Managerial Economics & Business Strategy

1 MICHAEL R. BAYEMICHAEL R. BAYE7eMANAGERIAL Economics AND Business STRATEGYMICHAEL R. 978-0-07-337596-0 MHID 0-07-337596-9 Managerial Economics AND Business STRATEGYBAYE7ePROVEN. Economics and Business Strategy is the best-selling Managerial Economics textbook on the market today. Michael Baye provides students with tools like intermediate microeconomics, game theory, and industrial organization that are crucial to making sound Managerial decisions. The Seventh Edition discusses the latest issues and research shaping Managerial Economics FEATURES OF THIS NEW EDITION INCLUDE: UPDATED HEADLINES: Updated and current Headlines begin each chapter with a real-world economic problem. These problems are essentially hand-picked mini-cases designed to motivate students to better understand the chapter material. NEW AND UPDATED INSIDE Business APPLICATIONS: New Inside Business boxes illustrate real-world applications of theory developed in the chapter; these examples are drawn from both current economic literature and the popular press.

2 TIME WARNER CASE STUDY: A Case Study in Business Strategy Challenges at Time Warner follows Chapter 14. The case engages students by applying core elements from Managerial Economics to a rich Business more information and resources, please visit the text s Online Learning Center: DALIM #1042728 8/14/09 CYAN MAG YELO BLKM anagerial Economics andBusiness 8/20/09 14:58 Page iConfirming PagesNash Equilibrium Predatory Pricing Mergers & Acquisitions Demand Elasticity Vertical Foreclosure Penetration Pricing Marginal Cost Bottlenecks First-Mover Advantage Signaling Learning Curve Marginal Revenue Repeated Games Microsoft Screening Network Effects Antitrust Cost Complementarities Two-Part Pricing Limit Pricing Tariffs Bargaining CournotOligopoly American Airlines Raising Rivals Costs Moral Hazard eBay Price Discrimination Adverse Selection Economies of Scope Auctions Bundling Block Pricing Stackelberg Oligopoly Advertising Perfect Equilibrium Coordination General Motors Quotas

3 Extensive Form Games Economies of Scale Netscape Hold-up Problem Patents Bertrand Oligopoly Commitment Economies of Scale Tariffs Antitrust Transfer Pricing Collusion Piece Rates Profit-Sharing Sunk Costs Takeovers TriggerStrategies Low-Price Guarantees Sony Time Warner FiveForces Framework AOL Globalization Best-Response Function Cannibalization Product Differentiation Value of 8/20/09 14:58 Page iiConfirming PagesSEVENTH EDITIONM anagerial Economics andBusiness StrategyMichael R. BayeBert Elwert Professor of Business Economics & Public PolicyKelley School of BusinessIndiana 8/20/09 14:58 Page iiiConfirming PagesMANAGERIAL Economics AND Business STRATEGYP ublished by McGraw-Hill/Irwin, a Business unit of The McGraw-Hill Companies, Inc., 1221 Avenue of theAmericas, New York, NY, 10020.

4 Copyright 2010, 2008, 2006, 2003, 2000, 1997, 1994 by The McGraw-HillCompanies, Inc. All rights reserved. No part of this publication may be reproduced or distributed in any form orby any means, or stored in a database or retrieval system, without the prior written consent of The McGraw-HillCompanies, Inc., including, but not limited to, in any network or other electronic storage or transmission, orbroadcast for distance ancillaries, including electronic and print components, may not be available to customers outside theUnited book is printed on acid-free 2 3 4 5 6 7 8 9 0 DOC/DOC 0 9 ISBN 978-0-07-337596-0 MHID 0-07-337596-9 Vice president and editor-in-chief: Brent GordonPublisher: Douglas ReinerDirector of development: Ann TorbertDevelopment editor: Anne E. HilbertVice president and director of marketing: Robin J. ZwettlerAssociate marketing manager: Dean KarampelasVice president of editing, design and production: Sesha BolisettySenior project manager: Bruce GinSenior production supervisor: Debra R.

5 SylvesterDesigner: Matt DiamondSenior media project manager: Greg BatesCover design: Matt DiamondInterior design: Matt DiamondTypeface: 10/12 Times RomanCompositor:Laserwords Private LimitedPrinter:R. R. DonnelleyLibrary of Congress Cataloging-in-Publication DataBaye, Michael R., 1958- Managerial Economics and Business Strategy / Michael R. Baye. 7th : 978-0-07-337596-0 ( )ISBN-10: 0-07-337596-9 (alk. paper)1. Managerial Economics . 2. Strategic planning. I. '658 8/20/09 14:58 Page ivConfirming PagesThe McGraw-Hill Series EconomicsESSENTIALS OFECONOMICSBrue, McConnell, and FlynnEssentials of EconomicsSecond EditionMandelEconomics: The BasicsFirst EditionSchillerEssentials of EconomicsSeventh EditionPRINCIPLES OFECONOMICSC olanderEconomics, Microeconomics, andMacroeconomicsEighth EditionFrank and BernankePrinciples of Economics , Principles ofMicroeconomics, Principles ofMacroeconomicsFourth EditionFrank and BernankeBrief Editions: Principles of Economics ,Principles of Microeconomics,Principles of MacroeconomicsFirst EditionMcConnell, Brue, and FlynnEconomics, Microeconomics, andMacroeconomicsEighteenth EditionMcConnell, Brue, and FlynnBrief Editions.

6 Microeconomics andMacroeconomicsFirst EditionMillerPrinciples of MicroeconomicsFirst EditionSamuelson and NordhausEconomics, Microeconomics, andMacroeconomicsNineteenth EditionSchillerThe Economy Today, The MicroEconomy Today, and The MacroEconomy TodayTwelfth EditionSlavinEconomics, Microeconomics, andMacroeconomicsNinth EditionECONOMICS OFSOCIALISSUESG uellIssues in Economics TodayFifth EditionSharp, Register, and GrimesEconomics of Social IssuesNineteenth EditionECONOMETRICSG ujarati and PorterBasic EconometricsFifth EditionGujarati and PorterEssentials of EconometricsFourth EditionMANAGERIALECONOMICSBayeManagerial Economics and BusinessStrategySeventh EditionBrickley, Smith, and ZimmermanManagerial Economics andOrganizational ArchitectureFifth EditionThomas and MauriceManagerial EconomicsTenth EditionINTERMEDIATEECONOMICSB ernheim and WhinstonMicroeconomicsFirst EditionDornbusch, Fischer, and StartzMacroeconomicsTenth EditionFrankMicroeconomics and BehaviorEighth EditionADVANCEDECONOMICSR omerAdvanced MacroeconomicsThird EditionMONEY ANDBANKINGC ecchettiMoney, Banking, and Financial MarketsSecond EditionURBANECONOMICSO SullivanUrban EconomicsSeventh EditionLABORECONOMICSB orjasLabor EconomicsFifth EditionMcConnell, Brue, and MacphersonContemporary Labor EconomicsNinth EditionPUBLICFINANCER osen and GayerPublic FinanceNinth EditionSeidmanPublic FinanceFirst EditionENVIRONMENTALECONOMICSF ield and FieldEnvironmental Economics : An IntroductionFifth EditionINTERNATIONALECONOMICSA ppleyard, Field, and CobbInternational EconomicsSeventh EditionKing and KingInternational Economics ,Globalization, and Policy: A ReaderFifth EditionPugelInternational EconomicsFourteenth 8/20/09 14:58 Page vConfirming PagesviABOUT THE AUTHORM ichael Baye is the Bert Elwert Professor of Business Economics & Public Policy atIndiana University s Kelley School of Business .

7 He received his in economicsfrom Texas A&M University in 1980 and earned a in Economics from PurdueUniversity in 1983. Prior to joining Indiana University, he taught graduate and under-graduate courses at The Pennsylvania State University, Texas A&M University, andthe University of Kentucky. Professor Baye served as the Director of the Bureau ofEconomics at the Federal Trade Commission from July 2007 December Baye has won numerous awards for his outstanding teaching andresearch and regularly teaches courses in Managerial Economics and industrialorganization at the undergraduate, , and levels. Professor Baye hasmade a variety of contributions to the fields of game theory and industrial organi-zation. His research on mergers, auctions, and contests has been published in suchjournals as the American economic Review,the Review of economic Studies,andthe economic Baye s research on pricing strategies in online andother environments where consumers search for price information has been pub-lished in Economics journals (such as the American economic Review, Economet-rica,and the Journal of Political Economy), featured in the popular press(including The Wall Street Journal, Forbes, andThe New York Times), and pub-lished in leading marketing journals.

8 His research has been supported by theNational Science Foundation, the Fulbright Commission, and other Baye has held visiting appointments at Cambridge, Oxford, ErasmusUniversity, Tilburg University, and the New economic School in Moscow, has served on numerous editorial boards in Economics as well as marketing,including economic Theoryand the Journal of Public Policy & is not teaching or engaged in research, Michael enjoys activities ranging fromcamping to shopping for electronic Natalie and Mitchell Thanks for teaching me about the buyer side of thecollege 8/20/09 14:58 Page viConfirming PagesviiPREFACE TO THE SEVENTH EDITIONT hanks to feedback from users around the world, Managerial Economics and Busi-ness Strategyremains the top selling Managerial text in the market. I am grateful toall of you for allowing me to provide this updated and improved product. Beforehighlighting some of the new features of the seventh edition, I would like to stressthat the fundamental goal of the book providing students with the tools fromintermediate microeconomics, game theory, and industrial organization that theyneed to make sound Managerial decisions has not book begins by teaching managers the practical utility of basic economictools such as present value analysis, supply and demand, regression, indifferencecurves, isoquants, production, costs, and the basic models of perfect competition,monopoly, and monopolistic competition.

9 Adopters and reviewers also praise thebook for its real-world examples and because it includes modern topics not con-tained in any other single Managerial Economics textbook: oligopoly, penetrationpricing, multistage and repeated games, foreclosure, contracting, vertical and hori-zontal integration, networks, bargaining, predatory pricing, principal agent prob-lems, raising rivals costs, adverse selection, auctions, screening and signaling,search, limit pricing, and a host of other pricing strategies for firms enjoying mar-ket power. This balanced coverage of traditional and modern microeconomic toolsmakes it appropriate for a wide variety of Managerial Economics classrooms. Anincreasing number of Business schools are adopting this book to replace (or usealongside) Managerial Strategy texts laden with anecdotes but lacking the micro- economic tools needed to identify and implement the Business strategies that areoptimal in a given seventh edition of Managerial Economics and Business Strategyhas beenthoroughly updated but retains all of the content that made previous editions suc-cessful.

10 The basic structure of the textbook is unchanged. KEY PEDAGOGICAL FEATURESThe seventh edition retains all of the class-tested features of previous editionsthat enhance students learning experiences and make it easy to teach from in previous editions, each chapter begins with a Headlinethat is based on a real-world economic problem a problem that students should be able to address aftercompleting the chapter. These Headlinesare essentially hand-picked mini-cases designed to motivate students to learn the material in the chapter. Each 8/20/09 14:58 Page viiConfirming PagesviiiPreface answered at the end of the relevant chapter when the student is better prepared todeal with the complications of real-world problems. Reviewers as well as users ofprevious editions praise the Headlinesnot only because they motivate students tolearn the material in the chapter, but also because the answers at the end of eachchapter help students learn how to use Economics to make Business ObjectivesEach chapter includes learning objectives designed to enhance the learning ProblemsThe best way to learn Economics is to practice solving economic problems.