Managerial Economics

1 Introduction To Economic Decision Making 1

Seven Examples of Managerial Decisions 2

Six Steps to Decision Making 4

Step 1: Define the Problem 5

Step 2: Determine the Objective 6

Step 3: Explore the Alternatives 6

Step 4: Predict the Consequences 7

Step 5: Make a Choice 8

Step 6: Perform Sensitivity Analysis 9

Private and Public Decisions: an Economic View 10

Public Decisions 12

Things to Come 13

2 Optimal Decisions Using Marginal Analysis 17

A Simple Model 18

A Microchip Manufacturer 19

Marginal Analysis 24

Marginal Analysis and Calculus 25

Marginal Revenue and Marginal Cost 27

Marginal Revenue 27

Marginal Cost 29

Profit Maximization Revisited 29

Sensitivity Analysis 31

Asking What If 32

Appendix to Chapter 2: Calculus and Optimization Techniques 42

Special Appendix to Chapter 2: Optimization Using Spreadsheets 50

3 Demand Analysis and Optimal Pricing 53

Determinants of Demand 54

The Demand Function 54

The Demand Curve and Shifting Demand 55

General Determinants of Demand 57

Elasticity of Demand 58

Price Elasticity 58

Factors Affecting Price Elasticity 61

Other Elasticities 61

Price Elasticity and Prediction 62

Demand Analysis and Optimal Pricing 63

Price Elasticity, Revenue, and Marginal Revenue 63

Maximizing Revenue 66

Optimal Markup Pricing 67

Price Discrimination 69

Information Goods 72

Appendix to Chapter 3: Consumer Preferences and Demand 84

4 Estimating and Forecasting Demand 90

Collecting Data 91

Consumer Surveys 91

Controlled Market Studies 92

Uncontrolled Market Data 93

Regression Analysis 94

Ordinary Least-Squares Regression 94

Interpreting Regression Statistics 100

Potential Problems in Regression 104

Forecasting 107

Time-Series Models 107

Fitting a Simple Trend 109

Barometric Models 115

Forecasting Performance 116

Final Thoughts 118

Appendix to Chapter 4: Regression Using Spreadsheets 129

Special Appendix to Chapter 4: Statistical Tables 133

5 Production 135

Basic Production Concepts 136

Production in the Short Run 136

Optimal Use of an Input 140

Production in the Long Run 142

Returns to Scale 142

Least-Cost Production 143

Measuring Production Functions 148

Linear Production 148

Production with Fixed Proportions 149

Polynomial Functions 149

The Cobb-Douglas Function 150

Other Production Decisions 151

Multiple Plants 151

Multiple Products 152

6 Cost Analysis 163

Relevant Costs 164

Opportunity Costs and Economic Profits 164

Fixed and Sunk Costs 167

The Cost of Production 169

Short-Run Costs 170

Long-Run Costs 173

Returns to Scale and Scope 177

Returns to Scale 177

Economies of Scope 181

Cost Analysis and Optimal Decisions 183

A Single Product 183

The Shut-Down Rule 184

Multiple Products 186

Appendix to Chapter 6: Transfer Pricing 195

7 Perfect Competition 198

The Basics of Supply and Demand 199

Shifts in Demand and Supply 201

Competitive Equilibrium 203

Decisions of the Competitive Firm 203

Market Equilibrium 206

Market Efficiency 208

Private Markets: Benefits and Costs 208

International Trade 215

Tariffs and Quotas 215

President Trump’s Tariffs 218

8 Monopoly 227

Pure Monopoly 228

Monopoly Behavior 228

Barriers to Entry 230

Perfect Competition versus Pure Monopoly 232

Cartels 234

Natural Monopolies 237

Monopolistic Competition 239

9 Oligopoly 248

Oligopoly 249

Five-Forces Framework 250

Industry Concentration 251

Concentration and Prices 255

Quantity Competition 257

A Dominant Firm 257

Competition among Symmetric Firms 257

Price Competition 261

Price Rigidity and Kinked Demand 261

Price Wars and the Prisoner’s Dilemma 262

Other Dimensions of Competition 267

Strategic Commitments 267

Advertising 269

Appendix to Chapter 9: Bundling and Tying 278

10 Game Theory and Competitive Strategy 282

Sizing Up Competitive Situations 283

Analyzing Payoff Tables 286

Equilibrium Strategies 288

Competitive Strategy 292

Market Entry 294

Bargaining 295

Sequential Competition 296

Repeated Competition 299

Appendix to Chapter 10: Mixed Strategies 312

11 Regulation, Public Goods, and Benefit-Cost Analysis 317

I. Market Failures and Regulation 318

Market Failure Due to Monopoly 318

Government Responses 319

Market Failure Due to Externalities 324

Remedying Externalities 326

Promoting Positive Externalities 330

Market Failure Due to Imperfect Information 332

II. Benefit-Cost Analysis and Public Goods Provision 333

Public Goods 333

Public Goods and Efficiency 333

The Basics of Benefit-Cost Analysis 335

Applying the Net Benefit Rule 335

Dollar Values 336

Efficiency versus Equity 336

Evaluating a Public Project 337

Public Investment in a Bridge 337

Valuing Benefits and Costs 339

Market Values 339

Nonmarketed Benefits and Costs 339

12 The Economics of Non-Profit Organizations 350

The World of Non-Profits 351

A Simple Model of the Non-Profit Firm 353

Production and Pricing 353

Potential Differences between Non-Profits and For-Profits 357

The Non-Profit’s Goal when the World is Uncertain 358

When do Non-Profits and For-Profits Take Identical Actions? 360

Appendix to Chapter 12: The Firm’s Long-Term Value 368

13 Decision Making Under Uncertainty 373

Uncertainty, Probability, and Expected Value 374

Probability 374

Expected Value 375

Decision Trees 376

An Oil Drilling Decision 377

Features of the Expected-Value Criterion 378

Sequential Decisions 382

Risk Aversion 388

Expected Utility 390

Why the Expected-Utility Method Works 392

Expected Utility and Risk Aversion 394

14 The Value of Information 404

The Value of Information 405

The Oil Wildcatter Revisited 405

Imperfect Information 406

Revising Probabilities 408

Bayes’ Theorem 409

Other Applications 411

Predicting Credit Risks 412

Business Behavior and Decision Pitfalls 414

Auctions and Competitive Bidding 417

Private-Value Auctions 418

Common-Value Auctions 419

Expected Auction Revenue 421

15 Asymmetric Information and Organizational Design 433

Asymmetric Information 434

Adverse Selection 434

Signaling 435

Principals, Agents, and Moral Hazard 436

Organizational Design 440

The Nature of the Firm 440

The Boundaries of the Firm 441

Assigning Decision-Making Responsibilities 442

Monitoring and Rewarding Performance 446

Separation of Ownership and Control in the Modern Corporation 449

16 Bargaining and Negotiation 460

The Economic Sources of Beneficial Agreements 461

Resolving Disputes 463

Differences in Values 465

Contingent Contracts 467

Multiple-Issue Negotiations 468

Negotiation Strategy 472

Perfect Information 473

Imperfect Information 474

Repetition and Reputation 475

17 Linear Programming 485

Linear Programs 486

Graphing the LP Problem 488

A Minimization Problem 490

Sensitivity Analysis and Shadow Prices 493

Changes in the Objective Function 493

Shadow Prices 495

Optimal Decisions and Shadow Prices 497

Formulation and Computer Solution for Larger LP Problems 499

Production Decisions 499

Computer Solutions 502

18 Auctions and Competitive Bidding Available Online

The Advantages of Auctions

Bidder Strategies

English and Dutch Auctions

Sealed-Bid Auctions

Common Values and the Winner’s Curse

Optimal Auctions

Expected Auction Revenue

Competitive Procurement

Index I-1