12e Managerial Economics Mark Hirschey University of Kansas Australia • Brazil • Japan • Korea • Mexico • Singapore • Spain • United Kingdom • United States This page intentionally left blank Managerial Economics, 12th Edition © 2009, 2006 South-Western, a part of Cengage Learning Mark Hirschey ALL RIGHTS RESERVED. No part of this work covered by the copyright herein may be reproduced, transmitted, stored or used in any form VP/Editorial Director: Jack W. Calhoun or by any means graphic, electronic, or mechanical, including but not limited to photocopying, recording, scanning, digitizing, taping, Web Acquisitions Editor: Mike Roche distribution, information networks, or information storage and retrieval Developmental Editor: Amy Ray systems, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without the prior written permission of Editorial Assistant: Laura Cothran the publisher. 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For your course and learning solutions, visit academic.cengage.com Purchase any of our products at your local college store or at our preferred online store www.ichapters.com Printed in the United States of America 1 2 3 4 5 6 7 12 11 10 09 08 This page intentionally left blank Dedication For Christine—I still do. This page intentionally left blank About the Author Mark Hirschey, Ph.D. (University of Wisconsin-Madison), is the Anderson W. Chandler Professor of Business at the University of Kansas, where he teaches undergraduate and graduate courses in managerial economics and finance. Professor Hirschey is president of the Association of Financial Economists and member of several professional organizations. He has published articles in the American Economic Review, Review of Economics and Statistics, Journal of Business, Journal of Business and Economic Statistics, Journal of Finance, Journal of Financial Economics, Journal of Industrial Economics, and other leading academic journals. He is editor of Advances in Financial Economics, and past editor of Managerial and Decision Economics. Professor Hirschey is also author of Fundamentals of Managerial Economics and Investments: Analysis & Behavior. vii This page intentionally left blank Brief Contents Preface xxiii Part 1: Overview of Managerial Economics 1 1. Nature and Scope of Managerial Economics 3 2. Economic Optimization 23 3. Demand and Supply 77 Part 2: Demand Analysis and Estimation 111 4. Demand Analysis 113 5. Demand Estimation 161 6. Forecasting 199 Part 3: Production and Competitive Markets 243 7. Production Analysis and Compensation Policy 245 8. Cost Analysis and Estimation 289 9. Linear Programming 331 10. Competitive Markets 379 11. Performance and Strategy in Competitive Markets 413 Part 4: Imperfect Competition 455 12. Monopoly and Monopsony 457 13. Monopolistic Competition and Oligopoly 501 14. Game Theory and Competitive Strategy 549 15. Pricing Practices 585 Part 5: Long-Term Investment Decisions 629 16. Risk Analysis 631 17. Capital Budgeting 671 18. Organization Structure and Corporate Governance 713 19. Government in the Market Economy 747 Appendix A: Compounding and the Time Value of Money 787 Appendix B: Interest Factor Tables 803 Appendix C: Statistical Tables 811 Selected Figures for End of Chapter Problems 817 Index 825 ix This page intentionally left blank Contents Part 1: Overview of Managerial Economics 1 Chapter 1: Nature and Scope of Managerial Chapter 2: Economic Optimization 23 Economics 3 Economic Optimization Process 23 How is Managerial Economics Useful? 3 Optimal Decisions, 23 • Maximizing the Value Evaluating Choice Alternatives, 3 • Making of the Firm, 24 the Best Decision, 5 Revenue Relations 25 Managerial Application 1.1: Business Ethics 5 Price and Total Revenue, 25 • Marginal Revenue, Theory of the Firm 6 28 • Revenue Maximization Example, 29 Expected Value Maximization, 6 • Constraints Managerial Application 2.1: The Ethics of Greed and the Theory of the Firm, 7 • Limitations of the Versus Self-Interest 25 Theory of the Firm, 8 Managerial Application 2.2: Do Firms Profit Measurement 9 Really Optimize? 30 Business Versus Economic Profit, 9 • Variability Cost Relations 30 of Business Profits, 10 Total Cost, 30 • Marginal and Average Cost, 32 Managerial Application: 1.2 The World Is • Average Cost Minimization Example, 33 Turning to Capitalism and Democracy 9 Profit Relations 34 Why do Profits Vary Among Firms? 12 Total and Marginal Profit, 34 • Profit Maximization Disequilibrium Profit Theories, 12 • Compensatory Example, 35 Profit Theories, 12 • Role of Profits in the Economy, 13 Managerial Application 2.3: Market-Based Management 34 Managerial Application: 1.3 Google on Social Responsibility 13 Incremental Concept in Economic Analysis 38 Role of Business in Society 14 Marginal Versus Incremental Concept, 38 • Incremental Profits, 38 • Incremental Concept Why Firms Exist, 14 • Social Responsibility Example, 40 of Business, 15 Managerial Application 2.4: Behavioral Economics 39 Managerial Application 1.4: The Internet Revolution 16 Summary 41 Structure of this Text 16 Questions 42 Development of Topics, 17 Self-Test Problems and Solutions 43 Summary 18 Problems 48 Questions 19 Case Study: Spreadsheet Analysis of the EOQ Case Study: Is Coca-Cola the “Perfect” Business? 19 at the Neighborhood Pharmacy, Inc. 53 Selected References 22 Selected References 54 xi xii Contents Appendix 2A: Math Analysis for Managers 55 Determinants of Demand, 79 • Industry Demand Properties of Real Numbers 55 Versus Firm Demand, 80 Transitive Property, 55 • Commutative Demand Curve 81 Properties, 55 • Associative Properties, 56 Demand Curve Determination, 81 • Relation • Distributive Properties, 56 • Inverse Properties, 56 Between the Demand Curve and • Exponents and Radicals, 56 Demand Function, 82 Equations 57 Managerial Application 3.2: ISP Customers Learn About Demand and Supply 84 Equivalent Operations, 57 • Linear Equations, 58 • Quadratic Equations, 58 • Multiplicative Basis for Supply 85 Equations, 58 • Exponential Functions, 58 How Output Prices Affect Supply, 85 • Other • Logarithmic Functions, 59 Factors That Influence Supply, 86 Concept of a Marginal 60 Market Supply Function 86 Rules for Differentiating a Function 62 Determinants of Supply, 86 • Industry Supply Versus Firm Supply, 87 Constants, 62 • Powers, 63 • Sums and Differences, 63 • Products, 64 • Quotients, 65 Managerial Application 3.3: The Import Supply • Logarithmic Functions, 65 • Function Battle in the U.S. Auto Industry 88 of a Function (Chain Rule), 66 Supply Curve 89 Appendix 2B: Multivariate Optimization Supply Curve Determination, 89 • Relation and the Lagrangian Technique 68 Between Supply Curve and Supply Function, 89 Partial Derivative Concept, 68 • Maximizing Managerial Application 3.4: MBA Demand Multivariate Functions, 69 and Supply 92 Constrained Optimization 70 Market Equilibrium 93 Role of Constraints, 71 • Lagrangian Surplus and Shortage, 93 • Comparative Statics: Multipliers, 72 Changing Demand, 95 • Comparative Statics: Changing Supply, 97 • Comparative Statics: Problem 76 Changing Demand and Supply, 98 Summary 99 Chapter 3: Demand and Supply 77 Questions 99 Basis for Demand 77 Self-Test Problems and Solutions 100 Direct Demand, 77 • Derived Demand, 78 Problems 103 Managerial Application 3.1: How the Case Study: Spreadsheet Analysis of Demand Internet Affects Demand and Supply 79 and Supply for Sunbest Orange Juice 107 Market Demand Function 79 Selected References 109 Part 2: Demand Analysis and Estimation 111 Chapter 4: Demand Analysis 113 Basic Characteristics, 118• Perfect Substitutes Utility Theory 113 and Perfect Complements, 120 Basic Assumptions, 113 • Utility Functions, 114 Budget Constraints 120 • Marginal Utility, 115 • Law of Diminishing Characteristics of Budget Constraints, 120 Marginal Utility, 116 • Effects of Changing Income and Changing Managerial Application 4.1: Odd-number Prices, 123 • Income and Substitution Pricing Riddle 118 Effects, 124 Indifference Curves 118 Individual Demand 124 Contents xiii Price–Consumption Curve, 124 Managerial Application 5.1: Sampling • Income–Consumption Curve, 127 Technology for TV Advertising 163 • Engle Curves, 127 Simple Market Demand Curve Estimation 165 Managerial Application 4.2: Relationship Marketing 130 Graphing the Market Demand Curve, 165 Optimal Consumption 130 • Evaluating Market Demand, 166 Marginal Utility and Consumer Choice, 130 Identification Problem 168 • Marginal Rate of Substitution, 131 Changing Nature of Demand Relations, 168 • Utility Maximization, 133 • Interplay of Demand and Supply, 168 Demand Sensitivity Analysis: Elasticity