Managerial economics and business strategy 8th baye

CHAPTER ONE The Fundamentals of Managerial Economics 1 Headline: Amcott Loses $3.5 Million; Manager Fired 1Introduction 2 The Manager 3Economics 3Managerial Economics Defined 3The Econom

Managerial Economics

and

Business Strategy

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ISBN 978-0-07-352322-4 MHID 0-07-352322-4

new digital Offerings for your Managerial Economics Course!

Baye and Prince’s Managerial Economics and Business Strategy provides a complete solution

designed to help students use tools from intermediate microeconomics, game theory, and

industrial organization to make sound managerial decisions A range of print and digital formats

combined with frontier research, inclusion of modern topics, and balanced coverage of traditional

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New for this edition:

McGraw-Hill’s premier online assignment and assessment tool, Connect Plus ® , is now offered with the 8th edition Connect gives instructors the ability to assign and automatically grade literally hundreds of end-of-chapter problems (including algorithmic variants), and options to provide

students with immediate, detailed feedback and answers Connect Plus also offers an integrated

eBook, enabling anytime, anywhere access to the textbook.

• Available within Connect or standalone, LearnSmart is an adaptive learning tool that allows

students to continually test their mastery of basic and more complex concepts within each

chapter LearnSmart identifies what an individual student knows and doesn’t know, and helps

students learn faster, study more efficiently, and retain more knowledge.

• Each chapter contains many Demonstration Problems along with detailed answers One key

Demonstration Problem in each chapter now features an accompanying video tutorial, which

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To learn more about the resources available to you, visit www.mhhe.com/baye8e

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and Prince’s Managerial Economics and Business Strategy,

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The Eighth Edition of Baye and Prince includes many components specific to this product proven to increase

student success McGraw-Hill’s adaptive learning component, LearnSmart ™, provides assignable modules that help students master core concepts and come to class more prepared

Graphing Tools allow students to complete relevant graphing exercises and problems associated with the

end-of-chapter materials and then receive immediate feedback

Videos for selected Demonstration Problems provide an additional method for students to learn key

quantitative concepts These problems can be linked to through the ConnectPlus eBook, and also are on the text’s Online Learning Center

See the next two pages for more details on LearnSmart, the graphing tool, eBooks, and Tegrity lecture capture – all available with Connect Plus Economics!

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McGraw-Hill LearnSmart is an adaptive learning program that identifies what

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FEATURES

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Lecture Capture

eBooks

Connect Plus includes a media-rich eBook that allows you to share your notes with your students Your students can insert and review their own notes, highlight the text, search for specific information, and interact with media resources Using an eBook with Connect Plus gives your students a complete digital solution that allows them to access

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Videos of key Demonstration Problems are linked next to the applicable Demonstration Problems

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Make your classes available anytime, anywhere With simple, one-click recording, students can search for a word

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Managerial Economics and Business Strategy

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MANAGERIAL ECONOMICS AND BUSINESS STRATEGY

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Library of Congress Cataloging-in-Publication Data

Baye, Michael R.,

1958-Managerial economics and business strategy / Michael R Baye, Bert Elwert Professor of Business

Economics & Public Policy Kelley, School of Business, Indiana University, Jeffrey T Prince, Associate

Professor of Business Economic & Public Policy Kelly, School of Business, Indiana University.—

Eighth edition.

pages cm.—(The McGraw-Hill series economics)

Includes index.

ISBN-13: 978-0-07-352322-4 (alk.paper)

ISBN-10: 0-07-352322-4 (alk paper)

1 Managerial economics 2 Strategic planning I Prince, Jeffrey T II Title.

HD30.22.B38 2014

338.5024'658—dc23

2012048859 The Internet addresses listed in the text were accurate at the time of publication The inclusion of a website does

not indicate an endorsement by the authors or McGraw-Hill, and McGraw-Hill does not guarantee the accuracy

of the information presented at these sites.

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ABOUT THE AUTHORS

Michael R Baye is the Bert Elwert Professor of Business Economics & Public Policy

at Indiana University’s Kelley School of Business, and served as the Director

of the Bureau of Economics at the Federal Trade Commission from July 2007 toDecember 2008 He received his B.S in economics from Texas A&M University in

1980 and earned a Ph.D in economics from Purdue University in 1983 Prior tojoining Indiana University, he taught graduate and undergraduate courses at ThePennsylvania State University, Texas A&M University, and the University of Kentucky He has held a variety of editorial posts in economics, marketing, and

business, and currently serves as a co-editor for the Journal of Economics and

Management Strategy.

Professor Baye has won numerous awards for his outstanding teaching andresearch, and teaches courses in managerial economics and industrial organization atthe undergraduate, M.B.A., and Ph.D levels His research has been published in the

American Economic Review, Journal of Political Economy, Econometrica, the Review of Economic Studies, the Economic Journal, and Management Science It has

also been featured in the Wall Street Journal, Forbes, the New York Times, and

numerous other outlets When he is not teaching or engaged in research, Mike enjoysactivities ranging from camping to shopping for electronic gadgets

Jeffrey T Prince is Associate Professor of Business Economics & Public Policy at

Indiana University’s Kelley School of Business He received his B.A in economicsand B.S in mathematics and statistics from Miami University in 1998 and earned aPh.D in economics from Northwestern University in 2004 Prior to joining IndianaUniversity, he taught graduate and undergraduate courses at Cornell University

Professor Prince has won top teaching honors as a faculty member at both IndianaUniversity and Cornell, and as a graduate student at Northwestern He has a broadresearch agenda within applied economics, having written and published on topics thatinclude demand in technology markets, Internet diffusion, regulation in health care,risk aversion in insurance markets, and quality competition among airlines He is one

of a small number of economists to have published in both the top journal in

econom-ics (American Economic Review) and the top journal in management (Academy of

Management Journal) He currently serves on the editorial board for Information Economics and Policy In his free time, Jeff enjoys activities ranging from poker and

bridge to running and racquetball

PREFACE TO THE EIGHTH EDITION

Thanks to feedback from users around the world, Managerial Economics and

Busi-ness Strategy remains the best-selling managerial text in the market We are

grate-ful to all of you for allowing us to provide this updated and improved edition.Before highlighting some of the new features of the eighth edition, we would like tostress that the fundamental goal of the book—providing students with the toolsfrom intermediate microeconomics, game theory, and industrial organization that

they need to make sound managerial decisions—has not changed What has

changed is the examples used to make managerial economics come to life for thisgeneration of students and—thanks to the addition of Jeff Prince to this edition—

the utilization of new technologies (such as Connect) for enhancing the teaching

and learning experiences of instructors and their students

This book begins by teaching managers the practical utility of basic economictools such as present value analysis, supply and demand, regression, indifferencecurves, isoquants, production, costs, and the basic models of perfect competition,monopoly, and monopolistic competition Adopters and reviewers also praise thebook for its real-world examples and because it includes modern topics not contained

in any other single managerial economics textbook: oligopoly, penetration pricing,multistage and repeated games, foreclosure, contracting, vertical and horizontal inte-gration, networks, bargaining, predatory pricing, principal–agent problems, raisingrivals’ costs, adverse selection, auctions, screening and signaling, search, limit pric-ing, and a host of other pricing strategies for firms enjoying market power This bal-anced coverage of traditional and modern microeconomic tools makes it appropriatefor a wide variety of managerial economics classrooms An increasing number ofbusiness schools are adopting this book to replace (or use alongside) managerial strat-egy texts laden with anecdotes but lacking the microeconomic tools needed to iden-tify and implement the business strategies that are optimal in a given situation

This eighth edition of Managerial Economics and Business Strategy has been

revised to include updated examples and problems, but it retains all of the basiccontent that made previous editions a success The basic structure of the textbook isunchanged to ensure a smooth transition to this edition

KEY PEDAGOGICAL FEATURES

The eighth edition retains all of the class-tested features of previous editions thatenhance students’ learning experiences and make it easy to teach from this book Butthis edition includes a number of new features available to those using McGraw-Hill’s

wonderful interactive learning products, Connect and LearnSmart Connect offers

hundreds of variations of end-of-chapter problems that may be electronically gradedand provide students with immediate, detailed, feedback Students and instructors canaccess these and other powerful resources directly from their laptops, tablets andphones For more information, please refer to pp xiv–xvii of the preface

As in previous editions, each chapter begins with a Headline that is based on a

real-world economic problem—a problem that students should be able to address after

completing the chapter These Headlines are essentially hand-picked “mini-cases” designed to motivate students to learn the material in the chapter Each Headline is

answered at the end of the relevant chapter—when the student is better prepared todeal with the complications of real-world problems Reviewers as well as users of

previous editions praise the Headlines not only because they motivate students to

learn the material in the chapter, but also because the answers at the end of eachchapter help students learn how to use economics to make business decisions

Learning Objectives

Each chapter includes learning objectives designed to enhance the learning ence A listing is provided at the end of the chapter that identifies select end of chapter problems to the learning objective(s) to which they relate

experi-Demonstration Problems

The best way to learn economics is to practice solving economic problems So, in

addition to the Headlines, each chapter contains many Demonstration Problems

sprinkled throughout the text, along with detailed answers This provides studentswith a mechanism to verify that they have mastered the material, and reduces the cost

to students and instructors of having to meet during office hours to discuss answers toproblems One key demonstration problem in each chapter has an accompanyingvideo tutorial, which walks through the solution step-by-step These videos are available via the eBook included in Connect®Plus and the Online Learning Center,www.mhhe.com/baye8e For more information please refer to p xiv of the Preface

Inside Business Applications

Most chapters contain boxed material (called Inside Business applications) to

illus-trate how theories explained in the text relate to a host of different business tions As in previous editions, we have tried to strike a balance betweenapplications drawn from the current economic literature and the popular press

situa-Calculus and Non-situa-Calculus Alternatives

Users can easily include or exclude calculus-based material without losing content

or continuity That’s because the basic principles and formulae needed to solve a

particular class of economic problems (e.g., MR = MC) are first stated without

appealing to the notation of calculus Immediately following each stated principle

or formula is a clearly marked Calculus Alternative Each of these calculus

alterna-tives states the preceding principle or formula in calculus notation, and explains therelation between the calculus and non-calculus based formula More detailed calcu-

lus derivations are relegated to chapter Appendices Thus, the book is designed for

use by instructors who want to integrate calculus into managerial economics and bythose who do not require students to use calculus

Key Terms and Marginal Definitions

Each chapter ends with a list of key terms and concepts These provide an easy wayfor professors to glean material covered in each chapter, and for students to checktheir mastery of terminology In addition, marginal definitions are providedthroughout the text

End-of-Chapter Problems

Three types of problems are offered Highly structured but nonetheless challenging

Conceptual and Computational Questions stress fundamentals These are followed

by Problems and Applications, which are far less structured and, like real-world

deci-sion environments, may contain more information than is actually needed to solve theproblem Many of these applied problems are based on actual business events.Additionally, the Time Warner case that follows Chapter 14 includes 14 prob-lems called Memos that have a “real-world feel” and complement the text All ofthese case-based problems may be assigned on a chapter-by-chapter basis as spe-cific skills are introduced, or as part of a capstone experience Solutions to all of thememos are contained online at www.mhhe.com/baye8e

Detailed answers to all problems—including Problems and Applications and the Time Warner case Memos, are available to instructors on the password-pro-

tected website (www.mhhe.com/baye8e)

Case Study

A case study in business strategy—Challenges at Time Warner—follows Chapter

14 and was prepared especially for this text It can be used either as a capstone casefor the course or to supplement individual chapters The case allows students toapply core elements from managerial economics to a remarkably rich businessenvironment Instructors can use the case as the basis for an “open-ended” discus-sion of business strategy, or they can assign specific “memos” (contained at the end

of the case) that require students to apply specific tools from managerial economics

to the case Teaching notes, as well as solutions to all of the memos, are provided onthe book’s website

Flexibility

Instructors of managerial economics have genuinely heterogeneous textbook needs.Reviewers and users continue to praise the book for its flexibility, and they assure usthat sections or even entire chapters can be excluded without losing continuity Forinstance, an instructor wishing to stress microeconomic fundamentals might choose

to cover Chapters 2, 3, 4, 5, 8, 9, 10, 11, and 12 An instructor teaching a moreapplied course that stresses business strategy might choose to cover Chapters 1, 2, 3,

5, 6, 7, 8, 10, 11, and 13 Each may choose to include additional chapters (for ple, Chapter 14 or the Time Warner case) as time permits More generally, instructorscan easily omit topics such as present value analysis, regression, indifference curves,isoquants, or reaction functions without losing continuity

exam-CHANGES IN THE EIGHTH EDITION

We have made every effort to update and improve Managerial Economics and

Business Strategy while assuring a smooth transition to the eighth edition

Follow-ing is a summary of the pedagogical improvements, enhanced supplements, andcontent changes that make the eighth edition an even more powerful tool for teach-ing and learning managerial economics and business strategy

• McGraw-Hill’s homework management platform system, Connect®, is nowoffered for the eighth edition This allows students to access video tutorials forselected demonstration problems through an electronic version of the bookavailable in Connect®Plus, and gives instructors the ability to assign (andautomatically grade) literally hundreds of end-of-chapter problems (includingalgorithmic variants), and options to provide students with immediate,detailed feedback and answers In our experience, this allows both studentsand instructors to economize on the time required to set up one-on-oneappointments

• Also new to the eighth edition, LearnSmart is an adaptive learning tool thatallows students to continually test their mastery of basic and more complexconcepts

• Over 100 new variations of the class-tested problems from the previousedition plus several new end-of-chapter problems Where appropriate,problems from the previous edition have been updated to reflect the currenteconomic climate

• Suggested end-of-chapter problems for each learning objective, to helpfoster targeted learning

• The updated Test Bank has been rigorously quality tested, and now contains

over 100 new, challenging problems

• New and updated Headlines.

• New and updated Inside Business applications.

Chapter-by-Chapter Changes

• Chapter 1 contains new and updated examples, and an updated Inside Business

application It also contains twenty refreshed end-of-chapter problems

• Chapter 2 contains new and updated examples and Inside Business

applications This chapter has fourteen refreshed end-of-chapter problems

• Chapter 3 contains new and updated examples as well as an updated Inside

Business application It also has improved discussion of regression analysis.

This chapter has twenty refreshed end-of-chapter problems

• Chapter 4 contains updated examples, and two new Inside Business

applications; the first examines the relationship between the budget constraintand credit card usage, and the second examines output-oriented incentives Italso has two new and sixteen refreshed end-of-chapter problems

• Chapter 5 contains updated Inside Business applications, as well as a new

demonstration problem It also has sixteen refreshed end-of-chapter problems

• Chapter 6 offers a new Headline, and new examples It also has four new and

three refreshed end-of-chapter problems

• Chapter 7 contains thoroughly updated examples and industry data, as

well as updated Inside Business applications It also includes updates that account for the new 2010 Horizontal Merger Guidelines, and nine refreshed

end-of-chapter problems

• Chapter 8 contains an updated Headline and several new examples It also

has fifteen refreshed end-of-chapter problems

• Chapter 9 provides improved exposition of contestable markets, and a new

Inside Business application examining OPEC and the temptation to cheat on

collusive arrangements It also includes thirteen refreshed end-of-chapterproblems

• Chapter 10 contains a new Inside Business application examining cola wars

in India, as well as improved exposition of equilibrium strategies It also hassixteen refreshed end-of-chapter problems

• Chapter 11 contains an updated Headline, updated Inside Business

applications, and a new Inside Business application examining whether

price discrimination is necessarily bad for consumers There are fifteenrefreshed end-of-chapter problems

• Chapter 12 includes an improved explanation of the merits of standard

deviation as a measure of risk, and a new Inside Business application that

examines adverse selection in the context of a famous quote by GrouchoMarx It also has eleven refreshed end-of-chapter problems

• Chapter 13 contains a new Headline and new examples for commitment

mechanisms and network effects It also has eight refreshed end-of-chapterproblems

• Chapter 14 contains updated discussion of the 2010 Horizontal Merger

Guidelines, the Dodd-Frank Wall Street Reform and Consumer Protection Act, and updated Inside Business applications It also has seven refreshed

end-of-chapter problems

ORGANIZED LEARNING IN THE EIGHTH EDITION

Chapter Learning Objectives

Students and instructors can be confident that the organization of each chapter reflectscommon themes outlined by four to seven learning objectives listed on the first page of each chapter These objectives, along with AACSB and Bloom’s taxonomy learning categories, are connected to all end-of-chapter material and test bankquestions to offer a comprehensive and thorough teaching and learning experience

Assurance of Learning Ready

Many educational institutions today are focused on the notion of assurance of

learning, an important element of some accreditation standards Managerial nomics and Business Strategy is designed specifically to support your assurance of

Eco-learning initiatives with a simple, yet powerful solution

Each test bank question for Managerial Economics and Business Strategy

maps to a specific chapter learning outcome/objective listed in the text You can use

our test bank software, EZ Test, or Connect Economics to easily query for learning

outcomes/objectives that directly relate to the learning objectives for your course.You can then use the reporting features of EZ Test to aggregate student results insimilar fashion, making the collection and presentation of assurance of learningdata simple and easy

AACSB Statement

The McGraw-Hill Companies is a proud corporate member of AACSB

Interna-tional Understanding the importance and value of AACSB accreditation,

Manage-rial Economics and Business Strategy, Eighth edition, recognizes the curricula

guidelines detailed in the AACSB standards for business accreditation by ing questions in the test bank and end-of-chapter material to the general knowledgeand skill guidelines found in the AACSB standards

connect-The statements contained in Managerial Economics and Business Strategy,

Eighth edition, are provided only as a guide for the users of this textbook TheAACSB leaves content coverage and assessment within the purview of individualschools, the mission of the school, and the faculty

SUPPLEMENTS FOR THE INSTRUCTOR

We are pleased to report that the eighth edition of Managerial Economics and

Busi-ness Strategy truly offers adopters the most comprehensive and easily accessible

supplements in the market Below we discuss popular features of some of the plements that have been greatly expanded for this edition The following ancillariesare available for quick download and convenient access via the book website atwww.mhhe.com/baye8e and are password protected for security

sup-Cases

In addition to the Time Warner case, nearly a dozen full-length cases were prepared

to accompany Managerial Economics and Business Strategy These cases

comple-ment the textbook by showing how real-world businesses use tools like demandelasticities, markup pricing, third-degree price discrimination, bundling, Herfindahlindices, game theory, and predatory pricing to enhance profits or shape businessstrategies The cases are based on actual decisions by companies that includeMicrosoft, Heinz, Visa, Staples, American Airlines, Sprint, and Kodak Expandedteaching notes and solutions for all of the cases—including the Time Warner case—are also provided

PowerPoint Slides

Thoroughly updated and fully editable PowerPoint presentations with animated ures and graphs, prepared by Patrick Scholten of Bentley University, make teachingand learning a snap For instance, a simple mouse click reveals the firm’s demandcurve Another click reveals the associated marginal revenue curve Another clickshows the firm’s marginal cost A few more clicks, and students see how to determinethe profit-maximizing output, price, and maximum profits Animated graphs and tablesare also provided for all other relevant concepts (like Cournot and Stackelberg equilib-rium, normal form and extensive form games, and the like)

Computerized Test Bank

McGraw-Hill’s EZ Test is a flexible and easy-to-use electronic testing program thatallows you to create tests from book-specific items, customized to your needs Itaccommodates a wide range of question types, and you can add your own questions.Multiple versions of the test can be created, and any test can be exported for use withcourse management systems such as BlackBoard EZ Test Online gives you a place

to administer your EZ-Test created exams and quizzes online The program is able for Windows and Macintosh environments

avail-Digital Image Library

All the figures and tables presented in the book have been made available in tronic format, providing flexibility to integrate art from the textbook into Power-Point presentations, or to directly print the figures on overhead transparencies

elec-SUPPLEMENTS FOR THE STUDENT

Study Guide

We have prepared a study guide that offers a wealth of additional resources to masterthe course The study guide includes a study outline, a review of key concepts, a vari-ety of questions for additional practice, and the solutions to the questions so you cancheck your answers

Online Learning Center www.mhhe.com/baye8e

The book website is a central resource for students and instructors alike Students canaccess a glossary, Time Warner Case Study materials, data for key chapters, InsideBusiness assets, chapter overviews, and PowerPoint presentations Students can alsotest their knowledge of chapter concepts with auto-gradable practice quizzes

MCGRAW-HILL CONNECT ® ECONOMICS

Less Managing More Teaching Greater Learning

McGraw-Hill Connect ® Economics is an online

assignment and assessment solution that connectsstudents with the tools and resources they’ll need toachieve success

McGraw-Hill Connect Economics helps prepare

students for their future by enabling faster learning, more efficient studying, andhigher retention of knowledge

McGraw-Hill Connect ® Economics features

Connect Economics offers a number of powerful

tools and features to make managing assignmentseasier, so faculty can spend more time teaching

With Connect Economics, students can engage

with their coursework anytime and anywhere, making the learning process more

accessible and efficient Connect Economics offers the features described here.

Simple assignment management

With Connect Economics, creating assignments is easier than ever, so you can spend

more time teaching and less time managing The assignment management functionenables you to:

• Create and deliver assignments easily with selectable end-of-chapterquestions and test bank items

• Streamline lesson planning, student progress reporting, and assignmentgrading to make classroom management more efficient than ever

• Go paperless with the eBook and online submission and grading of studentassignments

Smart grading

When it comes to studying, time is precious Connect Economics helps students

learn more efficiently by providing feedback and practice material when they need

it, where they need it When it comes to teaching, your time also is precious Thegrading function enables you to:

• Have assignments scored automatically, giving students immediate feedback

on their work and side-by-side comparisons with correct answers

• Access and review each response; manually change grades or leave commentsfor students to review.

• Reinforce classroom concepts with practice tests and instant quizzes

Instructor library

The Connect Economics Instructor Library is your repository for additional

resources to improve student engagement in and out of class You can select and useany asset that enhances your lecture

Student study center

The Connect Economics Student Study Center is the place for students to access

additional resources The Student Study Center:

• Offers students quick access to lectures, practice materials, eBooks, and more

• Provides instant practice material and study questions, easily accessible onthe go

Diagnostic and adaptive learning of concepts: LearnSmart

Students want to make the best use of their study time The LearnSmart adaptive

self-study technology within Connect Economics provides students with a seamless

combination of practice, assessment, and remediation for every concept in the book LearnSmart’s intelligent software adapts to every student response and auto-matically delivers concepts that advance the student’s understanding whilereducing time devoted to the concepts already mastered The result for every stu-dent is the fastest path to mastery of the chapter concepts LearnSmart:

text-• Applies an intelligent concept engine to identify the relationships betweenconcepts and to serve new concepts to each student only when he or she isready

• Adapts automatically to each student, so students spend less time on the topicsthey understand and practice more those they have yet to master

• Provides continual reinforcement and remediation, but gives only as muchguidance as students need

• Integrates diagnostics as part of the learning experience

• Enables you to assess which concepts students have efficiently learned ontheir own, thus freeing class time for more applications and discussion

Student progress tracking

Connect Economics keeps instructors informed about how each student, section,

and class is performing, allowing for more productive use of lecture and officehours The progress-tracking function enables you to:

• View scored work immediately and track individual or group performancewith assignment and grade reports

• Access an instant view of student or class performance relative to learningobjectives.

• Collect data and generate reports required by many accreditationorganizations, such as AACSB and AICPA

• Record and distribute your lecture with a click of a button

• Record and index PowerPoint presentations and anything shown on yourcomputer so it is easily searchable, frame by frame

• Offer access to lectures anytime and anywhere by computer, iPod, or mobiledevice

• Increase intent listening and class participation by easing students’ concernsabout note-taking Lecture Capture will make it more likely you will seestudents’ faces, not the tops of their heads

MCGRAW-HILL CONNECT ® PLUS ECONOMICS

McGraw-Hill reinvents the textbook learning

experience for the modern student with Connect®

Plus Economics A seamless integration of an

eBook and Connect Economics, Connect Plus

Economics provides all of the Connect Economics features plus the following:

• An integrated eBook, allowing for anytime, anywhere access to the textbook

• Dynamic links between the problems or questions you assign to your studentsand the location in the eBook where that problem or question is covered

• A powerful search function to pinpoint and connect key concepts in a snap

In short, Connect Economics offers you and your students powerful tools and

fea-tures that optimize your time and energies, enabling you to focus on course content,

teaching, and student learning Connect Economics also offers a wealth of content

resources for both instructors and students This state-of-the-art, thoroughly testedsystem supports you in preparing students for the world that awaits

For more information about Connect, please visit www.mcgrawhillconnect.com,

or contact your local McGraw-Hill sales representative

TEGRITY CAMPUS: LECTURES 24/7

Tegrity Campus is a service that makesclass time available 24/7 by automaticallycapturing every lecture in a searchable for-mat for students to review when they studyand complete assignments With a simple one-click start-and-stop process, you cap-ture all computer screens and corresponding audio Students can replay any part ofany class with easy-to-use browser-based viewing on a PC or Mac

Educators know that the more students can see, hear, and experience classresources, the better they learn In fact, studies prove it With Tegrity Campus, stu-dents quickly recall key moments by using Tegrity Campus’s unique search feature.This search helps students efficiently find what they need, when they need it, across

an entire semester of class recordings Help turn all your students’ study time intolearning moments immediately supported by your lecture

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BRIEF CONTENTS

Chapter 1 The Fundamentals of Managerial Economics 1

Chapter 2 Market Forces: Demand and Supply 37

Chapter 3 Quantitative Demand Analysis 77

Chapter 4 The Theory of Individual Behavior 123

Chapter 5 The Production Process and Costs 163

Chapter 6 The Organization of the Firm 210

Chapter 7 The Nature of Industry 245

Chapter 8 Managing in Competitive, Monopolistic,

and Monopolistically Competitive Markets 274

Chapter 9 Basic Oligopoly Models 325

Chapter 10 Game Theory: Inside Oligopoly 364

Chapter 11 Pricing Strategies for Firms with Market Power 409

Chapter 12 The Economics of Information 447

Chapter 13 Advanced Topics in Business Strategy 487

Chapter 14 A Manager’s Guide to Government in the

Marketplace 523

Case Study Challenges at Time Warner 562Appendix Additional Readings and References 598Name Index 616

General Index 621

xxi

CHAPTER ONE

The Fundamentals of Managerial Economics 1

Headline: Amcott Loses $3.5 Million; Manager Fired 1Introduction 2

The Manager 3Economics 3Managerial Economics Defined 3The Economics of Effective Management 4Identify Goals and Constraints 4

Recognize the Nature and Importance of Profits 5Economic versus Accounting Profits 5

The Role of Profits 6The Five Forces Framework and Industry Profitability 8Understand Incentives 11

Understand Markets 12Consumer–Producer Rivalry 13Consumer–Consumer Rivalry 13Producer–Producer Rivalry 13Government and the Market 13Recognize the Time Value of Money 14Present Value Analysis 14

Present Value of Indefinitely Lived Assets 16Use Marginal Analysis 19

Discrete Decisions 20Continuous Decisions 22Incremental Decisions 24Learning Managerial Economics 25Answering the Headline 26

Key Terms and Concepts 26End-of-Chapter Problems by Learning Objective 27Conceptual and Computational Questions 27Problems and Applications 29

Connect Exercises 33Case-Based Exercises 34Selected Readings 34Appendix: The Calculus of Maximizing Net Benefits 34Inside Business 1–1: The Goals of Firms in Our Global Economy 7

xxii

Inside Business 1–2: Profits and the Evolution of the Computer Industry 11Inside Business 1–3: Joining the Jet Set 19

CHAPTER TWO

Market Forces: Demand and Supply 37

Headline: Samsung and Hynix Semiconductor to Cut Chip Production 37Introduction 38

Demand 38Demand Shifters 40Income 41Prices of Related Goods 42Advertising and Consumer Tastes 42Population 43

Consumer Expectations 43Other Factors 44

The Demand Function 44Consumer Surplus 46Supply 48

Supply Shifters 48Input Prices 49Technology or Government Regulations 49Number of Firms 49

Substitutes in Production 49Taxes 50

Producer Expectations 51The Supply Function 51Producer Surplus 53Market Equilibrium 54Price Restrictions and Market Equilibrium 56Price Ceilings 57

Price Floors 61Comparative Statics 62Changes in Demand 62Changes in Supply 64Simultaneous Shifts in Supply and Demand 64Answering the Headline 67

Summary 68Key Terms and Concepts 68End-of-Chapter Problems by Learning Objective 69Conceptual and Computational Questions 69Problems and Applications 71

Connect Exercises 75Case-Based Exercises 75Selected Readings 75

Inside Business 2–1: Asahi Breweries Ltd and the Asian Recession 41Inside Business 2–2: The Trade Act of 2002, NAFTA, and the Supply Curve 49Inside Business 2–3: Unpopular Equilibrium Prices 56

Inside Business 2–4: Price Ceilings and Price Floors around the Globe 60Inside Business 2–5: Globalization and the Supply of Automobiles 64Inside Business 2–6: Using a Spreadsheet to Calculate Equilibrium in the Supply and Demand Model 65

CHAPTER THREE

Quantitative Demand Analysis 77

Headline: Winners of Wireless Auction to Pay $7 Billion 77Introduction 78

The Elasticity Concept 78Own Price Elasticity of Demand 79Elasticity and Total Revenue 80Factors Affecting the Own Price Elasticity 84Available Substitutes 85

Time 86Expenditure Share 86Marginal Revenue and the Own Price Elasticity of Demand 87Cross-Price Elasticity 89

Income Elasticity 92Other Elasticities 94Obtaining Elasticities from Demand Functions 94Elasticities for Linear Demand Functions 95Elasticities for Nonlinear Demand Functions 96Regression Analysis 99

Evaluating the Statistical Significance of Estimated Coefficients 102Confidence Intervals 103

The t-Statistic 103Evaluating the Overall Fit of the Regression Line 104

The R-Square 104

The F-Statistic 106Regression for Nonlinear Functions and Multiple Regression 106Regression for Nonlinear Functions 106

Multiple Regression 108

A Caveat 111Answering the Headline 111Summary 113

Key Terms and Concepts 113End-of-Chapter Problems by Learning Objective 114Conceptual and Computational Questions 114Problems and Applications 117

Connect Exercises 121Case-Based Exercises 121

Selected Readings 121Inside Business 3–1: Calculating and Using the Arc Elasticity: An Application to theHousing Market 84

Inside Business 3–2: Inelastic Demand for Prescription Drugs 88Inside Business 3–3: Using Cross-Price Elasticities to Improve New Car Sales in theWake of Increasing Gasoline Prices 91

Inside Business 3–4: Shopping Online in Europe: Elasticities of Demand for PersonalDigital Assistants Based on Regression Techniques 107

CHAPTER FOUR

The Theory of Individual Behavior 123

Headline: Packaging Firm Uses Overtime Pay to Overcome Labor Shortage 123Introduction 124

Consumer Behavior 124Constraints 128

The Budget Constraint 129Changes in Income 131Changes in Prices 133Consumer Equilibrium 134Comparative Statics 135Price Changes and Consumer Behavior 135Income Changes and Consumer Behavior 138Substitution and Income Effects 140

Applications of Indifference Curve Analysis 141Choices by Consumers 141

Buy One, Get One Free 141Cash Gifts, In-Kind Gifts, and Gift Certificates 142Choices by Workers and Managers 145

A Simplified Model of Income–Leisure Choice 145The Decisions of Managers 147

The Relationship between Indifference Curve Analysis and Demand Curves 149Individual Demand 150

Market Demand 151Answering the Headline 152Summary 153

Key Terms and Concepts 153End-of-Chapter Problems by Learning Objective 154Conceptual and Computational Questions 154Problems and Applications 157

Connect Exercises 160Case-Based Exercises 161Selected Readings 161Appendix: A Calculus Approach to Individual Behavior 161Inside Business 4–1: Indifference Curves and Risk Preferences 128Inside Business 4–2: The Budget Constraints and Credit Cards 132

Inside Business 4–3: Price Changes and Inventory Management for MultiproductFirms 136

Inside Business 4–4: Income Effects and the Business Cycle 139Inside Business 4–5: The “Deadweight Loss” of In-Kind Gifts 146Inside Business 4–6: Public Health Centers and Output Oriented Incentives 149

CHAPTER FIVE

The Production Process and Costs 163

Headline: Boeing Loses the Battle but Wins the War 163Introduction 164

The Production Function 164Short-Run versus Long-Run Decisions 164Measures of Productivity 166

Total Product 166Average Product 166Marginal Product 166The Role of the Manager in the Production Process 168Produce on the Production Function 168

Use the Right Level of Inputs 169Algebraic Forms of Production Functions 172Algebraic Measures of Productivity 173Isoquants 175

Isocosts 178Cost Minimization 179Optimal Input Substitution 181The Cost Function 183

Short-Run Costs 184Average and Marginal Costs 186Relations among Costs 188Fixed and Sunk Costs 189Algebraic Forms of Cost Functions 190Long-Run Costs 191

Economies of Scale 193

A Reminder: Economic Costs versus Accounting Costs 194Multiple-Output Cost Functions 195

Economies of Scope 195Cost Complementarity 195Answering the Headline 198Summary 198

Key Terms and Concepts 199End-of-Chapter Problems by Learning Objective 199Conceptual and Computational Questions 200Problems and Applications 202

Connect Exercises 206Case-Based Exercises 207

Selected Readings 207Appendix: The Calculus of Production and Costs 207Inside Business 5–1: Where Does Technology Come From? 171Inside Business 5–2: Fringe Benefits and Input Substitution 184Inside Business 5–3: Estimating Production Functions, Cost Functions, and Returns

to Scale 192Inside Business 5–4: International Companies Exploit Economies of Scale 194

CHAPTER SIX

The Organization of the Firm 210

Headline: Google Buys Motorola Mobility to Vertically Integrate 210Introduction 211

Methods of Procuring Inputs 212Purchase the Inputs Using Spot Exchange 212Acquire Inputs Under a Contract 213

Produce the Inputs Internally 213Transaction Costs 214

Types of Specialized Investments 215Site Specificity 215

Physical-Asset Specificity 215Dedicated Assets 215

Human Capital 216Implications of Specialized Investments 216Costly Bargaining 216

Underinvestment 216Opportunism and the “Hold-Up Problem” 217Optimal Input Procurement 218

Spot Exchange 218Contracts 220Vertical Integration 223The Economic Trade-Off 224Managerial Compensation and the Principal–Agent Problem 227Forces That Discipline Managers 229

Incentive Contracts 229External Incentives 230Reputation 230Takeovers 230The Manager–Worker Principal–Agent Problem 231Solutions to the Manager–Worker Principal–Agent Problem 231Profit Sharing 231

Revenue Sharing 231Piece Rates 232Time Clocks and Spot Checks 232Answering the Headline 234

Summary 234

Key Terms and Concepts 234End-of-Chapter Problems by Learning Objective 235Conceptual and Computational Questions 235Problems and Applications 237

Connect Exercises 240Case-Based Exercises 241Selected Readings 241Appendix: An Indifference Curve Approach to Managerial Incentives 241Inside Business 6–1: The Cost of Using an Inefficient Method of

Procuring Inputs 218Inside Business 6–2: Factors Affecting the Length of Coal and Natural-Gas Contracts 222Inside Business 6–3: The Evolution of Input Decisions in the Automobile Industry 225Inside Business 6–4: Paying for Performance 233

CHAPTER SEVEN

The Nature of Industry 245

Headline: Microsoft Puts Halt to Intuit Merger 245Introduction 246

Market Structure 246Firm Size 246Industry Concentration 247Measures of Industry Concentration 248The Concentration of U.S Industry 249Limitations of Concentration Measures 251Technology 253

Demand and Market Conditions 253Potential for Entry 255

Conduct 256Pricing Behavior 257Integration and Merger Activity 258Vertical Integration 259

Horizontal Integration 259Conglomerate Mergers 260Research and Development 260Advertising 261

Performance 261Profits 261Social Welfare 261The Structure–Conduct–Performance Paradigm 263The Causal View 263

The Feedback Critique 263Relation to the Five Forces Framework 264Overview of the Remainder of the Book 264Perfect Competition 265

Monopoly 265

Monopolistic Competition 265Oligopoly 265

Answering the Headline 267Summary 267

Key Terms and Concepts 268End-of-Chapter Problems by Learning Objective 268Conceptual and Computational Questions 269Problems and Applications 270

Connect Exercises 273Case-Based Exercises 273Selected Readings 273Inside Business 7–1: The 2012 North American Industry Classification System(NAICS) 252

Inside Business 7–2: The Elasticity of Demand at the Firm and Market Levels 256Inside Business 7–3: The Evolution of Market Structure in the Computer Industry 266

CHAPTER EIGHT

Managing in Competitive, Monopolistic, and Monopolistically Competitive Markets 274

Headline: McDonald’s New Buzz: Specialty Coffee 274Introduction 275

Perfect Competition 275Demand at the Market and Firm Levels 276Short-Run Output Decisions 277

Maximizing Profits 277Minimizing Losses 281The Short-Run Firm and Industry Supply Curves 284Long-Run Decisions 285

Monopoly 287Monopoly Power 288Sources of Monopoly Power 289Economies of Scale 289Economies of Scope 290Cost Complementarity 291Patents and Other Legal Barriers 291Maximizing Profits 292

Marginal Revenue 292The Output Decision 296The Absence of a Supply Curve 299Multiplant Decisions 299

Implications of Entry Barriers 301Monopolistic Competition 303Conditions for Monopolistic Competition 303Profit Maximization 304

Long-Run Equilibrium 306Implications of Product Differentiation 309

Optimal Advertising Decisions 310Answering the Headline 312Summary 312

Key Terms and Concepts 313End-of-Chapter Problems by Learning Objective 313Conceptual and Computational Questions 314Problems and Applications 317

Connect Exercises 321Case-Based Exercises 321Selected Readings 321Appendix: The Calculus of Profit Maximization 322Appendix: The Algebra of Perfectly Competitive Supply Functions 323Inside Business 8–1: Peugeot-Citroën of France: A Price-Taker in China’s AutoMarket 283

Inside Business 8–2: Patent, Trademark, and Copyright Protection 293Inside Business 8–3: Product Differentiation, Cannibalization, and Colgate’s Smile 306

CHAPTER NINE

Basic Oligopoly Models 325

Headline: Crude Oil Prices Fall, but Consumers in Some Areas See

No Relief at the Pump 325Introduction 326

Conditions for Oligopoly 326The Role of Beliefs and Strategic Interaction 326Profit Maximization in Four Oligopoly Settings 328Sweezy Oligopoly 328

Cournot Oligopoly 330Reaction Functions and Equilibrium 330Isoprofit Curves 336

Changes in Marginal Costs 338Collusion 340

Stackelberg Oligopoly 342Bertrand Oligopoly 346Comparing Oligopoly Models 348Cournot 348

Stackelberg 349Bertrand 349Collusion 349Contestable Markets 351Answering the Headline 352Summary 353

Key Terms and Concepts 354End-of-Chapter Problems by Learning Objective 354Conceptual and Computational Questions 354

Problems and Applications 357Connect Exercises 360

Case-Based Exercises 361Selected Readings 361Appendix: Differentiated-Product Bertrand Oligopoly 361Inside Business 9–1: OPEC Members Can’t Help but Cheat 342Inside Business 9–2: Commitment in Stackelberg Oligopoly 344Inside Business 9–3: Price Competition and the Number of Sellers: Evidence fromOnline and Laboratory Markets 347

Inside Business 9–4: Using a Spreadsheet to Calculate Cournot, Stackelberg, andCollusive Outcomes 350

CHAPTER TEN

Game Theory: Inside Oligopoly 364

Headline: US Airways Brings Back Complimentary Drinks 364Introduction 365

Overview of Games and Strategic Thinking 365Simultaneous-Move, One-Shot Games 366Theory 366

Applications of One-Shot Games 369Pricing Decisions 369

Advertising and Quality Decisions 372Coordination Decisions 373

Monitoring Employees 374Nash Bargaining 376Infinitely Repeated Games 377Theory 377

Review of Present Value 378Supporting Collusion with Trigger Strategies 378Factors Affecting Collusion in Pricing Games 381Number of Firms 381

Firm Size 382History of the Market 382Punishment Mechanisms 383

An Application of Infinitely Repeated Games to Product Quality 383Finitely Repeated Games 384

Games with an Uncertain Final Period 384Repeated Games with a Known Final Period: The End-of-Period Problem 387Applications of the End-of-Period Problem 389

Resignations and Quits 389The “Snake-Oil” Salesman 389Multistage Games 390

Theory 390Applications of Multistage Games 393The Entry Game 393

Innovation 394Sequential Bargaining 395Answering the Headline 398Summary 398

Key Terms and Concepts 399End-of-Chapter Problems by Learning Objective 399Conceptual and Computational Questions 400Problems and Applications 403

Connect Exercises 408Case-Based Exercises 408Selected Readings 408Inside Business 10–1: Hollywood’s (not so) Beautiful Mind: Nash or “Opie”

Equilibrium? 370Inside Business 10–2: Cola Wars in India 372Inside Business 10–3: Trigger Strategies in the Waste Industry 382Inside Business 10–4: Entry Strategies in International Markets: Sprinkler orWaterfall? 394

CHAPTER ELEVEN

Pricing Strategies for Firms with Market Power 409

Headline: Mickey Mouse Lets You Ride “for Free” at Disney World 409Introduction 410

Basic Pricing Strategies 410Review of the Basic Rule of Profit Maximization 410

A Simple Pricing Rule for Monopoly and Monopolistic Competition 411

A Simple Pricing Rule for Cournot Oligopoly 414Strategies That Yield Even Greater Profits 416Extracting Surplus from Consumers 416Price Discrimination 416

Two-Part Pricing 422Block Pricing 424Commodity Bundling 426Pricing Strategies for Special Cost and Demand Structures 429Peak-Load Pricing 429

Cross-Subsidies 430Transfer Pricing 431Pricing Strategies in Markets with Intense Price Competition 433Price Matching 434

Inducing Brand Loyalty 435Randomized Pricing 436Answering the Headline 437Summary 438

Key Terms and Concepts 439End-of-Chapter Problems by Learning Objective 439Conceptual and Computational Questions 439

Problems and Applications 442Connect Exercises 445

Case-Based Exercises 445Selected Readings 445Inside Business 11–1: Pricing Markups as Rules of Thumb 412Inside Business 11–2: Is Price Discrimination Bad for Consumers? 417Inside Business 11–3: Bundling and “Price Frames” in Online Markets 428Inside Business 11–4: The Prevalence of Price-Matching Policies and Other Low-Price Guarantees 435

Inside Business 11–5: Randomized Pricing in the Airline Industry 437

CHAPTER TWELVE

The Economics of Information 447

Headline: Firm Chickens Out in the FCC Spectrum Auction 447Introduction 448

The Mean and the Variance 448Uncertainty and Consumer Behavior 451Risk Aversion 451

Managerial Decisions with Risk-Averse Consumers 451Consumer Search 453

Uncertainty and the Firm 456Risk Aversion 456

Producer Search 460Profit Maximization 460Uncertainty and the Market 462Asymmetric Information 462Adverse Selection 463Moral Hazard 465Signaling and Screening 466Auctions 468

Types of Auctions 469English Auction 469First-Price, Sealed-Bid Auction 469Second-Price, Sealed-Bid Auction 470Dutch Auction 470

Information Structures 471Independent Private Values 471Correlated Value Estimates 472Optimal Bidding Strategies for Risk-Neutral Bidders 472Strategies for Independent Private Values Auctions 473Strategies for Correlated Values Auctions 475

Expected Revenues in Alternative Types of Auctions 477Answering the Headline 479

Summary 479Key Terms and Concepts 480

End-of-Chapter Problems by Learning Objective 480Conceptual and Computational Questions 480Problems and Applications 483

Connect Exercises 486Case-Based Exercises 486Selected Readings 486Inside Business 12–1: Risk Aversion and the Value of Selling the Firm: The

St Petersburg Paradox 452Inside Business 12–2: The Value of Information in Online Markets 457Inside Business 12–3: Groucho Marx the Economist? 464

Inside Business 12–4: Second-Price Auctions on eBay 470Inside Business 12–5: Auctions with Risk-Averse Bidders 478

CHAPTER THIRTEEN

Advanced Topics in Business Strategy 487

Headline: Local Restaurateur Faces Looming Challenge from Morton’s 487Introduction 488

Limit Pricing to Prevent Entry 489Theoretical Basis for Limit Pricing 489Limit Pricing May Fail to Deter Entry 491Linking the Preentry Price to Postentry Profits 492Commitment Mechanisms 492

Learning Curve Effects 493Incomplete Information 494Reputation Effects 494Dynamic Considerations 495Predatory Pricing to Lessen Competition 497Raising Rivals’ Costs to Lessen Competition 500Strategies Involving Marginal Cost 500Strategies Involving Fixed Costs 501Strategies for Vertically Integrated Firms 502Vertical Foreclosure 503

The Price–Cost Squeeze 503Price Discrimination as a Strategic Tool 503Changing the Timing of Decisions or the Order of Moves 504First-Mover Advantages 504

Second-Mover Advantages 507Penetration Pricing to Overcome Network Effects 507What Is a Network? 508

Network Externalities 509First-Mover Advantages Due to Consumer Lock-In 510Using Penetration Pricing to “Change the Game” 512Answering the Headline 513

Summary 514Key Terms and Concepts 514End-of-Chapter Problems by Learning Objective 514

Conceptual and Computational Questions 515Problems and Applications 518

Connect Exercises 521Case-Based Exercises 521Selected Readings 521Inside Business 13–1: Business Strategy at Microsoft 490Inside Business 13–2: U.S Steel Opts against Limit Pricing 497Inside Business 13–3: First to Market, First to Succeed? Or First to Fail? 506Inside Business 13–4: Network Externalities and Penetration Pricing by Yahoo!Auctions 511

CHAPTER FOURTEEN

A Manager’s Guide to Government in the Marketplace 523

Headline: FTC Conditionally Approves $10.3 Billion Merger 523Introduction 524

Market Failure 524Market Power 524Antitrust Policy 525Price Regulation 529Externalities 534The Clean Air Act 535Public Goods 538Incomplete Information 542Rules against Insider Trading 543Certification 543

Truth in Lending 544Truth in Advertising 545Enforcing Contracts 545Rent Seeking 547

Government Policy and International Markets 548Quotas 548

Tariffs 550Lump-Sum Tariffs 550Excise Tariffs 551Answering the Headline 552Summary 553

Key Terms and Concepts 553End-of-Chapter Problems by Learning Objective 553Conceptual and Computational Questions 554Problems and Applications 557

Connect Exercises 560Case-Based Exercises 560Selected Readings 560Inside Business 14–1: European Commission Asks Airlines to Explain PriceDiscrimination Practices 528

Inside Business 14–2: Electricity Deregulation 533Inside Business 14–3: Canada’s Competition Bureau 546

CASE STUDY

Challenges at Time Warner 562

Important Note about the Case 561Headline 562

Background 563Overview of the Industry and Time Warner’s Operations 564America Online 564

Market Conditions 565AOL Operations 566AOL Europe 567Filmed Entertainment 567Motion Picture Production and Distribution 568The Film Industry 568

Competition 570Television Programming 571Home Video Distribution 571Publishing 571

Magazine Publishing 572Magazines Online 573Book Publishing 573Programming Networks 574Cable Systems 575

Analog and Digital Cable TV 575High-Speed Internet Service 576Telephone Service 576

Competition 577Direct Broadcast Satellite Operators 577Overbuilders 577

Bundling 578Regulatory Considerations 579Technological Considerations 579High-Definition Television (HDTV) 579Digital Video Recorders (DVRs) 580Challenges 581

Case-Based Exercises 581Memos 581

Selected Readings and References 590Appendix: Exhibits 592

Appendix Additional Readings and References 598

Name Index 616

General Index 621