Management Economics

Glossary
Chapter 1 business profit compensatory profit theory economic profit expected value maximization frictional profit theory innovation profit theory managerial economics monopoly profit theory normal rate of return optimize present value profit margin return on Accounting net income divided by the book value of total assets minus total liabilities Abnormal profits observed following unanticipated changes in demand or cost conditions Optimization of profits in light of uncertainty and the time value of money Residual of sales revenue minus the explicit accounting costs of doing business

Above-normal rates of return that reward efficiency

Business profit minus the implicit costs of capital and any other owner-provided inputs

Above-normal profits that follow successful invention or modernization

Applies economic tools and techniques to business and administrative decision making

Above-normal profits caused by barriers to entry that limit competition

Average profit necessary to attract and retain investment Seek the best solution Worth in current dollars Accounting net income divided by sales

stockholders equity satisfice theory of the firm value of the firm Chapter 2 average cost minimization

Seek satisfactory rather than optimal results Basic model of business

Present value of the firms expected future net cash flows

Activity level that generates the lowest average cost, MC = AC

Presented by Suong Jian & Liu Yan, MGMT Panel , Guangdong University of Finance. -1-

Management Economics

breakeven point constrained optimization dependent variable derivative equation graph incremental change incremental profit independent variable inflection point Lagrangian multiplier, l Lagrangian technique marginal

Output level at which total profit is zero

Decision situations that involve limited choice alternatives

Y variable determined by X values Precise specification of the marginal relation Analytical expression of functional relationships Visual representation of data Difference resulting from a given decision

Gain or loss associated with a given decision

X variable determined separately from the Y variable

Point of maximum or minimum slope Marginal effect on the objective function of decreasing or increasing the constraint requirement by one unit Method for solving constrained optimization problems Change in the dependent variable caused by a 1-unit change in an independent variable

marginal cost marginal profit marginal revenue multivariate optimization optimal decision profit maximization revenue

Change in total cost following a 1-unit change in output

Change in total profit due to a 1-unit change in output

Change in total revenue associated with a 1-unit change in output

Process of optimization for equations with three or more variables Choice alternative that produces a result most consistent with managerial objectives Activity level that generates the highest profit, MR = MC and M? = 0 Activity level that generates the highest revenue, MR = 0

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Management Economics

maximization second derivative slope spreadsheet table tangent Derivative of a derivative Measure of the steepness of a line Table of electronically stored data List of economic data Straight line with the same slope as a given curve at their single point of intersection

Chapter 3 change in the quantity demanded Movement along a given demand curve reflecting a change in price and quantity change in the quantity supplied Movement along a given supply curve reflecting a change in price and quantity comparative statics analysis Study of changing demand and supply conditions demand Total quantity customers are willing and able to purchase demand curve Relation between price and the quantity demanded, holding all else constant demand function Relation between demand and factors influencing its level derived demand Demand for inputs used in production direct demand Demand for consumption products equilibrium Perfect balance in demand and supply market equilibrium price Market clearing price shift in demand Switch from one demand curve to another following a change in a nonprice determinant of demand shift in supply Movement from one supply curve to another following a change in a nonprice determinant of supply shortage Excess demand supply Total quantity offered for sale supply curve The relation between price and the quantity supplied, holding all else constant supply function Relation between supply and all factors influencing its level surplus Excess supply utility Value

Chapter 4 budget constraint Combinations of products that can be purchased for a fixed amount bundle pricing When products are purchased together as a package of goods or services cardinal utility An understanding of the intensity of preference, e.g., A = 2B complements Products that are best consumed together consumer surplus Value of purchased goods and services above and beyond the amount paid to sellers consumption path Optimal combinations of products as consumption increases
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Management Economics

Engle curve A plot of the relationship between income and the quantity consumed of a good or service income effect Increase in overall consumption made possible by a price cut, or decrease in overall consumption that follows a price increase income-consumption curve Utility-maximizing combinations of goods and services at every income level indifference If two goods provide the same amount of satisfaction or utility indifference curves Representation of all market baskets that provide a given consumer the same amount of utility or satisfaction inferior goods Goods and services with falling consumption at higher levels of income law of diminishing marginal utility As an individual increases consumption of a given product within a set period of time, the marginal utility gained from consumption eventually declines marginal rate of substitution Change in consumption of Y (goods) necessary to offset a given change in the consumption of X (services) if the consumers overall level of utility is to remain constant marginal utility Added satisfaction derived from a 1-unit increase in consumption market baskets Bundles of items desired by consumers nonsatiation principle More is better normal goods Goods and services with rising consumption at higher levels of income optimal market basket Best feasible combination of goods and services ordinal utility A rank ordering of preferences, e.g., A is better than B perfect complements Goods and services consumed together in the same combination perfect substitutes Goods and services that satisfy the same need or desire price-consumption curve Market baskets that maximize utility at different prices for a given item revealed preference Documented desire substitutes Products that serve the same purpose substitution effect Change in relative consumption that occurs as consumers substitute cheaper products for more expensive products two-part pricing A per unit fee equal to marginal cost, plus a fixed fee equal to the amount of consumer surplus generated at that per unit fee utility Satisfaction tied to consumption utility function Descriptive statement that relates well-being to the consumption of goods and services utils Unit of utility or well-being

Chapter 5 arc elasticity Average elasticity over a given range of a function complements Products that are inversely related in terms of price and quantity countercyclical Falls with rising income, and rises with falling income cross-price elasticity Responsiveness of demand for one product to changes in the price of another cyclical normal goods Products for which demand is strongly affected by changing income elastic demand Situation in which a price change leads to a more than proportionate change in
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Management Economics

quantity demanded elasticity Percentage change in a dependent variable resulting from a 1 percent change in an independent variable endogenous variables Factors controlled by the firm exogenous variables Factors outside the control of the firm income elasticity Responsiveness of demand to changes in income, holding constant the effect of all other variables inelastic demand Situation in which a price change leads to a less than proportionate change in quantity demanded inferior goods Products with sales that rise when income falls market demand curve Total amount of a specific good or service customers are willing to buy at various prices under present market conditions noncyclical normal goods Products for which demand is relatively unaffected by changing income normal goods Products with sales that rise when income increases optimal price formula For any downward-sloping demand curve, maximum profits result when P = MC/[1 + (1/P)] point elasticity Elasticity at a given point on a function price elasticity of demand Responsiveness of the quantity demanded to changes in the price of the product, holding constant the values of all other variables in the demand function substitutes A direct relation between the price of one product and the demand for another product unitary elasticity Situation in which price and quantity changes exactly offset each other

Chapter 6 coefficient of determination Measure of the goodness of fit for a multiple regression model; the square of the coefficient of multiple correlations consumer interview Questioning customers to estimate demand relations corrected coefficient of determination Downward adjustment to R2 in light of the number of data points and estimated coefficients correlation coefficient Goodness of fit measure for a simple regression model cross section Sample of firm, market, or product data taken at a given point in time degrees of freedom Number of observations beyond the minimum needed to calculate a given regression statistic deterministic relation Association that is known with certainty F statistic Measure of statistical significance for the share of dependent variable variation explained by the regression model identification problem Difficulty of estimating an economic relation in the presence of simultaneous relations linear model Straight-line relation market experiments Demand estimation in a controlled environment multiple regression model Relation between one Y variable and two or more X variables
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Management Economics

multiplicative model Nonlinear relation that involves X variable interactions one-tail t tests Tests of direction or comparative magnitude regression analysis Statistical technique that describes relations among dependent and independent variables scatter diagram Plot of XY data simple regression model Relation between one dependent Y variable and one independent X variable simultaneous relation Concurrent association standard error of the estimate (SEE) Standard deviation of the dependent Y variable after controlling for the influence of all X variables statistical relation Imprecise link between two variables t statistic Approximately normal test statistic with a mean of zero and a standard deviation of 1 time series Daily, weekly, monthly, or annual sequence of economic data two-tail t tests Tests of the b = 0 hypothesis

Chapter 8 average product Total product divided by units of input employed constant returns to scale When a given percentage increase in all inputs leads to an identical percentage increase in output continuous production function Production function where inputs can be varied in an unbroken marginal fashion decreasing returns to scale When output increases at a rate less than the proportionate increase in inputs discrete production function Production function with distinct input patterns economic efficiency Achieved when all firms equate input marginal revenue product and marginal cost (maximize profits) expansion path Optimal input combinations as the scale of production expands increasing returns to scale When the proportional increase in output is larger than an under-lying proportional increase in input input substitution Systematic replacement of productive factors isocost curve (or budget line) Line of constant costs isoquant Different input combinations used to efficiently produce a specified output labor productivity Output per worker hour law of diminishing returns As the quantity of a variable input increases, the resulting rate of output increase eventually diminishes marginal product Change in output associated with a 1-unit change in a single input marginal rate of technical substitution (MRTS) Amount of one input that must be substituted for another to maintain constant output marginal revenue product Amount of revenue generated by employing the last input unit multifactor productivity Output relative to the combined inputs of labor, capital, and intermediate purchases
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Management Economics

net marginal revenue Marginal revenue after all variable costs output elasticity Percentage change in output associated with a 1 percent change in all inputs power production function Multiplicative relation between input and output production function Maximum output that can be produced for a given amount of input productivity growth Rate of increase in output per unit of input returns to a factor Relation between output and variation in only one input returns to scale Output effect of a proportional increase in all inputs ridge lines Graphic bounds for positive marginal products technical efficiency Least-cost production of a target level of output total product Whole output from a production system

Chapter 9 breakeven quantity A zero profit activity level capacity Output level at which short-run average costs are minimized cost elasticity Percentage change in total cost associated with a 1 percent change in output cost function The cost/output relation cost-volume-profit analysis Analytical technique used to study relations among costs, revenues, and profits current cost Amount paid under prevailing market conditions degree of operating leverage Percentage change in profit from a 1 percent change in output economies of scale Decreasing long-run average costs economies of scope Cost reduction from producing complementary products explicit cost Out-of-pocket expenditures fixed cost Expense that does not vary with output historical cost Actual cash outlay implicit cost Noncash costs incremental cost Change in cost caused by a given managerial decision learning curve Average cost reduction over time due to production experience long run Planning period with complete input flexibility long-run cost curve Cost/output relation for the optimal plant in the present operating environment long-run cost functions Basis for long-range planning minimum efficient scale Output level at which long-run average costs are minimized multiplant diseconomies of scale Cost disadvantages from managing multiple facilities in the same line of business or industry multiplant economies of scale Cost advantages from operating multiple facilities in the same line of business or industry operating curves Short-run cost relationship opportunity cost Foregone value associated with current rather than next-best use of an asset planning curves Long-run cost relationship profit contribution Profit before fixed charges
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Management Economics

replacement cost The cost of duplicating productive capability using current technology short run Operating period during which at least one input is fixed short-run cost curve Cost/output relation for a specific plant and operating environment short-run cost functions Basis for day-to-day operating decisions sunk cost Cost that does not vary across decision alternatives variable cost Expense that fluctuates with output Chapter 10 barrier to entry Any factor or industry characteristic that creates an advantage for incumbents over new arrivals barrier to exit Any restriction on the ability of incumbents to redeploy assets from one industry or line of business to another barrier to mobility Any factor or industry characteristic that creates an advantage for large leading firms over smaller nonleading rivals competitive firm long-run supply curve The marginal cost curve, so long as P > ATC competitive firm short-run supply curve The marginal cost curve, so long as P > AVC competitive markets Markets characterized by vigorous rivalry among competitors offering essentially the same product economic losses Realized profits that are insufficient to attract and retain capital investment economic profit An above-normal rate of return marginal analysis Study of changes caused by economic decisions market Firms and individuals willing and able to buy or sell a given product market structure The competitive environment normal profit Rate of return necessary to attract and retain capital perfect competition Market characterized by a large number of buyers and sellers of a homogenous product potential entrant Person or firm posing a sufficiently credible threat of market entry to affect market price/output decisions price takers Buyers and sellers that accept market prices as given and devise their buying and selling strategies accordingly product differentiation Real or perceived differences in the quality of goods and services

Chapter 11 competitive strategy Search for a durable advantage over competitors consumer sovereignty Individual control over economic decisions deadweight loss of taxation Decline in social welfare due to decline in economic activity caused by taxes deadweight loss problem Decline in social welfare due to competitive market distortion disequilibrium losses Below-normal returns suffered in the short run prior to long-term market adjustment disequilibrium profits Short-term economic profits prior to long-term market adjustment economic efficiency Least-cost production of desired goods and services
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Management Economics

economic luck Temporary good fortune due to some unexpected change in industry demand or cost conditions economic regulation Government control of production and/or consumption economic rents Profits due to uniquely productive inputs externalities Uncompensated benefits or costs tied to production or consumption failure by incentive Situation when competitive markets malfunction because of externalities failure by market structure Situation when competitive markets malfunction because of market power leverage Ratio of total assets divided by stockholders equity limit concentration Restrict economic and political power market failure Situation when competitive market outcomes fail to efficiently allocate economic resources market power Ability to set prices and obtain above-normal profits for extended periods price ceiling Maximum price price floor Minimum price producer surplus Net benefit derived by producers from production profit margin Net income expressed as a percentage of sales revenue return on stockholders equity (ROE) Net income divided by the book value of total assets minus total liabilities reversion to the mean Tendency of firm profit rates to converge over time toward long-term averages social equity Fairness social welfare Material well-being of society subsidy policy Government support strategy tax burden Economic hardship due to tax tax incidence Point of tax collection total asset turnover Sales revenue divided by the book value of total assets tradable emission permits Transferable pollution licenses welfare economics Study of how the allocation of economic resources affects the material well-being of consumers and producers welfare loss triangle Graphic representation of deadweight loss when linear supply and demand curves are employed

Chapter 12 antitrust laws Laws designed to promote competition bilateral monopoly Markets in which a monopsony buyer faces a monopoly seller deadweight loss from monopoly problem Decline in social welfare due to the drop in mutually beneficial trade activity caused by monopoly market niche A segment of a market that can be successfully exploited through the special capabilities of a given firm or individual monopoly A market structure characterized by a single seller of a highly differentiated product monopoly underproduction Tendency for monopoly firms to restrict output to increase prices and earn economic profits
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Management Economics

monopsony Market in which there is a single buyer of a desired product or input monopsony power Ability to obtain prices below those that exist in a competitive market natural monopoly Market in which the market-clearing price occurs at a point at which the monopolists long-run average costs are still declining oligopsony Market demand dominated by few buyers patents Explicit monopoly rights conferred by public policy price makers Buyers and sellers whose large transactions affect market prices regulatory lag Delay between when a change in regulation is appropriate and the date it becomes effective wealth transfer problem Difficulty that monopoly results in an unwarranted transfer of wealth, measured by the transformation of a consumer surplus into producer surplus

Chapter 13 barometric price leadership Situation in which one firm in an industry announces a price change in response to what it perceives as a change in industry supply and demand conditions and other firms respond by following the price change Bertrand model Theory that firms in oligopoly markets make simultaneous and independent price decisions cartel Firms operating with a formal agreement to fix prices and output collusion A covert, informal agreement among firms in an industry to fix prices and output levels concentration ratios The percentage market share held by (concentrated in) a group of top firms contestable markets theory Hypothesis that oligopoly firms will behave much like perfectly competitive firms when sunk costs are minor Cournot equilibrium Definition needed Cournot model Theory that firms in oligopoly markets make simultaneous and independent output decisions Duopoly Market dominated by two firms economic census A comprehensive statistical profile of the economy, from the national, state, and local levels first-mover advantage Competitive advantage for the oligopoly firm that initiates the process of determining market output Herfindahl-Hirschmann Index (HHI) The sum of squared market shares for all n industry competitors high-price/low-output equilibrium In monopolistic competition, where differentiated products allow P > MC but P = AR = AC kinked demand curve Firm demand curve that has different slopes for price increases as compared with price decreases low-price/high-output equilibrium In monopolistic competition, where entry of identical products drives prices down to where P = MR = MC = AC (the competitive market solution) monopolistic competition A market structure characterized by a large number of sellers of differentiated products
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Management Economics

North American Industry Classification System (NAICS) A method for categorizing establishments by principal economic activity oligopoly A market structure characterized by few sellers and interdependent price/output decisions oligopoly theory Models that together help explain competition among the few output-reaction curve Relation between an oligopoly firms profit-maximizing output and rival output price leadership Situation in which one firm establishes itself as the industry trendsetter and all other firms in the industry accept its pricing policy price signaling Informal collusion by announcing pricing strategy in the hope that competitors will follow suit price-reaction curve Relation between an oligopoly firms profit-maximizing price and rival price Stackelberg model Theory of sequential output decisions in oligopoly markets Sweezy model Theory that explains why an established price level tends to remain fixed for extended periods of time in some monopoly markets

Chapter 15 by-product Output that is customarily produced as a direct result of an increase in the production of some other output common costs Expenses that are necessary for manufacture of a joint product competitive market pricing rule-of-thumb In competitive markets, set P = MR = MC for maximum profits first-degree price discrimination Charging different prices to each customer imperfectly competitive market pricing rule-of-thumb When P = f (Q), set P = MC/[1 + (1/P)] for maximum profits Lerner Index of Monopoly Power An interpretation of the optimal markup on price as an indicator of monopoly power market segment A division or fragment of the overall market with essentially unique characteristics markup on cost The difference between price and cost, measured relative to cost, expressed as a percentage markup on price The difference between price and cost, measured relative to price, expressed as a percentage off-peak Period with excess capacity optimal markup on cost When P = f (Q), set (P MC)/MC = 1/(P + 1) for maximum profits optimal markup on price When P = f (Q), set (P MC)/P = 1/P for maximum profits peak Period with fully utilized capacity price discrimination A pricing practice that sets prices in different markets that are not related to differences in costs profit margin The difference between the price and cost of a product second-degree price discrimination Charging different prices based on use rates or quantities
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Management Economics

purchased third-degree price discrimination Charging different prices to each customer class transfer pricing The pricing of products transferred among divisions of a firm vertical integration When a single company controls various links in the production chain from basic inputs to final output vertical relation When the output of one division or company is the input to another

Chapter 17 absolute risk Overall dispersion of possible payoffs beta Measure of the systematic variability of one assets returns with returns on other assets business risk Chance of loss associated with a given managerial decision certainty equivalent Assured sum that equals an expected risky amount in utility terms certainty equivalent adjustment factor, a Ratio of a certain sum divided by an expected risky amount, where both dollar values provide the same level of utility chance events Possible outcomes following each decision point computer simulation Use of computer software and workstations or sophisticated desktop computers to create outcome scenarios cost of uncertainty Minimum expected opportunity loss credit risk Chance that another party will fail to abide by its contractual obligations cultural risk Chance of loss because of product market differences due to distinctive social customs currency risk Loss due to changes in the domestic-currency value of foreign profits decision points Instances when management must select among choice alternatives decision tree Map of a sequential decision-making process derivative risk Chance that volatile financial derivatives such as commodities futures and index options could create losses in underlying investments by increasing rather than decreasing price volatility diminishing marginal utility When additional increments of money bring ever smaller increments of added benefit Dutch auction Winning bidder is the first participant willing to pay the auctioneers price economic risk Chance of loss due to the fact that all possible outcomes and their probability of occurrence are unknown English auction Most familiar type of auction where an auctioneer keeps raising the price until a single highest bidder remains expected value Anticipated realization expropriation risk Danger that business property located abroad might be seized by host governments game theory Study of human interaction and decision strategy government policy risk Chance of loss because foreign government grants of monopoly franchises, tax abatements, and favored trade status can be tenuous inflation risk Danger that a general increase in the price level will undermine the real economic value of any legal agreement that involves a fixed promise to pay over an extended period
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Management Economics

interest-rate risk Market risk that stems from the fact that changing interest rates affect the value of any agreement that involves a fixed promise to pay over a specified period liquidity risk Difficulty of selling corporate assets or investments that have only a few willing buyers or are otherwise not easily transferable at favorable prices under typical market conditions market risk Chance that a portfolio of investments can lose money because of swings in the financial markets as a whole maximin criterion Decision choice method that provides the best of the worst possible outcomes (also a secure strategy) minimax regret criterion Decision choice method that minimizes the maximum possible regret (opportunity loss) associated with a wrong decision after the fact normal distribution Symmetrical distribution about the mean or expected value opportunity loss Difference between a given payoff and the highest possible payoff for the resulting state of nature payoff matrix Table that shows outcomes associated with each possible state of nature probability Chance of occurrence probability distribution List of possible events and probabilities relative risk Variation in possible returns compared with the expected payoff amount risk aversion Desire to avoid or minimize uncertainty risk neutrality Focus on expected values, not return dispersion risk premium Added expected return for a risky asset over that of a riskless asset risk seeking Preference for speculation risk-adjusted discount rate Risk-free rate of return plus the required risk premium risk-adjusted valuation model Valuation model that reflects time-value and risk considerations sealed-bid auction Auction where all bids are secret, and the highest bid wins sensitivity analysis Limited form of computer simulation that focuses on important decision variables standardized variable Variable with a mean of 0 and a standard deviation equal to 1 uncertainty When the outcomes of managerial decisions cannot be predicted with absolute accuracy but all possibilities and their associated probabilities of occurrence are known Vickrey auction Where the highest sealed bid wins, but the winner pays the price of the second-highest bid winners curse Where overly aggressive bidders pay more than the economic value of auctioned off items

Chapter 18 beta coefficient Measure of relative stock-price variability capital budgeting Long-term investment planning process component cost of debt Interest rate investors require on debt, adjusted for taxes component cost of equity Rate of return stockholders require on common stock cost of capital Discount rate cost reduction projects Expenditures to replace obsolete plant and equipment crossover discount rate Interest factor that equates NPV for two or more investments expansion projects Expenditures to increase availability of existing products
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Management Economics

incremental cash flows Change in net cash flows due to an investment project internal rate of return (IRR) Discount rate that equates present value of cash inflows and outflows investment opportunity schedule (IOS) Pattern of returns for all potential investment projects marginal cost of capital (MCC) Financing cost of an additional investment project, expressed on a percentage basis net present-value (NPV) Current-dollar difference between marginal revenues and marginal costs net present-value profile Graph relating NPV to the discount rate optimal capital budget Funding required to underwrite a value-maximizing level of new investment optimal capital structure Combination of debt and equity that minimizes the firms weighted-average cost of capital payback period Number of years required to recover initial investment postaudit Careful reconciliation of actual and predicted results profitability index (PI) Benefit/cost ratio replacement projects Maintenance of business investments risk premium (RP) Investor reward for risk taking risk-free rate of return (RF) Investor reward for postponing consumption safety and environmental projects Mandatory nonrevenue-producing investments weighted-average cost of capital Marginal cost of a composite dollar of debt and equity financing

Chapter 20 benefit/cost (B/C) ratio analysis Present value of marginal social benefits per dollar of marginal social cost Coase Theorm Proposition that externalities can be eliminated when private parties have complete property rights and can bargain freely command-and-control regulation Government rules to compel behavior common resources Goods and services that are rival but nonexclusionary cost-effectiveness analysis Method used to determine how to best employ resources in a given social program or public-sector investment project exclusion concept When it is inexpensive to confine the benefits of consumption to paying customers free-rider problem Tendency of consumers to avoid making any contribution toward covering the costs of public goods hidden preferences problem Difficulty of determining true desires for public goods internalize the externality Altering incentives so that externalities are considered in production and consumption decisions marginal external benefits Value enjoyed by nonpurchasers and not reflected in market prices marginal external costs Expenses that are not directly borne by producers or their customers marginal private benefits Value enjoyed by those who directly pay for any good or service
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Management Economics

marginal private costs Production expenses borne by producers and their customers marginal social benefits Added private and public advantages marginal social costs Added private and public expenses negative externality Uncompensated damage tied to production or consumption nonexclusion concept When it is impossible or prohibitively expensive to confine the benefits of consumption to paying customers nonrival consumption When use by certain individuals does not reduce availability for others Pareto optimal When all Pareto satisfactory programs and investment projects have been undertaken Pareto satisfactory If investment in a public project makes at least one individual better off and no one worse off Pigovian taxes Taxes set to correct the effects of negative externalities positive externality Uncompensated benefit tied to production or consumption potential Pareto improvement When an anticipated program or project involves positive net benefits private good Goods that are both excludable and rival privatization Transfer of public-sector resources to the private sector public good Goods that are neither excludable nor rival rival consumption When one persons use diminishes another persons ability to use it social internal rate of return Interest or discount rate that equates the present value of the future benefits to the initial cost or outlay social net present-value Present-value difference between marginal social benefits and marginal social costs social rate of discount Interest-rate cost of public funds tragedy of the commons Tendency to overexploit and destroy common resources transactions costs Expenses incurred in voluntary bargaining

Presented by Suong Jian & Liu Yan, MGMT Panel , Guangdong University of Finance. - 15 -