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DQ (P) - Discussion Question 1 – (PDQ directed at upcoming PA) Graduate Level Prior to reading this DQ, please read the PA 2 assignment and understand what the assignment is asking you to complete. Once you have an understanding of the PA 2 assignment, please continue to the paragraph below to complete DQ1. Using the Library Information Resource Network (LIRN), JSTOR, or any other electronic journal database, research six (6) peer-reviewed articles that can be used to answer your upcoming PA 2 assignment. Your discussion should summarize the articles in such a way that it can justify any arguments you may present in your PA 2 assignment and should be different from the abstract. In addition to your researched peer-reviewed article, you must include an example of the article researched as it is applied by industry (company, business entity, and so forth). Please note: This article summary should not be the only article researched for your PA 2 assignment. You may (and should) have several other articles researched to fully answer your PA 2 assignment. The concept of this DQ is to allow students to be proactive in the research necessary to complete this assignment. You may use your article summary, partially or in its entirety in your PA 2 assignment. Important: Please ensure that your reference for the article is in correct APA format, as your reference in your discussion post. Depending on which electronic database you use, you should see a “Cite” selection for your article. In addition, there should be a variety of articles summarized and as such, students should have different articles summarized. Your summary MUST include ALL of the following in your DQ post (include every item in the bullet list below, or you will not receive full credit): Do these in order:   - In correct APA format, write the Reference of the article.   - Clearly state what the article is about and its purpose.   - Describe how you will use it in your upcoming assignment.   - Repeat for a total of six (6) peer-reviewed sources. Note:  1. Please find the related PowerPoint and textbook in the attachment.  2. Article List: (Needs to add one more peer-reviewed article) Ali, B. J., & Anwar, G. (2021). Business strategy: The influence of Strategic Competitiveness on competitive advantage. International Journal of Electrical, Electronics and Computers, 6(2). Galletta, S., Mazzù, S., & Naciti, V. (2021). Banks business strategy and environmental effectiveness: The monitoring role of the board of directors and the managerial incentives. Business Strategy and the Environment. Ke, Y. (2021). Applications of Managerial Economics in Business Pricing Strategies. In E3S Web of Conferences (Vol. 235). EDP Sciences. LESTARI, S. D., LEON, F. M., WIDYASTUTI, S., BRABO, N. A., & Putra, A. H. P. K. (2020). Antecedents and consequences of innovation and business strategy on performance and competitive advantage of SMEs. The Journal of Asian Finance, Economics, and Business, 7(6), 365-378. Rahman, M. H., & Majumder, S. C. (2021). Relationship between developing manager and managerial economics: a theoretical overview. Independent Journal of Management & Production, 12(5), 1339-1356. 3. Please find the Course Learning Outcome list of this course in the attachment.  Textbook Information: Baye, M. R., & Prince, J. T. (2017). Managerial economics and business strategy (9th ed.). McGraw-Hill Education ISBN 9781259290619 Pricing Strategies for Firms with Market Power © 2017 by McGraw-Hill Education. All Rights Reserved. Authorized only for instructor use in the classroom. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Chapter 11 Learning Objectives Apply simple elasticity-based markup formulas to determine profit-maximizing prices in environments where a business enjoys market power, including monopoly, monopolistic competition, and Cournot oligopoly. Formulate pricing strategies that permit firms to extract additional surplus from consumers—including price discrimination, two-part pricing, block pricing, and commodity bundling—and explain the conditions needed for each of these strategies to yield higher profits than standard pricing. Formulate pricing strategies that enhance profits for special cost and demand structures—such as peak-load pricing, cross-subsidies, and transfer pricing—and explain the conditions needed for each strategy to work. Explain how price-matching guarantees, brand loyalty programs, and randomized pricing strategies can be used to enhance profits in markets with intense price competition. © 2017 by McGraw-Hill Education. All Rights Reserved. 2 Review of Basic Profit Maximization Firms with market power face a downward-sloping demand. Implication: there is a trade-off between selling many units at a low price and selling a few units at a high price. Managers of firms with market power balance these competing forces by selecting the quantity that equates marginal revenue and marginal cost , and charging the maximum price that consumer will pay for this level of output. © 2017 by McGraw-Hill Education. All Rights Reserved. 11-3 Basic Pricing Strategies 3 Basic Profit Maximization In Action Suppose the (inverse) demand for a firm’s product is given by and the cost function is . What is the profit-maximizing level of output and price for this firm? Answer: The marginal revenue function is: . The marginal cost function is: . Equating these two functions yields , so . The profit-maximizing price is . © 2017 by McGraw-Hill Education. All Rights Reserved. 11-4 Basic Pricing Strategies 4 Simple Pricing Rule: Monopoly and Monopolistic Competition What if estimates of the demand and cost functions are not available? Managers have a “crude” estimate of marginal cost; the price paid to a supplier. the price elasticity of demand, since it is typically available for a representative firm in an industry. With this information, the monopoly and monopolistically competitive firm’s profit-maximizing price (markup) is computed from: MC = , where . So, set price such that: . © 2017 by McGraw-Hill Education. All Rights Reserved. 11-5 Basic Pricing Strategies 5 Simple Pricing Rule In Action: Problem The manager of a convenience store competes in a monopolistically competitive market and buys cola from a supplier at a price of $1.25 per liter. The manager thinks that because there are several supermarkets nearby, the demand for cola sold at her store is slightly more elastic than the elasticity for the representative food store. Specifically, the elasticity of demand for cola sold by her store is . What price should the manager charge for a liter of cola to maximize profits? © 2017 by McGraw-Hill Education. All Rights Reserved. 11-6 Basic Pricing Strategies 6 Simple Pricing Rule In Action: Answer The marginal cost of cola to the firm is , or per liter, and the markup factor is . The profit-maximizing pricing rule for a monopolistically competitive firm is: , or about per liter. © 2017 by McGraw-Hill Education. All Rights Reserved. 11-7 Basic Pricing Strategies 7 Simple Pricing Rule for Cournot Oligopoly When each of the firms operating in a Cournot oligopoly has identical cost structures and produces similar products, the simple profit-maximizing price (markup) in Cournot equilibrium is: , where is the market elasticity of demand. © 2017 by McGraw-Hill Education. All Rights Reserved. 11-8 Basic Pricing Strategies 8 Beyond the Single-Price-Per-Unit Model In some markets, managers can enhance profits beyond those resulting from charging all consumers a single, per-unit price. Models that yield greater profits fall into three categories: Pricing strategies: that extract surplus from consumers. for special cost and demand structures. in markets with intense price competition. © 2017 by McGraw-Hill Education. All Rights Reserved. 11-9 Strategies that Yield Even Greater Profits 9 Models that Extract Surplus from Consumers Strategies for surplus extraction: Price discrimination (first, second and third degrees) Two-part pricing Block pricing Commodity bundling Each strategy is appropriate for firms with various cost structures and degrees of market interdependence. © 2017 by McGraw-Hill Education. All Rights Reserved. 11-10 Strategies that Yield Even Greater Profits 10 Surplus Extraction: First-Degree Price Discrimination Price discrimination is the practice of charging different prices to consumers for the same good or service. First-degree price discrimination is the practice of charging each consumer the maximum price he or she would be willing to pay for each unit of the good purchased. Implication: the firm extracts all surplus from consumers and earns the highest possible profit. Problem: managers rarely know each consumers’ maximum willingness to pay for each unit of the product. © 2017 by McGraw-Hill Education. All Rights Reserved. 11-11 Strategies that Yield Even Greater Profits 11 First-Degree Price Discrimination © 2017 by McGraw-Hill Education. All Rights Reserved. 11-12 Strategies that Yield Even Greater Profits Price Quantity Demand MC Firm profit under first-degree price discrimination 12 Surplus Extraction: Second-Degree Price Discrimination Second-degree price discrimination is the practice of posting a discrete schedule of declining prices for different ranges of quantity. Implication: firm extracts some surplus from consumers without needing to know the identity of various consumers’ demand. © 2017 by McGraw-Hill Education. All Rights Reserved. 11-13 Strategies that Yield Even Greater Profits 13 Second-Degree Price Discrimination © 2017 by McGraw-Hill Education. All Rights Reserved. 11-14 Strategies that Yield Even Greater Profits Price Quantity Demand MC Contribution to profits under second-degree price discrimination 14 Surplus Extraction: Third-Degree Price Discrimination Third-degree price discrimination is the practice of charging different prices based on systematic differences in demand across demographic consumer groups. Implication: marginal revenue will be different for each group. That is, if there are two groups, , for example. © 2017 by McGraw-Hill Education. All Rights Reserved. 11-15 Strategies that Yield Even Greater Profits 15 Surplus Extraction: Third-Degree Price Discrimination Rule To maximize profits, a firm with market power produces the output at which the marginal revenue (left-hand side of the following equations) to each group equals marginal cost. © 2017 by McGraw-Hill Education. All Rights Reserved. 11-16 Strategies that Yield Even Greater Profits 16 Third-Degree Price Discrimination Rule In Action: You are the manager of a pizzeria that produces at a marginal cost of $6 per pizza. The pizzeria is a local monopoly near campus. During the day, only students eat at your restaurant. In the evening, while students are studying, faculty members eat there. If students have an elasticity of demand for pizza of and faculty has an elasticity of demand of , what should your pricing policy be to maximize profits? © 2017 by McGraw-Hill Education. All Rights Reserved. 11-17 Strategies that Yield Even Greater Profits 17 Third-Degree Price Discrimination Rule In Action: Assuming faculty would be unwilling to purchase cold pizzas from students, the conditions for effective third-degree price discrimination hold. It will be profitable to charge a “lunch menu” price and a “dinner menu” price. These prices are determined as follows: Solving these equations yield, and . © 2017 by McGraw-Hill Education. All Rights Reserved. 11-18 Strategies that Yield Even Greater Profits 18 Surplus Extraction: Two-Part Pricing Two-part pricing is a pricing strategy whereby a firm with market power charges a fixed fee for the right to purchase its goods, plus a per-unit charge for each unit purchased. © 2017 by McGraw-Hill Education. All Rights Reserved. 11-19 Strategies that Yield Even Greater Profits 19 Two-Part Pricing © 2017 by McGraw-Hill Education. All Rights Reserved. 11-20 Strategies that Yield Even Greater Profits Price Quantity Demand MC = AC Fixed fee = $32 = profits Consumer surplus = $0 Per-unit fee = $2 20 Surplus Extraction: Block Pricing Block pricing is a pricing strategy in which identical products are packaged together in order to enhance profits by forcing customers to make an all-or-none decision to purchase. The profit-maximizing price on a package is the total value the consumer receives for the package. © 2017 by McGraw-Hill Education. All Rights Reserved. 11-21 Strategies that Yield Even Greater Profits 21 Block Pricing © 2017 by McGraw-Hill Education. All Rights Reserved. 11-22 Strategies that Yield Even Greater Profits Price Quantity Demand MC = AC Profit with block pricing = $32 Price charged for a block of 8 units = $48 22 Surplus Extraction: Commodity Bundling Commodity bundling is the practice of bundling several different products together and selling them at a single “bundle price.” Key assumption: Consumers differ with respect to the amounts they are willing to pay for multiple products sold by a firm. Managers cannot observe different consumers’ valuations. © 2017 by McGraw-Hill Education. All Rights Reserved. 11-23 Strategies that Yield Even Greater Profits 23 Pricing Strategies for Special Cost and Demand Structures: Peak-Load Pricing Peak-load pricing is a pricing strategy in which higher prices are charged during peak hours than during off-peak hours. © 2017 by McGraw-Hill Education. All Rights Reserved. 11-24 Strategies that Yield Even Greater Profits 24 Special Demand and Costs: Peak-Load Pricing © 2017 by McGraw-Hill Education. All Rights Reserved. 11-25 Strategies that Yield Even Greater Profits Price Quantity Demand High MC MR High Demand Low MR Low 25 Special Demand and Costs: Cross-Subsidies Cross-subsidy is a pricing strategy in which profits gained from the sale of one product are used to subsidize sales of a related product. Cross-Subsidization Principle: Whenever the demands for two products produced by a firm are interrelated through costs or demand, the firm may enhance profits by cross-subsidization: selling one product at or below cost and the other product above cost. © 2017 by McGraw-Hill Education. All Rights Reserved. 11-26 Strategies that Yield Even Greater Profits 26 Special Demand and Costs: Transfer Pricing Transfer pricing is a pricing strategy in which a firm optimally sets the internal price at which an upstream division sells an input to a downstream division. Important since most division managers are provided an incentive to maximize their own division’s profits. Transfer pricing aligns division manager’s incentives with that of the overall firm, and increases overall firm’s profit. © 2017 by McGraw-Hill Education. All Rights Reserved. 11-27 Strategies that Yield Even Greater Profits 27 Special Demand and Costs: Double Marginalization Consider a large firm with two divisions: upstream division is the sole provider of a key input. downstream division uses the input produced by the upstream division to produce the final output. Upstream division has market power and incentive to maximize divisional profits leads managers to produce where . Implication: . A similar situation exists for the downstream division; profit-maximization leads to . Both divisions mark price up over marginal cost resulting in a phenomenon called double marginalization. © 2017 by McGraw-Hill Education. All Rights Reserved. 11-28 Strategies that Yield Even Greater Profits 28 Special Demand and Costs: Transfer Pricing Rule Transfer pricing is used to overcome double marginalization. A transfer pricing rule sets the internal price at which an upstream division sells inputs to a downstream division in order to maximize the overall firm profits. Require the upstream division to produce such that its marginal cost, , equals the net marginal revenue to the downstream division: © 2017 by McGraw-Hill Education. All Rights Reserved. 11-29 Strategies that Yield Even Greater Profits 29 Intense Price Competition: Price Matching Price matching is a strategy in which a firm advertises a price and a promise to match any lower price offered by a competitor. Used to mitigate the stark outcome associated with firms competing in a homogeneous-product, Bertrand oligopoly. Outcome: If all firms in the market adopt a price matching policy, all firms can set the monopoly price and earn monopoly profits; instead of the zero profits it would earn in the usual one-shot Bertrand oligopoly. Potential issues: Dealing with false consumer claims of low prices. Competitor’s with lower cost structures. © 2017 by McGraw-Hill Education. All Rights Reserved. 11-30 Strategies that Yield Even Greater Profits 30 Intense Price Competition: Inducing Brand Loyalty Brand loyal customers continue to buy a firm’s product even if another firm offers a (slightly) better price. Strategy used to mitigate the tension of Bertrand competition. Methods for inducing brand loyalty. Advertising campaigns. “Frequent-buyer” programs. © 2017 by McGraw-Hill Education. All Rights Reserved. 11-31 Strategies that Yield Even Greater Profits 31 Intense Price Competition: Randomized Pricing Randomized pricing is a strategy in which a firm intentionally varies its price in an attempt to “hide” price information from consumers and rivals. Benefits of randomized pricing to firms: Consumers cannot learn from experience which firm charges the lowest price in the market. Reduces the ability of rival firms to undercut a firm’s price. Not always profitable. © 2017 by McGraw-Hill Education. All Rights Reserved. 11-32 Strategies that Yield Even Greater Profits 32 The Economics of Information © 2017 by McGraw-Hill Education. All Rights Reserved. Authorized only for instructor use in the classroom. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Chapter 12 Learning Objectives Identify strategies to manage risk and uncertainty, including diversification and optimal search strategies. Calculate the profit-maximizing output and price in an environment of uncertainty. Explain why asymmetric information about “hidden actions” or “hidden characteristics” can lead to moral hazard and adverse selection, and identify strategies for mitigating these potential problems. Explain how differing auction rules and information structures impact the incentives in auctions, and determine the optimal bidding strategies in a variety of auctions with independent or correlated values. © 2017 by McGraw-Hill Education. All Rights Reserved. 2 Measuring Uncertain Outcomes A variable that measures the outcome of an uncertain event is called a random variable. Probabilities can be attached to different values of a random variable that denote the chance that a value occurs. Information about uncertain outcomes can be summarized by the mean (or, expected value) and variance of a random variable. © 2017 by McGraw-Hill Education. All Rights Reserved. 12-3 The Mean and the Variance 3 Measuring Uncertain Outcomes: Mean The mean of a random variable is the sum of the probabilities that different outcomes will occur multiplied by the resulting payoffs. If denote the possible outcomes of the random variable and the corresponding probabilities of the outcomes, then the mean of is: , where . The mean does not provide information about the risk associated with the random variable. © 2017 by McGraw-Hill Education. All Rights Reserved. 12-4 The Mean and the Variance 4 Measuring Uncertain Outcomes: Variance and Standard Deviation The variance of a random variable is the sum of the probabilities that different outcomes will occur multiplied by the squared deviation from the mean of the resulting payoffs. If denote the possible outcomes of the random variable, their corresponding probabilities are , and the expected value of is , then the variance of is: The variance is a common measure of risk. The standard deviation is the positive square root of the variance: . © 2017 by McGraw-Hill Education. All Rights Reserved. 12-5 The Mean and the Variance 5 Risk Aversion Attitudes toward risk differ among consumers. A risk-averse consumer prefers a sure amount of to a risky prospect with an expected value of . A risk-loving consumer prefers a risky prospect with an expected value of to a sure amount of . A risk-neutral consumer is indifferent between a risky prospect with an expected value of and a sure amount of . © 2017 by McGraw-Hill Education. All Rights Reserved. 12-6 Uncertainty and Consumer Behavior 6 Managerial Decisions with Risk-Averse Consumers: Product Quality Risk analysis can used to examine situations where consumers are uncertain about product quality. Consider a consumer who regularly uses Brand X. If a new product enters the market, Brand Y, under what conditions will the consumer be willing to try the new product? Issues to overcome and consider: Relative certainty about Brand X. At equal prices among other things, a risk averse consumer will continue to purchase Brand X, since a risk averse consumer prefers the sure thing (Brand X) to a risky prospect (Brand Y). Two tactics can be employed to induce a risk averse consumer to try a new product: Lower the price of Brand Y. Try to convince consumer the new product’s quality is higher than the old product. © 2017 by McGraw-Hill Education. All Rights Reserved. 12-7 Uncertainty and Consumer Behavior 7 Managerial Decisions with Risk- Averse Consumers Chain stores: may be in a firm’s best interest to become part of a chain store Standardization, reputation, increased chance of survival Online reviews Insurance: the fact that consumers are risk averse implies they are willing to pay to avoid risk. © 2017 by McGraw-Hill Education. All Rights Reserved. 8 Consumer Search To identify the low-price seller from among many firms selling an identical product, consumers sometimes incur a cost, , to obtain each price quote. After observing each price quote, a consumer faces must weigh the expected benefit from acquiring an additional price quote with the additional cost. © 2017 by McGraw-Hill Education. All Rights Reserved. 12-9 Uncertainty and Consumer Behavior 9 Consumer Search Suppose that three-quarters of stores in a market charge and one-quarter charge . A consumer observing a price of should stop searching since there is no price below . What should a risk-neutral consumer do after observing a price of , if search occurs with free recall and with replacement? One-quarter of the time the consumer will save . Three-quarters of the time the consumer will save nothing. The expected benefit from an additional search is: . A consumer should search for a lower price as long as the expected benefits for an additional search are greater than the cost of an additional search. © 2017 by McGraw-Hill Education. All Rights Reserved. 12-10 Uncertainty and Consumer Behavior 10 Optimal Search Strategy © 2017 by McGraw-Hill Education. All Rights Reserved. 12-11 Uncertainty and Consumer Behavior Price Reservation price: Price at which a consumer is indifferent between purchasing at that price and searching for a lower price. Expected benefits and costs Acceptance Price Region Rejection Price Region 11 Consumer’s Search Rule The optimal search rule is such that the consumer rejects prices above the reservation price, , and accepts prices below the reservation price. Stated differently, the optimal search strategy is to search for a better price when the price charged by a firm is above the reservation price and stop searching when a price below the reservation price is found. © 2017 by McGraw-Hill Education. All Rights Reserved. 12-12 Uncertainty and Consumer Behavior 12 Increasing Cost of Search © 2017 by McGraw-Hill Education. All Rights Reserved. 12-13 Uncertainty and Consumer Behavior Price Expected benefits and costs Due to Increase in search costs. 13 Manager’s Risk Attitudes While manager must understand the impact of uncertainty on consumer behavior, uncertainty also impacts the manager’s input and output decisions. Manager’s risk profiles: Risk averse: a manager who prefers a risky project with a lower expected value if the risk is lower than a project with a higher expected value. Risk loving: manager who prefers a risky project with higher expected value and higher risk to one with lower expected value and lower risk. Risk neutral: manager interested in maximizing expected profits; the variance of profits does not impact a risk-neutral manager’s decisions. © 2017 by McGraw-Hill Education. All Rights Reserved. 12-14 Uncertainty and the Firm 14 Risk Aversion In Action: Problem A risk-averse manager is considering two projects. The first project involves expanding the market for bologna; the second involves expanding the market for caviar. There is a 10 percent chance of recession and a 90 percent chance of an economic boom. The following table summarizes the profits under the different scenarios. Which project should manager undertake, and why? a © 2017 by McGraw-Hill Education. All Rights Reserved. 12-15 Uncertainty and the Firm Project Boom (90\%) Recession (10\%) Mean Standard Deviation Bologna -$10,000 $12,000 -$7,800 $6,600 Caviar 20,000 -8,000 17,200 8,400 Joint 10,000 4,000 9,400 1,800 Safe (T-Bill) 3,000 3,000 3,000 0 15 Risk Aversion In Action: Answer Managers should not invest in T-Bills The joint project is assured of making at least $4,000, which is greater than $3,000 under the T-Bill scenario. Since the expected returns of the bologna project are negative, neither a risk-neutral nor a risk-averse manager would choose to undertake this project. The manager should adopt either the caviar project or the joint project. Which project will depend on his or her risk preferences. © 2017 by McGraw-Hill Education. All Rights Reserved. 12-16 Uncertainty and the Firm Project Boom (90\%) Recession (10\%) Mean Standard Deviation Bologna -$10,000 $12,000 -$7,800 $6,600 Caviar 20,000 -8,000 17,200 8,400 Joint 10,000 4,000 9,400 1,800 Safe (T-Bill) 3,000 3,000 3,000 0 16 Manager’s Risk Attitudes and Diversification Notice from the previous problem that by investing in multiple projects, the manager may be able to reduce risk. The process of potentially reducing risk by investing in multiple projects is called diversification. Whether it is optimal to diversify depends on a manager’s risk preferences and the incentives provided to the manager to avoid risk. © 2017 by McGraw-Hill Education. All Rights Reserved. 12-17 Uncertainty and the Firm 17 Producer Search When producers are uncertain about the prices of inputs, an optimizing firm will use optimal search strategies. These strategies mimic consumer search previously developed. © 2017 by McGraw-Hill Education. All Rights Reserved. 12-18 Uncertainty and the Firm 18 Profit Maximization and Uncertainty The basic principles of profit maximization can be modified to deal with uncertainty. If demand (hence, revenue) is uncertain and the manager is risk neutral, then the manager will want to maximize expected profits by producing the output where the expected marginal revenue equals marginal cost: © 2017 by McGraw-Hill Education. All Rights Reserved. 12-19 Uncertainty and the Firm 19 Profit Maximization and Uncertainty In Action: Problem Appleway Industries produces apple juice and sells it in a competitive market. The firm’s manager must determine how much juice to produce before he knows what the market (competitive) price will be. Economists estimate that there is a 30 percent chance the market price will be $2 per gallon and a 70 percent chance it will be $1 per gallon when the juice hits the market. If the firm’s cost function is , how much juice should be produced to maximize expected profits? What are the expected profits of Appleway Industries? © 2017 by McGraw-Hill Education. All Rights Reserved. 12-20 Uncertainty and the Firm 20 Profit Maximization and Uncertainty In Action: Answer Appleway Industries’ profits are Since price is uncertain, the firm’s revenues and profit are uncertain. To maximize expected profits, the manager equates expected price with marginal cost. The expected price is: . Therefore, manager should produce output where gallons. Expected profits are $645. © 2017 by McGraw-Hill Education. All Rights Reserved. 12-21 Uncertainty and the Firm 21 Asymmetric Information Uncertainty can profoundly impact markets abilities to efficiently allocate resources. Some markets are characterized by individuals who have better information than others. Implication: Those individuals with the least information may choose not to participate in a market. When some people have better information than others in a market, the information people have is called asymmetric information. There are two specific manifestations related to asymmetric information in markets: Adverse selection Moral hazard © 2017 by McGraw-Hill Education. All Rights Reserved. 12-22 Uncertainty and the Market 22 Asymmetric Information: Adverse Selection Adverse selection refers to situations where individuals have hidden characteristics and in which a selection process results in a pool of individuals with undesirable characteristics. In this context, a hidden characteristic is something that one party to a transaction knows about itself but which are unknown by the other party. © 2017 by McGraw-Hill Education. All Rights Reserved. 12-23 Uncertainty and the Market 23 Asymmetric Information: Moral Hazard Moral hazard refers to a situation where one party to a contract takes a hidden action that benefits his or her at the expense of another party. In this context, a hidden action is an action taken by one party in a relationship that cannot be observed by the other party. One way to mitigate the moral hazard problem is an incentive contract. © 2017 by McGraw-Hill Education. All Rights Reserved. 12-24 Uncertainty and the Market 24 Signaling Another way to mitigate the problem of moral hazard is signaling, which is an attempt by an informed party to send an observable indicator of his or her hidden characteristics to an uninformed party. For signaling to be effective it must be: observable by the uninformed party. a reliable indicator of the unobservable characteristic(s) and difficult for parties with other characteristics to easily mimic. © 2017 by McGraw-Hill Education. All Rights Reserved. 12-25 Uncertainty and the Market 25 Screening A final way to mitigate the moral hazard problem is by screening, which is an attempt by an uninformed party to sort individuals according to their characteristics. Screening may be achieved through a self-selection device. A self-selection device is a mechanism in which informed parties are presented with a set of options, and the options they choose reveal their hidden characteristics to an uninformed party. © 2017 by McGraw-Hill Education. All Rights Reserved. 12-26 Uncertainty and the Market 26 Types of Auctions An auction is a mechanism where potential buyers compete for the right to own a good, service, or, more generally, anything of value. Sellers participating in an auction offer an item for sale, and wish to obtain the highest price. Buyers participating in an auction seek to obtain the item at the lowest possible price. Bidders’ risk preferences can affect bidding strategies and the expected revenue a seller receives. Four basic auction types: English (ascending-bid) First-price, sealed-bid Second-price, sealed-bid Dutch (descending-bid) © 2017 by McGraw-Hill Education. All Rights Reserved. 12-27 Auctions 27 Differences Among Auctions Types The timing of bidder decisions (simultaneously or sequentially) The amount the winner is required to pay. © 2017 by McGraw-Hill Education. All Rights Reserved. 12-28 Auctions 28 English Auction An English auction is an ascending sequential-bid auction in which bidders observe the bids of others and decide whether or not to increase the bid. The auction ends when a single bidder remains; this bidder obtains the item and pays the auctioneer the amount of the bid. Bidders continually obtain information about one another’s bids. Bidder who values the item the most will win. © 2017 by McGraw-Hill Education. All Rights Reserved. 12-29 Auctions 29 First-Price, Sealed-Bid Auction A first-price, sealed-bid auction is a simultaneous-move auction in which bidders simultaneously submit bids to an auctioneer. The auctioneer awards the item to the highest bidder, who pays the amount bid. Bidders obtain no information about one another’s bids. Bidder who values the item the most will win. © 2017 by McGraw-Hill Education. All Rights Reserved. 12-30 Auctions 30 Second-Price, Sealed-Bid Auction A second-price, sealed-bid auction is a simultaneous-move auction in which bidders simultaneously submit bids to an auctioneer. The auctioneer awards the item to the highest bidder, who pays the amount bid by the second-highest bidder. Bidders obtain no information about one another’s bids. Bidder who values the item the most will win, but pays the second-highest bid. © 2017 by McGraw-Hill Education. All Rights Reserved. 12-31 Auctions 31 Dutch Auction A Dutch auction is a descending sequential-bid auction in which the auctioneer beings with a high asking price and gradually reduces the asking price until one bidder announces a willingness to pay that price for the item. Bidders obtain no information about one another’s bids throughout the auction process. Bidder who values the item the most will win and pay the amount of his or her bid. © 2017 by McGraw-Hill Education. All Rights Reserved. 12-32 Auctions 32 Strategic Equivalence of Dutch and First-Price Auctions The Dutch and first-price, sealed-bid auctions are strategically equivalent; that is, the optimal bids by participants are identical for both types of auctions. © 2017 by McGraw-Hill Education. All Rights Reserved. 12-33 Auctions 33 Information Structures While the four auction types differ with respect to the information bidders have about the bids of other bidders, bidders also have different information structures about the value of their own bids. Perfect information Independent private values Affiliated (or correlated) value estimates Special case: common-value auctions © 2017 by McGraw-Hill Education. All Rights Reserved. 12-34 Auctions 34 Optimal Bidding Strategies for Risk-Neutral Bidders An optimal bidding strategy for risk-neutral bidders is a strategy that maximizes a bidder’s expected profit. Optimal bids depends on the type of auction. information available to bidders at the time of bidding. © 2017 by McGraw-Hill Education. All Rights Reserved. 12-35 Auctions 35 Strategies for Independent Private Value Auctions With independent private values, bidders know his or her own values prior to the auction start. English auction Remain active until the price exceeds his or her own valuation of the object. Second-price, sealed-bid auction Bid his or her own valuation of the item. This is a dominant strategy. First-price, sealed-bid auction (strategically equivalent to the Dutch auction) Bid less than his or her valuation of the item. If there are bidders who all perceive valuations to be evenly (or uniformly) distributed between a lowest and highest possible valuations, and , respectively, then the optimal bid, , for a player whose own valuation is is: © 2017 by McGraw-Hill Education. All Rights Reserved. 12-36 Auctions 36 Strategies for Independent Private Value Auctions In Action: Problem Consider an auction where bidders have independent private values. Each bidder perceives that valuations are evenly distributed between and . Sam knows his own valuation is . Determine Sam’s optimal bidding strategy in: A first-price, sealed-bid auction with two bidders. A Dutch auction with three bidders. A second-price, sealed-bid auction with 20 bidders. © 2017 by McGraw-Hill Education. All Rights Reserved. 12-37 Auctions 37 Strategies for Independent Private Value Auctions In Action: Answer Sam’s optimal bid in a first-price, sealed-bid auction with two bidders is . Sam’s optimal bid in a Dutch auction with three bidders is . Sam’s optimal bid in a second-price, sealed-bid auction with 20 bidders is to bid his true valuation, which is . © 2017 by McGraw-Hill Education. All Rights Reserved. 12-38 Auctions 38 Strategies for Correlated Values Auctions Bidders do not know their own valuations for an item, nor others’ valuations. Implication: makes bidders vulnerable to the winner’s curse, which is the “bad news” conveyed to the winner that his or her estimate of the item’s value exceeds the estimates of all other bidders. To avoid the winner’s curve in a common-value auction, a bidder should revise downward his or her private estimate of the value to account for this fact. The auction process may reveal information about how much the other bidders value the object. The winner’s curse is most pronounced in sealed-bid auctions since bidders don’t learn about other player’s valuation. English auction, in contrast, provides bidders with information. Therefore, bidders may have to revise up their initial bids. © 2017 by McGraw-Hill Education. All Rights Reserved. 12-39 Auctions 39 Expected Revenues in Alternative Types of Auctions Comparison of expected revenue in auctions with risk-neutral bidders © 2017 by McGraw-Hill Education. All Rights Reserved. 12-40 Auctions Information structure Expected revenues Independent private values English=Second-price = First-Price = Dutch Affiliated value estimates English > Second-price > First-price = Dutch 40 bay90611_fm_i-xxviii.indd i 10/31/16 04:45 PM Managerial Economics and Business Strategy NINTH EDITION Final PDF to printer bay90611_fm_i-xxviii.indd ii 10/31/16 04:45 PM The McGraw-Hill Series Economics ESSENTIALS OF ECONOMICS Brue, McConnell, and Flynn Essentials of Economics Third Edition Mandel M: Economics: The Basics Third Edition Schiller and Gebhardt Essentials of Economics Tenth Edition PRINCIPLES OF ECONOMICS Asarta and Butters Connect Master: Principles of Economics First Edition Colander Economics, Microeconomics, and Macroeconomics Tenth Edition Frank, Bernanke, Antonovics, and Heffetz Principles of Economics, Principles of Microeconomics, Principles of Macroeconomics Sixth Edition Frank, Bernanke, Antonovics, and Heffetz A Streamlined Approach for: Principles of Economics, Principles of Microeconomics, Principles of Macroeconomics Third Edition Karlan and Morduch Economics, Microeconomics, and Macroeconomics Second Edition McConnell, Brue, and Flynn Economics, Microeconomics, and Macroeconomics Twenty-First Edition Samuelson and Nordhaus Economics, Microeconomics, and Macroeconomics Nineteenth Edition Schiller and Gebhardt The Economy Today, The Micro Economy Today, and The Macro Economy Today Fourteenth Edition Slavin Economics, Microeconomics, and Macroeconomics Eleventh Edition ECONOMICS OF SOCIAL ISSUES Guell Issues in Economics Today Eighth Edition Register and Grimes Economics of Social Issues Twenty-First Edition ECONOMETRICS Gujarati and Porter Basic Econometrics Fifth Edition Hilmer and Hilmer Practical Econometrics First Edition MANAGERIAL ECONOMICS Baye and Prince Managerial Economics and Business Strategy Ninth Edition Brickley, Smith, and Zimmerman Managerial Economics and Organizational Architecture Sixth Edition Thomas and Maurice Managerial Economics Twelfth Edition INTERMEDIATE ECONOMICS Bernheim and Whinston Microeconomics Second Edition Dornbusch, Fischer, and Startz Macroeconomics Twelfth Edition Frank Microeconomics and Behavior Ninth Edition ADVANCED ECONOMICS Romer Advanced Macroeconomics Fourth Edition MONEY AND BANKING Cecchetti and Schoenholtz Money, Banking, and Financial Markets Fifth Edition URBAN ECONOMICS O’Sullivan Urban Economics Eighth Edition LABOR ECONOMICS Borjas Labor Economics Seventh Edition McConnell, Brue, and Macpherson Contemporary Labor Economics Eleventh Edition PUBLIC FINANCE Rosen and Gayer Public Finance Tenth Edition Seidman Public Finance First Edition ENVIRONMENTAL ECONOMICS Field and Field Environmental Economics: An Introduction Seventh Edition INTERNATIONAL ECONOMICS Appleyard and Field International Economics Ninth Edition Pugel International Economics Sixteenth Edition Final PDF to printer bay90611_fm_i-xxviii.indd iii 10/31/16 04:45 PM Managerial Economics and Business Strategy Michael R. Baye Bert Elwert Professor of Business Economics & Public Policy Kelley School of Business Indiana University Jeffrey T. Prince Associate Professor of Business Economics & Public Policy Harold A. Poling Chair in Strategic Management Kelley School of Business Indiana University NINTH EDITION Final PDF to printer bay90611_fm_i-xxviii.indd iv 11/07/16 03:10 PM MANAGERIAL ECONOMICS AND BUSINESS STRATEGY, NINTH EDITION Published by McGraw-Hill Education, 2 Penn Plaza, New York, NY 10121. Copyright © 2017 by McGraw-Hill Education. All rights reserved. Printed in the United States of America. Previous editions © 2014, 2010, 2008 and 2006. No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of McGraw-Hill Education, including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning. Some ancillaries, including electronic and print components, may not be available to customers outside the United States. This book is printed on acid-free paper. 1 2 3 4 5 6 7 8 9 LWI 21 20 19 18 17 16 ISBN 978-1-259-29061-9 MHID 1-259-29061-1 Chief Product Officer, SVP Products & Markets: G. Scott Virkler Vice President, General Manager, Products & Markets: Marty Lange Vice President, Content Design & Delivery: Betsy Whalen Managing Director: James Heine Brand Manager: Katie Hoenicke Director, Product Development: Rose Koos Lead Product Developer: Michele Janicek Product Developer: Christina Kouvelis Marketing Manager: Virgil Lloyd Marketing Specialist: Dave O’Donnell Director of Digital Content Development: Douglas Ruby Digital Product Developer: Tobi Philips Director, Content Design & Delivery: Linda Avenarius Program Manager: Mark Christianson Content Project Managers: Kathryn D. Wright, Kristin Bradley, and Karen Jozefowicz Buyer: Laura M. Fuller Design: Matt Diamond Content Licensing Specialist: Beth Thole Cover Image: © Pasieka/Getty Images Compositor: SPi Global Typyface: 10/12 STIX MathJax Main Printer: LSC Communications All credits appearing on page or at the end of the book are considered to be an extension of the copyright page. Library of Congress Control Number: 2016042214 The Internet addresses listed in the text were accurate at the time of publication. The inclusion of a website does not indicate an endorsement by the authors or McGraw-Hill Education, and McGraw-Hill Education does not guarantee the accuracy of the information presented at these sites. mheducation.com/highered Final PDF to printer bay90611_fm_i-xxviii.indd v 10/31/16 04:45 PM DEDICATION To my former students. —Michael R. Baye To Annie, Kate, and Elise. —Jeffrey T. Prince Final PDF to printer bay90611_fm_i-xxviii.indd vi 10/31/16 04:45 PM vi Michael R. Baye is the Bert Elwert Professor of Business Economics & Public Policy at Indiana University’s Kelley School of Business, and served as the Director of the Bureau of Economics at the Federal Trade Commission from July 2007 to December 2008. He received his BS in economics from Texas A&M University in 1980 and earned a PhD in economics from Purdue University in 1983. Prior to joining Indiana University, he taught graduate and undergraduate courses at The Pennsylvania State University, Texas A&M University, and the University of Kentucky. He has held a variety of editorial posts in economics, mar- keting, and business, and currently serves as a co-editor for the Journal of Economics and Management Strategy. Professor Baye has won numerous awards for his outstanding teaching and research, and teaches courses in managerial economics and industrial organization at the undergrad- uate, MBA, and PhD levels. His research has been published in the American Economic Review, Journal of Political Economy, Econometrica, Review of Economic Studies, Economic Journal, and Management Science. It has also been featured in The Wall Street Journal, Forbes, the New York Times, and numerous other outlets. When he is not teaching or engaged in research, Mike enjoys activities ranging from camping to shopping for electronic gadgets. Jeffrey T. Prince is Associate Professor of Business Economics & Public Policy at Indiana University’s Kelley School of Business. He is also the Harold A. Poling Chair in Strategic Management. He received his BA in economics and BS in mathematics and statistics from Miami University in 1998 and earned a PhD in economics from Northwestern University in 2004. Prior to joining Indiana University, he taught graduate and undergraduate courses at Cornell University. Professor Prince has won top teaching honors as a faculty member at both Indiana University and Cornell, and as a graduate student at Northwestern. He has a broad research agenda within applied economics, having written and published on topics that include demand in technology markets, Internet diffusion, regulation in health care, risk aversion in insurance markets, and quality competition among airlines. He is one of a small number of economists to have published in both the top journal in economics (American Economic Review) and the top journal in management (Academy of Management Journal). He currently serves as a co-editor for the Journal of Economics and Management Strategy and on the editorial board for Information Economics and Policy. In his free time, Jeff enjoys activities ranging from poker and bridge to running and racquetball. About the Authors Final PDF to printer bay90611_fm_i-xxviii.indd vii 10/31/16 04:45 PM vii Thanks to feedback from users around the world, Managerial Economics and Business Strategy remains the best-selling managerial text in the market. We are grateful to all of you for allowing us to provide this updated and improved edition. Before highlighting some of the new features of the ninth edition, we would like to stress that the fundamental goal of the book—providing students with the tools from intermediate microeconomics, game the- ory, and industrial organization that they need to make sound managerial decisions—has not changed. What has changed are the examples used to make managerial economics come to life for this generation of students and the utilization of new technologies (such as Connect) for enhancing the teaching and learning experiences of instructors and their students. This book begins by teaching managers the practical utility of basic economic tools such as present value analysis, supply and demand, regression, indifference curves, isoquants, pro- duction, costs, and the basic models of perfect competition, monopoly, and monopolistic com- petition. Adopters and reviewers also praise the book for its real-world examples and because it includes modern topics not contained in any other single managerial economics textbook: oligopoly, penetration pricing, multistage and repeated games, foreclosure, contracting, ver- tical and horizontal integration, networks, bargaining, predatory pricing, principal–agent problems, raising rivals’ costs, adverse selection, auctions, screening and signaling, search, limit pricing, and a host of other pricing strategies for firms enjoying market power. This balanced coverage of traditional and modern microeconomic tools makes it appropriate for a wide variety of managerial economics classrooms. An increasing number of business schools are adopting this book to replace (or use alongside) managerial strategy texts laden with anec- dotes but lacking the microeconomic tools needed to identify and implement the business strategies that are optimal in a given situation. This ninth edition of Managerial Economics and Business Strategy has been revised to include updated examples and problems, but it retains all of the basic content that made pre- vious editions a success. The basic structure of the textbook is unchanged to ensure a smooth transition to this edition. KEY PEDAGOGICAL FEATURES The ninth edition retains all of the class-tested features of previous editions that enhance students’ learning experiences and make it easy to teach from this book. But this edition includes a number of new features available to those using McGraw-Hill’s wonderful interac- tive learning products, Connect and SmartBook. McGraw-Hill Connect® offers hundreds of variations of end-of-chapter problems that may be electronically graded and provide students with immediate, detailed, feedback. SmartBook® provides an adaptive reading experience. Students and instructors can access these and other powerful resources directly from their laptops, tablets, and phones. We know how important quality and accuracy is for both instruc- tors and students when utilizing these enhanced features. For this reason, and unlike many Preface Final PDF to printer bay90611_fm_i-xxviii.indd viii 10/31/16 04:45 PM viii Preface competing books, we are directly involved in the generation and editing of material offered through both Connect and SmartBook. Headlines As in previous editions, each chapter begins with a Headline that is based on a real-world economic problem—a problem that students should be able to address after completing the chapter. These Headlines are essentially hand-picked “mini-cases” designed to motivate stu- dents to learn the material in the chapter. Each Headline is answered at the end of the relevant chapter—when the student is better prepared to deal with the complications of real-world prob- lems. Reviewers as well as users of previous editions praise the Headlines not only because they motivate students to learn the material in the chapter, but also because the answers at the end of each chapter help students learn how to use economics to make business decisions. Learning Objectives Each chapter includes learning objectives designed to enhance the learning experience. End- of-chapter problems are denoted with the learning objective(s) to which they relate. Demonstration Problems The best way to learn economics is to practice solving economic problems. So, in addition to the Headlines, each chapter contains many Demonstration Problems sprinkled throughout the text, along with detailed answers. This provides students with a mechanism to verify that they have mastered the material, and reduces the cost to students and instructors of having to meet during office hours to discuss answers to problems. Some of the more challenging demonstration problems have an accompanying video tutorial that walks through the solution step-by-step. These videos are available via Connect and at www.mhhe.com/baye9e. Inside Business Applications Most chapters contain boxed material (called Inside Business applications) to illustrate how theories explained in the text relate to a host of different business situations. As in previous editions, we have tried to strike a balance between applications drawn from the current eco- nomic literature and the popular press. Calculus and Non-Calculus Alternatives Users can easily include or exclude calculus-based material without losing content or con- tinuity. That’s because the basic principles and formulae needed to solve a particular class of economic problems (e.g., MR = MC) are first stated without appealing to the notation of calculus. Immediately following each stated principle or formula is a clearly marked Calculus Alternative. Each of these calculus alternatives states the preceding principle or formula in calculus notation, and explains the relation between the calculus-based and non- calculus- based formula. More detailed calculus derivations are relegated to chapter Appendices. Thus, the book is designed for use by instructors who want to integrate calculus into managerial economics and by those who do not require students to use calculus. Variety of End-of-Chapter Problems Three types of problems are offered. Highly structured but nonetheless challenging Conceptual and Computational Questions stress fundamentals. These are followed by Problems and Final PDF to printer bay90611_fm_i-xxviii.indd ix 10/31/16 04:45 PM Preface ix Applications, which are far less structured and, like real-world decision environments, may contain more information than is actually needed to solve the problem. Many of these applied problems are based on actual business events. Additionally, the Time Warner Cable case that follows Chapter 14 includes 13 problems called Memos that have a “real-world feel” and complement the text. All of these case-based problems may be assigned on a chapter-by-chapter basis as specific skills are introduced, or as part of a capstone experience.  Detailed answers to all problems can be found among the instructor resource material available via Connect. Case Study A case study in business strategy—Time Warner Cable—follows Chapter 14 and was pre- pared especially for this text. It can be used either as a capstone case for the course or to supplement individual chapters. The case allows students to apply core elements from man- agerial economics to a remarkably rich business environment. Instructors can use the case as the basis for an “open-ended” discussion of business strategy, or they can assign specific “memos” (contained at the end of the case) that require students to apply specific tools from managerial economics to the case. Teaching notes, as well as solutions to all of the memos, are provided among the instructor resource material available via Connect. Flexibility Instructors of managerial economics have genuinely heterogeneous textbook needs. Reviewers and users continue to praise the book for its flexibility, and they assure us that sections or even entire chapters can be excluded without losing continuity. For instance, an instructor wishing to stress microeconomic fundamentals might choose to cover Chapters 2, 3, 4, 5, 8, 9, 10, 11, and 12. An instructor teaching a more applied course that stresses business strategy might choose to cover Chapters 1, 2, 3, 5, 6, 7, 8, 10, 11, and 13. Each may choose to include additional chapters (for example, Chapter 14 or the Time Warner Cable case) as time permits. More generally, instructors can easily omit topics such as present value analysis, regression, indifference curves, isoquants, or reaction functions without losing continuity. CHANGES IN THE NINTH EDITION We have made every effort to update and improve Managerial Economics and Business Strategy while assuring a smooth transition to the ninth edition. Following is a summary of the pedagogical improvements, enhanced supplements, and content changes that make the ninth edition an even more powerful tool for teaching and learning managerial economics and business strategy. ∙ A brand new Case Study—Time Warner Cable—which introduces a whole new set of managerial challenges beyond those posed in our previous case, Challenges at Time Warner. ∙ New and updated end-of-chapter problems. ∙ Learning objective labels for each end-of-chapter problem, to help foster targeted learning. ∙ New and updated Headlines. ∙ New and updated Inside Business applications. Final PDF to printer bay90611_fm_i-xxviii.indd x 10/31/16 04:45 PM x Preface Chapter-by-Chapter Changes ∙ Chapter 1 contains new and updated examples, several updated end-of-chapter prob- lems, and a new end-of-chapter problem that carefully distinguishes total benefits and total costs from marginal benefits and marginal costs in an applied setting. ∙ Chapter 2 contains updated demonstration problems and an expanded discussion of price floors in the text and demonstration problems. ∙ Chapter 3 contains a new Headline and an updated table with accompanying discus- sion. It also has several updated end-of-chapter problems. ∙ Chapter 4 contains an updated Headline and updated Inside Business applications. It also has several updated end-of-chapter problems. ∙ Chapter 5 contains an updated Inside Business application with details about the Affordable Care Act. It also includes a formal definition of the law of diminishing marginal returns and has several updated end-of-chapter problems. ∙ Chapter 6 offers a new Inside Business on the duration of franchise contracts, updated examples, and several updated end-of-chapter problems. ∙ Chapter 7 contains a new Headline, updated examples and industry data, as well as several updated end-of-chapter problems. ∙ Chapter 8 contains an updated Inside Business concerning automobile competition in China, updated examples, and several updated end-of-chapter problems. ∙ Chapter 9 contains an updated end-of-chapter problem, as well as a new end-of- chapter problem looking at contestability within airline markets. ∙ Chapter 10 contains a new Inside Business application examining airline competition, as well as improved Demonstration Problem exposition. It also has several updated end-of-chapter problems. ∙ Chapter 11 contains a new Inside Business application discussing the use of fuel points by major U.S. grocery chains. It also has several updated end-of-chapter problems. ∙ Chapter 12 includes a new discussion of online reviews as a means of attracting risk- averse customers. It also includes a new Inside Business application, as well as several updated end-of-chapter problems. ∙ Chapter 13 contains a new Inside Business on limit pricing and the “Southwest Effect.” It also has two updated end-of-chapter problems. ∙ Chapter 14 contains a new Inside Business application discussing the Small Business Act for Europe as a key distinction in competition policy between Europe and the United States. In addition, it has two updated end-of-chapter problems, including one discussing the Trans-Pacific Partnership (TPP). ORGANIZED LEARNING IN THE NINTH EDITION Chapter Learning Objectives Students and instructors can be confident that the organization of each chapter reflects com- mon themes outlined by four to seven learning objectives listed on the first page of each chapter. These objectives, along with AACSB and Bloom’s taxonomy learning categories, are connected to all end-of-chapter material and test bank questions to offer a comprehensive and thorough teaching and learning experience. Final PDF to printer bay90611_fm_i-xxviii.indd xi 10/31/16 04:45 PM Preface xi Assurance of Learning Ready Many educational institutions today are focused on the notion of assurance of learning, an important element of some accreditation standards. Managerial Economics and Business Strategy is designed specifically to support your assurance of learning initiatives with a sim- ple, yet powerful solution. Instructors can use Connect to easily query for learning outcomes/objectives that directly relate to the learning objectives of the course. You can then use the reporting features of Connect to aggregate student results in similar fashion, making the collection and presenta- tion of assurance of learning data simple and easy. AACSB Statement McGraw-Hill Global Education is a proud corporate member of AACSB International. Understanding the importance and value of AACSB accreditation, Managerial Economics and Business Strategy, 9/e, has sought to recognize the curricula guidelines detailed in the AACSB standards for business accreditation by connecting questions in the test bank and end-of-chapter material to the general knowledge and skill guidelines found in the AACSB standards. It is important to note that the statements contained in Managerial Economics and Business Strategy, 9/e, are provided only as a guide for the users of this text. The AACSB leaves content coverage and assessment within the purview of individual schools, the mission of the school, and the faculty. While Managerial Economics and Business Strategy, 9/e, and the teaching package make no claim of any specific AACSB qualification or evaluation, we have labeled questions according to the general knowledge and skill areas. ACKNOWLEDGMENTS We thank the many users of Managerial Economics and Business Strategy who provided both direct and indirect feedback that has helped improve your book. This includes thousands of students at Indiana University’s Kelley School of Business and instructors worldwide who have used this book in their own classrooms, colleagues who unselfishly gave up their own time to provide comments and suggestions, and reviewers who provided detailed suggestions to improve this and previous editions of the book. We especially thank the following profes- sors, past and present, for enlightening us on the market’s diverse needs and for providing suggestions and constructive criticisms to improve this book. Contributing reviewers for this edition: Narine Badasyan, Murray State University Cristanna Cook, Husson University Robert Daffenbach, University of Oklahoma Jeffrey Edwards, North Carolina A&T University Silke Forbes, Case Western Reserve University Martin Heintzelman, Clarkson University Craig Hovey, Brenau University, Gainesville Anand Jha, Texas A&M International University Harlan Platt, Northeastern University Stefan Ruediger, Arizona State University Charles Sebuhara, Virginia Technical University Thomas White, Fontbonne University Keith Willett, Oklahoma State University, Stillwater Laura Youderian, Xavier University Final PDF to printer bay90611_fm_i-xxviii.indd xii 10/31/16 04:45 PM xii Preface Contributing reviewers for previous editions: Fatma Abdel-Raouf, Goldey-Beacom College Burton Abrams, University of Delaware Rashid Al-Hmoud, Texas Tech University Anthony Paul Andrews, Governors State University Sisay Asefa, Western Michigan University Simon Avenell, Murdoch University Joseph P. Bailey, University of Maryland Dale G. Bails Christian Brothers University Dean Baim, Pepperdine University Sheryl Ball, Virginia Polytechnic University Klaus Becker, Texas Tech University Richard Beil, Auburn University Barbara C. Belivieu, University of Connecticut Dan Black, University of Chicago Louis Cain, Northwestern University Kerem Cakirer, Indiana University Leo Chan, University of Kansas Robert L. Chapman, Florida Metropolitan University Joni Charles, Texas State University—San Marcos Basanta Chaudhuri, Rutgers University— New Brunswick Shuo Chen, State University of New York at Geneseo Xiujian Chen, State University of New York—Binghamton University Kwang Soo Cheong, Johns Hopkins University Christopher B. Colburn, Old Dominion University Daniel Patrick Condon, Dominican University Michael Conlin, Syracuse University Cristanna Cook, Husson University Keith Crocker, Penn State University Ian Cromb, University of Western Ontario Dean Croushore, Federal Reserve Wilffrid W. Csaplar Jr., Bethany College Shah Dabirian, California State University, Long Beach Joseph DaBoll-Lavioe, Nazareth College of Rochester George Darko, Tusculum College Tina Das, Elon University Ron Deiter, Iowa State University Jonathan C. Deming, Seattle Pacific University Casey Dirienzo, Appalachian State University Eric Drabkin, Hawaii Pacific University Martine Duchatelet, Barry University Keven C. Duncan, University of Southern Colorado Yvonne Durham, Western Washington University Eugene F. Elander, Brenau University Ibrahim Elsaify, Goldey-Beacom College David Ely, San Diego State University Mark J. Eschenfelder, Robert Morris University Li Feng, Texas State University–San Marcos David Figlio, University of Florida Ray Fisman, Graduate School of Business, Columbia University Silke Forbes, University of California—San Diego David Gerard, Carnegie Mellon University Sharon Gifford, Rutgers University Lynn G. Gillette, Northeast Missouri State University Otis Gilley, Louisiana Tech University Roy Gobin, Loyola University Stephan Gohmann, University of Louisville Steven Gold, Rochester Institute of Technology Julie Hupton Gonzalez, University of California—Santa Cruz Thomas A. Gresik, Mendoza College of Business (University of Notre Dame) Final PDF to printer bay90611_fm_i-xxviii.indd xiii 10/31/16 04:45 PM Preface xiii Andrea Mays Griffith, California State University Madhurima Gupta, University of Notre Dame Carl Gwin, Pepperdine University Gail Heyne Hafer, Lindenwood College Karen Hallows, George Mason University William Hamlen Jr., SUNY Buffalo Shawkat Hammoudeh, Drexel University Mehdi Harian, Bloomsburg University Nile W. Hatch, Marriott School (Brigham Young University) Clifford Hawley, West Virginia University Ove Hedegaard, Copenhagen Business School Steven Hinson, Webster University Hart Hodges, Western Washington University Robert L. Holland, Purdue University Jack Hou, California State University— Long Beach Lowel R. Jacobsen, William Jewell College Thomas D. Jeitschko, Michigan State University Jaswant R. Jindia, Southern University Russell Kashian, University of Wisconsin—Whitewater Paul Kattuman, Judge Business School (Cambridge University) Brian Kench, University of Tampa Kimberley L. Kinsley, University of Mary Washington Peter Klein, University of Georgia, University of Missouri—Columbia Audrey D. Kline, University of Louisville Robert A. Krell, George Mason University Paul R. Kutasovic, New York Institute of Technology W. J. Lane, University of New Orleans Daniel Lee, Shippensburg University Dick Leiter, American Public University Canlin Li, University of California—Riverside Chung-Ping Loh, University of North Florida Vahe Lskavyan, Ohio University—Athens Heather Luea, Newman University Nancy L. Lumpkin, Georgetown College Thomas Lyon, University of Michigan Richard Marcus, University of Wisconsin—Milwaukee Vincent Marra, University of Delaware Wade Martin, California State University, Long Beach Catherine Matraves, Michigan State University—East Lansing John Maxwell, Indiana University David May, Oklahoma City University Alan McInnes, California State University, Fullerton Christopher McIntosh, University of Minnesota Duluth Kimberly L. Merritt, Oklahoma Christian University Edward Millner, Virginia Commonwealth University John Moran, Syracuse University Shahriar Mostashari, Campbell University John Morgan, Haas Business School (University of California—Berkeley) Ram Mudambi, …