200899131428125

INSTRUCTORS MANUAL
to accompany
Thomas and Maurice
MANAGERIAL ECONOMICS
NINTH EDITION
Prepared By
Christopher R. Thomas
University of South Florida
CONTENTS
PART I
Answers: Applied Problems, Mathematical Exercises, and Student

Workbook Homework Exercises
Part I: Some Preliminaries
Chapter 1 Managers, Profits, and Markets................................................................1
Chapter 2 Demand, Supply, and Market Equilibrium.................................................5
Chapter 3 Marginal Analysis for Optimal Decision Making ...................................... 11
Chapter 4 Basic Estimation Techniques ................................................................. 19
Part II: Demand Analysis
Chapter 5 Theory of Consumer Behavior................................................................ 23
Chapter 6 Elasticity and Demand............................................................................ 25
Chapter 7 Demand Estimation and Forecasting...................................................... 29
Part III: Production and Cost Analysis
Chapter 8 Production and Cost in the Short Run .................................................... 33
Chapter 9 Production and Cost in the Long Run ..................................................... 37
Chapter 10 Production and Cost Estimation ............................................................ 41
Part IV: Profit-Maximization in Various Market Structures
Chapter 11 Managerial Decisions in Competitive Markets ....................................... 45
Chapter 12 Managerial Decisions for Firms with Market Power ............................... 49
Chapter 13 Strategic Decision Making in Oligopoly Markets .................................... 55
Part V: Advanced Managerial Decision Making
Chapter 14 Advanced Pricing Techniques .............................................................. 63
Chapter 15 Decisions Under Risk and Uncertainty .................................................. 69
Chapter 16 Government Regulation of Business ..................................................... 73
PART II Additional Teaching and Learning Resources: Students Resource

CD, Instructors Resource CD and McGraw-Hill Web Site
Students Resource CD (Packaged with each textbook)
Student Workbook ............................................................................................. 79
Review of Fundamental Mathematics ................................................................ 79
Brief Review of Derivatives and Optimization..................................................... 79
Statistix 8 Tutorial .............................................................................................. 79
Data Files for Empirical Chapters....................................................................... 79
PowerPoint Slides of Tables and Figures in Managerial Economics .................. 80
Chapter Summaries and Key Terms .................................................................. 80
Instructors Resource CD (Provided by McGraw-Hill to adopters)......................... 80

Instructors Manual ............................................................................................ 80
Illustrations from Previous Editions .................................................................... 80
Animated PowerPoint Slideshows ..................................................................... 80
Answers to Consulting Projects ......................................................................... 80
PowerPoint Slides of Tables and Figures in Managerial Economics .................. 80
McGraw-Hill Web Site for Managerial Economics, 9e ............................................ 80
Instructor Resource Section of Web Site:
Test Bank ................................................................................................. 81
Online Topics ........................................................................................... 81
Answers to Consulting Projects................................................................. 81
Online Topics ............................................................................................ 81
Statistix Case Studies ............................................................................... 81
Answers to Statistix Case Studies ............................................................. 81
Student Resource Section of Web Site:
Self-Quizzes.............................................................................................. 81
Career Center ........................................................................................... 81
Economics on the Web ............................................................................. 81
PART I: ANSWERS
Applied Problems
Mathematical Exercises
Student Workbook Homework Exercises
Chapter 1:
MANAGERS, PROFITS, AND MARKETS

Answers to Applied Problems
1.
a.
b.
c.
d.
Total explicit cost = $793,000 (= 555,000 + 45,000 + 28,000 + 165,000)

Total implicit cost = $190,000 (= 175,000 + 0.15 100,000)
Total economic cost = $983,000 (= 793,000 + 190,000)
Accounting profit = $177,000 (= 970,000 793,000)
Economic profit = $13,000 (= 970,000 983,000)
The owners accounting profit is $13,000 less than what he could have earned in salary
and return on investment of his $100,000, i.e., his economic profit is $13,000. Thus, he
would have made $13,000 more if he had kept his job and invested his $100,000 in stocks
of other businesses.
2.
The $8,000 of lost income, even though not tax-deductible, is indeed part of the economic cost
the doctor incurs by going to Mexico to treat patients, and the doctor should consider this $8,000
cost in making her decision to travel to Mexico.
3.
a.
b.
c.
Burton's explicit cost's are $18,000 per month. His implicit costs are $20,000 per month
($15,000 + $5,000).
Opportunity cost = explicit + implicit costs = $18,000 + 20,000 = $38,000 per month
Burton Cummings costs of production (= $38,000/month) exceed his revenues by
$13,000 (= 38,000 25,000). Rather than lose $13,000 per month, Burton could rent his
rig (and receive $15,000 per month) and drive trucks for another firm (and earn $5,000
per month). With this use of his resources he would earn $20,000 per month. Or, Burton
could try his luck as a singer in a rock band.
4.
One cost of opening a tennis shop would be the forgone salary of the previous job. Given that
Andres or Venus foregone income would be much larger than that of a university coach, their
opportunity cost would be higher.
5.
Linking the board of directors' compensation to return on equity creates an incentive for
management to pursue profit-maximization as a goal, thereby reducing the agency problem
between managers and shareholders. Directors have better, easier, and cheaper access to
information about the firm's revenues and costs. Shareholders are numerous and each one has
only a relatively small stake in the profitability of the firm. It is generally easier for a shareholder
simply to sell its shares and reinvest in another company.
6.
a.
b.
c.
7.
Some Marriott franchises are shirking their responsibility to maintain high quality hotels,
and this shirking damages the reputation of all Marriott franchises.
Poorly run franchises damage the Marriott reputation and reduce the profitability of
hotels owned by Marriott.
Where there is little repeat business, there is less incentive for a hotel to provide quality
service. Where there is a lot of repeat business, franchises will have an incentive to
maintain quality to attract repeat business.
Even though the financial arrangement with Delta and United limited the growth in SkyWests
economic profits in future years, the agreement decreased the risk associated with SkyWests
profits. In the Fortune article, one financial analyst states, They (SkyWest) shield themselves
from the factors that lead to volatility in earningsfuel prices, ticket prices, and load factors
and bring investors the certainty they are looking for. The lower level of risk reduces the riskadjusted discount rate, and, for a given stream of profits, the value of the SkyWest rises.
Chapter 1: Managers, Profits, and Markets
1
8.
A good answer can be found in Glenn R. Simpons article Multinational Firms Take Steps to
Avert Boycotts over War, in the Wall Street Journal, April 4, 2003. According to South
Carolina Commerce Secretary Bob Faith, The global economy is so interconnected today, youd
be shooting yourself in the foot. As it turns out, the French firm Group Michelin SA has a
number of tire factories across South Carolina. The new realities of globalization have reshaped
the politics of consumer boycotts.
Answers to Mathematical Exercises

PV = NCF/(1 + r)t = $1,000/(1.065) = $938.97
PV = $1,000/(1.065)2 = $881.66
PV = $1,000/(1.065)3 = $827.85
1.
a.
b.
c.
2.
The present value is calculated as follows:

5
PV = !
t =0
NCFt
(1 + r)t
$10,000
(1.12)1
$20,000
(1.12) 2
$50,000
(1.12)3
$75,000
(1.12) 4
$50,000
(1.12)5
= $8,929 + 15,944 + 35,589 + 47,664 + 28,371

= $136,497
3.
Option A:
Burt pays Loni $1,000,000 each year for 10 years (Burt wishes to make each
payment at year-end.)
Option B:
Burt pays Loni $5,000,000 in cash now.
If the appropriate interest rate is 8 percent:
PVOption A = $1,000,000/(1.08)1 + + $1,000,000/(1.08)10 = $6,710,081
PVOption B = $5,000,000
Clearly, Loni should take option A and Burt should want to pay her $5,000,000 now.
If the appropriate interest rate is 20 percent:
PVOption A = $1,000,000/(1.20)1 + + $1,000,000/(1.20)10 = $4,192,472
PVOption B = $5,000,000
In this case, Loni should demand $5,000,000 cash now, and Burt should try to talk her into taking
$10,000,000 spread over ten years.
Answers to Homework Exercises in Student Workbook

1.
a.
b.
c.
d.
e.
f.
$47,177,000
$5,880,000
$53,057,000
$6,573,000
$693,000
907,000
2.
a.
b.
$12,635,513
$11,336,861
3.
a.
b.
c.
d.
monopolistic competition
oligopoly
perfect competition
monopoly
2
4.
SunKist is just one of many citrus producers. Consumers are generally not brand conscious with
respect to fresh fruits and vegetables.
5.
Lexus has market power because product differentiation, even within the market for luxury cars,
gives Lexus some ability to raise price without losing all sales. In addition, a dealership in one
city seldom loses sales to Lexus dealers in other towns or cities, unless they are only a short
distance away.

3

4
Chapter 2:
DEMAND, SUPPLY, AND MARKET EQUILIBRIUM

1.
a.
b.
c.
d.
e.
f.
g.
Demand will decrease, so price will decrease.

Supply will increase, so price will decrease.
Demand will increase, so price will increase.
Supply will decrease, so price will increase.
Supply will increase, so price will decrease.
Supply will increase (when the price of a complement in production increases), so price
will decrease.
h.
2.
a.
b.
c.
d.
Supply will decrease, so price will increase and output will decrease.
Supply will increase, so price will decrease and output will increase.
Demand will increase, so price will increase and output will increase.
This one is challenging. An increase in the price of grapefruit could be interpreted as
either a demand shifter (change in the price of a substitute in consumption) or a supply
shifter (change in the price of a substitute in production) or BOTH simultaneously. If
only demand decreases (supply constant), then price will decrease and output will
decrease. If only supply increases (demand constant), then price will decrease and output
will increase. If both happen simultaneously, then price will decrease but the change in
output will be indeterminate.
3.
a.
An increase in demand for home heating oil causes demand for heating oil to shift
rightward. In the absence of price controls, no shortage occurs because market price is
bid up to PB. An increase in demand causes equilibrium price and quantity to rise.
A decrease in supply of RAM chips does not cause a shortage in the absence of a price
ceiling. A supply decrease shifts supply leftward, causing the equilibrium price of RAM
chips to rise and equilibrium quantity to fall.
b.
S'
PB
PA
Price of RAM chips
Price of heating oil
B
A
S
B
PB
PA
D'
D
QA QB
Quantity of heating oil
4.
Q
QB
QA
Quantity of RAM chips
An increase in food prices should result in a fall in the number of meals demanded and hence a
corresponding fall in the number of patrons. Those who are willing and able to pay the higher
price will have a shorter wait because there will be fewer customers.
Chapter 2: Demand, Supply, and Market Equilibrium
5
5.
a.
b.
c.
d.
6.
Construct a demand and supply diagram like Panel A of Figure 2.11.

a.
Imposing rent controls creates a shortage of low-income housing, which decreases the
quantity supplied at the lower rent imposed by the controls compared to the amount of
housing supplied at the market-clearing (higher) rent level.
b.
No, the shortage created by rent controls means that more low-income families are
willing and able to pay for rent-controlled housing than the amount of rent controlled
housing that is available. Compare this to the situation before rent-controls in which
markets clear at higher rent levels.
c.
In the short run, families who are able to get housing at the lower rent levels may be
better off. In many cases, however, families must pay large bribes under the table to
get into the rent-controlled homes. And, as time passes, landlords have little or no
incentive to make repairs to the rent-controlled units. Politicians may also gain from rent
controls because it appears to be a compassionate policy to help the poor. The losers are
the families who cannot get the rent-controlled housing even though they are willing and
able to pay the higher market-clearing rent.
d.
History has shown that rent-controlled districts over time fall into a state of decay and
ruin. Rent-controlled properties undermine the incentive for landlords to maintain the
housing. With a shortage of low-income housing, low rent housing will be fully rented
no matter what condition the roof or plumbing might be in. Furthermore, if landlords let
the property decay sufficiently, renters will leave, and the property can be converted to
some other use (commercial or industrial use) not subject to rent controls.
e.
Taxpayers, genuinely compassionate about providing more housing for low-income

families, could offer builders subsidies to build low-income housing. In the absence of
rent controls, this would shift supply rightward and equilibrium rents would fall. Also,
there would be no shortage of low income housing. Owners would have incentives to
properly maintain roofs and plumbing. Of course building subsidies would cost real
money; but everyone knows that theres no such thing as a free lunch (well, maybe not
everyone knows this).
In the graph, let D0 be the initial demand for

tickets to Disneyland and S0 be the supply
of tickets to Disneyland. Slowing tourism
causes demand to decrease, as represented
by the demand curve D1 . The new rides at
Six Flags further reduce demand to D2.
These events all result in lower ticket prices
at Disneyland as well as reduced
attendance. This is not a violation of the
law of demand since price is falling due to a
decrease (shift) in demand, not a movement
along a given demand curve.
Price of a ticket (dollars)
7.
No effect on demand (no shift)just a movement up the demand.

Decrease demand for hotels.
Demand for rental cars decreases.
Supply of overnight mail decreases.
S
P0
P2
D2
Q2

6
D1
Q0
Number of tickets
D0
To the extent that consumers really do care about whether or not a firm behaves in a "socially
responsible" manner, disseminating information about "progressive business practices" causes
demand to increase for products produced by the socially responsible firms. An increase in
demand, ceteris paribus, results in a higher price for products of socially responsible firms.
9.
In the graph, S0 and D0 are the

$
S1
supply and demand curves for auto
insurance before Proposition 103 is
S0
passed. PE is the price of auto
insurance. After Proposition 103
B
passes, Pprop103 is the ceiling price
A
established
by
passage
of
PE
Proposition 103. The result is a
shortage of auto insurance in
California.
This shortage gets
worse over time as the costs of
Pprop 103
providing insurance rise because
D0
supply shifts leftward (S1) increasing the gap between Qd and Qs
Q
(at P = Pprop 103). If Proposition 103
Qs
Qd
is defeated, no price ceiling will be
Quantity of auto insurance (# of cars insured)
forthcoming and no shortage will
occur. The increasing costs of providing insurance will cause insurance rates to rise (from A to
B).
10.
Over the next year, maybe two years, the excess supply of lawyers will cause wages for lawyers
to fall until equilibrium is reached. When wages fall to the point that quantity demanded equals
quantity supplied, a new, lower equilibrium wage will be reached. Over the longer time period,
the falling wages will alter expectations about future wages. This will reduce the future supply of
lawyers as the number of students entering law school declines. This reduction in supply of
lawyers, other things constant, will tend to push wages upward five or six years into the future.
11.
a.
Price of auto insurance (dollars)
8.
b.
c.
d.
e.
12.
a.
Increase in the price of a complement goods causes demand to shift leftward. Movie
ticket prices fall and ticket sales fall.
Decrease in the price of a substitute good causes demand to shift leftward. Movie ticket
prices fall and ticket sales fall.
Presumably, pay-per-view movies on cable are more convenient to some consumers than
going to the movie theater, thereby changing some consumers= tastes away from theater
movies toward pay-per-view movies. Demand shifts leftward due to the change in tastes,
and movie theater ticket prices fall and ticket sales fall.
The end of the strike increases the number of movie scripts available, lowering the price
producers must pay to get a movie script. The decrease in price of an input (movie
scripts) increases the supply of movies out of Hollywood. Supply shifts rightward.
Movie ticket prices fall and ticket sale rise.
As in part d, a decrease in the price of an input causes supply to shift rightward. Movie
ticket prices fall and ticket sales rise.
The new process causes an increase in supply, shown as a rightward shift in the supply of
crude oil curve. The rightward shift in supply of crude oil does NOT cause a surplus
because the equilibrium price of crude oil falls until quantity demanded equals quantity
supplied. The market clears at the now lower price of crude oil. No surplus arises
because the lower crude price results in an increase in quantity demanded of crude oil
7
b.
which works to eliminate any surplus. The end result of the new process is to decrease
the equilibrium price of crude oil and increase the quantity of crude oil consumed and
produced in equilibrium.
Even in the unlikely event that no new oil deposits are ever discovered, growing worldwide demand for crude oil would still be met. Rightward shifts in demand, supply
constant, would simply drive up the equilibrium price of crude oil. No shortage would
occur unless governments impose price ceilings on crude oil preventing its price from
rising to market clearing levels.
13.
When a fixed fee (tax) is charged to pick up all the garbage a household puts out at the curb, the
price to the household of putting out additional bags of garbage is zero. By charging a fee for
each bag put out at the curb, the household now must pay a price for each extra bag of garbage.
By changing from a fixed fee to a fee-per-bag, the price of a bag of garage has increased from $0
to some positive price (equal to the fee set by the city). When price rises, quantity demanded
decreases. This is a movement upward along a given demand curve. The demand for garbage
has NOT shifted in this case.
14.
In the figure, the environmental curbs on burning wood causes supply to shift leftward from S0 to
S1. The substitution from burning wood to gas hearths is represented by the leftward shift in
demand from D0 to D1. Comparing initial equilibrium point A to B, the price of firewood has
remained unchanged while the quantity of firewood burned decreases.
15.
Demand and supply both increase simultaneously. An increase in customers (N) causes demand
to shift rightward. An increase in the number of businesses in a market (F) causes supply to shift
rightward. Equilibrium output definitely increases, but the effect of the Internet on equilibrium
price is indeterminate.
$
Price of firewood (dollars)
S1
PE
S0
B
D0
D1
Quantity of firewood

8

Normal. The coefficient on M is positive. Thus !Qd !M is positive and housing is a normal
good.
2.
Substitutes. The coefficient on R is positive. Thus !Qd !R is positive, and three-bedroom

apartments are substitutes for new housing.
3.
Qd = 160 2P
4.
See the figure below:

Price of new housing (dollars per square foot)
1.
P
S0
80
70
D1
60
D0
S1
50
40
30
20
10
Q
10
20
30
40
50
60
70
80
90
100 110 120 130
140 150
160
Quantity of new housing (thousands of square feet/month)
5.
Yes, because an increase in a factor price should cause Qs to get smaller (i.e., !Qs !PF is
negative).
6.
Qs = 40 + 2P
7.
See the figure above.
8.
PE = $50 and QE = 60
9.
Yes; yes.
10.
CS = .5 60 ($80 $50) = $900; PS = .5 60 ($50 $20) = $900; SS = $1,800
10.
Qd = 140 2P
11.
Qs = 20 + 2P
12.
PE = $40 and QE = 60
9

10
Chapter 3:
MARGINAL ANALYSIS FOR OPTIMAL DECISIONS

1.
a.
One way of reducing traffic deaths is to reduce speed. While it may be possible to
eliminate all traffic deaths by allowing motorists to drive no faster than 15 MPH in cars
equipped with driver and passenger air bags, most American drivers would not view a 15
MPH speed limit as optimal. Most drivers seem willing to accept some additional
probability of death in return for faster speeds. The 70 MPH speed limit would be
optimal if the marginal benefit of reducing speed limits equals the marginal cost of
reducing speed limits. Just because reducing speed limits to 65 MPH would save even
more lives does not, by itself, mean that further reduction in speed limits should be
undertaken. The marginal benefit of speed reduction must be compared to the marginal
cost.
b.
If it costs nothing to eliminate pollution (i.e. MC = 0), then the optimal level of pollution
would indeed be zero. When the marginal cost of pollution abatement is greater than
zero, as it is for virtually every type of pollution, the optimal level of pollution occurs at
that level of pollution for which the marginal benefit to society of eliminating more
pollution just equals the marginal cost of eliminating more pollution. In fact, it is
possible to have too little pollution if pollution abatement activities have been undertaken
such that the marginal cost of abatement exceeds the marginal benefit.
c.
To maximize net benefit, troops should be left in Iraq if the marginal benefit exceeds the
marginal cost. Since marginal benefit and marginal cost are measures of additional (or
extra) benefits and costs, benefits and costs already incurred do not matter (i.e. do not
affect MB and MC). Sunk costs or benefits do not enter the decision making process,
only incremental benefits and costs matter.
d.
See answer to part c.
e.
Insurance premiums are fixed costs. The optimal level has nothing to do with how high
or how low fixed costs go.
2.
Appalachian Coal Mining should minimize net cost by choosing that level of pollution (P) where
the marginal benefit of pollution reduction equals the marginal cost of pollution reduction:
1,000 10P = 40P
P* = 20 units of pollution.
3.
The second partner is basing his objection to the move on costs that are sunk. The money spent
on office stationary, business cards, and a sign that cannot be moved to the new office are not
marginal costs in the decision to move and should thus be ignored. In other words, the cost of the
old cards, old stationary, and old sign are sunk costs to be ignored in making the decision to move
the office, while any costs of purchasing new business cards, new stationary, or a new sign are
part of the marginal cost of making the move. If, as the first partner seems to believe, MB
exceeds MC for making the move, then net benefit rises even though new cards, stationary, and a
sign must be purchased.
Chapter 3: Marginal Analysis for Optimal Decisions

11
4.
a.
b.
c.
2
$500 (= $25 20 radios not stolen due to hiring 1 guard)
4
5.
a.
The following graph illustrates such a situation. Clean-up activity is plotted along the
horizontal axis and marginal benefits and costs along the vertical. For any amount of
clean up greater than A*, MC exceed MB, and that amount of clean-up activity is too
much.
b.
The following graph illustrates such a situation. Notice that the shape of MB reflects
Breyers assertion that most of the benefit of clean-up comes at relatively low levels of
clean up activity. The shape of MC puts most of the clean-up cost at relatively high
levels of clean-up.

12
6.
Never give up: You should give up an activity when MC > MB for extra units of the activity.
Anything worth doing is worth doing well: How well you choose to do something should be
determined by weighing costs and benefits at the margin.
Waste not, want not: If saving a unit of a resource costs more than the value of the resource
(usually measured by the price of a unit of the resource), it is NOT optimal to save the
resource. For example, if a manufacturer must spend $100 to prevent $15 worth of a raw material
from being wasted, then it is optimal to waste the raw material.
7.
8.
9.
a.
With a payroll of $160,000, the manager should hire five people with high school
diplomas and two people with bachelor's degrees. This choice maximizes the number of
customers served because the last dollar spent on each type of employee yields the same
addition to the number of customers served; MBHS / PHS (60 / $20,000) = MBB / PB (90 /
$30,000) = 0.003.
b.
No, she is not making the correct decision. If the manager hires three employees of each
type, the marginal contributions of the last person hired are the same for both types of
employees (80), but the marginal contribution per dollar is higher for a high school
diploma (80/$20,000) than for a bachelor's degree (80/$30,000). By hiring more
employees with a high school diploma and fewer with a bachelor's degree, the manager
can spend the same amount on payroll and increase the number of customers served.
c.
With a budget of $240,000, she should hire six people with high school diplomas and
four people with bachelor's degrees.
a.
Q* = 6,000 wine decanters

MR6,000 = $70
b.
TR6,000 = 70 6,000 = $420,000

TC6,000 = 10,000 + 40(6,000) + 0.0025(6,000)2
= $340,000
Profit = $420,000 $340,000 = $80,000
c.
The 6,001st decanter adds $70 to total revenue and slightly more than $70 to total cost.
Therefore the 6,001st unit would (slightly) reduce profit.
a.
b.
c.
5
4
3

1.
a.
b.
MB = 170 2x; MC = 10 + 4x
NB = 170x x2 100 + 10x 2x2
dNB
dx
= 170 2x + 10 4x = 180 6x = 0;

13
x* =
2.
180
= 30
c.
NB = 170(30) (30)2 100 +10(30) 2(30)2 = 2,600
a.
b.
MB = 100 4x; MC = x2 12x + 52

NB = 100x 2x2 (1/3)x3 + 6x2 52x 80
dNB
= 100 4x x2 + 12x 52 = 48 + 8x x2 = 0
dx
This factors to (x + 4)( x + 12) = 0
x = 4, x = 12 x* = 12 maximizes NB
NB = 100(12) 2(12)2 (1/3)(12)3 + 6(12)2 52(12) 80 = 496
c.
3.
Z = 3x + xy + y + (70 4x 2y)
!Z
!x
!Z
!y
!Z
!"
= 3 + y 4 = 0
= x + 1 2 = 0
= 70 4x 2y = 0
Dividing the first equation by the second,
3+ y
x +1
4
2
; 3 + y = 2x + 2; y = 2x 1
Substituting this solution into the third equation:

70 4x 2(2x 1) = 0
and solving for x = 9; y = 2(9) 1 = 17
Bmax = 3(9) + 9(17) + 17 = 197

14
4.
Z = 6x + 3y + (288 xy)
!Z
= 6 y = 0
!x
!Z
!y
!Z
!"
y
= 3 x = 0
= 288 xy = 0
= 2 ; y = 2x; substituting into the third equation, 2x(x) = 2x2 = 288; x = 144 = 12; y = 2(12) =
2
24.
Min c = 6(12) + 3(24) = $144
5.
MB =
dTB
= 8 ! 0.008 A . At
dA
point C, MB = 8 0.008(200) = $6.40. The rest of the points can be similarly verified.
a. Marginal benefit is the derivative of TB with respect to A:
b. Marginal cost is the derivative of TC with respect to A: MC =
dTC
= 1 + 0.012 A . At point
dA
C, MC = 1+ 0.012(200) = $3.40. The rest of the points can be similarly verified.
c. NB = TB TC = 8A A 0.004A2 0.006A2 = 7A 0.010A2. The derivative of NB equals
MB MC.
d. Yes.

1.
a.
a.
2.50
b.
7.00
c.
150
d.
7.50
e.
f.
4.50
b.
50; NB; $225
c.
0; 0; 0; negative
d.
TB; TC; NB
e.
TC; TB; NB

15
2.
Your table should look like:

Level of
Activity
A
a.
b.
Total
Benefit
Total
Cost
Marginal
Benefit
Marginal
Cost
Net
Benefit
--
--
$ 31.75
$ 2.50
$ 31.75
$ 2.50
$ 29.25
60.75
6.25
29.00
3.75
54.50
87.25
11.25
26.50
5.00
76.00
111.40
18.00
24.15
6.75
93.40
133.60
26.30
22.20
8.30
107.30
154.60
35.40
21.00
9.10
119.20
174.10
49.20
19.50
13.80
124.90
192.10
66.95
18.00
17.75
125.15
209.20
88.95
17.10
22.00
120.25
10
223.45
114.95
14.25
26.00
108.50
11
235.90
145.45
12.45
30.50
90.45
12
247.10
180.05
11.20
34.60
67.05
d.
A* = 8
Undertaking the 5th unit of activity causes total benefit to increase by $22.20, but total
cost increases by only $8.30. Since more is added to total benefit than is added to total
cost, net benefit rises when the 5th unit of activity is undertaken. Thus 4 units cannot be
optimal since net benefit can be further increased by increasing the activity level by one
unit.
By reducing output to 11 units, total benefit decreases by $11.20 and total cost decreases
by $34.60. Since total cost falls by more than total benefit falls, net benefit rises by
reducing output to eleven units. Therefore, twelve units could not be optimal since net
benefit can be increased.
A* = 8. Yes it is the same as in part a.
3.
a.
b.
X * = 3; Y * = 2; TB* = $185,000 (= 75,000 + 110,000)

X * = 5: Y * = 6; TB* = $306,000 (= 100,000 + 206,000)
4.
a.
b.
increasing; total; increases; total; increasing; increase; equal

decreasing; total; decreases; total; decreasing; decrease; equal
5.
The money spent getting the Brazilian plant operating is now a sunk cost for the purposes of
deciding whether to continue operating the plant. Sunk costs should be ignored in this decision.
The plant should continue operating if the marginal benefit from operation exceeds the marginal
cost from operation.
6.
A graph should be drawn showing a downward sloping MB curve for saving additional owls and
an upward sloping MC curve for saving additional owls. Saving owls past the point of
intersection of MB and MC means that more than the optimal number of owls are being saved.
c.

16
7.
a.
b.
8.
The publisher should ignore the costs of setting the type since these costs are sunk costs
that cannot be recovered.
The publisher should ignore the $1 million advertising cost since it is a fixed amount that
does not vary with the number of copies printed.
a.
1 round of golf and 5 tennis matches.
b.
0 rounds of golf and 4 tennis matches.

17

18
Chapter 4:
BASIC ESTIMATION TECHNIQUES

1.
2.
a.
The intercept a is expected to be positive because even if no advertising is undertaken,

some sales are expected to occur. b is expected to have a positive sign since Vanguard's
sales are positively related to its level of advertising expenditures. Vanguard's sales
should be inversely related to its rivals' expenditures on advertising, so c is expected to be
negative.
b.
a is the sales of Bright Side detergent when neither Vanguard nor its rivals advertise. b is
S/A, the increase in Bright Side sales attributable to a $1,000 per week increase in
advertising expenditures by Vanguard. c is S/R, the decrease in Bright Side sales
attributable to a $1,000 per week increase in advertising expenditures by Vanguard's
rivals.
c.
The exact level of significance of b is 0.0128. There is only a 1.28% chance that b = 0,
which is better than the 10 percent level required by the marketing director.
d.
The exact level of significance of c is 0.0927. There is a 9.27% chance that rivals
spending on advertising does not affect Vanguards sales (i.e., b = 0), which is just barely
better than the 10 percent level required by the marketing director.
e.
About 78 percent of the variation in sales remains unexplained. Find additional

explanatory variables that have a significant affect on S. The manager might try adding
the price of its detergent and the prices of its rivals detergents.
f.
S = 175,086 + 0.855 40,000 0.284 100,000 = $180,886 of sales each week.
a.
At the 95% level of confidence, the critical F-value is Fk 1,n k = F1,15 = 4.54. Since the
computed F-ratio 42.674 is greater than 4.54, the regression equation provides evidence
of a statistically significant relation. Note also that 74% of the variation in V is explained
by the equation.
b.
The critical t-value for n k = 15 degrees of freedom and a 95% level of confidence is
2.131. For a : t = 25.418 > 2.131; statistically significant. If Proposition 103 has no
impact on auto insurance premiums in any given county, P = 0, and the expected
percentage of voters favoring Proposition 103 in that particular county is given by:
V = 53.682 0.528(0) = 53.682,
or 53.7% are expected to favor Proposition 103.
c.
For b : t = | 6.519| > 2.131; statistically significant

Remember that both V and P are measured as percentages. Thus, a 1% increase in P is
estimated to result in a 0.53% decrease in V. A 10% increase in P is expected to result in
a 5.3% (= 0.53 10) decrease in V.
Note: All of the p-values are so small that you could quickly determine that all tests
would find significance at extremely high levels of confidence.
Chapter 4: Basic Estimation Techniques

19
3.
4.
a.
The F-statistic provides evidence that the regression equation as a whole is statistically
significant. The p-value for the F-statistic is significant at less than 0.01%. The R2
indicates the regression equation explains 83% of the variation in E. The p-values for the
individual coefficients are:
For a : the p-value = 0.2369, or there is a 23.69% chance that a = 0.
For b the p-value = 0.0023, or there is only a 0.23% chance that b = 0.
b.
Since E/N is estimated to be 32.31, each extra ticket sold in December is expected to
increase annual earnings by $32.31.
c.
E = 25,042,000 + 32.31 950,000 = $55,736,500 for the year.
a.
Estimate the model

Q' = a' + bH ' + cS ' ,
where Q' = ln Q, a' = ln a, H ' = ln H, and S ' = ln S.
b.
b = %Q/%H
c = %Q/%S
A 20% increase in S will increase Q by 5.1% (= 0.2550 x 20).
c.
Perform an F-test. The 5 percent F-value is Fk 1,n k = F2,50 = 3.18. Since 29.97 > 3.18,
the overall equation is statistically significant. The p-value for the F indicates
significance below the 0.01% level.
d.
54.52% of the variation in Q is explained by this model. The R2 could be increased by

adding some additional explanatory variables such as the sales experience of the
salespersons employed. Whether the sales day is a weekday or a Saturday/Sunday, and
the level of advertising in newspapers the previous week.
e.
The critical t-ratio is tn k = t50 2.

For a ' : t = 3.80 > 2; statistically significant. The p-value indicates exact significance at
the 0.04% level. Since a ' = ln a , a = ea', and a = 2.5. Since Q = 2.5 H 0 .3517S 0 .2550,
Q = 2.5(0)0.3517 (0)0.2550 = 0.
Sales are expected to be zero because in the nonlinear form Q is zero when either H or S
is zero.
f.
For b : t = 3.44 > 2; statistically significant. The p-value indicates exact significance at
the 0.12% level.
Since b = %Q / %H, b is the estimated percentage increase in sales attributable to
increase the hours of operation by 1%, all else constant. Since b = 0.3517, a 10 percent
decrease in H will decrease sales by 3.52 percent (= 0.3517 ! 10).

20

1.
a.
b.
c.
d.
e.
f.
g.
h.
Y = 93.54 ! 3.25 X
28; 2.763
is not; is
2.467; is not; is
0.09%; committing a Type I error
7.64; is
1,531.46 (= 93.54 3.25 500)
67%
i.
The estimated value of b is a random variable because the value of b varies from sample
to sample. For any single sample, we wish to determine if the estimated value of b is far
enough away from zero that we can be relatively sure (say 95% sure) that the true value
of b cannot be zero. The larger is b , all else constant, the more certain we can be that b
is not equal to zero, and X does indeed influence Y. If b is small (relatively close to
zero), then the true value of b may indeed be zero, which indicates X is not influencing Y.
2.
a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
ln Y = ln a + b ln R + c ln S
23; 2.807
is; is not; is not
20 (= e2.9957)
1.34; committing a Type I error
5.66; is not
648 (= 20 122.34 30 0.687 )
63.53%
32.76%
decreases; 10%
3.
COMPUTER EXERCISE
a.
The regression output for the log-linear regression:
LNP
R-SQUARE
F-RATIO
P-VALUE ON F
20
0.8625
53.33
0.00001
VARIABLE
PARAMETER
ESTIMATE
STANDARD
ERROR
T-RATIO
P-VALUE
INTERCEPT
1.82542
1.90669
0.96
0.3518
LNN
0.83655
0.08694
9.62
0.0001
LNC
0.53334
0.21197
2.52
0.0222
DEPENDENT VARIABLE:
OBSERVATIONS:
b.
c.
d.
e.
f.
g.
h.
ln P = ln a + b ln N + c ln C
P = 0.1611N 0.8366C 0.5334 Note that e !1.82542 = 0.1611
17 (= n ! k = 20 3); 2.567
is not; is; is
%!P
%!P
4.99. b =
" 0.8316 =
" %!P = 4.99%
%!N
6%
%!P
10%
increases; 18.75%. c =
" 0.5334 =
" %!C = 18.75%
%!C
%!C
The F-ratio and R2 are both larger for the linear model.
21

22
Chapter 5:
THEORY OF CONSUMER BEHAVIOR

1.
a.
No, Bridget is not making the utility-maximizing choice. Currently, MUW /PW = 50/10
= 5 < MUC / PC = 40/4 = 10; the last dollar spent on cheese yielded more satisfaction
than the last dollar spent on wine, and she can increase utility by changing her
consumption choice.
b.
Bridget should buy more cheese and less wine. By spending one more dollar on cheese
and one less dollar on wine, total expenditures will be unchanged and utility will increase
by 5 units. She can increase utility by continuing to purchase more cheese and less wine
until the marginal utility per dollar is equal for cheese and wine.
2.
a.
b.
3, 7, and 5 cups per day of Rice Krispies, cottage cheese, and popcorn, respectively.
2, 6, 4
3.
Any benefit package might be preferred by employees over higher wages due to the increased
income tax liability that arises from increased money income. A flexible package gives the
employees a larger choice set from which they can substitute and maximize utility. Thus, the
recent trend towards flexible benefit packages will probably incite more employee interest in
benefits relative to higher wages.
4.
No. Consumer theory can account for the presence of uncertainty in the choices consumers
make. By maximizing utility over many possible states, individuals adhere to the theory of
consumer behavior and can make mistakes and have bad luck also.
5.
Let be profits, which depend on the level of output (Q), and K be the level of charitable
contributions. The utility function can be written as U = U[(Q),K]. The firm's total cost is the
cost of producing output, C(Q), plus the level of charitable contributions, K. The firm's objective
would be to choose the levels of Q and K that will minimize C(Q) + K subject to U[(Q),K] = U*,
where U* is a specified level of utility. As in the typical constrained optimization problem, the
marginal utility of output per dollar of marginal cost must equal the marginal utility per dollar of
charitable contributions. The equilibrium condition would the same if the firm's objective were to
maximize utility subject to a given level of total cost.
6.
a.
b.
c.
d.
e.
f.
7.
a.
b.
c.
d.
Substitution and Income effects of a price increase in gasoline resulted in lower

consumption.
Income effect of a gasoline price increase.
Substitution effect of a gasoline price increase.
Substitution effect of a gasoline price increase.
MUNike / PNike > MUReebok / PReebok
MUBoxster / PBoxster < MUMiata / PMiata
For Don, even though his income is greater than the price of a trip to Mexico,
(MU/P)Trip to Mexico is less than MU/P for all other goods and services he wishes to
consume.
Jack is indifferent between chocolate chip or coffee ice cream.
Chapter 5: Theory of Consumer Behavior
23
8.
a.
b.
No
No, he meant the ratio of marginal benefit (quality of the plane) to price of the plane was
higher for the Lockheed plane. Per dollar spent, the Lockheed provided more of what the
Defense Department wanted (in terms of attributes) than the Northrop or McDonnell
Douglas planes. Since this is a ratio, we cannot deduce that Lockheed's price was lower
or quality higher than for the rival planes. It could be either or both.

1.
a.
b.
c.
d.
e.
f.
g.
h.
$32
$1 (This follows from the fact that bundle A costs $32.)
2
Y = 32 2X
$1
22
1
$32. The consumer's budget remains constant when deriving a demand schedule.
2.
a.
b.
c.
d.
e.
f.
MUy for the fifth unit = 24

MUx for the sixth unit = 10
MUx /Px for the fourth unit = 0.35
MUy /Py for the third unit = 0.5
3X and 5Y when income is $420
1X and 3Y when income is $220
Chapter 5: Theory of Consumer Behavior

24
Chapter 6:
ELASTICITY AND DEMAND

1.
The analyst believes demand is inelastic because he believes an increase in price will increase
total revenue. The publisher believes demand is elastic because he believes an increase in price
will decrease total revenue.
2.
a.
b.
c.
d.
e.
f.
3.
a.
b.
c.
d.
True; price and quantity are inversely related.

False; |%Q| is less than |%P|.
False; demand is inelastic, not perfectly inelastic.
False; quantity demanded is relatively unresponsive to changes in price.
True; increases in quantity (decreases in price) lead to decreased total expenditure when
demand is inelastic.
True; marginal revenue is negative when demand is inelastic.
more elastic
more elastic
No direct effect on price elasticity of demand. However, if the higher costs result in
higher prices for corporate jets, then price elasticity will increase because of the
movement up the demand curve for corporate jets.
Businesses may now view commercial airlines as a less desirable substitute for corporate
jets. Demand for corporate jets would then be less elastic.
4.
E = 1 at Aztec because changes in the price of advertising have no effect on total advertising expenditures. Quantity of ads demanded = $2,000,000/Pad or Q = 2,000,000P 1.
5.
The WSJ reported that cigarette companies hiked cigarette prices by 76 cents per pack to an
average retail price of $2.71 in 2000a 37% increase. The price increase was successful
because demand for cigarettes at the current prices was inelastic, and thus total revenue increased
with the price hike. Had demand for cigarettes been elastic, a price increase could not have
increased revenues, and bankruptcy might have resulted.
6.
Sales of whisky will fall; %Q/20% = 0.2, so %Q = 4%, and sales fall by 4%.
7.
a. and b. P = $25 per month and Q = 50 lockers per month

c.
Since costs are irrelevant in this problem, the manager sets a price that maximizes TR.
TR is maximized at the unit elastic point on demand which occurs at P = 25, Q = 50.
8.
a.
b.
9.
E = 8%/5% = 1.6, demand is elastic. During 1991, average household income fell due to a
recession. The falling income may also account for some of the decline in movie attendance.
10.
a.
No. At P = $9, E = 9/(9 15) = 1.5. Since |E| > 1, an increase in price will decrease TR.
Yes. At P = $9, E = 9/(9 22) = 0.69. Since |E| < 1, an increase in price will increase
TR.
!1.432 =
115,040 ! 12,790
66 ! 233
"
149.50
63,915
Chapter 6: Elasticity and Demand

25
b.
!1.464 =
c.
!1.410 =
68,100 ! 35,690
107 ! 165
94,116 ! 11,960
57 ! 196
"
"
136
51,895
126.50
53,038
The price elasticities are remarkably similar in value. In each case, the price elasticities suggest
that travelers are rather responsive to price reductions. In all cases, demand is elastic, and a 1%
price reduction results in about a 1.4% increase in travel.
1.
a.
b.
c.
d.
e.
P = P(Q) = 40 2Q
TR = R(Q) = (40 2Q)Q = 40Q 2Q2
The first-order condition for a maximum is dR/dQ = 0. dR/dQ = 40 4Q. Set dR/dQ = 0
and solve to find Qrmax = 10. Prmax = P(Qrmax) = 40 2(10)2 = $200.
MR = R(Q) = 40 4Q. Total revenue reaches its maximum at the output level for with
MR = 0. Set MR = 0, and solve for Qrmax = 10.
E = 20/(20 40) = 1. As expected, demand is unitary elastic because total revenue
reaches its maximum value.
2.
a.
b.
E = b(P/Q) = b[1/b(Q a)]/Q. Thus, E = (Q a)/Q.

dE/dQ = a/Q2 > 0. As Q gets larger moving down demand, E gets larger algebraically,
and demand becomes more inelastic (i.e., |E| gets smaller).
3.
a.
E=
b.
dQ P
dP Q
= !36P
!2
"
P
36P !1
= !1
TR = PQ = P 36P !1 = 36
MR = 0

1.
a.
b.
c.
d.
TR = P Q = $800 at every point on demand.

stays the same; stays the same; stays the same.
Yes, since TR is constant along this demand, it appears to have a constant elasticity equal
to 1.
(Since P Q = 800, it follows that) Q = 800P !1 ; equal to; unitary elastic
Perfectly constructed tangent lines would look like the following tangent lines:

26
P
16
14
12
Demand
10
B
8
6
C
4
D
2
Q
0
50
100
200
300
400
Using the tangent lines shown in the figure above, the point elasticities at points B, C,
and D can be calculated as follows:
E B = 8 / (8 ! 16) = (200 / 16)(8 / 100) = !1
EC = 4 / (4 ! 8) = (400 / 8)(4 / 200) = !1

e.
2.
a.
b.
c.
d.
e.
E D = 2 / (2 ! 4) = !1
Either answer is acceptable since the tangent lines are constructed by hand:
i.
Yes, the computed price elasticities using the tangent lines are all equal to 1.
ii.
No, one (or more) of the computed price elasticities did not equal 1, probably
because the constructed tangent line was not perfectly tangent.
2,368,750
0.451; normal; fall; 1.28 percent
1.283; elastic; 6.42 percent
0.861; 0.528; positive; substitutes
The BMW has the larger cross-price elasticity, which indicates demand for Chrysler
Crossfires is more sensitive to changes in the price of BMWs 330i than to changes in the
price of Porsches Boxster S. The Boxster is much more expensive than the Chrysler
(and BMW), consequently a small percentage price reduction on the Boxster is not likely
to cause many BMW buyers to switch to the Boxster. Neither will a small price increase
in the price of a Boxster cause many Boxster buyers to switch to the less expensive
Chrsyler Crossfire or BMW 330i.

27
3.
a. and b.
$
10
Price (dollars)
MR = 10 - 0.25Q
6
P = 10 - 0.125Q
4
2
Q
0
10
20
30
40
50
60
70
80
90
Quantity
Panel A: Demand and Marginal Revenue

$
200
Total revenue (dollars)
Total revenue
160
120
80
40
Q
0
10
20
30
40
50
60
70
80
90
Quantity
Panel B: Total Revenue
c.
d.
0; 40; 40; 80; 40

see Panel B in the figure above
4.
In the past, cigarette prices have been low enough that demand remained inelastic, so price
increases could be used to increase revenues. As prices continued to rise along cigarette demand,
however, price elasticity eventually became elastic and further price increases caused revenues to
fall. The graph should show past prices in the inelastic region of demand and current prices in the
elastic region of demand.
5.
The excise tax would increase price by 34.6% [= (0.45/1.30) 100]. Since the short-run price
elasticity is 0.43 for gasoline (from Illustration 6.2), the percentage decrease in gasoline sales is
14.88% (solve 0.43 = %Q/34.6). Since demand is inelastic, the increase in price will cause
total consumer expenditure on gasoline to rise in the short-run.
6.
When copayments rise from 20 percent to 25 percent, health care consumers see the prices they
pay rise by 25%. Thus, quantity demanded of doctor visits can be expected to fall by 6.25%
(%Q = 0.25 25).
28
Chapter 7:
DEMAND ESTIMATION AND FORECASTING

1.
a.
All parameters are significantly different from zero at the 7.16 percent level of
significance or better. The signs of the parameter estimates are consistent with consumer
theory: b is negative as the law of demand predicts, c is positive indicating tennis balls
are a normal good, and d is negative as it should be for complements (tennis balls and
tennis rackets).
b.
240,134 cans per quarter = 425,120 + ( 37260.6 1.65) + (1.49 24,600) + ( 1456
110)
c.
E = 37260.6(1.65/240,134) = 0.256
E M = 1.49(24,600/240,134) = 0.153
E = 1456(110/240,134) = 0.667
XR
% change in Q / 15% = 0.256 ! Sales rise by 3.84 percent.
e.
% change in Q / 20% = 0.153 !
f.
% change in Q / 25% = 0.667 !
a.
If Cypress River's sales vary cyclically, sales forecasts will be biased unless the cyclical
variation is taken into account. In the figure below, a, b, and c were estimated using a
dummy variable to account for seasonal variation. The parameters a and b were
estimated without treating seasonal observations differently. In the situation depicted, the
time trend parameter estimate b is biased upward; i.e., the trend line is too steep.
Sales rise by 2.98 percent

Sales fall by 16.67 percent
Qt
Q t= a + bt
Q t= a + c + bt
Sales
2.
d.
Q t= a + bt
t
Time
Chapter 7: Demand Estimation and Forecasting

29
3.
b.
If a regression includes a dummy variable when there is no cyclical variation, the

estimates will be less precise and the degrees of freedom will be reduced.
a.
Consider the statistical significance of b . The critical value of t for 28 5 = 23 degrees

of freedom and a 95% confidence level is 2.069, and the t-ratio for b is much greater.
The p-value for b indicates strong statistical significance. Thus, the regression analysis
provides very strong statistical evidence of an upward trend in shoe sales.
b.
Looking at either t-tests (at 5% significance level) or p-value on the seasonal dummies:
For c1 : t = 2.17 > 2.069; statistically significant or exact significance = 4.04%.
Since all seasonal dummies are significantly different from zero, the data suggest that
athletic shoe sales tend to exhibit a seasonal pattern. Ceteris paribus, sales are expected
to be 3,280 units higher in the winter than in the fall, 6,250 units higher in the spring than
in the fall, and 7,010 units higher in the summer than in the fall.
c.
For 2008III and 2009II, t = 31 and 34, respectively.

Q2008III = 184500 + 2100(31) + 3280(0) + 6250(0) + 7010(1) = 256,610 units
Q2009II = 184500 + 2100(34) + 3280(0) + 6250(1) + 7010(0) = 262,150 units
d.
You might be able to improve this forecast equation by adding some additional
explanatory variables that affect both demand and supply of athletic shoes. This would
require using a simultaneous equations model.

1.
a.
b.
c.
d.
tb = 0.03/0.01 = 3.0 > 2.021 ! b is statistically significant. Thus there is a statistically

significant upward trend in delinquencies.
181.93 > F1,46 = 4.05 ! the model is statistically significant.
DRJan 2008 = 2.6 + 0.03(49) = 4.07%
DRMar 2008 = 2.6 + 0.03(51) = 4.13%
Yes
t = 0.018/0.004 = 4.5 > 2.021 ! b is statistically significant.
b
e.
f.
g.
tc = 0.81/0.21 = 3.86 > 2.021 ! c is statistically significant. Therefore, December and
January are significantly worse months for mortgage payments.

DRJan 2008 = 2.2 + 0.018(49) + 0.81(1) = 3.89%
DRMar 2008 = 2.2 + 0.018(51) + 0.81(0) = 3.12%
The initial forecasts fail to consider the cyclical variation in the months of December and
January. The t-test on c and the higher value of F indicate that the cyclical variation was
significant. By including the dummy we get a more precise estimate of the upward trend
in DR. The management consultant appears to have been correct.

30
COMPUTER HOMEWORK EXERCISES

2.
a.
b.
c.
d.
e.
f.
When N is included in the model, its p-value is 0.4061, which is not small
enough to be statistically significant at the 2 percent level. So N is dropped from
the model and the equation is estimated again without N:
Q = 5357.08 ! 1906.86P + 0.08033M + 1615.65PR
85.85%
3.5
E = !1906.86
= !0.934 ; inelastic; 10.71%
7144.87
45000
E M = 0.08033
= 0.506 ; normal; 3.036%
7144.87
3
E XR = 1615.65
= 0.678 ; Yes, because the two goods are substitutes;
7144.87
5.424%
When the log of N is included in the model, its p-value is 0.5737, which is not
small enough to be statistically significant at the 2 percent level. So lnN is
dropped from the model and the equation is estimated again without lnN:
Q = 62.934P !0.97627 M 0.48352 P 0.70197
R
where e
= 62.934
No
E = !0.97627
E M = 0.48352
E = 0.70199
4.14209
g.
h.
XR
The elasticity estimates are identical in algebraic sign and similar in magnitude.
3.
a.
Your computer printout will look like:
DEPENDENT VARIABLE:
QT
R-SQUARE
F-RATIO
P-VALUE ON F
OBSERVATIONS:
36
0.0722
2.62
0.1130
VARIABLE
PARAMETER
ESTIMATE
STANDARD
ERROR
T-RATIO
P-VALUE
INTERCEPT
8011.26
202.890
39.49
0.0000
15.5568
9.56258
1.63
0.1130
Looking at b , the data suggest an upward trend of 15.5568 units per month. The
statistical significance of the trend is not very convincing, as the p-value
indicates the probability of finding significance when none exists (i.e., the
probability of a Type I error) is 11.3 percent. Furthermore, the model explains
only 7.22 percent of the variation in sales.

31
b.
Your computer printout will look like:
DEPENDENT VARIABLE:
QT
R-SQUARE
F-RATIO
P-VALUE ON F
OBSERVATIONS:
36
0.7591
24.42
0.0000
VARIABLE
PARAMETER
ESTIMATE
STANDARD
ERROR
T-RATIO
INTERCEPT
7892.04
163.155
48.37
0.0000
11.9888
5.39177
2.22
0.0336
D1
501.212
157.596
3.18
0.0033
D2
859.488
153.389
5.60
0.0000
D3
382.633
150.809
2.54
0.0164
P-VALUE
Looking at b , the data suggest a statistically significant (at the 3.36% level)
upward trend of 11.9888 units per month. The estimates of c1 , c2 , and c3 are
individually highly significant, suggesting a seasonal pattern to sales of Titan II
golf clubs. For winter months (Jan., Feb., and Mar.), sales are expected to be 501
units lower than during the fall months (Oct., Nov., and Dec.). For spring
months (Apr., May, and June), sales are expected to be 859 units higher than
during the fall months (Oct., Nov., and Dec.). For summer months (July, Aug.,
and Sept.), sales are expected to be 383 units higher than during the fall months
(Oct., Nov., and Dec.).
c.
Since the seasonal dummies are statistically significant, you would expect to get
a biased estimate of the trend if you estimate the linear trend model in part a.
d.
Forecasts are shown in the table below:

T
D1
D2
D3
Forecasted Q
January 2007
37
7,834
July 2007
43
8,790
January 2008
49
7,978
July 2008
55
8,934

32
Chapter 8:
PRODUCTION AND COST IN THE SHORT RUN

1.
Diminishing returns begin when a new worker adds less to total product than the previous worker.
When diminishing returns set in, marginal product begins to decrease; total product is still
increasing, but at a decreasing rate. The managers may be confusing diminishing returns and
negative marginal product; a company should not hire a worker if the new person has negative
marginal product i.e., causes total output to decrease.
2.
a.
b.
c.
3.
Energy efficiency in the context of this problem simply means producing a mile of
transportation with the least amount of a particular input, namely gasoline. Economic
efficiency means producing the mile of transportation at the lowest possible total cost.
These are generally different objectives.
If gasoline is extremely expensive relative to the other inputs needed to produce
transportation miles (such as aluminum, rubber, glass, plastic, and highly trained design
engineers), then is may be economically efficient to use more of these other scarce
resources to reduce the amount of gasoline needed to drive a mile.
Economic efficiency looks at the total cost of all scarce resources. After all, the various
resources used to reduce the amount of gasoline burned cannot be used to produce other
socially desirable goods such as food, clothing, and shelter.
a.
All the sheet metal workers at CF&D could be working as hard as they can, and the
firm could still experience diminishing productivity as suggested by the law of
diminishing marginal productivity. If the production increases at CF&D were achieved
without adding new machinery (keeping capital constant), then beyond some level of
employment, marginal productivity of sheet metal workers will fall. The decline in
productivity embodied in the law of diminishing productivity is not the result of worker
laziness. Remember, the production function assumes technical efficiency, so the
downward sloping portion of the MP curve cannot be caused by lazy workers or poor
management of workers. If the plant is technically efficient, no amount of cracking
down on labor can increase productivity.
b.
Adding new sheet metal working machines will cause the MP and AP curves to shift
upward. Workers will have more (and perhaps better) with which to work, thereby
increasing their productivity levels (measured as either MP or AP).
4.
Improvements in productivity, as measured by increases in MP and AP, directly result in

reductions in SMC and AVC, respectively. Lower costs make it possible to maintain, and possibly
even increase, profits in the face of falling prices.
5.
The move was economically efficient if the same amount of furniture was produced at a lower
total cost after the change. Throwing away wood scrap costs the factory money, but so does
reducing the amount of wood scrap. The decision was economically efficient only if the cost of
reducing the wood scrap was less than $93,000 (the cost savings from the change).
Chapter 8: Production and Cost in the Short Run

33

1.
2.
a.
f(L,16) = g(L) = 20 4 L2 = 80L2 .
b.
AP = Q/L = 80L 2
c.
MP = dg(L)/dL = 40L 2
d.
dMP/dL = g(L) = 20L 1.5 , which is negative for all L.
a.
From equation (9) in the Math Appendix, the slope of ATC = 1/Q(SMC ATC). Similarly,
it can be shown that the slope of AVC, dAVC/dQ, is equal to 1/Q(SMC AVC). Clearly,
the slopes of ATC and AVC are not equal for any given Q.
b.
Let D = slope AVC slope ATC. It is easy to show that D is positive for all output levels:
D = slope AVC slope ATC = 1/Q(SMC AVC) 1/Q(SMC ATC)
= 1/Q (AFC) > 0 for all Q.
When both AVC and ATC are falling , both slopes are negative. The algebraic difference
between the two slopes, D, cannot be positive unless |slope ATC| > |slope AVC|; that is,
ATC falls faster than AVC falls. In contrast, when both are rising, AVC rises faster than
ATC [D is positive].
3.
a.
AVC = AVC(Q) = TVC/Q = 20L/Q. Solving for L in the production function, L = L(Q) =
Q2/6400. Substituting into AVC, AVC = [20(Q2/6400)]/Q = Q/320.
b.
L = (160)2/6400 = 4 units of labor; AP = 160/4 = 40; AVC = (20 40)/160 = $0.50
c.
SMC = SMC(Q) = dTVC(Q)/dQ = d[20L(Q)]/dQ = d[Q2/320]/dQ = Q/160.
d.
When Q = 160, L = 40 (from 3b). So MP = 40(4) 2 = 20; SMC = 20/20 = $1 ; or SMC

= 1/160 (160) = $1 [Verified at marks.]

1.
a.
1,500
b.
$4; $4
c.
$8
d.
1,728
e.
$4.167; $8.33
NOTE: Marginal cost is calculated at a point, L = 36. So, SMC = $200/24 = $8.333.
Some students may compute it over the interval of output from 1,500 to 1,728 by finding
the ratio of the change in total variable costs to the change in output:
!TVC / !Q = 1, 200 / 228 = $5.26 .
34
f.
2.
Your table should look like:

Output
3.
increasing; increasing
TC
TFC
AFC
AVC
ATC
SMC
60
60
xx
xx
xx
xx
10
140
60
80
6.00
8.00
14.00
8.00
20
150
60
90
3.00
4.50
7.50
1.00
30
215
60
155
2.00
5.17
7.17
6.50
40
287
60
227
1.50
5.68
7.18
7.20
50
367
60
307
1.20
6.14
7.34
8.00
60
452
60
392
1.00
6.53
7.53
8.50
70
542
60
482
0.86
6.89
7.74
9.00
80
642
60
582
0.75
7.28
8.03
10.00
TVC
a.
$15
b.
$10
c.
$25
d.
$1,500
e.
$1,000
f.
$2,500
g.
approximately $4
h.
$5
i.
$10
j.
$15
k.
$1,500 = 300 $5
l.
$3,000
m.
$4,500
n.
$25

35

36
Chapter 9:
PRODUCTION AND COST IN THE LONG RUN

1.
a.
Over this period the price of computers decreased relative to the price of other inputs.
Optimizing firms thus would choose to use more of the now relatively less expensive
input (computers) to produce a given level of output.
b.
If the price of an input (personal computers) falls relative to the price of other inputs, we
would expect firms to substitute toward the input that becomes relatively less expensive
and away from inputs that become relatively more expensive. Thus we would expect
firms to use more personal computers and fewer inputs that are substitutes for personal
computers (e.g., clerical workers).
2.
The publishing house is not making the optimal choice because the last dollar spent on printers
added one book to total output (20/$20=1), while the last dollar spent on printing presses added
only one-half book to total output (50/$100=1/2). The publisher can produce more books at the
same total cost (or produce the same number of books at a lower total cost) by using more
printers and fewer printing presses.
3.
Managers of government bureaus can apply the principles of efficient production by employing
inputs so at to maximize the output of their bureaus, given the budgets they must work within.
Similarly, the manager of a nonprofit club will want to maximize the provision of club services to
club members, given the club cannot spend more than the dues collected from members.
4.
a.
By purchasing one textile machine, 9 laborers must be fired to keep the level of output
exactly equal to 5,400 units per day. This reduces the labor bill by 9 $50 = $450 and
increases the capital bill by $600. Clearly, substituting the machine for an equally
productive amount of labor increases the total cost of producing 5,400 units.
b.
At w = $100, the reduction in wage expense associated with laying off 9 workers is 9
$100 = $900 which is greater than the $600 the machine costs. Thus, the higher wages
make buying a machine efficient.
5.
Efficiency requires that inputs be employed so that marginal products per dollar spent are equal.
Since MPL/w (= 10/20 = 0.5) MPK/r (= 15/15 = 1), the Beta Corporation is not operating
efficiently. The new manager of Beta Corporation can improve efficiency by increasing the
amount of capital used and decreasing the amount of labor used.
6.
a. Spreading the overhead refers to spreading total fixed cost over the number of units of output
produced; average fixed cost declines as output increases.
b. A break-even level of production is the level of output at which total revenue equals total cost
(profit equals zero).
c. The efficiency of mass production refers to savings in unit cost at larger levels of output, i.e.,
economies of scale.
Chapter 9: Production and Cost in the Long Run
37
7.
a. Since the slope of the isocost curves (w/r) are equal to 5 (= 90/18 = 60/12 = 40/8), then
$200/r = 5, and r = $20.
b. 30K and 6L will minimize total cost of producing 180 units.
c. TC120 = $800 = $100(4) + $20(20)
TC180 = $1200 = $100(6) + $20(30)
TC240 = $1800 = $100(8) + $20(50)
d. L = 14 and K = 30
e. SRTC240 = $100(14) + $20(30) = $2,000
ATC240 = $2,000/240 = $8.33
AVC240 = $1400/240 = $5.83
AFC240 = $600/240 = $2.50
8.
Managers of bakeries in one geographic market could specialize in the production of one product,
say bread, in order to take advantage of the scale economies in baking bread. They would then
trade (or sell) some of their excess bread production to bakeries in other geographic markets that
specialize in other baked goods, such as rolls or cakes. In this way, bakeries in different markets
(i.e., noncompeting bakeries) could offer complete lines of baked goods and take advantage of the
economies of scope in marketing while, at the same time, benefiting from the lower per unit costs
associated with specialization.
9.
While doctors have a higher marginal product than R.N.=s, the price of R.N.=s may be so much
lower than the price of M.D.=s that the marginal product per dollar spent on R.N.=s may be
greater than the marginal product per dollar spent on M.D.=s. In such a case, costs can be
decreased by using more R.N.=s and fewer M.D.=s.
10.
In some cases, foreign workers may be less productive than U.S. workers. Thus, the marginal
product per dollar spent on U.S. workers may be greater than the marginal product per dollar
spent on foreign workers, even with lower wages in foreign countries. Consequently, keeping
production at home is probably not motivated primarily by patriotism but rather by efficiency
concerns.

1.
a.
b.
c.
d.
MPL = aALa-1Kb
MPK = bALa Kb-1
MRTS = aK/bL
If the isoquant is convex, increasing L will cause MRTS to get smaller since
MRTS is defined to be a positive number. Thus MRTS / L is negative for
convex isoquants. For this production function, MRTS / L = (aK)/(bL2) < 0.
e.
MRTS =
w
r
aK *
*
bL
w
r
! K* =
bw
a r
L*

38
2.
a.
!b
# Q $ a + b # bw $ a + b
#a w $
Q ! AL %
L & = 0 " L* = % & %
&
'b r (
' A ( ' ar (
a
"Q
#
%
& A'
1
a +b
b !1
" a # a +b
" w # a +b
b.
K =$
c.
$ Q % a +b
LTC = LTC (Q; w, r ) = wL + rK = ( ) w a + b r a + b
* A+
$ %
&b'
$ %
&r'
$ 1 % a +b
LAC = LTC / Q = LMC = ( ) w a + b r a + b
* A+
d.
"w
"LAC
"r
4.
" a a!+bb
&$( %)
&* b +
,
" a a!+bb
&$( %)
&* b +
,
b !1
#
$ a % a +b '
+( )
*b+ '
-
b !1
#
$ a % a +b '
+( )
*b+ '
-
For all values of Q, the following derivatives are all positive:
"LAC
3.
"LMC
"w
"LMC
"r
a % 1 & a + b a + b !1 a + b
=
) * w r
a+b+ A,
# a a!+bb
'%) &*
'-+ b ,
b !1
a & a +b $
%
+) * (
+b, (
.
b % 1 & a + b a + b a + b !1 #% a & a + b % a & a + b $

') * + ) * (
=
) * w r
a+b+ A,
+b, (
'+ b ,
1
!b
b !1
a.
b.
c.
Q = 24L0.5(121)0.5 = 264L0.5 = g(L)

MPL = dg(L)/dL = 132L0.5; dMPL/dL = 66L1.5 < 0 for all L.
K = 121 for all L
d.
e.
TVC = TVC(Q) = wL = 10Q2/69696 = 0.00143Q2; TFC = rK = 2420;

TC = TC(Q; w, r) = 0.000143Q2 + 2420
AVC = SMC = 0.000143Q; AFC = 2420/Q; ATC = 0.000143Q + 2420Q1
a.
b.
c.
d.
K* = (w/r)L*
L* = (w/r)1/2Q/24 and K* = (w/r)1/2Q/24
LTC = LTC(Q; w, r) = (Q/12)w1/2r1/2; LAC = LTC/Q = (1/12)w1/2r1/2 = LMC
dLAC/dQ = 0 for all Q.

39

1.
K
Units of capital
10
9
2,000 units
8
7
6
1,000 units
Expansion path
Short-run
expansion path
(K = 2)
2
1
0
L
10
20
30
40
50
60
70
80
90
100
Units of labor
a.
b.
c.
d.
e.
f.
g.
j.
k.
$40
40
0.10
50
K = 6 0.10L
3
R is technically efficient because decreasing either L or K results in a decrease in output
(i.e., a movement to a lower isoquant would occur).
R is economically efficient because it is the least-cost input combination for producing
1,000 units of output.
Economies of scale because LAC falls. LAC1,000 = $0.24 (= $240/1,000) and LAC2,000 =
$0.18 (= $360/2,000).
See the figure above. The short-run expansion path is the horizontal line at K = 2.
80; $400; reduce; $40. See point V in the figure above.
a.
b.
c.
MRTS; the input price ratio (w/r); MPL / w; MPK /r; labor; capital
the input price ratio (w/r); MRTS; MPK / r; MPL /w; capital; labor
h.
i.
2.

40
Chapter 10:
PRODUCTION AND COST ESTIMATION

1.
a.
The scatter diagram for these data (shown below) strongly suggest a TP curve with an Sshape. This scatter resembles the one shown in Figure 10.2 of the text. Thus, a cubic
specification seems most appropriate for these data.
TP
30
TP
O utput
25
20
15
10
5
L
5
b.
10
15
20
Labor
25
30
35
The estimated short-run cubic production function is

Q = !0.0007451L3 + 0.04873L2
The parameter estimates have the appropriate signs: the estimated coefficient for L3 is
negative and the estimated coefficient for L2 is positive. Both parameter estimates
A and B are significant at better than the 5 percent level: their p-values are 0.0044 and
c.
d.
0.0001, respectively.
Beyond about 21.8 (= 0.04873/(3 0.0007451) units of labor, diminishing returns set
in and marginal product is falling.
At 23 units of labor:
Q = 16.71 = !0.0007451(23)3 + 0.04873(23) 2
!
AP = 0.7266 = !0.0007451(23) 2 + 0.04873(23)
!
MP = 1.0592 = !0.002235(23) 2 + 0.09746(23)
2.
e.
SMC is rising because MP is falling beyond 21.8 units of labor.
a.
TP = 0.015625 (8)3 L3 + 10 (8)2 L2

= 8L3 + 640L2
AP = 8L2 + 640L
MP = 24L2 + 1280L
Lm = B/3A = 640/3(8) = 26.67
Marginal product will begin to decline beyond about 27 man-hours per day.
b.
Chapter 10: Production and Cost Estimation

41
3.
c.
At L = 50,
TP = 8(50)3 + 640(50)2 = 1,000,000 + 1,600,000 = 600,000 units of output
AP = 8(50)2 + 640(50) = 12,000 or TP/L = 600,000/50 = 12,000
MP = 24(50)2 + 1280(50) = 60,000 + 64,000 = 4,000
a.
Only a and b are significant at the 2 percent level. c is significant at the 2.62 percent
level.
b.
AVC is U-shaped because a > 0 , b < 0 , and c > 0 .
c.
AVC8,000 = $101.53; MC8,000 = $164.73; TVC8,000 = $812,240; TC8,000 = $992,240
d.
AVC10,000 = $126.93; MC10,000 = $301.93; TVC10,000 = $1,269,300; TC10,000 = $1,449,300
e.
Qmin = 6,354; AVCmin = $95.03

1.
In order to have MP rise then fall, the slope of MP (MPLL) must first be positive at low levels of
labor usage and then negative at higher levels of labor usage. Since MPLL = 6AL + 2B, letting A >
0 and B < 0 means that MPLL is first positive at low L only if 6AL > 2B. But this causes a
problem. As L increases, 6AL can only get larger, and MPLL can never become negative, and MP
can never diminish, as it must.
2.
Lm ( K ) = !
bK 2
aK
=!
b
a
K !1 . Taking the derivative of Lm with respect to K , we see that this
derivative is positive definite:
dLm
dK
b
a
K !2 > 0 .
3.
a.
b.
c.
MPL = 1.0 Q/L and MPK = 0.5 Q/K

MRTS = 2 K/L; EL = 1.0; EK = 0.5
1.5; increasing
4.
a.
Yes, because the exponents on w and r sum to one. Thus, LTC (Q; 2w, 2r) = 1/12 Q
(2w)0.5(2r)0.5 = 2LTC(Q; w, r).
b.
Elasticity of total cost = 1.
c.
LAC = LMC = $1.67. Flat LMC and LAC curves are consistent with constant returns to
scale.

42
d.
Yes, constant returns to scale implies neither economies nor diseconomies of scale.

1.
2.
a.
b.
c.
TP = !0.0016L3 + 0.40L2 ;
0.32%; 0.02%
83 13
AP = !0.0016L2 + 0.40L ;
MP = !0.0048L2 + 0.80L
d.
e.
f.
125
$12.00; $12.00
2,400; $12.50; $9.38
a.
All coefficients have the appropriate signs (a > 0, b < 0, and c > 0).
t a = 175/25 = 7 > 2.021 ! a is statistically significant
tb = !3.2 0.80 = !4 = 4 > 2.021 ! b is statistically significant
tc = 0.08 0.01 = 8 > 2.021 ! c is statistically significant

b.
SMC = 175 ! 6.4Q + 0.24Q 2
c.
Qmin = !b 2c = 3.2 0.16 = 20

AVCmin = 175 3.2(20) + 0.08(20)2 = 143
d.
AVCQ =8 = 175 ! 3.2(8) + 0.08(8) 2 = $154.52

SMCQ =8 = 175 ! 6.4(8) + 0.24(8) 2 = $139.16

43
3.
COMPUTER EXERCISE
a.
Your regression output should like:

DEPENDENT
VARIABLE:
AVC
R-SQUARE
F-RATIO
P-VALUE ON F
12
0.7317
12.27
0.0027
VARIABLE
PARAMETER
ESTIMATE
STANDARD
ERROR
T-RATIO
P-VALUE
INTERCEPT
296.749
33.5380
8.85
0.0000
4.28252
1.56081
2.74
0.0227
Q2
0.03484
0.01684
2.07
0.0685
OBSERVATIONS:
b.
All parameter estimates have the correct algebraic signs and are significant at better than
the 10 percent level.
c.
AVC = 296.749 ! 4.28252Q + 0.03484Q 2

TVC = 296.749Q ! 4.28252Q 2 + 0.03484Q 3
SMC = 296.749 ! 8.5650Q + 0.10452Q 2
d.
Qmin = b/2c = 61.46; AVCmin = $165.15
e.
AVCQ=20 =$225
SMCQ=20 = $167.26
Since SMC is less than AVC, AVC must be falling at 20 units of output.
f.
61.46; SMC = AVC at AVCs minimum point.

44
Chapter 11:
MANAGERIAL DECISIONS IN COMPETITIVE MARKETS

1.
The fact that the club closed implies that it incurred economic losses, i.e., implicit costs must
have exceeded $100,000. Assuming that the opportunity cost of capital is the only omitted
implicit cost, the owner must have alternative investment opportunities with an expected rate of
return greater than 10%.
2.
It is hard to say. Clearly fixed costs should not affect production decisions. What it probably
means is that fixed costs make up a very high proportion of total costs, so variable costs are
relatively low. Therefore, if revenues cover variable costs firms keep producing at lower prices.
3.
a.
b.
c.
d.
e.
Number of Real
Estate Agents
Marginal Revenue
Product
$40,000
34,000
30,000
24,000
16,000
8,000
Two agents should be hired. The third agent adds only $30,000 to total revenue but adds
$32,000 to total cost.
Four agents.
1, $60,000; 2, $51,000; 3, $45,000; 4, $36,000; 5, $24,000; 6, $12,000.
Four agents.
4.
A support price above the price that would prevail in the absence of controls will induce new
farmers to enter the market. These new (marginal) firms will have higher costs than the farmers
already producing because their land (and perhaps other inputs) will be less productive. Even
higher support prices would only attract even more marginal farmers.
5.
In the short run, increased insurance rates could raise the income of insurance agents. If the
demand for insurance is inelastic, an increase in insurance rates will increase agents' income. In
the long run, the increase in income will attract new agents into the market (provided that entry is
unrestricted). The new agents will take some of the established customers and potential new
customers from the incumbent agents, reducing the number of policies written per agent. Agents'
income will continue to decrease until entry ceases, i.e., until income again reaches a "normal"
level.
Chapter 11: Managerial Decisions in Competitive Markets

45
6.
Firms engage in research and development (R&D) in order to earn profits from introducing new
products or from discovering more efficient methods of production. Firms in a competitive
industry have little incentive to invest in R&D because any profit would be quickly competed
away. Anything that lengthens the period before innovations are imitated will encourage R&D.
Note, however, that if firms do develop new products, one of the assumptions of a competitive
market (a homogeneous product) will be violated.
7.
a.
The plant in Miami should continue to be operated because the firm loses only $60,000
per month if the plant is operated; but would lose $68,000 if the plant is shut down. We
can deduce that total revenue exceeds variable costs by $8,000. This $8,000 can be
applied toward fixed costs so the firm loses only TFC $8,000, which in this case is
68,000 8,000 = $60,000. Thus, the President is correct in recommending that the firm
continue to operate the Miami plant in the short run.
b.
While it is true that the level of fixed costs do not, in any way, influence the shut down
(or output) decision, TFC does represent the loss to the firm of shutting down operations.
If the manager makes the correct shutdown decision by comparing P to AVC, the loss
from producing will be less than TFC. The president's statement implies that P > AVC.
Even if TFC were higher than $68,000, the firm still loses $8,000 less when it produces
where MR = MC than when it shuts down.
a.
Production costs will rise because the entry of new firms encouraged by economic profits
will bid up input prices for all the firms in the remodeling industry. Input prices would
not be bid up if the industry is a constant cost industry.
b.
Price will fall because profit will encourage entry, supply will shift rightward, and
equilibrium price will fall.
c.
Economic profits will fall to zero as entry occurs in the long run.
8.
9.
The pushcart owner must at least be covering his opportunity costs at this fee. The city of New
York is earning the rent in this case because it controls the location, which is the reason for the
high returns. The pushcart owner is probably not making much, if any, economic profit with the
new license fee.
10.
a.
b.
There are two ways grocery and gasoline markets may fail to be competitive markets.
(1)
Even though a large city has many grocery stores and gasoline stations within the
metropolitan area, consumers of groceries and gasoline typically shop close to
home. So a large city comprises many smaller geographic markets for groceries
and gasoline. Within these smaller local markets, there may be only a few
grocery stores and gasoline retailers, a situation which provides some ability for
individual firms to influence price.
(2)
Another possible divergence from competition results if the firms sell

differentiated products. The characteristics of grocery stores and gasoline
stations may not be as standardized as they seem. Grocery stores and gasoline
stations can vary in terms of the quality of customer service, the various brand
names offered, and particularly location.
For either of the two reasons in part a, grocery and gasoline firms may possess some
degree of market power, and so face demand curves that are not perfectly elastic (i.e.
horizontal).

46
c.
Because entry and exit in grocery and gasoline markets is typically unrestricted, we
would expect firms in these markets to earn zero economic profit in the long run. As you
will see in the next chapter, this outcome is predicted for monopolistically competitive
markets in long-run equilibrium.
11.
The statement is correct in the sense that the Brazilian division should be shut down if losses
exceed TFC. If management mistakenly continues to operate the Brazilian division if and when
price falls below AVC, then more than TFC could be lost.
12.
a.
AVC = 125 0.21Q + 0.0007Q2
b.
Qm = b/2c = (0.21)/(2)(0.0007) = 150.00

AVCmin = 125 0.21(150) + 0.0007(150)2 = $109.25
c.
d.
Since P = $115 > $109.25 = AVCmin, the firm should produce.

Setting P = MC, 115 = 125 0.42Q + 0.0021Q2 ! 0.0021Q2 0.42Q + 10 = 0
Q1, Q2 = (0.42 0.09240 )/(2 0.0021)
Q1 = 0.116/0.0042 = 27.62 28
Q2 = 0.724/0.0042 = 172.38 172
AVC172 = 125 0.21(172) + .0007(172)2 = $109.59; P > AVC so produce
AVC28 = 125 0.21(28) + 0.0007(28)2 = $119.67; P < AVC so would not produce Q = 28.
e.
TR = PQ = (115)(172) = $19,780
TVC = 172 AVC172 = 172 109.59 = $18,849.48
TC = TVC + TFC = $18,849 + 3,500 = $22,349
= TR TC = $2,569
f.
No, fixed costs do not matter. Note that when fixed costs are $4,000, the firm loses
$3,069 ($500 more than when TFC = $3,500). Since neither P nor AVC changed, P is
still greater than AVC and the firm should produce 172 units where P still equals MC.

1.
a.
b.
c.
d.
e.
f.
g.
h.
i.
35
$10; $350
$70
25
$200; $200; $0
20
ATC = $9; TC = $180; TR = $120; ! = 60
TVC = $4 20 = $80; $40 left over to apply toward fixed costs.
$2. When P < $2, TR does not cover variable costs and the firm will lose less by shutting
down.

47
2.
See the table below.

a.
2; 6
b.
increases; $6
decreases; $200
c.
6; $2,746 (= $2 1,373)
d.
5; 1,370; $548; greater
e.
falls; rises
f.
5; P; SMC; MRP; w
g.
$1,700
h.
5; 1,370. Fixed costs do not matter in the output decision. No matter how high Ajax's
fixed costs, it will still be optimal to hire 5 units of labor and produce 1,370 units of
output.
(1)
(2)
Units of
Labor
Output
(3)
(4)
Marginal
Product
Marginal
Revenue
Product
(5)
Average
product
(6)
Average
revenue
product
(7)
(8)
(9)
Marginal
Cost
Profit
when
TFC =
$1,000
Profit
when
TFC =
$5,000
xx
xx
xx
xx
xx
1,000
5,000
400
400
800
400
800
0.02
208
4,208
950
550
1,100
475
950
0.01
884
3,116
1,250
300
600
416.67
833.33
0.03
1,476
2,524
1,350
100
200
337.50
675
0.08
1,668
2,332
1,370
20
40
274
548
0.40
1,700
2,300
1,373
228.83
457.67
2.67
1,698
2,302
1,369
195.57
391.14
xx
1,682
2,318
1,364
10
170.50
341.00
xx
1,664
2,336
3.
a.
b.
c.
d.
e.
f.
400
12
SMC = 20 ! 0.08Q + 0.00015Q 2
575
4,789
0; 1,200
4.
a.
b.
c.
d.
e.
$20 (the long-run supply price at Q = 20,000)

$20, $0
40,000;$30
$30; $30
True. Firms employing superior resources must pay these resources economic rent,
which is a cost to the firm and which reduces after-rent economic profit to zero.
$400,000 (area of triangle under price above supply up to 40,000 units)
The owners of the superior resources will receive the rents created by using these
superior resources in this industry.
f.
g.

48
Chapter 12:
MANAGERIAL DECISIONS FOR FIRMS WITH MARKET POWER

1.
a.
A monopolist, although the only supplier in the market, still faces the constraint of
market demand. Suppose that a monopolist is suffering losses even though it is charging
the price associated with the level of output at which MR = SMC. If the firm raises price,
even larger losses will be incurred. A monopoly market structure is no guarantee that a
firm can earn economic profits.
b.
Market power could be measured by estimating the elasticity of demand. The less elastic
is demand, the greater the market power. It would also be useful to estimate the crossprice elasticity of demand of QuadPlex Cinema with the Cedar Bluff Twin. The larger
the (positive) cross price elasticity, the more substitutable the two theaters and the smaller
the degree of market power.
c.
If there are economies of scale, QuadPlex could increase its scale of operation.
QuadPlex might lobby the local government for ordinances which prevent any new
theaters from opening. QuadPlex should also try advertising as a means of creating brand
loyalty. If all fails it might go out of business in the long run.
2.
MR
SMC
xx
xx
1,000
1.50
0.10
2,000
1.00
0.10
3,000
0.50
0.16
4,000
0.25
0.16
5,000
0.20
0.18
6,000
0.175
0.19
7,000
0.10
0.20
8,000
0.10
0.22
9,000
0.15
0.24
a.
5,000 newspapers per day
b.
= TR TC = $3,450 $2,700 = $750 per day
c.
see figure below
Chapter 12: Managerial Decisions for Firms with Market Power

49
d.
TFC = $2,000. When TFC = 5,000, Q* = 5,000 in the short run because changes in TFC
do not affect Q*. In the long run, the owners should see if any other plant size exists for
which P > ATC. If not, they should exit the industry.
1.50
Marginal Revenue and Marginal Cost (dollars)
1.40
1.30
1.20
1.00
.90
.80
.70
.60
.50
.40
.30
MC
.20
.10
0
2,000
4,000
6,000
8,000
Quantity
-.10
MR
-.20
3.
Tots-R-US should begin advertising immediately in order to enhance brand loyalty which will
decrease elasticity of demand. Also the less elastic is demand, the greater the fall in price that
results when new firms enter. To the extent that potential entrants consider post-entry price, they
will be less likely to enter the more inelastic is demand.
4.
One piece of evidence to support your firm's contention that the merger did not increase market
power would be showing that your firm's elasticity of demand either was unchanged by the
merger, or even got larger. By measuring own-price elasticity (E) before and after the merger,
you may be able to convince the FTC that consumers still have ample substitutes for your product
post merger. You may also wish to show that (post merger) there are "enough" other products
that are close substitutes to ensure a competitive market. This would involve presenting the FTC
with evidence of large, positive cross-price elasticities.
50
5.
Significant economies of scale could force your bank out of business if your bank is a smallscale bank and a large-scale bank, facing lower long-run average costs, lowers price (i.e., lowers
interest rates changed on loans and/or increases interest rates paid on deposits) below your banks
average cost (but greater than or equal to the large bank's LAC). If the demand for banking
services in your geographic market is not sufficient to allow your bank to expand its scale of
operation in order to take advantage of the economies of scale, then your bank would exit in the
long run.
6.
Possibly as a barrier to the entry of other firms into Harley-Davidson=s segment of the
motorcycle market. Also the name and the engine roar increase the brand loyalty of the firm=s
customers.
7.
A monopolistically competitive firm will maximize profit by producing the level of output at
which MR = MC, and by charging the price associated with that level of output. At the profitmaximizing level of advertising, the MR from advertising equals the MC of advertising. In order
to implement these optimizing rules, the firm needs estimates of cost and demand. Estimating
cost is fairly straightforwardinformation on average cost can be used to estimate marginal cost.
The primary problem lies in estimating MR. Because each firm produces a product that is a close
substitute for the products of rival firms, each firm's demand depends not only on its price and
advertising decisions, but also on the price and advertising choices of rival firms. And there are
many rival firms. MR is thus difficult to estimate because any one firm's MR depends on the
actions of a large number of other firms.
8.
In the absence of entry barriers, collusion among monopolistically competitive firms will not
prevent new firms from entering causing demand to decrease and become more elastic. The price
will be the same or higher with collusion but in the long run P = LAC.
9.
a.
Q = 112,000 500P + 5M = 112,000 500P + 5(20,000) = 212,000 500P; P = 424

0.002Q; MR = 424 0.004Q ; SMC = 200 0.024Q + 0.000006Q2;
Set SMC = MR: 200 0.024Q + 0.000006Q2 = 424 0.004Q;
Solve: 0.000006Q2 0.02Q 224 = 0, for Q* to find that
Q* =
0.02 + 0.005776
0.000012
= 8, 000
b.
P* = 424 0.002(8,000) = $408
c.
TR = $408(8,000) = $3,264,000:
AVC = 200 0.012(8,000) + 0.000002(8,000)2 = $232;
TVC = $232(8,000) = $1,856,000; = TR TVC TFC = $3,264,000 $1,856,000
$100,000 = $1,308,000
d.
Q = 112,000 500P + 5(30,000) = 262,000 500P;

P = 524 0.002Q; MR = 524 0.004Q; MC = MR:
200 0.024Q + 0.000006Q2 = 524 0.004Q and solve 0.000006Q2 0.02Q 324 = 0 for
Q* =
0.02 + 0.008176
0.000012
= 9, 202 P* = 524 0.002(9,202) = $506.

51
AVC = 200 0.012(9,202) + 0.000002(9,202)2 = $258.93.

TR = $506(9,202) = $4,656,212; TVC = $258.93(9,202) = $2,382,675; = TR TVC
TFC = $4,656,212 $2,382,674 $100,000 = $2,173,538.
10.
a.
P = 2,400 5Q
b.
MR = 2,400 10Q
c.
Must set MR = SMC. SMC = 6Q2 30Q + 400

2,400 10Q = 6Q2 30Q + 400 6Q2 20Q 2,000 = 0
Q* = 20
d.
P* = 2,400 5(20) = $2,300
e.
= TR TVC TFC
= (2,300)(20) (900)(20) 8,000
= 46,000 18,000 8,000
= $20,000
11.
a.
The firm is not maximizing profit. At the current allocation between the two factories,
the last unit produced in Michigan added more to total cost ($5) than the last unit
produced in Texas ($3). By switching one unit of output from the Michigan factory to
Texas, total revenue will be unchanged, total cost will decrease $2, and thus profit will
increase $2. The firm should continue to switch output from Michigan to Texas until the
factories' marginal costs are equal.
b.
By switching one unit of output from the Texas factory to Michigan, total revenue will be
unchanged, total cost will increase $2, and thus profit will decrease $2.

1.
a.
b.
c.
d.
700 units
P = $11
! = ($11 7)700 = $2,800
600 units; P = $12; ! = ($12 4)600 = $4,800

52
2.
a.
b.
c.
3.
4.
Your table should look like this:

(1)
(2)
(3)
Price
Marginal
Product
Marginal
Revenue
Marginal
Revenue
Product
Labor
Quantity
200
$50
--
--
--
280
48
80
$43
$3,440
340
46
60
36.67
2,200
390
44
50
30.40
1,520
430
42
40
22.50
900
450
40
20
60
10
460
38
10
52
520
Cascade should shut down when w = $3,000 per month. You should have compared ARP
to MRP at L = 5. ARP = P AP = 48 56 = $2,688, which is less than $3,440 (= MRP at
L = 5). You could also see to shut down by computing profit. Since Cascade would lose
more by producing 280 units than it would lose if it shut down, the manager should shut
down.
i.
L* = 7
ii.
Q* = 390
iii.
P* = 44
iv.
! = $17,160 ($1,400 7) $2,000 = $5,360
a.
Q = 26,000 0.2P
b.
P = 130,000 5Q
c.
MR = 130,000 10Q
d.
SMC = 40,000 400Q + 3Q2
e.
Q* = 250
f.
P* = 130,000 5(250) = $128,750
g.
= TR TVC TFC = ($128,750 250) ($52,500 250) 15,000,000 = $4,062,500
a.
b.
c.
d.
See the figure below

700; $50; $50
200; 500
$80

53
Price, marginal revenue, and cost (dollars)
$
MC A
MC B
80
MC T
60
50
40
MR
20
Q
0
200
400
500
600
700
800
1,000
Quantity

54
1,200
Chapter 13:
STRATEGIC DECISION MAKING IN OLIGOPOLY MARKETS

1.
McDonalds major rivals responded with price cuts of their own. The WSJ reported that Burger
King responded by selling its flagship Whopper, with no strings attached, for 99 cents, $1 off
regular price. Wendys responded with their own promotion. Each of the firms was caught in a
pricing version of the prisoners dilemma.
2.
Politicians who are seeking office appear to be caught in a prisoners dilemma. Even a politician
who wants to campaign positively would strongly reduce the probability of election by not
campaigning negatively while his or her opponent did. An election is not quite a repeated game,
so even if they were able to reach an agreement, there is a great incentive for the candidate
running behind late in the campaign to cheat on the agreement.
3.
While all of these firms compete in the same market, personal-computers, Dells profits are more
interdependent with profits of HP and Gateway than with the profit of Apple because consumers
can more easily switch from a Dell computer to another computer using Intel chips and the
Windows operating system. Since PC buyers are much less likely to view Apple computers as
substitutes for Dell computers, the cross-price elasticity will be smaller between Dell and Apple
than between either Dell and HP or Dell and Gateway. The smaller the (positive) cross-price
elasticity between Dell and its rival Apple, the less interdependent their profits will be and the
less strategically important Apple will be for making all types of decisions at Dell.
4.
The retailers were in a prisoners dilemma. They all wanted to close on Sunday to save money
with little loss of sales. But if one or a few closed, they would lose a great deal of sales to the
firms that were open. The government would enforce cooperation with Sunday closing laws.
5.
By binding oneself to take an action that would otherwise not be in your best interest, you can
alter your rivals beliefs about your response to their actions. By irreversibly committing yourself
to an action, you may be able to manipulate your rivals in a way that provides you with a better
outcome.
6.
Although the evidence is not conclusive as to which type of market is most conducive to
innovation, more research and development (R&D) may occur in oligopoly markets due to
mutual interdependence. Each oligopolist knows that an innovation by a rival is likely to
decrease the firm's market share. Hence, oligopolists may engage in "defensive" innovation.
Moreover, oligopolists are more likely to be large enough to support the extensive facilities often
necessary for successful R&D.
7.
If Gore can make a better decision for himself by knowing who Bush will choose to be his
running mate, then Gore experiences a second-mover advantage.
8.
Crandalls brass-knuckle style could be of strategic value if it gives Crandall a reputation for
being a tough guy who will seldom, if ever, back down on his threats or promises. Crandalls
tough-guy image probably made it easier for him to make credible strategic moves, which would
be advantageous to American Airlines in its pricing decisions, wage negotiations, and entry
deterrence efforts.
Chapter 13: Strategic Decision Making in Oligopoly Markets

55
9.
Apparently Mr. Rodriquez believes OPEC members are more willing to lower prices together
than to raise prices together. The theory of cartels suggests he may be right. Suppose the price of
crude oil is higher than the level that maximizes profit. Mr. Rodriquez knows that if members
resist an explicit policy of lowering crude oil prices, he can probably count on members to cheat
by increasing their production levels above their quotas. This will cause price to come down. If
instead, prices are too low, members will not cheat by reducing their production levels. Higher
prices can be achieved only through cooperation, while lower prices can be reached through
cheating.
10.
If you believe there is no tomorrow, you may feel that there can be no future penalty for actions
you take today. Whether this is true or not may be a moral issue, but it nonetheless may explain
why bad behavior seems rational for those who truly believe there will be no consequences in
the future for actions taken today. Perhaps it is best to view life as a repeated game, one lasting
forever.
11.
Mercedes USA, by asking all of its dealers to charge the same prices, appears to be dangerously
close to engaging in illegal price fixing. Perhaps the New Jersey dealer refused to follow the nohaggling pricing policy because he thought it would reduce his profits to charge the same price as
his rivals. He might have believed he could best compete in price (low prices) rather than in
other nonprice dimensions (customer service, dealer financing, etc.). Maybe he wanted to be able
to secretly price low while his rivals priced high. Of course, such cheating makes all dealers
worse off than if they cooperated. Maybe he was not strategically astute. In the New York Times
article, he was quoted as saying, I was told that if customers shop the dealers and find that prices
are the same, theyll just buy the car at the higher price and every one will make more money.
Its hard to know for sure why he didnt want to cooperate. Maybe he was honestly concerned
about illegal price fixing!
12.
Price matching makes cooperation to set high prices easier to achieve, which is bad news for
consumers.
13.
a.
Initially, when the program goes into effect, some buyers who were postponing a planned
purchase will buy in the current period, seeming to increase demand. After these buyers
have made their purchases, demand should return to approximately the same level as
before the plan started, as long as no other demand-side factors have changed.
b.
This program is a sale-price guarantee, and, as such, could be a tactic for facilitating
cooperative pricing in the oligopolistic retail electronics market. By increasing the cost
of price-cutting, this firm has an incentive to keep prices constant. Unless the other
electronics market rivals implement similar policies, this firm will be at a disadvantage
when it comes to lowering price to attract customers. If the primary reason for the saleprice guarantee is to discourage price-cutting behavior, then this company will see little
reason for such a program (at least after the demand increase dissipates in 30 days) and
will likely drop its program.
a.
By delaying the implementation, Advanta may be trying to protect itself should its rival
credit-card companies choose not to follow its initiative to raise fees. Furthermore, by
just announcing its intentions (i.e., signaling its desire to raise fees), Advanta does not
actually raise its fees on any customers, thereby avoiding a potentially unilateral price
hike that could cost it substantial market share as customers switch to rival cards with
lower fees. Apparently, Advanta believes any loss of profit by waiting to implement
higher fees is justified by potentially higher losses from being the first, and only, firm to
raise fees.
14.

56
b.
c.
15.
16.
No, there is no second-mover advantage here because this is not a one-time decision. If
Advanta, or any of the oligopoly credit-card companies, raises its fees first, the decision
to raise fees can be reversed perhaps at a cost of lost goodwill or market shareif other
firms do not follow the fee increase. Thus there can be no second-mover advantage in
this repeated decision situation. The oligopoly rivals are probably waiting to raise fees
because customers most likely will react negatively to higher fees and punish any one
firm that raises fees by switching to rival credit cards. If they all raise fees, customers
have little or no incentive to switch card companies.
Yes, Advanta might wish to show other credit card companies that it is a bold firm
capable of quickly and accurately detecting pricing moves that can increase everyones
profits. If successful, Advanta may be able to lead prices up or down in a cooperative
fashion, and all credit card companies could earn higher profits.
a.
For cell B (C), any pair of values with Americas payoff less (greater) than 1,000 and
Britains payoff greater (less) than 1,000 will work. For example: in cell B, $600, $1500
and in cell C, $1500, $600 will create a prisoners dilemma.
b.
Since the decision on antiterrorism spending will be a repeated decision, nations may end
up in a kind of antiterrorism arms race. Each nation has an incentive to behave
noncooperatively by increasing its spending above that of its allies, as in cells B or C.
Allies then respond by matching any other nations increases because no nation wants to
be perceived by terrorists as the easier target for terrorism. So, nations end up in
something like a price war. And, as the table shows, $100 per capita is optimal, so that
the equiproportionate ramping up of antiterrorism spending across nations causes net
benefits to fall.
a.
If PV = $200, then Golden Inn faces the following demand-related functions:

Demand:
QG = 5,000 ! 25 PG + 10(200) = 7,000 ! 25 PG
Inverse Demand:
Marginal Revenue:
QG = f ( PG ) = 7,000 ! 25 PG
MRG = 280 ! 0.08QG
" PG = f !1 (QG ) = 280 ! 0.04QG
The profit-maximizing price for Golden Inn is found by setting MR = LMC to get QG* :
280 ! 0.08QG = 50 " QG* = 2,875, and so

PG* = $165 = 280 ! 0.04(2,875)
To verify that $165 can be obtained from one of the best-response curves provided in the
question, you use the best-response curve for Golden Inn:
PG = BRG (200) = 125 + 0.2(200) = $165
b.
To find Nash equilibrium, you must find the intersection of the two best-response curves:
PGN = 125 + 0.2[125 + 0.3125 PGN ]
= 125 + 25 + 0.0625 PGN

(1 ! 0.0625) PGN = 150
PGN = $160
Then, PVN = BRV (160) = 125 + 0.3125(160)
= $175

57
To get the Nash quantities, QGN and QVN :
QGN = 5,000 ! 25(160) + 10(175) = 2,750

QVN = 4, 200 ! 24(175) + 15(160) = 2, 400
To find the profits:
! GN = ( PGN " LACG )QGN = (160 " 50)2,750 = $302,500
! VN = ( PVN " LACV )QVN = (175 " 75)2, 400 = $240,000

c.
For prices PG = $165 and PV = $180, profits are:

! Go = (165 " 50)[5,000 " 25(165) + 10(180)]
= $307,625
! = (180 " 75)[4,200 " 24(180) + 15(165)]

o
V
= $247,275
Comparing these profits to profits in Nash equilibrium:
! GN = $302,500 < $307,625 = ! Go
! VN = $240,000 < $247, 275 = ! Vo

Even though the pair of prices PG = $165 and PV = $180 creates higher profit for both
firms, noncooperative oligopolists do not expect the other to set price at these levels
because each one can unilaterally choose a different price and do better.
For example, suppose Golden Inn believes Village Diner will set its price at
$180. Golden can set its price at $161 [= 125 + 0.2(180)] and earn more profit than
$307,625:
! Goo = $308,025 = (161" 50)[5,000 " 25(161) + 10(180)] > ! Go
Similarly, if Village Diner believes Golden Inn will price at $165, Village Diner can
unilaterally price below $180 and increase its profit. Both know the other firm can
unilaterally decrease price to increase profit, so neither would believe the other would set
price to support the pair of prices PG = $165 and PV = $180.
17.
a.
If Whirlpool enters the market, Maytags best-response is to price at $1,000. Maytags

threat is not credible, so Whirlpool ignores it and enters the market. At a price of $1,000,
Whirlpool would make $17 million by entering the market. (Note: If Maytag could find a
way to make an irreversible decision to price low at $500, which would be a strategic
commitment to price low, then entry would indeed be blocked.)
b.
If Maytag invests in extra production capacity, its best-response to entry by Whirlpool is

to price at $500, which discourages Whirlpool from entering since Whirlpool would lose
$6 million by entering when price is $500. In order for the threat to be credible,
investment in capacity must be sunk so that Maytag cannot reverse the decision. If the
capacity expansion could be reversed, then Maytag could sell the extra capacity if
Maytag did enter, and then its best-response would be to price at $1,000 and earn $17
million. Once again, constraining oneself to do something that would not otherwise be a
best-response is the key to making a successful strategic move.

58
c.
The diagram below shows the Nash equilibrium path that leads to Maytag earning $24
million and Whirlpool earning $0 because it does not enter the market.

1.
Set P = c and solve for Qc to get Qc = (c a)/b.

Set MR = c to get Qm
MR = a + 2bQ = c
"
Qm =
c!a
2b
Since c < a:
Qc > QDuopoly > Qm

And, substituting Qc, Qm, and QDuopoly into the inverse demand function provides the following
results:
Pc = c
Pm =
a+c
PDuopoly =
2
Using the restriction c < a, it is straightforward to show that
a + 2c
3
Pc < PDuopoly < Pm

59
2.
a.
qJ = BRJ ( qS ) = 1500 !
qs = BRS ( qJ ) = 1500 !
1
2
qS
qJ
2
Note: For graphing purposes, the inverse best-response function is employed for Jones:
qs = BRJ!1 ( qJ ) = 3000 ! 2qJ
b.
qS
3000
BRJ!1 : qS = BRJ!1 (qJ ) = 3000 ! 2qJ
1500
1000
qs = BRS ( qJ ) = 1500 !
1
2
qJ
qJ
1000
3.
1500
3000
c.
BRS(500) = 1,250
BRS(750) = 1,125
d.
qSN = qJN = 1000 Each firm earns $2,000,000 per year.
e.
Each earn $2,250,000 per year. This is not strategically stable.
f.
Qm = 1,500; Pm = $4,000. The monopolist earns $4,500,000 [= (4,000 1,000)1,500]
g.
annually.
If the market is perfectly competitive, P = LMC = c and 3,000 patients are treated
annually. Economic profit is zero since P = LAC.
a.
PA = BRA ( PB ) = 13.5 + 0.188 PB

PB = BRB ( PA ) = 31.5 + 0.125 PA

60
b.
See figure below. Note that the inverse of BRB ( PA ) , BRB!1 ( PB ) = !252 + 8 PB , is shown
in the figure below:
PA
BRB!1 ( PB ) = !252 + 8 PB
N
19.87
PA = BRA ( PB ) = 13.5 + 0.188 PB
13.5
31.5
c.
33.98
PB
BRA (20) = $17.25

BRB (36) = $36
d.
PAN = $19.87
PBN = $33.98
e.
! A = (19.87 " 2)71.48 = $1, 277
f.
! B = (33.98 " 3)61.97 = $1, 920

! A = (22 " 2)64.5 = $1, 290
! B = (35 " 3)61 = $1, 952

1.
a.
b.
c.
d.
e.
f.
g.
low price
it has no dominant strategy
high price
it has no dominated strategy
A
is not
is not; If St. Pete Times believes Tampa Tribune is going to price high, St. Pete Times
could unilaterally lower price to $0.50 and increase its payoff form $40,000 to $45,000.
2.
a.
first-mover advantage; Since St. Pete Times has a higher payoff when it goes first
($40,000 > $30,000), it does better going first.
second-mover advantage; Tampa Tribune does better going second.
In this situation, there would likely be tacit cooperation to let St. Pete Times go first and
then Tampa Tribune second since that sequence is best for both newspapers.
b.
c.
3.
a.
b.
cooperate; $1.474 million; $3.831 million

cooperate; $0.9828 million; $5.7456 million
61

62
Chapter 14:
ADVANCED PRICING TECHNIQUES

1.
STIHL may be practicing second-degree price discrimination by offering different qualities at

different prices, where the price-to-marginal cost ratios differ across quality lines. STIHL knows
that most buyers are only going to buy one chain saw, so quantity discounts are not useful. By
letting consumers choose the level of quality they prefer, STIHL can sort buyers accorging to
their valuations or willingness to pay, so this may be a second-degree form of price
discrimination that uses multiple quality categories to achieve self-selection. Occasional use
saws are priced lower than mid-range, and mid-range lower than professional, which are
probably slightly lower in price than the top of the line arborist quality line. STIHL cannot
identify the type of buyer by looking at them. But, unless we know that the price/marginal cost
ratio differs across quality lines, we cannot conclude that price differences are second-degree
price discrimination; the higher quality lines are presumably more costly to manufacture.
2.
Low income people may benefit from price discrimination, because they are likely to be more
price sensitive buyers and thus be on the receiving end of lower prices. Price discrimination may
make it profitable to serve poorer market segments that would go unserved or underserved if
the firm had to rely only on uniform pricing. One might interpret price discrimination as taking
consumer surplus from rich buyers, who are not very price sensitive, and giving consumer
surplus to poor buyers, who are quite price sensitive.
3.
Before airlines began requiring photo IDs, there was an active market in newspapers for cheap
airline tickets. If you wanted to fly to New York unexpectedly, you would not likely qualify for
supersaver airfares. However, you might find a ticket in the newspaper being resold for a price
much lower than the airlines price, because airfares tend to rise sharply at the departure date and
time draws nearer. Airlines could kill this market for cheap tickets by requiring that the name
on the ticket match the name on the photo ID.
4.
Firms must have market power to practice any one of the forms of price discrimination. Since
global competition reduces market power, firms facing global competition will find it more
difficult to raise prices much above marginal cost. This reduces the benefit of undertaking price
discrimination methods, making uniform pricing attractive.
5.
If the number of blocks equals the number of units where P = MC, then all consumer surplus is
extracted and declining block pricing results in the same profit as first-degree (or perfect) price
discrimination. When multiple units are sold for the same price within pricing blocks, uniform
pricing is essentially being practiced in each declining block. Thus, declining block pricing is a
crude form of perfect price discrimination because the firm extracts some, but not all, of the
buyers consumer surplus. An important difference between perfect price discrimination and
declining block pricing is that the former requires the firm to haggle over price for every unit
sold, while the latter completely avoids all haggling by offering the same price schedule to every
buyer. The firm requires much less information about consumer demand in order to implement
declining block pricing compared with perfect or precise demand information needed to practice
first-degree price discrimination.
6. a.
b.
MRT = MC ! QT* = 40
QT = 40 ! MRT = MC = $0.60
Chapter 14: Advanced Pricing Techniques
63
MRS = $0.60 ! QS = 10
MRB = $0.60 ! QB = 30
c.
From their respective demand curves, PS = $0.70 and PB = $0.90.

$
1.20
Price and cost (dollars)
1.00
MC
0.90
0.80
0.70
0.60
0.40
DB
MRS
0.20
MRB
DS
MRT
Q
10
20
30
40
50
60
70
80
90
100
110
120
Quantity (thousands of units)
7.
a.
b.
PC = $60 = (1 + 2) ! 20 and PS = $90 = (1 + 2) ! 30

! = $260,000 = $60(3,750) + $90(2,000) " $20(3,750) " $30(2,000) " $10,000
c.
Using the procedure set forth in footnote 9 in the textbook:
MRC = 136 ! 0.032QC ! 0.016QS

MRS = 168 ! 0.016QC ! 0.048QS
d.
MRC = 136 ! 0.032QC ! 0.016QS = 20

MRS = 168 ! 0.016QC ! 0.048QS = $30
Solve the two equations simultaneously to get QC* = 2,625 and QS* = 2,000
e.
Substituting the above quantities into the inverse demand functions provides the profitmaximizing prices:
PC* = $78 = 136 ! 0.016(2,625) ! 0.008(2,000)

PS* = $99 = 168 ! 0.008(2,625) ! 0.024(2,000)

64
f.
Using Andrews Consulting firms profit-maximizing prices, EZ Sharp can earn monthly
profit of $280,250, which is better than $260,000 with cost-plus pricing. The extra
$246,000 of annual profit is likely to increase the present value of the firm by at least
several million dollars. The owner/manager might want to think about how much profit
he sacrificed over the years using the cost-plus pricing technique.
8.
Price discrimination could explain price differentials not based on cost differences. Hardcover
books sell for more than paperbacks, implying that the purchasers of hardcover books are
relatively less responsive to price changes (have a less elastic demand) than the purchasers of
paperbacks.
9.
The fee differences could indicate price discrimination by the dating service. If men tend to have
a less elastic demand for dating services than women, the firm can increase total revenue (and
profit) by charging men a higher price than women.
10.
a.
First find the marginal revenues:

MRG = 15.625 0.0078125QG
MRB = 150 0.5QB
Then express marginal revenues as functions of the number of hours of the production
facility devoted to the two goods:
MRG = 15.625 0.0078125(4HG)
= 15.625 0.031250HG
MRB = 150 0.5(4HB)
= 15 2HB
Then compute marginal revenue products:
MRPG = MRG MPG = MRG 4
= 62.5 0.125HG
MRPB = MRB MPB = MRB 4
= 600 8HG
Next, horizontally sum MRPG and MRPB to get MRPT
MRPT = 70.76923 0.12307692HT
Set MRPT = MC and solve for the optimal level of HT:
70.76923 0.12307692HT = 5 0.05HT
H*T = 380
b.
Allocate so that MRPC = MRPB = MRPT.

MRPT at HT = 380 is
70.76923 0.12307692(380) = 24
Setting MRPG = 24 and MRPB = 24:
24 = 62.5 0.125HG
H*G = 308
24 = 600 8HB
H*B = 72
65
c.
Q*G = 4H*G = 1,232

Q*B = 4H*B = 288
d.
P*G = 15.625 0.00390625(1.232) = $10.81

P*B = 150 0.25(288) = $78
11.
a.
Business travelers tend to pay the higher price because they qualify for discounts less
frequently than do leisure travelers.
b.
Business travelers have fewer substitutes for air travel than do leisure travelers. Business
travelers must reach destinations in a timely fashion. Driving or taking the bus is not a
good substitute for flying in many cases. Leisure travelers, on the other hand, do find
driving and taking the bus to be substitutes for air travel in many cases. Business
travelers are also less sensitive to price because the company is paying for the ticket. For
leisure travelers the price of air fare is a significant fraction of their budgets. Thus the
more elastic market (Leisure travelers) is paying the lower price. This is consistent with
profit-maximizing which requires charging the higher price to the less elastic market.
c.
(1)
(2)
(3)
12.
Business people must often travel on short notice, leisure travelers usually can
plan 14 days in advance.
Business travelers often wish to return to families for the weekend. Leisure
travelers usually wish to stay over weekends.
Business travelers often must travel at peak times during the day. Leisure travel
allows for more flexibility in departure times.
d.
In each of the above cases the leisure traveler qualifies more often for discounts and thus
pays lower price. Since lower P is charged in the more elastic market, this pricing
scheme is consistent with -max.
a.
If the shirts are truly the same (only the size differs), then costs are the same and the
laundry is practicing price discrimination.
b.
A price-discriminating firm maximizes profits by charging the lower price to the more
elastic group of buyers and the higher price to the less elastic group. Women would seem
to have the more elastic demand, for at least a couple reasons:
(1)
Compared to men, women can more easily substitute home laundering and
ironing for professional laundry service. Thus women have a readily available
(and close) substitute for professional laundering.
(2)
Compared to the average man, women have lower incomes on average, so the
fraction of women's income spent on laundering clothes is higher than for men.
This too would suggest |Ewomen| > |Emen|.
After discussing this issue with our wives, we cannot find any reasons why men would
have a more elastic demand for professional laundering than men. Consequently, as
economists, we conclude that the price difference must be due to cost differences, since
profit-maximization requires men (with less elastic demand) to pay the higher price and
women (with the more elastic demand).
c.
Abby's advice to bundle all shirts together is a clever way to make it difficult (and costly)
for a laundry to separate markets. While women's blouses often have some differences
(buttons are on the opposite side of a blouse), it will be costly, perhaps too costly, for
66
laundries to profitably separate markets for the purpose of price discrimination. Some
women are now buying small sized men's shirts for themselves to avoid price
discrimination.
13.
a.
The bar is not maximizing profit. At the current prices, the last male customer added
more to total revenue ($1.50) than the last female customer ($.50). By selling more
drinks to male customers and fewer drinks to female customers, the bar can increase total
revenue and profit. The bar thus should lower price (to sell more drinks) to male
customers, and raise price (to sell fewer drinks) to female customers. Only when
marginal revenue is equal for both male and female patrons will profit be maximized.
b.
By selling one more drink to make customers and one less drink to female customers,
total cost will be unchanged, total revenue will increase $1, and thus profit will increase
$1.

1.
To answer this question, the marginal revenue curve for uniform pricing must be constructed
(MR) and the three block pricing schedule is also useful to construct. See the figure below:
a.
b.
$55; 100 cleanings per year; = $62,500 [= (($55 $30) 100) 25]; $1,250 (= .5
100 $25) consumer surplus for each business
$80 + $30
$11,000 (= 200 (
)); 200 cleanings per year; $125,000 (= $5,000 25); $0
2
67
c.
Total expenditure:
TE(q) = $0 + $60q
for q ! 80 (Block 1)
= $4, 800 + $40(q " 80) for q ! 160 (Block 2)

= $8, 000 + $20(q " 160) for q ! 240 (Block 3)
160 cleanings per year; TE(160) = $8,000; $80,000 = [(8,000 (160 $30)) 25];
$1,600 (= .5 80 $20 + .5 80 $20)
2.
3.
a.
P = 1200 ! 2Q
b.
MR = 1200 ! 4Q
c.
At the price of $350, quantity demanded is 425 (= 600 0.5P).
d.
AVC = $240; AFC = $90 (= $36,000/400); ATC = $330 (= AVC + AFC); profit = $8,000
= (350 330)400
e.
m = 0.75; P = (1 + .75)330 = $577.50
f.
If she could really service 400 patients at $577.50, then her profit would turn out to be
$99,000 per month [= (577.50 240)400 36,000]. However, only about 311 (= 600
0.5 577.50) patients will demand her services at the price of $577.50. So, her actual
profit is about $68,962.50 [= (577.50 240)311 36,000], which is less than the amount
she expected to make if she could have sold her service to 400 patients at a price of
$577.50.
g.
MR = SMC 1200 4Q = 240 Q* = 240 patients per month P* = $720 (= 1200

2 240); maximum profit = $79,200 = (720 240)240 36,000.
h.
Since cost-plus pricing does not use any demand information, there was no reason for Dr.
Rogers to believe 400 patients would demand her services at the cost-plus price of
$577.50.
a.
PUS = 80 0.001QUS
MRUS = 80 0.002QUS
b.
MRT = 72 0.0012QT
c.
35,000
d.
25,000; 10,000
e.
$55; $45
f.
lower; EUS = 2.20; EE = 3.00
PE = 60 0.0015QE
MRE = 60 0.003QE

68
Chapter 15:
DECISIONS UNDER RISK AND UNCERTAINTY

1.
a.
Maximax rule: operate plants in US, Mexico, Canada
b.
Maximin rule: operate plants in US only
c.
The potential regret matrix is

OINC Passes
OINC Fails
OINC Stalls
US only
10 million
2 million
US and Mexico
5 million
3 million
2.5 million
5 million
US, Mexico, Canada

Maximum potential regrets are:
US only
10 million
US and Mexico
5 million
US, Mexico, Canada
5 million
Minimax regret rule: either operate in US and Mexico or operate in US, Mexico, and
Canada.
d.
Average payoffs are:

US only
11/3
= 3.7 million
US and Mexico
12.5/3 = 4.2 million
US, Mexico, Canada
18/3
= 6.0 million
Equal probability rule: operate in US, Mexico, and Canada.

2.
Maximin rule
3.
A portfolio manager needs to pick "winning portfolios" rather than individual stocks that are
"winners". The performance of a portfolio reflects interactions among stocks as well as the
performance of individual stocks. For instance, the volatility of a portfolio is lower than the
average of the volatilities of the individual stocks. A successful portfolio manager will choose a
portfolio that either provides the highest possible return for an investor's desired level of risk or
provides the lowest possible risk for an investor's desired level of return.
Chapter 15: Decisions Under Risk and Uncertainty

69
4.
5.
6.
a.
E(profit of option A) = 0.3(800,000) + 0.7(1,200,000)

= 240,000 + 840,000
= 1,080,000
E(profit of option B) = 0.3(1,000,000) + 0.7(875,000)
= 300,000 + 612,500
= 912,500
b.
Option A
c.
In order to be indifferent, the expect profits must be the same. Thus,

Pf (1,200,000) + (1 Pf)(800,000) = Pf (875,000) + (1 Pf)(1,000,000)
where Pf = probability that the tariff fails, and
1 Pf = probability that the tariff passes.
Solving for Pf, we have:
400,000Pf + 800,000 = 125,000Pf + 1,000,000
525,000Pf = 200,000
Pf = 0.38
1 Pf = 0.62
d.
VarA = 0.7(1,200,000 1,080,000)2 + 0.3(800,000 1,080,000)2 = 33,600,000,000

A = 183,303
VarB = .7(875,000 912,500)2 + .3(1,000,000 912,500)2 = 3,281,250,000
B = 57,282
e.
Cannot decide using mean-variance rule since option A has both higher expected profit
and higher risk than option B.
f.
A = 183,303/1,080,000 = 0.17
B = 57,282/912,500 = 0.06
Based on the coefficient of variation rule, option B would be chosen.
a.
Maximax rule Option A
b.
Maximin rule Option B
c.
Minimax regret Option A
d.
Equal probability criterion Option A
a.
E(Profit)US
E(Profit)US,Mexico
E(Profit)US,Mexico,Canada
b.
Using the expected value rule, the firm should operate plants in the US, Mexico, and
Canada.
= $4.9 million
= $6.35 million
= $9.4 million

70
c.
The standard deviations are, respectively, 4.25, 7.24, and 9.12. None of the three options
dominates by mean-variance rules.
d.
US
= 0.87
US,M = 1.14
US,M,C = 0.97
Under the coefficient of variation rule, the firm should operate only in the US.

1.
maximax 2.0 million units of output

maximin 1 million units of output
minimax regret 2.0 million units of output
equal probability 2.0 million units of output
2.
Output
E()
!2
1 million units
146
2,480
50
0.34
1.5 million units
163
4,219
65
0.40
2.0 million units
288
37,969
195
0.68
3.
2.0 million units
4.
Cannot apply mean variance analysis to this problem
5.
1 million units
6.
14,626; 16,250; 28,750 (in the three blanks); 2.0 million units; The utility function for profit is
linear, so the manager is risk neutral. In this case, the decision is the same whether the manager
is maximizing E() or E[U()].

71

72
Chapter 16:
GOVERNMENT REGULATION OF BUSINESS

1.
While it is true that a different allocation of resources that makes everyone better off (i.e., a winwin situation) clearly increases social welfare, win-win is a more restrictive condition for
identifying welfare improving allocations of resources. All that is required to insure a welfare
improvement is for no one to be made worse off (i.e., no lose) and at least one person is made
better off. In other words, no lose-win is a less restrictive condition than win-win for
identifying social welfare improving changes in resource allocation. This increases the size of the
set of all possible welfare-improving changes.
2.
A shortage definitely results in an underallocation of resources to an industry. However,

underallocation can happen without any shortage. For example, in a monopoly market there is no
shortage buyers can buy all they want at the price set by the monopolist yet P > MC at the
profit-maximizing output level. Many situations of market failure due to underallocation of
resources do not cause shortages. Thus, a shortage is not a necessary condition for
underallocation of resources.
3.
Price ceilings set below the market-clearing price encourage buyers with low values i.e.,
consumers who value units of the good at less than the market-clearing price to enter the market
and compete or the good with high-valued buyers. When a good is in short supply, it is usually
rationed by waiting lines on a first-come, first-served basis. This queuing process in no way
guarantees that the good will end up in the hands of the highest-valued users. Indeed, buyers with
relatively low time values, will tend to be the ones willing to wait in lines to get the shortsupplied goods. Obviously, such a rationing procedure is not likely to allocate goods
systematically to the highest valued users. One way to overcome this allocation problem is to use
rationing coupons that can be bought and sold legally. When property rights to coupons exist, a
market for the coupons themselves will arise. Competition for coupons, in order to buy the tiedgood, will bid up the price of the coupons until both the coupon market and the product market
clear, even in the presence of a price ceiling in the product market. Of course, the effective price
of the product, which is the ceiling price plus the coupon price, is then equal to the marketclearing price that buyers would have paid had there been no price ceiling in the first place. So
why do you suppose anyone would want a price ceiling with ration coupons in the first place?
4.
Anti-gouging laws are unlikely to be helpful to society. We provide the following editorial from
the Wall Street Journal (September 7, 2005, p. A 16):
In Praise of gouging
In Praise of Gouging
Copyright (c) 2005, Dow Jones & Company Inc. Reproduced with permission of
copyright owner. Further reproduction or distribution is prohibited without permission.
One test of leadership in a crisis is whether politicians keep cool enough to resist populist
furies, especially when it comes to the inevitable economic fallout. Sadly, that's not what
we're seeing in the current demagoguery over alleged oil-profiteering.
"Price gouging," says Missouri GOP Governor Matt Blunt, "is unconscionable
and illegal . . . and should be rooted out and punished." In Georgia, Republican Governor
Sonny Perdue has signed an emergency executive order imposing sanctions on service
stations that raise their prices too much. In Illinois, Democratic Governor Rod
Blagojevich has pledged to prosecute gas companies that profit from the price spike, as
has Ernie Fletcher, his Republican counterpart in Kentucky.
Chapter 16: Government Regulation of Business
73
Some 20 states, most of them in the south, already have anti-price- gouging laws
on their books -- and many governors have declared emergencies to invoke them. These
de facto price controls typically place ceilings of between 10% and 25% on how much
companies can raise prices in the wake of a natural disaster. In almost all cases such laws
are wrong-headed, because they exacerbate supply problems by short-circuiting the price
system that matches supply with demand.
As infuriating as higher gas prices will be over the next weeks and perhaps
months, there is one economic certainty here: If governments will not allow the price
system to ration the demand for gas, a new "price" system will emerge called gas lines,
which have already appeared in many locales.
Let's explain why prices have been rising. Katrina has knocked out about 90% of
Gulf crude oil production and about 80% of natural gas output. That translates into about
two million barrels a day that are not available to consumers, an 11% decrease in supply.
This means that in the near term Americans are going to have to consume two million
fewer barrels of gas every day, at least until the refineries are brought back on line and
increased output and supplies from other nations arrive. The way the market achieves this
reduction in consumption is through a higher price.
The argument is also made that energy companies are reaping windfall profits
from the Katrina catastrophe. That is in one sense true -- the oil they've already extracted
and refined is more valuable now, and we would be pleased to see some of these extra
profits donated to the relief effort. But artificially holding down the price of gas makes a
bad situation worse.
This is also why many of the nation's governors are misguided, even if wellintentioned, in their attempts to suspend state gas taxes. Given the high demand for gas
and constricted supply, this gas tax cut will have one of two undesirable consequences. If
the savings are somehow passed on to consumers at the pump, demand will be elevated,
thus heightening the risk of gas lines and/or "sold out" signs at service stations. The
alternative is that energy companies will keep the market-clearing pump price the same,
and pocket the 10 to 20 cents a gallon reduction in the tax -- which would only increase
their windfall. Either way, consumers won't benefit.
So are the gas sellers guilty of "profiteering?" Price gouging laws say companies
can't charge significantly more than their "cost." But what matters for wholesalers and
gas stations isn't what they paid for the last tanker of fuel but what they expect to pay for
the next one. Economists call this the "replacement cost," and any gas station owner
would soon be out of business if he charged $2 a gallon for gas that he knew would cost
him $2.50 a gallon to replace. As these replacement costs soar, it is entirely appropriate
for gas stations to raise prices on a daily, or even hourly, basis.
"If prices do not increase," explained the White House Council of Economic
Advisers in a section on "unexpected shortages" its 2004 Report to the President,
"consumers do not receive a signal to cut their consumption and suppliers might not have
the proper incentives to increase supply adequately."
Anti-gouging laws also punish companies for building excess capacity and
reserves in advance of a crisis like the one we're now having. One lesson of Katrina is
that we should reward companies for stockpiling oil and gas for the times when it is most
urgently needed. Price gouging laws give them no incentive to endure the costs of
carrying this excess inventory.
We could fill these pages with all the ways government has undermined U.S.
energy security and raised production costs. These include reformulated gas mandates,
prohibitions on offshore and Alaska oil drilling, and environmental regulations and price
controls that go a long way to explaining why not a single new oil refinery has been built
in the U.S. since 1976. Not one -- in 29 years.
74
These are the longer-term causes of the post-Katrina price increases. And they
are energy policy dysfunctions that Congress would do well to fix before the memory of
this catastrophe fades. In the meantime we can only hope politicians don't make this crisis
worse by engaging in profiteering of their own, at everyone else's expense.
5.
The following figure shows the demand, marginal revenue, and constant cost conditions faced by
Mirk Labs for Zatab:
a.
b.
c.
Mirk Labs sets the wholesale price at $40 per unit and sells 7 million units annually.
It earns annual profit of $245 million [= ($40 $5) 7 million units].
Once this market becomes perfectly competitive, price will be bid down to LAC, $5.
Point C in the figure shows the competitive outcome, 14 million units sold for $5 per
unit. The annual consumer surplus at point C is $490 million [= 0.5 $70 14
million]. The annual consumer surplus at point M is $122.5 million [= 0.5 $35 7
million]. Thus the gain in consumer surplus is $367.5 million [= $490 million
122.5 million].
Annual deadweight loss is the area of triangle bCM in the figure: $122.5 million [=
0.5 $35 7 million]. Deadweight loss in this case represents the amount of
consumer surplus lost because buyers do not get to consume the 7 million units from
point b to C, each of which is more valuable to buyers than the marginal cost of
producing the unit of the drug. There is no producer surplus lost on units sold for the
constant cost of $5 per unit.
75
d.
Even though the accumulated DWL over the 10-year period after the drug was
developed is staggering ($4.9 billion in nominal dollars), these are the rewards to
Mirks owners for risking $60 million in R&D to develop the drug. Without the
prospect of a huge future profit, investors will not undertake expensive and risky
R&D to develop new drugs. Note that at point M, consumers still enjoy annual
consumer surplus of $122.5 million annually under monopoly.

1.
a.
b.
c.
2.
Refer to figure below:
a.
b.
c.
d.
e.
social; consumer; producer; economic; productive; allocative

productive; total; minimized
allocative; price
$1; 10,000
$1 (= $2 $1); $0.50 (= $1 $0.50)
CS = $10,000 (= 0.5 10,000 $2); PS = $5,000 (= 0.5 10,000 $1); SS = $15,000 (=
CS + PS = 0.5 10,000 $3)
$1.80; 6,000
DWL = area MeC = $2,400 (= 0.5 4,000 $1.20)

76
PART II: ADDITIONAL TEACHING AND LEARNING RESOURCES

Students Resource CD
Instructors Resource CD
McGraw-Hill Web Site (www.mhhe.com/economics/thomas9)
Part II
Additional Teaching and Learning Resources
Instructors and students have a number of teaching and learning resources available in several
places: (1) a Students Resource CD, (2) an Instructors Resource CD, and (3) the McGraw-Hill
Web site designed specifically for the ninth edition of Thomas and Maurice, Managerial
Economics. Part II of this Instructors Manual describes these various teaching resources.
Student Resource CD (Packaged with each textbook)

Every new copy of the ninth edition of Managerial Economics comes with a Student Resource
CD attached inside the cover of the book itself. This Student Resource CD contains the following
items:
Student Workbook
Beginning with the ninth edition of Managerial Economics, the Student Workbook, which in
previous editions was sold to students separately, will come packaged at no charge as an Acrobat
PDF document on the Student Resource CD. The Student Workbook provides students with
chapter reviews and many extra problems with rather detailed answers. Each chapter of the
Student Workbook has five sections: Essential Concepts, Study Problems, Matching Definitions,
Multiple-Choice/True-False, and Homework Exercises. This is arguably the single most valuable
item on the Student Resource CD and its marginal cost to students is zero!
Review of Fundamental Mathematics
This eighteen page tutorial reviews the basic algebra and graphing skills needed to work all the
problems in the textbook. This tutorial is found in the Student Workbook (pages 1-18). It
contains simple explanations of how to use basic math tools, and it contains numerous
mathematical exercises with answers. My students genuinely rave about this math review,
frequently using it to refresh themselves for other economics and business courses.
Brief Review of Derivatives and Optimization
While calculus is not a part of any chapter, some instructors wish to teach a calculus-based
course, which they can do by relying on the Mathematical Appendixes in many of the chapters.
To facilitate calculus-based teaching, students will find a six-page review on the Student
Resource CD that briefly covers the basic calculus skills: taking derivatives and using derivatives
to find solutions to unconstrained and constrained optimization problems.
Statistix 8 Tutorial
For instructors who wish to teach the empirical chapters of Managerial Economics (basic
regression, demand estimation, forecasting, and empirical production and cost analysis),
McGraw-Hill will package for a very small additional fee the Student Edition of Statistix 8.
Statistix 8 is quite easy for students to use and it includes its own Help menu. Nevertheless,
some students benefit from seeing a sample problem from the textbook worked and explained in
this brief tutorial found on the Student Resource CD.
Data Files for Empirical Chapters
Additionally, for those instructors (and students) who will cover the empirical content in
Managerial Economics, the Student Resource CD contains a full set of all data sets used in the
empirical chapters. These data sets are provided in both Excel spreadsheet format and in the
79
proprietary Statistix 8 data set format. This makes it easier for students and instructors to confirm
the regression results presented in the textbook: seeing is believing!
PowerPoint Slides of Tables and Figures in Managerial Economics
Students and instructors find it useful to have readily accessible images of the tables and figures
from the textbook. These are provided for students and instructors as PowerPoint slides. [Please
note that these PowerPoint slides should not be confused with the Animated PowerPoint
Slideshows that are provided to instructors on the Instructors Resource CD.]
Chapter Summaries and Key Terms
Students will find all of the chapter summaries from the textbook, as well as lists of key terms,
collected here for convenient review.
Instructors Resource CD (Provided by McGraw-Hill to adopters)

Instructors Manual
For convenience, this Instructors Manual is both provided to adopters by McGraw-Hill sales
representatives and also available on the McGraw-Hill Web site (the password protected part of
the Web site).
Illustrations from Past Editions
With each new edition of the text, new Illustrations are added to replace some of the older
Illustrations. Many of these Illustrations from previous editions, while somewhat dated, remain
useful tools for showing students how economics can be applied to business decision-making.
We have compiled all of the Illustrations from the fourth through eighth editions that have been
replaced or updated. Instructors may wish to use these for class discussion, homework reading,
or lecture material. McGraw-Hill grants instructors copyright permission to copy and distribute
these Illustrations to students for educational use.
Animated PowerPoint Slideshows
In contrast to the PowerPoint images of tables and figures, the Animated PowerPoint Slideshows
provide for every chapter an animated presentation that flows in a step-by-step fashion.
Instructors who have only basic PowerPoint skills can easily modify these animated slideshows to
more closely match their own presentation style and organizational sequence. These animated
slideshows are not provided to students on the Student Resource CD, although instructors may
certainly choose to do so.
PowerPoint Slides of Tables and Figures in Managerial Economics
Students and instructors find it useful to have readily accessible images of the tables and figures
found in the textbook. These are provided for students and instructors as PowerPoint slides.
[Please note that these PowerPoint slides should not be confused with the Animated PowerPoint
Slideshows that are provided to instructors on the Instructors Resource CD.] These PowerPoint
slides are also provided for convenience on the Student Resource CD.
McGraw-Hill Web Site for Managerial Economics, 9e

McGraw-Hill maintains a web site specifically for the ninth edition of Thomas and Maurice,
Managerial Economics. This web site can be found at www.mhhe.com/economics/thomas9. The
web site has two sections: the Student Resources and the Instructor Resources (password
protected). Student Resources contains a variety of learning resources for students that can be
80
accessed freely (i.e., without a password) by students. These are items that do not come on the
Students Resource CD. Instructor Resources contains password protected teaching materials for
the exclusive use of instructors. In order to access the resources in Instructor Resources,
instructors must obtain a password from their McGraw-Hill sales representatives. The following
items are available on the Web site:
Test Bank (Instructor Resources Section)
The Test Bank offers multiple-choice and fill-in-the-blank style questions that closely match the
Technical Problems in each chapter. The Test Bank is available in several formats: soft cover,
CD containing Microsoft Word files, and a computerized software version that simplifies test
construction.
Online Topics (Instructor Resources Section)
The Web site contains three Online Topics containing material moved from previous editions of
the textbook to make room for new topics in the print editions. These are the following:
o
Online Topic 1:
Estimating and Forecasting Industry Demand for Price-Taking Firms
Online Topic 2:
Linear Programming
Online Topic 3:
The Investment Decision
Statistix Case Studies (Instructor Resources Section)

Four case studies present students with hypothetical business decision situations that require
statistical analysis of the data presented in the problem in order to analyze business conditions to
make profitable decisions. These case studies may require students to employ tools from more
than one chapter of the textbook, thereby providing some practice integrating the decisionmaking skills of managerial economics. The titles of the four Statistix Case Studies are (1)
Estimating Industry Demand for Fresh Market Carrots, (2) Estimation and Analysis of Demand
for Fast Food Meals, (3) Production Decisions at Harding Silicon Enterprises, Inc., and (4)
Pricing and Production Decisions at PoolVac, Inc.
Answers to Statistix Case Studies (Instructor Resources Section)
The Instructors Resource CD provides answers to the Statistix Case Studies.
Self-Quizzes (Student Resources Section)
As in the last edition, students will have instant-grading, self-tests for each chapter of the book.
Twenty multiple-choice questions are provided for each chapter. These follow the format of the
multiple-choice questions in the Test Bank.
Career Center (Student Resources Section)
This link takes students to McGraw-Hills Career Center for economics. This site presents
students with an overview of career opportunities for economics majors. Salary data are also
provided.
Economics on the Web (Student Resources Section)
This link takes students to McGraw-Hills Economics on the Web resource center. This site
provides students and instructors with a rich array of Internet resources to enhance the study of
economics.

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INSTRUCTORS MANUAL

Thomas and Maurice

Answers: Applied Problems, Mathematical Exercises, and Student

PART II Additional Teaching and Learning Resources: Students Resource

Instructors Resource CD (Provided by McGraw-Hill to adopters)......................... 80

MANAGERS, PROFITS, AND MARKETS

Total explicit cost = $793,000 (= 555,000 + 45,000 + 28,000 + 165,000)

Answers to Mathematical Exercises

The present value is calculated as follows:

= $8,929 + 15,944 + 35,589 + 47,664 + 28,371

Answers to Homework Exercises in Student Workbook

Chapter 1: Managers, Profits, and Markets

Chapter 1: Managers, Profits, and Markets

DEMAND, SUPPLY, AND MARKET EQUILIBRIUM

Demand will decrease, so price will decrease.

Price of RAM chips

Price of heating oil

Quantity of RAM chips

Construct a demand and supply diagram like Panel A of Figure 2.11.

Taxpayers, genuinely compassionate about providing more housing for low-income

In the graph, let D0 be the initial demand for

Price of a ticket (dollars)

No effect on demand (no shift)just a movement up the demand.

Chapter 2: Demand, Supply, and Market Equilibrium

In the graph, S0 and D0 are the

Price of auto insurance (dollars)

Price of firewood (dollars)

Chapter 2: Demand, Supply, and Market Equilibrium

Answers to Homework Exercises in Student Workbook

Substitutes. The coefficient on R is positive. Thus !Qd !R is positive, and three-bedroom

See the figure below:

100 110 120 130

Quantity of new housing (thousands of square feet/month)

See the figure above.

CS = .5 60 ($80 $50) = $900; PS = .5 60 ($50 $20) = $900; SS = $1,800

Chapter 2: Demand, Supply, and Market Equilibrium

MARGINAL ANALYSIS FOR OPTIMAL DECISIONS

See answer to part c.

Chapter 3: Marginal Analysis for Optimal Decisions

Chapter 3: Marginal Analysis for Optimal Decisions

Q* = 6,000 wine decanters

TR6,000 = 70 6,000 = $420,000

Answers to Mathematical Exercises

Chapter 3: Marginal Analysis for Optimal Decisions

NB = 170(30) (30)2 100 +10(30) 2(30)2 = 2,600

MB = 100 4x; MC = x2 12x + 52

Dividing the first equation by the second,

Substituting this solution into the third equation:

Chapter 3: Marginal Analysis for Optimal Decisions

a. Marginal benefit is the derivative of TB with respect to A:

b. Marginal cost is the derivative of TC with respect to A: MC =

Answers to Homework Exercises in Student Workbook

50; NB; $225

Chapter 3: Marginal Analysis for Optimal Decisions

Your table should look like:

X * = 3; Y * = 2; TB* = $185,000 (= 75,000 + 110,000)

increasing; total; increases; total; increasing; increase; equal

Chapter 3: Marginal Analysis for Optimal Decisions

1 round of golf and 5 tennis matches.

0 rounds of golf and 4 tennis matches.

Chapter 3: Marginal Analysis for Optimal Decisions

Chapter 3: Marginal Analysis for Optimal Decisions

BASIC ESTIMATION TECHNIQUES

The intercept a is expected to be positive because even if no advertising is undertaken,