MANAGERIAL ECONOMICS

S I X T H E D I T I O N

I n t e r n a t i o n a l S t u d e n t V e r s i o n

Will iam F. Samuelson Boston University

Stephen G. Marks Boston University

WILEY

JOHN WILEY & SONS, INC.

Contents

CHAPTER 1 Economic Decisions i SEVEN EXAMPLES OF MANAGERIAL DECISIONS 2

SIX STEPS TO DECISION MAKING 6

Step 1: Define the Problem 6

Step 2: Determine the Objective 8

Step 3: Explore the Alternatives 9

Step 4: Predict the Consequences 10

Step 5: Make a Choice 11

Step 6: Perform Sensitivity Analysis 12

PRIVATE AND PUBLIC DECISIONS:

AN ECONOMIC VIEW 13

THINGS TO COME 16

The Aim of This Book 18

SECTION I: Decisions w i t h i n Firms 23

CHAPTER 2 Profit Maximization 25 Siting a Shopping Mall 26

A SIMPLE MODEL OF THE FIRM 28

A Microchip Manufacturer 29

MARGINAL ANALYSIS 36

Marginal Analysis and Calculus 38

MARGINAL REVENUE AND MARGINAL COST 40

Marginal Revenue 42

Marginal Cost 43

Profit Maximization Revisited 43

SENSITIVITY ANALYSIS 46

Asking What if 46

APPENDDC TO CHAPTER 2: CALCULUS

AND OPTIMIZATION TECHNIQUES 59

SPECIAL APPENDIX TO CHAPTER 2: OPTIMIZATION USING SPREADSHEETS 70

xiv Contents

CHAPTER 3 Demand Analysis 71

DETERMINANTS OF DEMAND 75

The Demand Function 75

The Demand Curve and Shitting Demand 77

General Determinants of Demand 79

ELASTICITY OF DEMAND 80

Price Elasticity 80

Other Elasticities 85

Price Elasticity and Prediction 87

DEMAND ANALYSIS AND OPTIMAL PRICING 88

Price Elasticity, Revenue, and Marginal Revenue 88

Maximizing Revenue 91

Optimal Markup Pricing 93

Price Discrimination 96

Information Goods 101

APPENDIX TO CHAPTER 3: CONSUMER PREFERENCES AND DEMAND 115

CHAPTER 4 Estimating and Forecasting Demand 123

COLLECTING DATA 124

Consumer Surveys 121

Controlled Market Studies 12G

Uncontrolled Market Data 127

REGRESSION ANALYSIS 128

Ordinary 1.east-Squares Regression 128

INTERPRETING REGRESSION STATISTICS 135

Potential Problems in Regression 140

FORECASTING 114

Time-Series Models 145

Fitting a Simple Trend 147

Barometric Models 153

Forecasting Performance 155

Final Thoughts 157 APPENDLX TO CHAPTER 4: REGRESSION

USING SPREADSHEETS 171 SPECIAL APPENDIX TO CHAPTER 4:

STATISTICAL TABLES 176

CHAPTER 5 P r o d u c t i o n 179

BASIC PRODUCTION CONCEPTS 180

Production Technology 180

Contents xv

PRODUCTION WITH ONE VARIABLE INPUT 181 Short-Run and Long-Run Production 181 Optimal Use of an Input 185

PRODUCTION IN THE LONG RUN 187 Returns to Scale 187 Least-Cost Production 189

MEASURING PRODUCTION FUNCTIONS 190 Linear Production 196 Production with Fixed Proportions 196 Polynomial Functions 197 The Cobb-Douglas Function 197 Estimating Production Functions 199

OTHER PRODUCTION DECISIONS 200 Multiple Plants 200 Multiple Products 202 Final Remarks 203

CHAPTER 6 Cost Analysis 212 RELEVANT COSTS 215

Opportunity Costs and Economic Profits 211 Fixed and Sunk Costs 217 Profit Maximization with Limited Capacity:

Ordering a Best Seller 219 THE COST OF PRODUCTION 221

Short-Run Costs 222 Long-Run Costs 227

RETURNS TO SCALE AND SCOPE 231 Returns to Scale 231 Economies of Scope 235

COST ANALYSIS AND OPTIMAL DECISIONS 238 Л Single Product 238 The Shut-Down Rule 240 Multiple Products 212

APPENDIX TO CHAPTER 6: TRANSFER PRICING 255 SPECIAL APPENDIX TO CHAPTER 6:

SHORT-RUN AND LONG-RUN COSTS 259

SECTION II: Compet ing w i t h i n Markets 201

CHAPTER 7 Perfect Competition гез THE BASICS OF SUPPLY AND DEMAND 205

Shifts in Demand and Supply 267

xvi Contents

COMPETITIVE EQUILIBRIUM 269

Decisions of the Competitive Firm 269

Market Equilibrium 272

MARKET EFFICIENCY 275

Private Markets: Benefits and Costs 276

INTERNATIONAL TRADE 286

Tariffs and Quotas 286

CHAPTER 8 Monopoly 298

PURE MONOPOLY 299

Barriers to Entry 301

PERFECT COMPETITION VERSUS PURE MONOPOLY 304

Cartels 307

Natural Monopolies 310

MONOPOLISTIC COMPETITION 314

CHAPTER 9 Oligopoly 326

OLIGOPOLY 328

Five-Forces Framework 328

Industry Concentration 330

Concentration and Prices 334

QUANTITY COMPETITION 337

A Dominant Firm 337

Competition among Symmetric Firms 339

PRICE COMPETITION 342

Price Rigidity and Kinked Demand 342

Price Wars and the Prisoner's Dilemma 344

OTHER DIMENSIONS OF COMPETITION 350

Advertising 350

Strategic Commitments 353

APPENDTX TO CHAPTER 9: BUNDLING AND TYING 365

CHAPTER 10 Competit ive Strategy 370

SIZING UP COMPETITIVE SITUATIONS 371

ANALYZING PAYOFF TABLES 375

Equilibrium Strategies 378

COMPETITrVE STRATEGY 383

Market Entry 385

Bargaining 386

Sequential Competition 388

Repeated Competition 393

APPENDTX TO CHAPTER 10: MTXED STRATEGIES 409

Contents xvii

CHAPTER 11 Government Regulation and Policy 415 MARKET FAILURES AND REGULATION 416

MARKET FAILURE D U E T O M O N O P O L Y 417

Government Responses 418

MARKET FAILURE DUE TO EXTERNALITIES 424

Remedying Externalities 427

Promoting Positive Externalities 432

MARKET FAILURE DUE TO IMPERFECT

INFORMATION 435

BENEFIT-COST ANALYSIS AND PUBLIC GOODS PROVISION

438

PUBLIC GOODS 439

Public Goods and Efficiency 439

THE BASICS OF BENEFIT-COST ANALYSIS 442

Applying the Net Benefit Rule 442

Dollar Values 443

Efficiency versus Equity 443

EVALUATING A PUBLIC PROJECT 444

Public Investment in a Bridge 445

VALUING BENEFITS AND COSTS 448

Market Values 448

Nonmarketed Benefits and Costs 448

SECTION III: Dec is ion-Making Appl ica t ions 463

CHAPTER 12 Decision Making under Uncertainty 465 UNCERTAINTY, PROBABILITY, AND EXPECTED VALUE 466

Expected Value 468

DECISION TREES 469

An Oil Drilling Problem 469

Features of the Expected-Value Criterion 472

SEQUENTIAL DECISIONS 477

RISK AVERSION 484

Expected Utility 487

Expected Utility and Risk Aversion 492

CHAPTER 13 Putting Information to Work 506 THE VALUE OF INFORMATION 507

The Oil Wildcatter Revisited 507

Imperfect Information 509

xviii Contents

REVISING PROBABILITIES 512

Bayes Theorem 513

OTHER APPLICATIONS 516

Predicting Credit Risks 5 1 7

Business Behavior and Decision Pittalls 519

OPTIMAL SEARCH 523

Optimal Stopping 524

Optimal Seqtiential Decisions 526

THE VALUE OF ADDITIONAL ALTERNATIVES 527

Simultaneous Search 528

CHAPTER 14 Information Limits of Markets and the Firm 541

ASYMETRIC INFORMATION 545

Adverse Selection 545

Signalling 548

Principals, Agents, and Moral Hazard 550

ORGANIZATIONAL DESIGN 551

The Nature of the Firm 554

The Breadth of the Firm 550

Assigning Decision-Making Responsibilities 557

Monitoring and Rewarding Performance 502

Separation of Ownership and Control in the

Modern Corporation 509

APPENDIX TO CHAPTER 14: A PRINCIPAL-AGENT MODEL 585

CHAPTER 15 Negotiat ion 589

THE ECONOMIC SOURCES OF BENEFICIAL AGREEMENTS 591

Resolving Disputes 594

Differences in Values 595

Contingent Contracts 598

MULTIPLE-ISSUE NEGOTIATIONS 599

Continuous Variables 601

NEGOTIATION STRATEGY 004

Perfect Information 605

Imperfect Informal ion 605

CHAPTER 16 Auctions and Competitive Bidding 023

THE ADVANTAGES OF AUCTIONS 625

BIDDER STRATEGIES 629

English and Dutch Auctions 030

Contents xix

Sealed-Bid Auctions 631 Common Values and the Winner's Curse 639

OPTIMAL AUCTIONS 641 Expected Auction Revenue 641 Competitive Procurement 647

CHAPTER 17 Linear Programming ббо LINEAR PROGRAMS 662

Graphing the LP Problem 664 A Minimization Problem 668

SENSITIVITY ANALYSIS AND SHADOW PRICES 671 Changes in the Objective Function 672 Shadow Prices 674

FORMULATION AND COMPUTER SOLUTION FOR LARGER LP PROBLEMS 679

Computer Solutions 683

ANSWERS TO ODD-NUMBERED QUESTIONS 699

INDEX 732