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Contents

1 Introduction

What is Economics 1 Opportunity Cost 3 Macroeconomics Versus Microeconomics 3 What is Managerial Economics 4 Theories and Models 5 Descriptive Versus Prescriptive Managerial Economics 8 Quantitive Methods 8 Three Basic Economic Questions 9 Characteristics of Pure Capitalism 11 The Role of Government in Market Economies 13 The Role of Profit 16 Theory of the Firm 18 How Realistic is the Assumption of Profit Maximization? 21 Owner-Manager/Principle-Agent Problem 23 Manager-Worker/Principle-Agent Problem 25 Constraints on the Operations of the Firm 27 Accounting Profit Versus Economic Profit 27 Normal Profit 30 Variations in Profits Across Industries and Firms 31 Chapter Review 33 Key Terms and Concepts 35 Chapter Questions 37

vii

Chapter Exercises 39 Selected Readings 41

2 Introduction to Mathematical Economics

Functional Relationships and Economic Models 44 Methods of Expressing Economic and Business Relationships 45 The Slope of a Linear Function 47 An Application of Linear Functions to Economics 48 Inverse Functions 50 Rules of Exponents 52 Graphs of Nonlinear Functions of One Independent Variable 53 Sum of a Geometric Progression 56 Sum of an Infinite Geometric Progression 58 Economic Optimization 60 Derivative of a Function 62 Rules of Differentiation 63 Implicit Differentiation 71 Total, Average, and Marginal Relationships 72 Profit Maximization: The First-order Condition 76 Profit Maximization: The Second-order Condition 78 Partial Derivatives and Multivariate Optimization: The First-order

Condition 81 Partial Derivatives and Multivariate Optimization: The Second-order

Condition 82 Constrained Optimization 84 Solution Methods to Constrained Optimization Problems 85 Integration 88 Chapter Review 92 Chapter Questions 94 Chapter Exercises 94 Selected Readings 97

3 The Essentials of Demand and Supply

The Law of Demand 100 The Market Demand Curve 102

viii Contents

Other Determinants of Market Demand 106 The Market Demand Equation 110 Market Demand Versus Firm Demand 112 The Law of Supply 113 Determinants of Market Supply 114 The Market Mechanism: The Interaction of Demand and Supply 118 Changes in Supply and Demand: The Analysis of Price

Determination 123 The Rationing Function of Prices 129 Price Ceilings 130 Price Floors 134 The Allocating Function of Prices 136 Chapter Review 137 Key Terms and Concepts 138 Chapter Questions 140 Chapter Exercises 142 Selected Readings 144 Appendix 3A 145

4 Additional Topics in Demand Theory

Price Elasticity of Demand 149 Price Elasticity of Demand: The Midpoint Formula 152 Price Elasticity of Demand: Weakness of the Midpoint Formula 155 Refinement of the Price Elasticity of Demand Formula: Point-price

Elasticity of Demand 157 Relationship Between Arc-price and Point-price Elasticities

of Demand 160 Price Elasticity of Demand: Some Definitions 160 Point-price Elasticity Versus Arc-price Elasticity 162 Individual and Market Price Elasticities of Demand 164 Determinants of the Price Elasticity of Demand 165 Price Elasticity of Demand, Total Revenue, and Marginal

Revenue 168 Formal Relationship Between the Price Elasticity of Demand and

Total Revenue 174 Using Elasticities in Managerial Decision Making 181 Chapter Review 186 Key Terms and Concepts 188 Chapter Questions 190

Contents ix

Chapter Exercises 191 Selected Readings 194

5 Production

The Role of the Firm 195 The Production Function 197 Short-run Production Function 201 Key Relationships: Total, Average, and Marginal Products 202 The Law of Diminishing Marginal Product 205 The Output Elasticity of a Variable Input 207 Relationships Among the Product Functions 208 The Three Stages of Production 211 Isoquants 212 Long-run Production Function 218 Estimating Production Functions 222 Chapter Review 225 Key Terms and Concepts 226 Chapter Questions 229 Chapter Exercises 231 Selected Readings 232

6 Cost

The Relationship Between Production and Cost 235 Short-run Cost 236 Key Relationships: Average Total Cost, Average Fixed Cost, Average

Variable Cost, and Marginal Cost 238 The Functional Form of the Total Cost Function 241 Mathematical Relationship Between ATC and MC 243 Learning Curve Effect 247 Long-run Cost 250 Economies of Scale 251 Reasons for Economies and Diseconomies of Scale 255 Multiproduct Cost Functions 256 Chapter Review 259

x Contents

Key Terms and Concepts 260 Chapter Questions 262 Chapter Exercises 263 Selected Readings 264

7 Profit and Revenue Maximization

Profit Maximization 266 Optimal Input Combination 266 Unconstrained Optimization: The Profit Function 279 Constrained Optimization: The Profit Function 295 Total Revenue Maximization 299 Chapter Review 302 Key Terms and Concepts 303 Chapter Questions 305 Chapter Exercises 305 Selected Readings 309 Appendix 7A 309

8 Market Structure: Perfect Competition

and Monopoly

Characteristics of Market Structure 313 Perfect Competition 316 The Equilibrium Price 317 Monopoly 331 Monopoly and the Price Elasticity of Demand 337 Evaluating Perfect Competition and Monopoly 340 Welfare Effects of Monopoly 342 Natural Monopoly 348 Collusion 350 Chapter Review 350 Key Terms and Concepts 351 Chapter Questions 353