| PART I | INTRODUCTION page 1 |
| Chapter 1 | Nature, scope and methods of managerial economics 3 |
| 1.1 | Introduction 4 |
| Case study 1.1: Global warming 4 |
| 1.2 | Definition and relationships with other disciplines 7 |
| Definition 7 |
| Relationship with economic theory 8 |
| Relationship with decision sciences 10 |
| Relationship with business functions 10 |
| 1.3 | Elements of managerial economics 11 |
| Subject areas and relationships 11 |
| Presentation of topics 11 |
| 1.4 | Methods 12 |
| Scientific theories 12 |
| Learning economics 14 |
| Case study 1.2: Import quotas on Japanese cars 15 |
| Tools of analysis: demand and supply 16 |
| Case study 1.3: Equal prize money in tennis 17 |
| Summary 18 |
| Review questions 19 |
| Notes 19 |
| Chapter 2 | The theory of the firm 20 |
| 2.1 | Introduction 22 |
| 2.2 | The nature of the firm 23 |
| Economic organizations 23 |
| Transaction cost theory 25 |
| Motivation theory 26 |
| Property rights theory 29 |
| 2.3 | The basic profit-maximizing model 32 |
| Assumptions 32 |
| Limitations 35 |
| Usefulness 35 |
| 2.4 | The agency problem 36 |
| Contracts and bounded rationality 37 |
| Hidden information 38 |
| Hidden action 39 |
| Control measures 40 |
| Limitations of the agency model 43 |
| Case study 2.1: Corporate governance 44 |
| 2.5 | Measurement of profit 48 |
| Nature of measurement problems 48 |
| Efficient markets hypothesis* 50 |
| Limitations of the EMH* 51 |
| Case study 2.2: Enron 53 |
| 2.6 | Risk and uncertainty 57 |
| Attitudes to risk 58 |
| Risk and objectives 58 |
| Risk and the agency problem 59 |
| 2.7 | Multiproduct strategies 60 |
| Product line profit maximization 60 |
| Product mix profit maximization 61 |
| Case study 2.3: PC World 62 |
| 2.8 | Conclusion 62 |
| The public sector and non-profit organizations 63 |
| Satisficing 63 |
| Surveys of business objectives 64 |
| Ethics 64 |
| Profit maximization revisited 65 |
| Summary 66 |
| Review questions 67 |
| Notes 68 |
| PART II | DEMAND ANALYSIS 71 |
| Chapter 3 | Demand theory 73 |
| 3.1 | Introduction 74 |
| 3.2 | Definition and representation 74 |
| Meaning of demand 74 |
| Tables, graphs and equations 75 |
| Interpretation of equations 78 |
| 3.3 | Consumer theory 80 |
| Assumptions 81 |
| Analysis 83 |
| Limitations 88 |
| Alternative approaches* 88 |
| Conclusions 90 |
| 3.4 | Factors determining demand 91 |
| Controllable factors 92 |
| Uncontrollable factors 93 |
| Demand and quantity demanded 96 |
| Case study 3.1: Marks & Spencer 97 |
| 3.5 | Elasticity 98 |
| Price elasticity 99 |
| Promotional elasticity 105 |
| Income elasticity 107 |
| Cross-elasticity 108 |
| 3.6 | A problem-solving approach 110 |
| Examples of solved problems 110 |
| Case study 3.2: The Oresund bridge 115 |
| Case study 3.3: The Texas state bird 116 |
| Case study 3.4: Oil production 116 |
| Summary 118 |
| Review questions 118 |
| Problems 119 |
| Notes 120 |
| Chapter 4 | Demand estimation 122 |
| 4.1 | Introduction 124 |
| 4.2 | Methods 125 |
| Consumer surveys 125 |
| Market experiments 126 |
| Statistical methods 127 |
| 4.3 | Model specification 127 |
| Mathematical models 127 |
| Statistical models 129 |
| 4.4 | Data collection 129 |
| Types of data 129 |
| Sources of data 130 |
| Presentation of data 131 |
| 4.5 | Simple regression 133 |
| The OLS method 133 |
| Application of OLS 133 |
| 4.6 | Goodness of fit 135 |
| Correlation 135 |
| The coefficient of determination 136 |
| 4.7 | Power regression 137 |
| Nature of the model 138 |
| Application of the model 138 |
| 4.8 | Forecasting 139 |
| Nature 139 |
| Application 139 |
| 4.9 | Multiple regression 140 |
| Nature of the model 140 |
| Advantages of multiple regression 141 |
| Dummy variables* 142 |
| Mathematical forms* 143 |
| Interpretation of the model results* 144 |
| Selecting the best model* 148 |
| Case study 4.1: The demand for coffee 149 |
| 4.10 | Implications of empirical studies 150 |
| The price–quality relationship 150 |
| Lack of importance of price 150 |
| Dynamic relationships 151 |
| 4.11 | A problem-solving approach 151 |
| Examples of solved problems 152 |
| Case study 4.2: Determinants of car prices 155 |
| Case study 4.3: The Sports Connection* 155 |
| Appendix A: Statistical inference* 157 |
| Nature of inference in the OLS model 157 |
| Assumptions 157 |
| Calculations for statistical inference 159 |
| Consequences of assumptions 160 |
| Estimation 162 |
| Hypothesis testing 162 |
| Confidence intervals for forecasts 163 |
| Appendix B: Problems of the OLS model* 165 |
| Specification error 165 |
| The identification problem 165 |
| Violation of assumptions regarding the error term 166 |
| Multicollinearity 168 |
| Summary 169 |
| Review questions 169 |
| Problems 170 |
| Notes 171 |
| PART III | PRODUCTION AND COST ANALYSIS 175 |
| Chapter 5 | Production theory 175 |
| 5.1 | Introduction 176 |
| 5.2 | Basic terms and definitions 177 |
| Factors of production 177 |
| Production functions 178 |
| Fixed factors 179 |
| Variable factors 179 |
| The short run 180 |
| The long run 180 |
| Scale 180 |
| Efficiency 181 |
| Input-output tables 181 |
| 5.3 | The short run 182 |
| Production functions and marginal product 182 |
| Derivation of the short-run input-output table 183 |
| Increasing and diminishing returns 185 |
| Relationships between total, marginal and average product 186 |
| Determining the optimal use of the variable input 188 |
| Case study 5.1: Microsoft – increasing or diminishing returns? 191 |
| Case study 5.2: State spending 192 |
| 5.4 | The long run 193 |
| Isoquants 193 |
| The marginal rate of technical substitution 194 |
| Returns to scale 194 |
| Determining the optimal combination of inputs 198 |
| 5.5 | A problem-solving approach 203 |
| Planning 203 |
| Marginal analysis 203 |
| Example of a solved problem 204 |
| Evaluating trade-offs 205 |
| Example of a solved problem 206 |
| Case study 5.3: Factor Substitution in the National Health Service 207 |
| Summary 208 |
| Review questions 209 |
| Problems 210 |
| Notes 211 |
| Chapter 6 | Cost theory 212 |
| 6.1 | Introduction 213 |
| Importance of costs for decision-making 213 |
| Explicit and implicit costs 214 |
| Historical and current costs 214 |
| Sunk and incremental costs 215 |
| Private and social costs 215 |
| Relevant costs for decision-making 216 |
| Case study 6.1: Brewster Roofing 216 |
| Summary of cost concepts 216 |
| 6.2 | Short-run cost behaviour 217 |
| Classification of costs 217 |
| Types of unit cost 217 |
| Derivation of cost functions from production functions 218 |
| Factors determining relationships with output 220 |
| Efficiency 223 |
| Changes in input prices 223 |
| Different forms of cost function 223 |
| 6.3 | Long-run cost behaviour 226 |
| Derivation of cost functions from production functions* 226 |
| Economies of scale 227 |
| Diseconomies of scale 229 |
| Economies of scope 230 |
| Relationships between short- and long-run cost curves 231 |
| Strategy implications 234 |
| 6.4 | The learning curve 235 |
| 6.5 | Cost–volume–profit analysis 236 |
| Purpose and assumptions 236 |
| Break-even output 238 |
| Profit contribution 238 |
| Operating leverage* 239 |
| Limitations of CVP analysis 239 |
| 6.6 | A problem-solving approach 240 |
| Examples of solved problems 241 |
| Case study 6.2: Converting to LPG – is it worth it? 245 |
| Case study 6.3: Rescuing Nissan 245 |
| Case study 6.4: Earls Court Gym 246 |
| Summary 250 |
| Review questions 250 |
| Problems 251 |
| Notes 253 |
| Chapter 7 | Cost estimation 254 |
| 7.1 | Introduction 255 |
| Importance of cost estimation for decision-making 255 |
| Types of cost scenario 256 |
| Methodology 256 |
| 7.2 | Short-run cost estimation 259 |
| Types of empirical study 260 |
| Problems in short-run cost estimation 260 |
| Different forms of cost function, interpretation and selection 263 |
| Implications of empirical studies 265 |
| 7.3 | Long-run cost estimation 265 |
| Types of empirical study 266 |
| Problems in long-run cost estimation 266 |
| Different forms of cost function 268 |
| Implications of empirical studies 268 |
| Case study 7.1: Banking 270 |
| 7.4 | The learning curve 271 |
| Types of specification 271 |
| Case study 7.2: Airlines 272 |
| Case study 7.3: Electricity generation 273 |
| Application of the learning curve 275 |
| Example of a solved problem 275 |
| Implications of empirical studies 276 |
| 7.5 | A problem-solving approach 277 |
| Examples of solved problems 278 |
| Summary 280 |
| Review questions 280 |
| Problems 281 |
| Notes 282 |
| PART IV | STRATEGY ANALYSIS 285 |
| Chapter 8 | Market structure and pricing 287 |
| 8.1 | Introduction 288 |
| Characteristics of markets 289 |
| Types of market structure 289 |
| Relationships between structure, conduct and performance 290 |
| Methodology 291 |
| 8.2 | Perfect competition 291 |
| Conditions 291 |
| Demand and supply 292 |
| Graphical analysis of equilibrium 293 |
| Algebraic analysis of equilibrium 296 |
| Adjustment to changes in demand 297 |
| 8.3 | Monopoly 300 |
| Conditions 300 |
| Barriers to entry and exit 300 |
| Graphical analysis of equilibrium 304 |
| Algebraic analysis of equilibrium 305 |
| Pricing and price elasticity of demand 306 |
| Comparison of monopoly with perfect competition 309 |
| Case study 8.1: Electricity generation 311 |
| 8.4 | Monopolistic competition 313 |
| Conditions 313 |
| Graphical analysis of equilibrium 313 |
| Algebraic analysis of equilibrium 314 |
| Comparison with perfect competition and monopoly 316 |
| Comparison with oligopoly 316 |
| Case study 8.2: Price cuts for medicines 317 |
| 8.5 | Oligopoly 318 |
| Conditions 318 |
| The kinked demand curve model 319 |
| Collusion and cartels 321 |
| Price leadership 324 |
| Case study 8.3: Mobile phone networks 324 |
| Case study 8.4: Private school fees 325 |
| 8.6 | A problem-solving approach 327 |
| Summary 328 |
| Review questions 328 |
| Problems 329 |
| Notes 330 |
| Chapter 9 | Game theory 331 |
| 9.1 | Introduction 332 |
| Nature and scope of game theory 333 |
| Elements of a game 333 |
| Types of game 336 |
| 9.2 | Static games 338 |
| Equilibrium 338 |
| Oligopoly models 340 |
| Property rights* 349 |
| Nash bargaining 351 |
| Case study 9.1: Experiments testing the Cournot equilibrium 352 |
| 9.3 | Dynamic games 353 |
| Equilibrium 353 |
| Strategic moves and commitment 355 |
| Stackelberg oligopoly 358 |
| Case study 9.2: Monetary policy in Thailand 361 |
| 9.4 | Games with uncertain outcomes* 361 |
| Mixed strategies 362 |
| Moral hazard and pay incentives 365 |
| Moral hazard and efficiency wages 367 |
| 9.5 | Repeated games* 370 |
| Infinitely repeated games 370 |
| Finitely repeated games 375 |
| 9.6 | Limitations of game theory 375 |
| Case study 9.3: Credible commitments 376 |
| 9.7 | A problem-solving approach 378 |
| Summary 378 |
| Review questions 379 |
| Problems 379 |
| Notes 380 |
| Chapter 10 | Pricing strategy 382 |
| 10.1 | Introduction 384 |
| 10.2 | Competitive advantage 385 |
| Nature of competitive advantage 385 |
| Value creation 385 |
| Case study 10.1: Mobile phones – Nokia 388 |
| 10.3 | Market positioning, segmentation and targeting 389 |
| Cost advantage 390 |
| Benefit advantage 390 |
| Competitive advantage, price elasticity and pricing strategy 391 |
| Segmentation and targeting 392 |
| Role of pricing in managerial decision-making 394 |
| Case study 10.2: Handheld Computers – Palm 394 |
| 10.4 | Price discrimination 396 |
| Definition and conditions 396 |
| Types of price discrimination 397 |
| Price discrimination in the European Union 399 |
| Analysis 401 |
| Example of a solved problem 401 |
| Case study 10.3: Airlines 403 |
| 10.5 | Multiproduct pricing 405 |
| Context 405 |
| Demand interrelationships 406 |
| Production interrelationships 407 |
| Joint products 407 |
| Example of a solved problem 408 |
| 10.6 | Transfer pricing 411 |
| Context 411 |
| Products with no external market 412 |
| Example of a solved problem 412 |
| Products with perfectly competitive external markets 415 |
| Products with imperfectly competitive external markets 415 |
| 10.7 | Pricing and the marketing mix* 416 |
| An approach to marketing mix optimization 416 |
| The constant elasticity model 417 |
| Complex marketing mix interactions 420 |
| 10.8 | Dynamic aspects of pricing 421 |
| Significance of the product life-cycle 421 |
| Early stages of the product life-cycle 421 |
| Later stages of the product life-cycle 422 |
| 10.9 | Other pricing strategies 422 |
| Perceived quality 423 |
| Perceived price 423 |
| The price–quality relationship 423 |
| Perceived value 424 |
| Summary 424 |
| Review questions 426 |
| Problems 426 |
| Notes 428 |
| Chapter 11 | Investment analysis 430 |
| 11.1 | Introduction 431 |
| The nature and significance of capital budgeting 431 |
| Types of capital expenditure 432 |
| A simple model of the capital budgeting process 434 |
| 11.2 | Cash flow analysis 434 |
| Identification of cash flows 435 |
| Measurement of cash flows 435 |
| Example of a solved problem 435 |
| Case study 11.1: Investing in a corporate fitness programme 439 |
| 11.3 | Risk analysis 439 |
| Nature of risk in capital budgeting 439 |
| Measurement of risk 440 |
| 11.4 | Cost of capital 445 |
| Nature and components 445 |
| Cost of debt 446 |
| Cost of equity 447 |
| Weighted average cost of capital 449 |
| 11.5 | Evaluation criteria 450 |
| Net present value 450 |
| Internal rate of return 451 |
| Comparison of net present value and internal rate of return 452 |
| Other criteria 452 |
| Decision-making under risk 454 |
| Example of a solved problem 455 |
| Decision-making under uncertainty 458 |
| 11.6 | The optimal capital budget 459 |
| The investment opportunity (IO) schedule 460 |
| The marginal cost of capital (MCC) schedule 460 |
| Equilibrium of IO and MCC 462 |
| 11.7 | A problem-solving approach 462 |
| Case study 11.2: Under-investment in transportation infrastructure 462 |
| Case study 11.3: Over-investment in fibre optics 463 |
| Summary 465 |
| Review questions 466 |
| Problems 466 |
| Notes 468 |
| Chapter 12 | Government and managerial policy 469 |
| 12.1 | Introduction 471 |
| Importance of government policy 471 |
| Objectives of government policy 471 |
| 12.2 | Market failure 473 |
| Definition and types 473 |
| Monopolies 474 |
| Externalities 475 |
| Public goods 475 |
| Imperfect information 476 |
| Transaction costs 476 |
| 12.3 | Monopoly and Competition Policy 477 |
| Basis of government policy 477 |
| The structure–conduct–performance (SCP) model 479 |
| Detection of monopoly 480 |
| Public ownership 481 |
| Privatization and regulation 486 |
| Promoting competition 490 |
| Restrictive practices 493 |
| Case study 12.1: Electricity 499 |
| Case study 12.2: Postal services 503 |
| 12.4 | Externalities 507 |
| Optimality with externalities 508 |
| Implications for government policy 509 |
| Implications for management 511 |
| Case study 12.3: Fuel taxes and optimality 512 |
| 12.5 | Imperfect information 513 |
| Incomplete information 514 |
| Asymmetric information 514 |
| Implications for government policy 516 |
| Implications for management 518 |
| Summary 518 |
| Review questions 520 |
| Notes 520 |
| Index 522 |