Documente Academic
Documente Profesional
Documente Cultură
dX dX dX
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 10
Rules of Differentiation
Product Rule: The derivative of the
product of two functions U and V, is
defined as follows.
U g( X )
V h( X )
Y U V
dY
dV
dU
U
V
dX
dX
dX
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 11
Rules of Differentiation
Quotient Rule: The derivative of the
ratio of two functions U and V, is
defined as follows.
U g( X )
dY
dX
Prepared by Robert F. Brooker, Ph.D.
V h( X )
V dU
dX
U dV
V
U
Y
V
dX
2
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 12
Rules of Differentiation
Chain Rule: The derivative of a function
that is a function of X is defined as follows.
Y f (U )
U g( X )
dY dY dU
dX dU dX
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 13
Optimization With Calculus
Find X such that dY/dX = 0
Second derivative rules:
If d2Y/dX2 > 0, then X is a minimum.
If d2Y/dX2 < 0, then X is a maximum.
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 14
New Management Tools
Benchmarking
Total Quality Management
Reengineering
The Learning Organization
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 15
Other Management Tools
P / P P Q
Linear Function
P
EP a1
Q
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 10
Price Elasticity of Demand
Arc Definition
Prepared by Robert F. Brooker, Ph.D.
Q2 Q1 P2 P1
EP
P2 P1 Q2 Q1
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 11
Marginal Revenue and Price
Elasticity of Demand
1
MR P 1
EP
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 12
Marginal Revenue and Price
Elasticity of Demand
PX
EP 1
EP 1
EP 1
QX
MRX
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 13
Marginal Revenue, Total
Revenue, and Price Elasticity
TR MR>0
EP 1
EP 1 MR=0
Prepared by Robert F. Brooker, Ph.D.
MR<0
EP 1
QX
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 14
Determinants of Price
Elasticity of Demand
Demand for a commodity will be more
elastic if:
It has many close substitutes
It is narrowly defined
More time is available to adjust to a
price change
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 15
Determinants of Price
Elasticity of Demand
Demand for a commodity will be less
elastic if:
It has few substitutes
It is broadly defined
Less time is available to adjust to a
price change
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 16
Income Elasticity of Demand
Point Definition
Q / Q Q I
EI
I / I
I Q
Linear Function
I
EI a3
Q
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 17
Income Elasticity of Demand
Arc Definition
Q2 Q1 I 2 I1
EI
I 2 I1 Q2 Q1
Normal Good
Inferior Good
EI 0
EI 0
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 18
Cross-Price Elasticity of Demand
Point Definition
Linear Function
Prepared by Robert F. Brooker, Ph.D.
E XY
QX / QX QX PY
PY / PY
PY QX
E XY
PY
a4
QX
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 19
Cross-Price Elasticity of Demand
Arc Definition
Substitutes
E XY 0
Prepared by Robert F. Brooker, Ph.D.
E XY
QX 2 QX 1 PY 2 PY 1
PY 2 PY 1 QX 2 QX 1
Complements
E XY 0
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 20
Other Factors Related to
Demand Theory
International Convergence of Tastes
Globalization of Markets
Influence of International Preferences on
Market Demand
Growth of Electronic Commerce
Cost of Sales
Supply Chains and Logistics
Customer Relationship Management
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 21
Managerial Economics in a
Global Economy, 5th Edition
by
Dominick Salvatore
Chapter 4
Demand Estimation
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 1
The Identification Problem
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 2
Demand Estimation:
Marketing Research Approaches
Consumer Surveys
Observational Research
Consumer Clinics
Market Experiments
Virtual Shopping
Virtual Management
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 3
Regression Analysis
Year
X
Y
1
10
44
2
9
40
3
11
42
4
12
46
5
11
48
6
12
52
7
13
54
8
13
58
9
14
56
10
15
60
Prepared by Robert F. Brooker, Ph.D.
Scatter Diagram
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 4
Regression Analysis
Regression Line: Line of Best Fit
Regression Line: Minimizes the sum of
the squared vertical deviations (et) of
each point from the regression line.
Ordinary Least Squares (OLS) Method
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 5
Regression Analysis
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 6
Ordinary Least Squares (OLS)
Model:
Yt a bX t et
Yt a bX
t
et Yt Yt
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 7
Ordinary Least Squares (OLS)
Objective: Determine the slope and
intercept that minimize the sum of
the squared errors.
n
n
n
t 1
t 1
t 1
2
2
)2
e
(
Y
Y
)
(
Y
a
bX
t t t t
t
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 8
Ordinary Least Squares (OLS)
Estimation Procedure
n
b
(X
t 1
t
X )(Yt Y )
n
(X
t 1
Prepared by Robert F. Brooker, Ph.D.
t
X)
a Y bX
2
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 9
Ordinary Least Squares (OLS)
Estimation Example
Time
Xt
1
2
3
4
5
6
7
8
9
10
10
9
11
12
11
12
13
13
14
15
120
n 10
Yt
44
40
42
46
48
52
54
58
56
60
500
n
n
X t 120
Yt 500
t 1
n
X
t 1
X t 120
12
n
10
t 1
n
Yt 500
50
10
t 1 n
Y
Prepared by Robert F. Brooker, Ph.D.
Xt X
Yt Y
-2
-3
-1
0
-1
0
1
1
2
3
-6
-10
-8
-4
-2
2
4
8
6
10
n
(X
t 1
t 1
( X t X )2
12
30
8
0
2
0
4
8
12
30
106
4
9
1
0
1
0
1
1
4
9
30
t
X ) 2 30
106
b
3.533
30
t
X )(Yt Y ) 106
a 50 (3.533)(12) 7.60
n
(X
( X t X )(Yt Y )
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 10
Ordinary Least Squares (OLS)
Estimation Example
n
X
n 10
n
X
t 1
t 1
t 1
Y
n
t
X ) 30
106
b
3.533
30
t
X )(Yt Y ) 106
a 50 (3.533)(12) 7.60
t 1
t
500
Yt 500
50
10
t 1 n
Y
120
2
n
(X
n
t
n
(X
t 1
X t 120
12
n
10
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 11
Tests of Significance
Standard Error of the Slope Estimate
sb
2
(
Y
Y
)
t
(n k ) ( X t X )
Prepared by Robert F. Brooker, Ph.D.
2
2
e
t
(n k ) ( X t X ) 2
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 12
Tests of Significance
Example Calculation
Yt
et Yt Yt
et2 (Yt Yt )2
( X t X )2
44
42.90
1.10
1.2100
4
9
40
39.37
0.63
0.3969
9
3
11
42
46.43
-4.43
19.6249
1
4
12
46
49.96
-3.96
15.6816
0
5
11
48
46.43
1.57
2.4649
1
6
12
52
49.96
2.04
4.1616
0
7
13
54
53.49
0.51
0.2601
1
8
13
58
53.49
4.51
20.3401
1
9
14
56
57.02
-1.02
1.0404
4
10
15
60
60.55
-0.55
0.3025
9
65.4830
30
Time
Xt
Yt
1
10
2
n
n
e (Yt Yt )2 65.4830
t 1
2
t
t 1
Prepared by Robert F. Brooker, Ph.D.
(X
t 1
(Y Y )
( n k ) ( X X )
2
n
X ) 30
2
t
sb
t
t
2
65.4830
0.52
(10 2)(30)
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 13
Tests of Significance
Example Calculation
n
n
t 1
t 1
2
2
e
(
Y
Y
)
t t t 65.4830
n
2
(
X
X
)
30
t
t 1
2
(Yt Y )
65.4830
sb
0.52
2
( n k ) ( X t X )
(10 2)(30)
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 14
Tests of Significance
Calculation of the t Statistic
b 3.53
t
6.79
sb 0.52
Degrees of Freedom = (n-k) = (10-2) = 8
Critical Value at 5% level =2.306
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 15
Tests of Significance
Decomposition of Sum of Squares
Total Variation = Explained Variation + Unexplained Variation
2
2
(Yt Y ) (Y Y ) (Yt Yt )
2
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 16
Tests of Significance
Decomposition of Sum of Squares
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 17
Tests of Significance
Coefficient of Determination
R2
2
(
Y
Y
)
Explained Variation
2
TotalVariation
(
Y
Y
)
t
373.84
R
0.85
440.00
2
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 18
Tests of Significance
Coefficient of Correlation
r R2 withthe signof b
1 r 1
r 0.85 0.92
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 19
Multiple Regression Analysis
Model:
Prepared by Robert F. Brooker, Ph.D.
Y a b1 X 1 b2 X 2
bk X k
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 20
Multiple Regression Analysis
Adjusted Coefficient of Determination
R 2 1 (1 R 2 )
Prepared by Robert F. Brooker, Ph.D.
(n 1)
(n k )
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 21
Multiple Regression Analysis
Analysis of Variance and F Statistic
Explained Variation /(k 1)
F
Unexplained Variation /(n k )
R 2 /( k 1)
F
(1 R 2 ) /( n k )
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 22
Problems in Regression Analysis
Multicollinearity: Two or more
explanatory variables are highly
correlated.
Heteroskedasticity: Variance of error
term is not independent of the Y
variable.
Autocorrelation: Consecutive error
terms are correlated.
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 23
Durbin-Watson Statistic
Test for Autocorrelation
n
d
2
(
e
e
)
t t 1
t 2
n
2
e
t
t 1
If d=2, autocorrelation is absent.
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 24
Steps in Demand Estimation
1
b1
1 b1
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 13
Input-Output Forecasting
Three-Sector Input-Output Flow Table
Producing Industry
Supplying
Industry
A
B
C
Value Added
Total
Prepared by Robert F. Brooker, Ph.D.
A
20
80
40
60
200
B
60
90
30
120
300
C
30
20
10
40
100
Final
Demand
90
110
20
Total
200
300
100
220
220
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 14
Input-Output Forecasting
Direct Requirements Matrix
Direct
Requirements
=
Input Requirements
Column Total
Producing Industry
Supplying
Industry
A
B
C
Prepared by Robert F. Brooker, Ph.D.
A
0.1
0.4
0.2
B
0.2
0.3
0.1
C
0.3
0.2
0.1
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 15
Input-Output Forecasting
Total Requirements Matrix
Producing Industry
Supplying
Industry
A
B
C
Prepared by Robert F. Brooker, Ph.D.
A
1.47
0.96
0.43
B
0.51
1.81
0.31
C
0.60
0.72
1.33
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 16
Input-Output Forecasting
Total
Requirements
Matrix
1.47
0.96
0.43
Prepared by Robert F. Brooker, Ph.D.
0.51
1.81
0.31
0.60
0.72
1.33
Final
Total
Demand Demand
Vector
Vector
90
110
20
=
200
300
100
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 17
Input-Output Forecasting
Revised Input-Output Flow Table
Producing Industry
Supplying
Industry
A
B
C
Prepared by Robert F. Brooker, Ph.D.
A
22
88
43
B
62
93
31
C
31
21
10
Final
Demand
100
110
20
Total
215
310
104
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 18
Managerial Economics in a
Global Economy, 5th Edition
by
Dominick Salvatore
Chapter 6
Production Theory
and Estimation
Prepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division
of Thomson Learning. All rights reserved.
Slide 1
The Organization of
Production
Inputs
Labor, Capital, Land
Fixed Inputs
Variable Inputs
Short Run
At least one input is fixed
Long Run
All inputs are variable
Prepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division
of Thomson Learning. All rights reserved.
Slide 2
Production Function
With Two Inputs
Q = f(L, K)
K
6
5
4
3
2
1
Q
10
12
12
10
7
3
1
24
28
28
23
18
8
2
31
36
36
33
28
12
3
36
40
40
36
30
14
4
40
42
40
36
30
14
5
39
40
36
33
28
12
6 L
Prepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division
of Thomson Learning. All rights reserved.
Slide 3
Production Function
With Two Inputs
Discrete Production Surface
Prepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division
of Thomson Learning. All rights reserved.
Slide 4
Production Function
With Two Inputs
Continuous Production Surface
Prepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division
of Thomson Learning. All rights reserved.
Slide 5
Production Function
With One Variable Input
Total Product
Marginal Product
Average Product
Production or
Output Elasticity
TP = Q = f(L)
TP
MPL =
L
TP
APL =
L
MPL
EL = AP
L
Prepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division
of Thomson Learning. All rights reserved.
Slide 6
Production Function
With One Variable Input
Total, Marginal, and Average Product of Labor, and Output Elasticity
L
0
1
2
3
4
5
6
Q
0
3
8
12
14
14
12
MPL
3
5
4
2
0
-2
APL
3
4
4
3.5
2.8
2
EL
1
1.25
1
0.57
0
-1
Prepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division
of Thomson Learning. All rights reserved.
Slide 7
Production Function
With One Variable Input
Prepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division
of Thomson Learning. All rights reserved.
Slide 8
Production Function
With One Variable Input
Prepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division
of Thomson Learning. All rights reserved.
Slide 9
Optimal Use of the
Variable Input
Marginal Revenue
Product of Labor
MRPL = (MPL)(MR)
Marginal Resource
Cost of Labor
TC
MRCL =
L
Optimal Use of Labor MRPL = MRCL
Prepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division
of Thomson Learning. All rights reserved.
Slide 10
Optimal Use of the
Variable Input
Use of Labor is Optimal When L = 3.50
L
2.50
3.00
3.50
4.00
4.50
MPL
4
3
2
1
0
MR = P
$10
10
10
10
10
MRPL
$40
30
20
10
0
MRCL
$20
20
20
20
20
Prepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division
of Thomson Learning. All rights reserved.
Slide 11
Optimal Use of the
Variable Input
Prepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division
of Thomson Learning. All rights reserved.
Slide 12
Production With Two
Variable Inputs
Isoquants show combinations of two inputs
that can produce the same level of output.
Firms will only use combinations of two
inputs that are in the economic region of
production, which is defined by the portion
of each isoquant that is negatively sloped.
Prepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division
of Thomson Learning. All rights reserved.
Slide 13
Production With Two
Variable Inputs
Isoquants
Prepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division
of Thomson Learning. All rights reserved.
Slide 14
Production With Two
Variable Inputs
Economic
Region of
Production
Prepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division
of Thomson Learning. All rights reserved.
Slide 15
Production With Two
Variable Inputs
Marginal Rate of Technical Substitution
MRTS = - K/ L = MPL/MPK
Prepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division
of Thomson Learning. All rights reserved.
Slide 16
Production With Two
Variable Inputs
MRTS = -(-2.5/1) = 2.5
Prepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division
of Thomson Learning. All rights reserved.
Slide 17
Production With Two
Variable Inputs
Perfect Substitutes
Perfect Complements
Prepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division
of Thomson Learning. All rights reserved.
Slide 18
Optimal Combination of Inputs
Isocost lines represent all combinations of
two inputs that a firm can purchase with
the same total cost.
C wL rK
C Total Cost
w Wage Rate of Labor ( L)
C w
K L
r r
r Cost of Capital ( K )
Prepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division
of Thomson Learning. All rights reserved.
Slide 19
Optimal Combination of Inputs
Isocost Lines
AB
C = $100, w = r = $10
AB
C = $140, w = r = $10
AB
C = $80, w = r = $10
AB*
C = $100, w = $5, r = $10
Prepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division
of Thomson Learning. All rights reserved.
Slide 20
Optimal Combination of Inputs
MRTS = w/r
Prepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division
of Thomson Learning. All rights reserved.
Slide 21
Optimal Combination of Inputs
Effect of a Change in Input Prices
Prepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division
of Thomson Learning. All rights reserved.
Slide 22
Returns to Scale
Production Function Q = f(L, K)
Q = f(hL, hK)
If = h, then f has constant returns to scale.
If > h, then f has increasing returns to scale.
If < h, the f has decreasing returns to scale.
Prepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division
of Thomson Learning. All rights reserved.
Slide 23
Returns to Scale
Constant
Returns to
Scale
Increasing
Returns to
Scale
Decreasing
Returns to
Scale
Prepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division
of Thomson Learning. All rights reserved.
Slide 24
Empirical Production
Functions
Cobb-Douglas Production Function
Q = AKaLb
Estimated using Natural Logarithms
ln Q = ln A + a ln K + b ln L
Prepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division
of Thomson Learning. All rights reserved.
Slide 25
Innovations and Global
Competitiveness
Product Innovation
Process Innovation
Product Cycle Model
Just-In-Time Production System
Competitive Benchmarking
Computer-Aided Design (CAD)
Computer-Aided Manufacturing (CAM)
Prepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division
of Thomson Learning. All rights reserved.
Slide 26
Managerial Economics in a
Global Economy, 5th Edition
by
Dominick Salvatore
Chapter 7
Cost Theory and Estimation
Prepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division
of Thomson Learning. All rights reserved.
Slide 1
The Nature of Costs
Explicit Costs
Accounting Costs
Economic Costs
Implicit Costs
Alternative or Opportunity Costs
Relevant Costs
Incremental Costs
Sunk Costs are Irrelevant
Prepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division
of Thomson Learning. All rights reserved.
Slide 2
Short-Run Cost Functions
Total Cost = TC = f(Q)
Total Fixed Cost = TFC
Total Variable Cost = TVC
TC = TFC + TVC
Prepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division
of Thomson Learning. All rights reserved.
Slide 3
Short-Run Cost Functions
Average Total Cost = ATC = TC/Q
Average Fixed Cost = AFC = TFC/Q
Average Variable Cost = AVC = TVC/Q
ATC = AFC + AVC
Marginal Cost = TC/ Q = TVC/ Q
Prepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division
of Thomson Learning. All rights reserved.
Slide 4
Short-Run Cost Functions
Q
0
1
2
3
4
5
TFC
$60
60
60
60
60
60
TVC
$0
20
30
45
80
135
TC
$60
80
90
105
140
195
AFC
$60
30
20
15
12
AVC
$20
15
15
20
27
ATC
$80
45
35
35
39
Prepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division
of Thomson Learning. All rights reserved.
MC
$20
10
15
35
55
Slide 5
Prepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division
of Thomson Learning. All rights reserved.
Slide 6
Short-Run Cost Functions
Average Variable Cost
AVC = TVC/Q = w/APL
Marginal Cost
TC/ Q = TVC/ Q = w/MPL
Prepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division
of Thomson Learning. All rights reserved.
Slide 7
Long-Run Cost Curves
Long-Run Total Cost = LTC = f(Q)
Long-Run Average Cost = LAC = LTC/Q
Long-Run Marginal Cost = LMC = LTC/ Q
Prepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division
of Thomson Learning. All rights reserved.
Slide 8
Derivation of Long-Run Cost Curves
Prepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division
of Thomson Learning. All rights reserved.
Slide 9
Relationship Between Long-Run and
Short-Run Average Cost Curves
Prepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division
of Thomson Learning. All rights reserved.
Slide 10
Possible Shapes of
the LAC Curve
Prepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division
of Thomson Learning. All rights reserved.
Slide 11
Learning Curves
Average Cost of Unit Q = C = aQb
Estimation Form: log C = log a + b Log Q
Prepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division
of Thomson Learning. All rights reserved.
Slide 12
Minimizing Costs Internationally
Supply of Euros
Demand for Euros
Economies of scale
Large capital investment required
Patented production processes
Brand loyalty
Control of a raw material or resource
Government franchise
Limit pricing
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 3
Measures of Oligopoly
Concentration Ratios
4, 8, or 12 largest firms in an industry
Herfindahl Index (H)
H = Sum of the squared market shares of
all firms in an industry
Theory of Contestable Markets
If entry is absolutely free and exit is entirely
costless then firms will operate as if they
are perfectly competitive
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 4
Cournot Model
Proposed by Augustin Cournot
Behavioral assumption
Firms maximize profits under the
assumption that market rivals will not
change their rates of production.
Bertrand Model
Firms assume that their market rivals will
not change their prices.
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 5
Cournot Model
Example
Two firms (duopoly)
Identical products
Marginal cost is zero
Initially Firm A has a monopoly and then
Firm B enters the market
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 6
Cournot Model
Adjustment process
Entry by Firm B reduces the demand for
Firm As product
Firm A reacts by reducing output, which
increases demand for Firm Bs product
Firm B reacts by increasing output, which
reduces demand for Firm As product
Firm A then reduces output further
This continues until equilibrium is attained
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 7
Cournot Model
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 8
Cournot Model
Equilibrium
Firms are maximizing profits
simultaneously
The market is shared equally among the
firms
Price is above the competitive equilibrium
and below the monopoly equilibrium
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 9
Kinked Demand Curve Model
Proposed by Paul Sweezy
If an oligopolist raises price, other firms
will not follow, so demand will be elastic
If an oligopolist lowers price, other firms
will follow, so demand will be inelastic
Implication is that demand curve will be
kinked, MR will have a discontinuity,
and oligopolists will not change price
when marginal cost changes
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 10
Kinked Demand Curve Model
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 11
Cartels
Collusion
Cooperation among firms to restrict
competition in order to increase profits
Market-Sharing Cartel
Collusion to divide up markets
Centralized Cartel
Formal agreement among member firms to
set a monopoly price and restrict output
Incentive to cheat
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 12
Centralized Cartel
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 13
Price Leadership
Implicit Collusion
Price Leader (Barometric Firm)
Largest, dominant, or lowest cost firm in
the industry
Demand curve is defined as the market
demand curve less supply by the followers
Followers
Take market price as given and behave as
perfect competitors
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 14
Price Leadership
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 15
Efficiency of Oligopoly
Price is usually greater then long-run
average cost (LAC)
Quantity produced usually does
correspond to minimum LAC
Price is usually greater than long-run
marginal cost (LMC)
When a differentiated product is
produced, too much may be spent on
advertising and model changes
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 16
Sales Maximization Model
Proposed by William Baumol
Managers seek to maximize sales, after
ensuring that an adequate rate of return
has been earned, rather than to
maximize profits
Sales (or total revenue, TR) will be at a
maximum when the firm produces a
quantity that sets marginal revenue
equal to zero (MR = 0)
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 17
Sales Maximization Model
MR = 0
where
Q = 50
MR = MC
where
Q = 40
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 18
Global Oligopolists
Impetus toward globalization
Advances in telecommunications and
transportation
Globalization of tastes
Reduction of barriers to international trade
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 19
Architecture of the Ideal Firm
Core Competencies
Outsourcing of Non-Core Tasks
Learning Organization
Efficient and Flexibile
Integrates Physical and Virtual
Real-Time Enterprise
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 20
Extending the Firm
Virtual Corporation
Temporary network of independent
companies working together to exploit a
business opportunity
Relationship Enterprise
Strategic alliances
Complementary capabilities and resources
Stable longer-term relationships
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 21
Managerial Economics in a
Global Economy, 5th Edition
by
Dominick Salvatore
Chapter 10
Game Theory and
Strategic Behavior
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 1
Strategic Behavior
Decisions that take into account the
predicted reactions of rival firms
Interdependence of outcomes
Game Theory
Players
Strategies
Payoff matrix
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 2
Strategic Behavior
Types of Games
Zero-sum games
Nonzero-sum games
Nash Equilibrium
Each player chooses a strategy that is
optimal given the strategy of the other
player
A strategy is dominant if it is optimal
regardless of what the other player does
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 3
Advertising Example 1
Firm A
Advertise
Don t Advertise
Prepared by Robert F. Brooker, Ph.D.
Firm B
Advertise
Don t Advertise
(4, 3)
(5, 1)
(2, 5)
(3, 2)
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 4
Advertising Example 1
What is the optimal strategy for Firm A if Firm B chooses to
advertise?
Firm A
Advertise
Don t Advertise
Prepared by Robert F. Brooker, Ph.D.
Firm B
Advertise
Don t Advertise
(4, 3)
(5, 1)
(2, 5)
(3, 2)
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 5
Advertising Example 1
What is the optimal strategy for Firm A if Firm B chooses to
advertise?
If Firm A chooses to advertise, the payoff is 4. Otherwise,
the payoff is 2. The optimal strategy is to advertise.
Firm A
Advertise
Don t Advertise
Prepared by Robert F. Brooker, Ph.D.
Firm B
Advertise
Don t Advertise
(4, 3)
(5, 1)
(2, 5)
(3, 2)
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 6
Advertising Example 1
What is the optimal strategy for Firm A if Firm B chooses
not to advertise?
Firm A
Advertise
Don t Advertise
Prepared by Robert F. Brooker, Ph.D.
Firm B
Advertise
Don t Advertise
(4, 3)
(5, 1)
(2, 5)
(3, 2)
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 7
Advertising Example 1
What is the optimal strategy for Firm A if Firm B chooses
not to advertise?
If Firm A chooses to advertise, the payoff is 5. Otherwise,
the payoff is 3. Again, the optimal strategy is to advertise.
Firm A
Advertise
Don t Advertise
Prepared by Robert F. Brooker, Ph.D.
Firm B
Advertise
Don t Advertise
(4, 3)
(5, 1)
(2, 5)
(3, 2)
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 8
Advertising Example 1
Regardless of what Firm B decides to do, the optimal
strategy for Firm A is to advertise. The dominant strategy
for Firm A is to advertise.
Firm A
Advertise
Don t Advertise
Prepared by Robert F. Brooker, Ph.D.
Firm B
Advertise
Don t Advertise
(4, 3)
(5, 1)
(2, 5)
(3, 2)
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 9
Advertising Example 1
What is the optimal strategy for Firm B if Firm A chooses to
advertise?
Firm A
Advertise
Don t Advertise
Prepared by Robert F. Brooker, Ph.D.
Firm B
Advertise
Don t Advertise
(4, 3)
(5, 1)
(2, 5)
(3, 2)
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 10
Advertising Example 1
What is the optimal strategy for Firm B if Firm A chooses to
advertise?
If Firm B chooses to advertise, the payoff is 3. Otherwise,
the payoff is 1. The optimal strategy is to advertise.
Firm A
Advertise
Don t Advertise
Prepared by Robert F. Brooker, Ph.D.
Firm B
Advertise
Don t Advertise
(4, 3)
(5, 1)
(2, 5)
(3, 2)
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 11
Advertising Example 1
What is the optimal strategy for Firm B if Firm A chooses
not to advertise?
Firm A
Advertise
Don t Advertise
Prepared by Robert F. Brooker, Ph.D.
Firm B
Advertise
Don t Advertise
(4, 3)
(5, 1)
(2, 5)
(3, 2)
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 12
Advertising Example 1
What is the optimal strategy for Firm B if Firm A chooses
not to advertise?
If Firm B chooses to advertise, the payoff is 5. Otherwise,
the payoff is 2. Again, the optimal strategy is to advertise.
Firm A
Advertise
Don t Advertise
Prepared by Robert F. Brooker, Ph.D.
Firm B
Advertise
Don t Advertise
(4, 3)
(5, 1)
(2, 5)
(3, 2)
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 13
Advertising Example 1
Regardless of what Firm A decides to do, the optimal
strategy for Firm B is to advertise. The dominant strategy
for Firm B is to advertise.
Firm A
Advertise
Don t Advertise
Prepared by Robert F. Brooker, Ph.D.
Firm B
Advertise
Don t Advertise
(4, 3)
(5, 1)
(2, 5)
(3, 2)
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 14
Advertising Example 1
The dominant strategy for Firm A is to advertise and the
dominant strategy for Firm B is to advertise. The Nash
equilibrium is for both firms to advertise.
Firm A
Advertise
Don t Advertise
Prepared by Robert F. Brooker, Ph.D.
Firm B
Advertise
Don t Advertise
(4, 3)
(5, 1)
(2, 5)
(3, 2)
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 15
Advertising Example 2
Firm A
Advertise
Don t Advertise
Prepared by Robert F. Brooker, Ph.D.
Firm B
Advertise
Don t Advertise
(4, 3)
(5, 1)
(2, 5)
(6, 2)
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 16
Advertising Example 2
What is the optimal strategy for Firm A if Firm B chooses to
advertise?
Firm A
Advertise
Don t Advertise
Prepared by Robert F. Brooker, Ph.D.
Firm B
Advertise
Don t Advertise
(4, 3)
(5, 1)
(2, 5)
(6, 2)
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 17
Advertising Example 2
What is the optimal strategy for Firm A if Firm B chooses to
advertise?
If Firm A chooses to advertise, the payoff is 4. Otherwise,
the payoff is 2. The optimal strategy is to advertise.
Firm A
Advertise
Don t Advertise
Prepared by Robert F. Brooker, Ph.D.
Firm B
Advertise
Don t Advertise
(4, 3)
(5, 1)
(2, 5)
(6, 2)
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 18
Advertising Example 2
What is the optimal strategy for Firm A if Firm B chooses
not to advertise?
Firm A
Advertise
Don t Advertise
Prepared by Robert F. Brooker, Ph.D.
Firm B
Advertise
Don t Advertise
(4, 3)
(5, 1)
(2, 5)
(6, 2)
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 19
Advertising Example 2
What is the optimal strategy for Firm A if Firm B chooses
not to advertise?
If Firm A chooses to advertise, the payoff is 5. Otherwise,
the payoff is 6. In this case, the optimal strategy is not to
advertise.
Firm A
Advertise
Don t Advertise
Prepared by Robert F. Brooker, Ph.D.
Firm B
Advertise
Don t Advertise
(4, 3)
(5, 1)
(2, 5)
(6, 2)
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 20
Advertising Example 2
The optimal strategy for Firm A depends on which strategy
is chosen by Firms B. Firm A does not have a dominant
strategy.
Firm A
Advertise
Don t Advertise
Prepared by Robert F. Brooker, Ph.D.
Firm B
Advertise
Don t Advertise
(4, 3)
(5, 1)
(2, 5)
(6, 2)
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 21
Advertising Example 2
What is the optimal strategy for Firm B if Firm A chooses to
advertise?
Firm A
Advertise
Don t Advertise
Prepared by Robert F. Brooker, Ph.D.
Firm B
Advertise
Don t Advertise
(4, 3)
(5, 1)
(2, 5)
(6, 2)
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 22
Advertising Example 2
What is the optimal strategy for Firm B if Firm A chooses to
advertise?
If Firm B chooses to advertise, the payoff is 3. Otherwise,
the payoff is 1. The optimal strategy is to advertise.
Firm A
Advertise
Don t Advertise
Prepared by Robert F. Brooker, Ph.D.
Firm B
Advertise
Don t Advertise
(4, 3)
(5, 1)
(2, 5)
(6, 2)
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 23
Advertising Example 2
What is the optimal strategy for Firm B if Firm A chooses
not to advertise?
Firm A
Advertise
Don t Advertise
Prepared by Robert F. Brooker, Ph.D.
Firm B
Advertise
Don t Advertise
(4, 3)
(5, 1)
(2, 5)
(6, 2)
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 24
Advertising Example 2
What is the optimal strategy for Firm B if Firm A chooses
not to advertise?
If Firm B chooses to advertise, the payoff is 5. Otherwise,
the payoff is 2. Again, the optimal strategy is to advertise.
Firm A
Advertise
Don t Advertise
Prepared by Robert F. Brooker, Ph.D.
Firm B
Advertise
Don t Advertise
(4, 3)
(5, 1)
(2, 5)
(6, 2)
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 25
Advertising Example 2
Regardless of what Firm A decides to do, the optimal
strategy for Firm B is to advertise. The dominant strategy
for Firm B is to advertise.
Firm A
Advertise
Don t Advertise
Prepared by Robert F. Brooker, Ph.D.
Firm B
Advertise
Don t Advertise
(4, 3)
(5, 1)
(2, 5)
(6, 2)
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 26
Advertising Example 2
The dominant strategy for Firm B is to advertise. If Firm B
chooses to advertise, then the optimal strategy for Firm A
is to advertise. The Nash equilibrium is for both firms to
advertise.
Firm A
Advertise
Don t Advertise
Prepared by Robert F. Brooker, Ph.D.
Firm B
Advertise
Don t Advertise
(4, 3)
(5, 1)
(2, 5)
(3, 2)
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 27
Prisoners Dilemma
Two suspects are arrested for armed robbery. They are
immediately separated. If convicted, they will get a term
of 10 years in prison. However, the evidence is not
sufficient to convict them of more than the crime of
possessing stolen goods, which carries a sentence of
only 1 year.
The suspects are told the following: If you confess and
your accomplice does not, you will go free. If you do not
confess and your accomplice does, you will get 10
years in prison. If you both confess, you will both get 5
years in prison.
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 28
Prisoners Dilemma
Payoff Matrix (negative values)
Confess
Individual A
Don t Confess
Prepared by Robert F. Brooker, Ph.D.
Individual B
Confess
Don t Confess
(5, 5)
(0, 10)
(10, 0)
(1, 1)
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 29
Prisoners Dilemma
Dominant Strategy
Both Individuals Confess
(Nash Equilibrium)
Confess
Individual A
Don t Confess
Prepared by Robert F. Brooker, Ph.D.
Individual B
Confess
Don t Confess
(5, 5)
(0, 10)
(10, 0)
(1, 1)
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 30
Prisoners Dilemma
Application: Price Competition
Firm A
Low Price
High Price
Prepared by Robert F. Brooker, Ph.D.
Firm B
Low Price
High Price
(2, 2)
(5, 1)
(1, 5)
(3, 3)
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 31
Prisoners Dilemma
Application: Price Competition
Dominant Strategy: Low Price
Firm A
Low Price
High Price
Prepared by Robert F. Brooker, Ph.D.
Firm B
Low Price
High Price
(2, 2)
(5, 1)
(1, 5)
(3, 3)
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 32
Prisoners Dilemma
Application: Nonprice Competition
Firm A
Advertise
Don t Advertise
Prepared by Robert F. Brooker, Ph.D.
Firm B
Advertise
Don t Advertise
(2, 2)
(5, 1)
(1, 5)
(3, 3)
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 33
Prisoners Dilemma
Application: Nonprice Competition
Dominant Strategy: Advertise
Firm A
Advertise
Don t Advertise
Prepared by Robert F. Brooker, Ph.D.
Firm B
Advertise
Don t Advertise
(2, 2)
(5, 1)
(1, 5)
(3, 3)
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 34
Prisoners Dilemma
Application: Cartel Cheating
Firm A
Cheat
Don t Cheat
Prepared by Robert F. Brooker, Ph.D.
Firm B
Cheat
Don t Cheat
(2, 2)
(5, 1)
(1, 5)
(3, 3)
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 35
Prisoners Dilemma
Application: Cartel Cheating
Dominant Strategy: Cheat
Firm A
Cheat
Don t Cheat
Prepared by Robert F. Brooker, Ph.D.
Firm B
Cheat
Don t Cheat
(2, 2)
(5, 1)
(1, 5)
(3, 3)
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 36
Extensions of Game Theory
Repeated Games
Many consecutive moves and
countermoves by each player
Tit-For-Tat Strategy
Do to your opponent what your
opponent has just done to you
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 37
Extensions of Game Theory
Tit-For-Tat Strategy
Stable set of players
Small number of players
Easy detection of cheating
Stable demand and cost conditions
Game repeated a large and
uncertain number of times
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 38
Extensions of Game Theory
Threat Strategies
Credibility
Reputation
Commitment
Example: Entry deterrence
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 39
Entry Deterrence
No Credible Entry Deterrence
Firm A
Low Price
High Price
Credible Entry Deterrence
Firm A
Low Price
High Price
Prepared by Robert F. Brooker, Ph.D.
Firm B
Enter
Do Not Enter
(4, -2)
(6, 0)
(7, 2)
(10, 0)
Firm B
Enter
Do Not Enter
(4, -2)
(6, 0)
(3, 2)
(8, 0)
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 40
Entry Deterrence
No Credible Entry Deterrence
Firm A
Low Price
High Price
Credible Entry Deterrence
Firm A
Low Price
High Price
Prepared by Robert F. Brooker, Ph.D.
Firm B
Enter
Do Not Enter
(4, -2)
(6, 0)
(7, 2)
(10, 0)
Firm B
Enter
Do Not Enter
(4, -2)
(6, 0)
(3, 2)
(8, 0)
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 41
International Competition
Boeing Versus Airbus Industrie
Boeing
Produce
Don t Produce
Prepared by Robert F. Brooker, Ph.D.
Airbus
Produce
Don t Product
(-10, -10)
(100, 0)
(0, 100)
(0, 0)
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 42
Sequential Games
Sequence of moves by rivals
Payoffs depend on entire sequence
Decision trees
Decision nodes
Branches (alternatives)
Solution by reverse induction
From final decision to first decision
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 43
High-price, Low-price
Strategy Game
gh
i
H
c
P ri
e
Firm A
Firm B
rice
P
h
Hig
$100
$100
Low
P
$130
$50
$180
$80
$150
$120
B
rice
A
Lo
w
Pri
ric
P
h
g
Hi
ce
e
B
Low
P
rice
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 44
High-price, Low-price
Strategy Game
rice
P
h
Hig
gh
i
H
c
P ri
e
B
rice
A
Lo
w
X
X
Low
P
Pri
ric
P
h
g
Hi
ce
B
Low
P
e
rice
Prepared by Robert F. Brooker, Ph.D.
Firm A
Firm B
$100
$100
$130
$50
$180
$80
$150
$120
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 45
High-price, Low-price
Strategy Game
rice
P
h
Hig
A
e
B
X
igh
H
c
P ri
Lo
w
Pri
X
X
Low
P
rice
ric
P
h
g
Hi
ce
B
Low
P
e
rice
Prepared by Robert F. Brooker, Ph.D.
Firm A
Firm B
$100
$100
$130
$50
$180
$80
$150
$120
Solution:
Both firms
choose low
price.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 46
Airbus and Boeing
Airbus
J
Jet
o
b
um
Boeing
$50
$50
c Cr
uiser
$120
$100
et
$0
$150
$0
$200
B
80
3
A
Soni
No
A3
8
oJ
b
m
Ju
A
0
B
Soni
c Cr
uiser
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 47
Airbus and Boeing
Airbus
J
B
Jet
o
b
um
X
Boeing
$50
$50
c Cr
uiser
$120
$100
et
$0
$150
$0
$200
80
3
A
Soni
No
A3
8
oJ
b
m
Ju
A
0
X
B
Soni
c Cr
uiser
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 48
Airbus and Boeing
Airbus
J
B
X
Soni
80
3
A
A
Jet
o
b
um
X
No
A3
8
0
$120
$100
et
$0
$150
$0
$200
X
Soni
c Cr
uiser
Prepared by Robert F. Brooker, Ph.D.
$50
c Cr
uiser
oJ
b
m
Ju
B
$50
Boeing
Solution:
Airbus builds
A380 and
Boeing builds
Sonic Cruiser.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 49
Integrating
Case Study
gh
Hi
c
Pri
Firm A
Firm B
tise
r
e
v
Ad
60
70
Not
Adv
er
100
50
40
60
75
70
70
50
90
40
80
50
60
30
e A
tise
B
se
Pri
gh
P
ric
e
Lo
w
ce
erti
Adv
A
Hi
Not
A
dver
ti
se
A
w
Lo
tise
r
e
v
Ad
ic
Pr
e
gh
Hi
c
Pri
e A
Not
A
dver
tise
B
Lo
w
Pri
ce
e
ertis
v
d
A
A
Not
Prepared by Robert F. Brooker, Ph.D.
Adv
er
tise
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 50
Managerial Economics in a
Global Economy, 5th Edition
by
Dominick Salvatore
Chapter 11
Pricing Practices
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 1
Pricing of Multiple Products
Products with Interrelated Demands
Plant Capacity Utilization and Optimal
Product Pricing
Optimal Pricing of Joint Products
Fixed Proportions
Variable Proportions
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 2
Pricing of Multiple Products
Products with Interrelated Demands
For a two-product (A and B) firm, the marginal
revenue functions of the firm are:
TRA TRB
MRA
Q A
Q A
TRB TRA
MRB
QB QB
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 3
Pricing of Multiple Products
Plant Capacity Utilization
A multi-product firm using a single plant should produce
quantities where the marginal revenue (MR i) from each
of its k products is equal to the marginal cost (MC) of
production.
MR1 MR2
Prepared by Robert F. Brooker, Ph.D.
MRk MC
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 4
Pricing of Multiple Products
Plant Capacity Utilization
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 5
Pricing of Multiple Products
Joint Products in Fixed Proportions
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 6
Pricing of Multiple Products
Joint Products in Variable Proportions
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 7
Price Discrimination
Charging different prices for a product
when the price differences are not
justified by cost differences.
Objective of the firm is to attain higher
profits than would be available
otherwise.
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 8
Price Discrimination
1.Firm must be an imperfect competitor (a
price maker)
2.Price elasticity must differ for units of
the product sold at different prices
3.Firm must be able to segment the
market and prevent resale of units
across market segments
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 9
First-Degree
Price Discrimination
Each unit is sold at the highest possible
price
Firm extracts all of the consumers
surplus
Firm maximizes total revenue and profit
from any quantity sold
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 10
Second-Degree
Price Discrimination
Charging a uniform price per unit for a
specific quantity, a lower price per unit
for an additional quantity, and so on
Firm extracts part, but not all, of the
consumers surplus
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 11
First- and Second-Degree
Price Discrimination
In the absence of price discrimination, a firm
that charges $2 and sells 40 units will have
total revenue equal to $80.
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 12
First- and Second-Degree
Price Discrimination
In the absence of price discrimination, a firm
that charges $2 and sells 40 units will have
total revenue equal to $80.
Consumers will have consumers surplus
equal to $80.
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 13
First- and Second-Degree
Price Discrimination
If a firm that practices first-degree price
discrimination charges $2 and sells 40 units,
then total revenue will be equal to $160 and
consumers surplus will be zero.
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 14
First- and Second-Degree
Price Discrimination
If a firm that practices second-degree price
discrimination charges $4 per unit for the first
20 units and $2 per unit for the next 20 units,
then total revenue will be equal to $120 and
consumers surplus will be $40.
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 15
Third-Degree
Price Discrimination
Charging different prices for the same
product sold in different markets
Firm maximizes profits by selling a
quantity on each market such that the
marginal revenue on each market is
equal to the marginal cost of production
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 16
Third-Degree
Price Discrimination
Q1 = 120 - 10 P1 or P1 = 12 - 0.1 Q1 and MR1 = 12 - 0.2 Q1
Q2 = 120 - 20 P2 or P2 = 6 - 0.05 Q2 and MR2 = 6 - 0.1 Q2
MR1 = MC = 2
MR2 = MC = 2
MR1 = 12 - 0.2 Q1 = 2
MR2 = 6 - 0.1 Q2 = 2
Q1 = 50
Q2 = 40
P1 = 12 - 0.1 (50) = $7
P2 = 6 - 0.05 (40) = $4
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 17
Third-Degree
Price Discrimination
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 18
International
Price Discrimination
Persistent Dumping
Predatory Dumping
Temporary sale at or below cost
Designed to bankrupt competitors
Trade restrictions apply
Sporadic Dumping
Occasional sale of surplus output
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 19
Transfer Pricing
Pricing of intermediate products sold by
one division of a firm and purchased by
another division of the same firm
Made necessary by decentralization
and the creation of semiautonomous
profit centers within firms
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 20
Transfer Pricing
No External Market
Transfer Price = Pt
MC of Intermediate Good = MCp
Pt = MCp
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 21
Transfer Pricing
Competitive External Market
Transfer Price = Pt
MC of Intermediate Good = MCp
Pt = MCp
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 22
Transfer Pricing
Imperfectly Competitive External Market
Transfer Price = Pt = $4
Prepared by Robert F. Brooker, Ph.D.
External Market Price = Pe = $6
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 23
Pricing in Practice
Cost-Plus Pricing
Markup or Full-Cost Pricing
Fully Allocated Average Cost (C)
Average variable cost at normal output
Allocated overhead
Markup on Cost (m) = (P - C)/C
Price = P = C (1 + m)
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 24
Pricing in Practice
Optimal Markup
1
MR P 1
EP
EP
P MR
E 1
p
MR C
EP
P C
E 1
p
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 25
Pricing in Practice
Optimal Markup
EP
P C
E 1
p
P C (1 m)
EP
C (1 m) C
E 1
p
EP
m
1
EP 1
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 26
Pricing in Practice
Incremental Analysis
A firm should take an action if the
incremental increase in revenue from
the action exceeds the incremental
increase in cost from the action.
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 27
Pricing in Practice
n
2
(
X
X
)
Pi
i
i 1
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 8
Measuring Risk
Probability Distributions
Calculation of the Standard Deviation
Project A
(600 500)2 (0.25) (500 500)2 (0.50) (400 500)2 (0.25)
5, 000 $70.71
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 9
Measuring Risk
Probability Distributions
Calculation of the Standard Deviation
Project B
(800 500)2 (0.25) (500 500)2 (0.50) (200 500) 2 (0.25)
45, 000 $212.13
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 10
Measuring Risk
Probability Distributions
The Normal Distribution
i
Z
D
P
t
(1
k
)
t 1
e
D
ke
D
ke
P
P = Price of a share of stock
D = Constant dividend per share
ke = Required rate of return
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 13
The Cost of Capital
Cost of Equity Capital (ke):
Dividend Valuation Model
D
P
Ke g
P=
D=
ke =
g=
D
ke g
P
Price of a share of stock
Dividend per share
Required rate of return
Growth rate of dividends
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 14
The Cost of Capital
Cost of Equity Capital (ke):
Capital Asset Pricing Model (CAPM)
ke rf b ( k m rf )
rf = Risk-free rate of return
b = Beta coefficient
km = Average rate of return on all
shares of common stock
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 15
The Cost of Capital
Weighted Cost of Capital:
Composite Cost of Capital (kc)
kc wd kd we ke
wd =
kd =
we =
ke =
Prepared by Robert F. Brooker, Ph.D.
Proportion of debt
Cost of debt
Proportion of equity
Cost of equity
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reser
ved.
Slide 16