multiplant Firms 488

Multiplant Production at Mercantile Enterprises 490

12.8 Summary 493

Key Terms 494

Technical Problems 494

Applied Problems 502

Mathematical Appendix: Profit Maximization

for a Monopoly 506

CHAPTER 13 Strategic Decision Making in

Oligopoly Markets 509

13.1 Decision Making When Rivals Make Simultaneous

Decisions 511

The Prisoners’ Dilemma 514

Decisions with One Dominant Strategy 517

Successive Elimination of Dominated Strategies 518

Nash Equilibrium: Making Mutually Best

Decisions 520

Super Bowl Advertising: An Example of Nash

Equilibrium 523

Best-Response Curves and Continuous Decision

Choices 525

13.2 Strategy When Rivals Make Sequential Decisions 531

Making Sequential Decisions 532

First-Mover and Second-Mover Advantages 534

Strategic Moves: Commitments, Threats, and

Promises 537

13.3 Cooperation in Repeated Strategic Decisions 539

One-Time Prisoners’ Dilemma Decisions 540

Punishment for Cheating in Repeated

Decisions 542

Deciding to Cooperate 543

Trigger Strategies for Punishing Cheating 544

Pricing Practices That Facilitate Cooperation 545

Explicit Price-Fixing Agreements and Cartels 548

Tacit Collusion 553

13.4 Strategic Entry Deterrence 554

Limit Pricing 554

Capacity Expansion as a Barrier to Entry 558

13.5 Summary 560

Key Terms 561

Technical Problems 562

Applied Problems 566

Mathematical Appendix: Derivation of

Best-Response Curves for Continuous Simultaneous

Decisions 570

Mathematical Exercises 573

CHAPTER 14 Advanced Pricing

Techniques 575

14.1 Price Discrimination: Capturing Consumer

Surplus 576

The Trouble with Uniform Pricing 576

Types of Price Discrimination 578

Conditions for Profitable Price Discrimination 579

14.2 First-Degree (or Perfect) Price Discrimination 580

14.3 Second-Degree Price Discrimination Methods 583

Two-Part Pricing 584

Declining Block Pricing 593

14.4 Third-Degree Price Discrimination 594

Allocation of Sales in Two Markets to Maximize

Revenue 595

Profit Maximization with Third-Degree Price

Discrimination 598

14.5 Pricing Practices for Multiproduct Firms 603

Pricing Multiple Products Related in

Consumption 604

Bundling Multiple Products 607

14.6 Cost-Plus Pricing 610

Practical and Conceptual Shortcomings 611

14.7 Summary 615

Key Terms 616

Technical Problems 616

Applied Problems 619

Mathematical Appendix: Two-Part Pricing with two

Identical Groups of Buyers 623

Online Appendix 4: Pricing Multiple Products

Related in Production

CHAPTER 15 Decisions Under Risk and

Uncertainty 625

15.1 Distinctions Between Risk and Uncertainty 626

15.2 Measuring Risk with Probability

Distributions 627

Probability Distributions 627

Expected Value of a Probability Distribution 629

Dispersion of a Probability Distribution 629

15.3 Decisions Under Risk 632

Maximization of Expected Value 632

Mean–Variance Analysis 634

Coefficient of Variation Analysis 635

Which Rule Is Best? 635

15.4 Expected Utility: A Theory of Decision Making

Under Risk 637

A Manager’s Utility Function for Profit 638

Deriving a Utility Function for Profit 639

Maximization of Expected Utility 642

15.5 Decisions Under Uncertainty 645

The Maximax Criterion 645

The Maximin Criterion 647

The Minimax Regret Criterion 648

The Equal Probability Criterion 648

15.6 Summary 649

Key Terms 650

Technical Problems 651

Applied Problems 653

Mathematical Appendix: Decisions Under

Risk 655

CHAPTER 16 Government Regulation of

Business 656

16.1 Market Competition and Social Economic

Efficiency 658

Efficiency Conditions for Society 658

Social Economic Efficiency Under Perfect

Competition 659

16.2 Market Failure and the Case for Government

Intervention 662

16.3 Market Power and Public Policy 664

Market Power and Allocative Inefficiency 664

Market Power and Deadweight Loss 665

Promoting Competition through Antitrust

Policy 667

Natural Monopoly and Market Failure 668

Regulating Price Under Natural Monopoly 670

16.4 The Problem of Negative Externality 673

Pollution: Market Failure and Regulation 676

16.5 Nonexcludability 684

Common Property Resources 684

Public Goods 686

16.6 Information and Market Failure 688

Imperfect Information about Prices 688

Imperfect Information about Product Quality 689

Information as a Public Good 690

16.7 Summary 692

Key Terms 693

Technical Problems 694

Applied Problems 700

Web Chapter 1: The Investment Decision

APPENDIX: STATISTICAL TABLES 701

INDEX 705