Decision making lies at the heart of most important business and
government problems. The range of business decisions is vast: Should a
high-tech company undertake a promising but expensive research and
development program? Should a petrochemical manufacturer cut the
price of its best-selling industrial chemical in response to a new
competitor’s entry into the market? What bid should company
management submit to win a government telecommunications contract?
Should management of a food products company launch a new product?
After mixed test-marketing results? Likewise, government decisions
range far and wide: Should the Department of Transportation impose
stricter rollover standards for sports utility vehicles? Should a city
allocate funds for construction of a harbor tunnel to provide easy airport
and commuter access? These are all interesting, important, and timely
questions—with no easy answers. They are also all economic decisions.
In each case, a sensible analysis of what decision to make requires a
careful comparison of the advantages and disadvantages (often, but not
always, measured in dollars) of alternative courses of action.
As the term suggests, managerial economics is the analysis of major
management decisions using the tools of economics. Managerial
economics applies many familiar concepts from economics—demand and
cost, monopoly and competition, the allocation of resources, and
economic trade-offs—to aid managers in making better decisions. This
book provides the framework and the economic tools needed to fulfill this
goal.
The best way to become acquainted with managerial economics
is to come face to face with real-world decision-making
problems. The seven examples that follow represent the
different kinds of decisions that private– and public-sector
managers
1- face.Multinational Production and Pricing
Multinational Production and Pricing
Almost all firms face the problem of pricing their products.
Consider a U.S. multinational carmaker that produces and
sells its output in two geographic regions. It can produce cars
in its home plant or in its foreign subsidiary. It sells cars in
the domestic market and in the foreign market. For the next
year, it must determine the prices to set at home and abroad,
estimate sales for each market, and establish production
quantities in each facility to supply those sales. It recognizes
that the markets for vehicles at home and abroad differ with
respect to demand (that is, how many cars can be sold at
different prices). Also, the production facilities have different
costs and capacities. Finally, at a cost, it can ship vehicles
from the home facility to help supply the foreign market, or
vice versa. Based on the available information, how can the
company determine a profit maximizing pricing and
production plan for the coming year?
2- Market Entry
For 20 years, the two giants of the book business—Barnes
& Noble and Borders Group—engaged in a cutthroat
retail battle. In major city after major city, the rivals
opened superstores, often within sight of each other. By
the mid-1990s, more books were sold via chain stores than
by independent stores, and both companies continued to
open new stores at dizzying rates. The ongoing
competition raises a number of questions: How did either
chain assess the profitability of new markets? Where and
when should each enter new markets? What if a region’s
book-buying demand is sufficient to support only one
superstore? What measures might be taken by an
incumbent to erect entry barriers to a would-be entrant?
On what dimensions—number of titles, pricing, personal
service—did the companies most vigorously compete? In
view of accelerating book sales via the Internet and the
emerging e–book market, can mega “bricks and mortar”
bookstores survive?
3- Building a New Bridge
As chief city planner of a rapidly growing Sun Belt city, you
face the single biggest decision of your tenure: whether to
recommend the construction of a new harbor bridge to
connect downtown with the surrounding suburbs located
on a northern peninsula. Currently, suburban residents
commute to the city via a ferry or by driving a long-distance
circular route. Preliminary studies have shown that there is
considerable need and demand for the bridge. Indeed, the
bridge is expected to spur economic activity in the region as a
whole. The projected cost of the bridge is $75 million to $100
million. Part of the money would be financed with an issue of
municipal bonds, and the remainder would be contributed by
the state. Toll charges on commuting automobiles and
particularly on trucks would be instituted to recoup a portion
of the bridge’s costs. But, if bridge use falls short of
projections, the city will be saddled with a very expensive
white elephant. What would you recommend?
4- A Regulatory Problem
Environmental regulations have a significant effect on
business decisions and consumer behavior. Charles Schultze,
former chairperson of the President’s Council of Economic
Advisers, describes the myriad problems associated with the
regulations requiring electric utilities to convert from oil to
coal. Petroleum imports can be conserved by switching
[utilities] from oil-fired to coal-fired generation. But barring
other measures, burning high sulfur Eastern coal substantially
increases pollution. Sulfur can be “scrubbed” from coal
smoke in the stack, but at a heavy cost, with devices that turn
out huge volumes of sulfur wastes that must be disposed of
and about whose reliability there is some question.
Intermittent control techniques (installing high smoke stacks
and turning off burners when meteorological conditions are
adverse) can, at a lower cost, reduce local concentrations of
sulfur oxides in the air, but cannot cope with the growing
problem of sulphates and widespread acid rainfall. Use of
low-sulfur Western coal would avoid many of these
problems, but this coal is obtained by strip mining. Strip–
mine reclamation is possible but substantially hindered in
large areas of the West by lack of rainfall. Moreover, in some
coal-rich areas the coal beds form the underlying aquifer, and
their removal could wreck adjacent farming or ranching
economies. Large coal-burning plants might be located in
remote areas far from highly populated urban centers in order
to minimize the human effects of pollution. But such areas
are among the few left that are unspoiled by pollution, and
both environmentalists and the residents (relatively few in
number compared to those in metropolitan localities but large
among the voting populations in the particular states) strongly
object to this policy. Fears, realistic or imaginary, about
safety and accumulation of radioactive waste have
increasingly hampered the nuclear option.
Schultze’s points apply directly to today’s energy and
environmental tradeoffs. Actually, he penned this discussion in
1977! Important questions persist. How, when, and where
should the government intervene to achieve and balance its
energy and environmental objectives? How would one go about
quantifying the benefits and costs of a particular program of
intervention?
5- BP and Oil Exploration Risks
BP (known as British Petroleum prior to 2001) is in the business
of taking risks. As the third largest energy company in the
world, its main operations involve oil exploration, refining, and
sale.
The risks it faces begin with the uncertainty about where to find
oil deposits (including drilling offshore more than a mile
under the ocean floor), mastering the complex, risky methods of
extracting petroleum, cost-effectively refining that oil, and
selling those refined products at wildly fluctuating world prices.
In short, the company runs the whole gamut of risk: geological,
technological, safety, regulatory, legal, and market related.
Priding itself on 17 straight years of 100 percent oil reserve
replacement, BP is an aggressive and successful oil discoverer.
But the dark side of its strategic aspirations is its troubling
safety and environmental record, culminating in the explosion
of its Deepwater Horizon drilling rig in the Gulf of Mexico in
April 2010. This raises the question: What types of decisions
should oil companies like BP take to identify, quantify, manage,
and hedge against the inevitable risks they face?
6- An R&D Decision
A five-year-old pharmaceutical company faces a major
research and development decision. It already has spent a
year of preliminary research toward producing a protein that
dissolves blood clots. Such a drug would be of tremendous
value in the treatment of heart attacks, some 80 percent of
which are caused by clots. The primary method the company
has been pursuing relies on conventional, state–of-the-art
biochemistry. Continuing this approach will require an
estimated $10 million additional investment and should lead
to a commercially successful product, although the exact
profit is highly uncertain. Two of the company’s most
brilliant research scientists are aggressively advocating a
second R&D approach. This new biogenetic method relies on
gene splicing to create a version of the human body’s own
anticlotting agent and is considerably riskier than the
biochemical alternative. It will require a $20 million
investment and has only a 20 percent chance of commercial
