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Managerial economics theory and practice
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Managerial
Economics
Theory and Practice
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Managerial
Economics
Theory and Practice
Thomas J. Webster
Lubin School of Business
Pace University
New York, NY
Amsterdam Boston Heidelberg London New York Oxford Paris
San Diego San Francisco Singapore Sydney Tokyo
This book is printed on acid-free paper.
Copyright © 2003, Elsevier (USA).
All Rights Reserved.
No part of this publication may be reproduced or transmitted in any form or by any
means, electronic or mechanical, including photocopy, recording, or any information
storage and retrieval system, without permission in writing from the publisher.
Permissions may be sought directly from Elsevier’s Science & Technology Rights
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Academic Press
An imprint of Elsevier Science
525 B Street, Suite 1900, San Diego, California 92101-4495, USA
http://www.academicpress.com
Academic Press
84 Theobald’s Road, London WC1X 8RR, UK
http://www.academicpress.com
Library of Congress Catalog Card Number: 2003102999
International Standard Book Number: 0-12-740852-5
PRINTED IN THE UNITED STATES OF AMERICA
03 04 05 06 07 7 6 5 4 3 2 1
To my sons, Adam Thomas and Andrew Nicholas
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Contents
1
Introduction
What is Economics 1
Opportunity Cost 3
Macroeconomics Versus Microeconomics 3
What is Managerial Economics 4
Theories and Models 5
Descriptive Versus Prescriptive Managerial Economics 8
Quantitive Methods 8
Three Basic Economic Questions 9
Characteristics of Pure Capitalism 11
The Role of Government in Market Economies 13
The Role of Profit 16
Theory of the Firm 18
How Realistic is the Assumption of Profit Maximization? 21
Owner-Manager/Principle-Agent Problem 23
Manager-Worker/Principle-Agent Problem 25
Constraints on the Operations of the Firm 27
Accounting Profit Versus Economic Profit 27
Normal Profit 30
Variations in Profits Across Industries and Firms 31
Chapter Review 33
Key Terms and Concepts 35
Chapter Questions 37
vii
Chapter Exercises 39
Selected Readings 41
2
Introduction to Mathematical Economics
Functional Relationships and Economic Models 44
Methods of Expressing Economic and Business Relationships 45
The Slope of a Linear Function 47
An Application of Linear Functions to Economics 48
Inverse Functions 50
Rules of Exponents 52
Graphs of Nonlinear Functions of One Independent Variable 53
Sum of a Geometric Progression 56
Sum of an Infinite Geometric Progression 58
Economic Optimization 60
Derivative of a Function 62
Rules of Differentiation 63
Implicit Differentiation 71
Total, Average, and Marginal Relationships 72
Profit Maximization: The First-order Condition 76
Profit Maximization: The Second-order Condition 78
Partial Derivatives and Multivariate Optimization: The First-order
Condition 81
Partial Derivatives and Multivariate Optimization: The Second-order
Condition 82
Constrained Optimization 84
Solution Methods to Constrained Optimization Problems 85
Integration 88
Chapter Review 92
Chapter Questions 94
Chapter Exercises 94
Selected Readings 97
3
The Essentials of Demand and Supply
The Law of Demand 100
The Market Demand Curve 102
viii Contents
Other Determinants of Market Demand 106
The Market Demand Equation 110
Market Demand Versus Firm Demand 112
The Law of Supply 113
Determinants of Market Supply 114
The Market Mechanism: The Interaction of Demand and Supply 118
Changes in Supply and Demand: The Analysis of Price
Determination 123
The Rationing Function of Prices 129
Price Ceilings 130
Price Floors 134
The Allocating Function of Prices 136
Chapter Review 137
Key Terms and Concepts 138
Chapter Questions 140
Chapter Exercises 142
Selected Readings 144
Appendix 3A 145
4
Additional Topics in Demand Theory
Price Elasticity of Demand 149
Price Elasticity of Demand: The Midpoint Formula 152
Price Elasticity of Demand: Weakness of the Midpoint Formula 155
Refinement of the Price Elasticity of Demand Formula: Point-price
Elasticity of Demand 157
Relationship Between Arc-price and Point-price Elasticities
of Demand 160
Price Elasticity of Demand: Some Definitions 160
Point-price Elasticity Versus Arc-price Elasticity 162
Individual and Market Price Elasticities of Demand 164
Determinants of the Price Elasticity of Demand 165
Price Elasticity of Demand, Total Revenue, and Marginal
Revenue 168
Formal Relationship Between the Price Elasticity of Demand and
Total Revenue 174
Using Elasticities in Managerial Decision Making 181
Chapter Review 186
Key Terms and Concepts 188
Chapter Questions 190
Contents ix
Chapter Exercises 191
Selected Readings 194
5
Production
The Role of the Firm 195
The Production Function 197
Short-run Production Function 201
Key Relationships: Total, Average, and Marginal Products 202
The Law of Diminishing Marginal Product 205
The Output Elasticity of a Variable Input 207
Relationships Among the Product Functions 208
The Three Stages of Production 211
Isoquants 212
Long-run Production Function 218
Estimating Production Functions 222
Chapter Review 225
Key Terms and Concepts 226
Chapter Questions 229
Chapter Exercises 231
Selected Readings 232
6
Cost
The Relationship Between Production and Cost 235
Short-run Cost 236
Key Relationships: Average Total Cost, Average Fixed Cost, Average
Variable Cost, and Marginal Cost 238
The Functional Form of the Total Cost Function 241
Mathematical Relationship Between ATC and MC 243
Learning Curve Effect 247
Long-run Cost 250
Economies of Scale 251
Reasons for Economies and Diseconomies of Scale 255
Multiproduct Cost Functions 256
Chapter Review 259
x Contents
Key Terms and Concepts 260
Chapter Questions 262
Chapter Exercises 263
Selected Readings 264
7
Profit and Revenue Maximization
Profit Maximization 266
Optimal Input Combination 266
Unconstrained Optimization: The Profit Function 279
Constrained Optimization: The Profit Function 295
Total Revenue Maximization 299
Chapter Review 302
Key Terms and Concepts 303
Chapter Questions 305
Chapter Exercises 305
Selected Readings 309
Appendix 7A 309
8
Market Structure: Perfect Competition
and Monopoly
Characteristics of Market Structure 313
Perfect Competition 316
The Equilibrium Price 317
Monopoly 331
Monopoly and the Price Elasticity of Demand 337
Evaluating Perfect Competition and Monopoly 340
Welfare Effects of Monopoly 342
Natural Monopoly 348
Collusion 350
Chapter Review 350
Key Terms and Concepts 351
Chapter Questions 353
Chapter Exercises 355
Contents xi
Selected Readings 358
Appendix 8A 358
9
Market Structure: Monopolistic Competition
Characteristics of Monopolistic Competition 362
Short-run Monopolistically Competitive Equilibrium 363
Long-run Monopolistically Competitive Equilibrium 364
Advertising in Monopolistically Competitive Industries 371
Evaluating Monopolistic Competition 372
Chapter Review 373
Key Terms and Concepts 375
Chapter Questions 375
Chapter Exercises 376
Selected Readings 377
10
Market Structure: Duopoly and Oligopoly
Characteristics of Duopoly and Oligopoly 380
Measuring Industrial Concentration 382
Models of Duopoly and Oligopoly 385
Game Theory 404
Chapter Review 410
Key Terms and Concepts 411
Chapter Questions 413
Chapter Exercises 414
Selected Readings 417
11
Pricing Practices
Price Discrimination 419
Nonmarginal Pricing 443
Multiproduct Pricing 449
xii Contents
Peak-load Pricing 460
Transfer Pricing 462
Other Pricing Practices 470
Chapter Review 474
Key Terms and Concepts 476
Chapter Questions 479
Chapter Exercises 480
Selected Readings 482
12
Capital Budgeting
Categories of Capital Budgeting Projects 486
Time Value of Money 488
Cash Flows 488
Methods for Evaluating Capital Investment Projects 506
Capital Rationing 537
The Cost of Capital 538
Chapter Review 541
Key Terms and Concepts 542
Chapter Questions 544
Chapter Exercises 546
Selected Readings 549
13
Introduction to Game Theory
Games and Strategic Behavior 552
Noncooperative, Simultaneous-move, One-shot Games 554
Cooperative, Simultaneous-move, Infinitely Repeated Games 568
Cooperative, Simultaneous-move, Finitely Repeated Games 580
Focal-point Equilibrium 586
Multistage Games 589
Bargaining 601
Chapter Review 608
Key Terms and Concepts 610
Chapter Questions 612
Chapter Exercises 613
Selected Readings 619
Contents xiii
xiv Contents
14
Risk and Uncertainty
Risk and Uncertainty 622
Measuring Risk: Mean and Variance 623
Consumer Behavior and Risk Aversion 627
Firm Behavior and Risk Aversion 632
Game Theory and Uncertainty 648
Game Trees 651
Decision Making Under Uncertainty with Complete Ignorance 656
Market Uncertainty and Insurance 664
Chapter Review 677
Key Terms and Concepts 679
Chapter Questions 681
Chapter Exercises 682
Selected Readings 685
15
Market Failure and Government
Intervention
Market Power 688
Landmark U.S. Antitrust Legislation 690
Merger Regulation 695
Price Regulation 695
Externalities 701
Public Goods 715
Chapter Review 722
Key Terms and Concepts 723
Chapter Questions 724
Chapter Exercises 726
Selected Readings 727
Index 729