Give clear and detailed answers
1. Assume the price of product A increases from $1 to $1.50, while the price of competing
product B increases from $1.50 to $2.00. Based on the information, what we can say about
the absolute and relative price differences between the two products and the relative
attractiveness of the two products to consumers.
2. Assume there is an increase in the price of electricity (which is the result of a decrease in the
supply of electricity), and electricity and natural gas are substitutes. How would this affect
the demand for natural gas, and what would happen to the equilibrium price and quantity of
3. Using a change in supply and/or demand, explain the following phenomena:
a. All else constant, gasoline prices are higher in summer than winter months.
b. At the same time that the quality of personal computers has been increasing, the price of
personal computers has been falling.
4. The demand and supply functions for sweatshirts (the basic grey kind) are as follows:
a. Graph the demand and supply functions for sweatshirts and find the equilibrium price and
b. What effect will an increase in the price of gym shoes (a complement) have on the
equilibrium price and quantity of sweatshirts, all else constant? Illustrate the effect using
c. What effect will a wage increase for workers in the sweatshirt industry have on the
equilibrium price and quantity of sweatshirts, all else constant? Illustrate the effect using
5. Provide a definition of the price elasticity of demand and explain why knowing the price
elasticity for her product is useful to the firm's manager.
6. Summarize the relationship between elasticity, price changes, and changes in total revenue.
7. Explain the difference between the short run and the long run as it relates to the firm's
production function. Why is this distinction important to a firm's manager?
8. Use the following information on a hypothetical short-run production function to answer
Units of Labor/Day
Units of Output/Day
The price of labor is $20 per day. Ten units of capital are used each day, regardless of output
level. The price of capital is $50 per unit.
a. Calculate the marginal and average variable product of each unit of labor input.
b. Calculate total, average total, average variable, and marginal costs.
ANSWER FOR A & B:
c. Can you tell where diminishing marginal returns sets in?
9. Complete the table below, which represents the production costs for a typical firm. (Round
numbers to the nearest tenth.)
At what level of output do diminishing returns set in? How do you know?
10. Economists describe short-run decisions as "constrained" decisions, while long-run decisions
are described as "planning" decisions. Referring to a firm's short-run average cost function
and long-run average cost function, explain this distinction.
11. Explain the basic distinction between microeconomic analysis and macroeconomic analysis.
Assume an individual is considering opening a new car dealership in a medium-sized
metropolitan area (population = 200,000). Provide a list of economic variables you would
recommend that the person consider in making his decision whether to open the business,
and explain your rationale for including each variable.
12. Assume the current price of good X is too high, i.e., it is above the equilibrium price.
Describe the changes that would occur in a market as a result, i.e., explain how the market
would adjust to equilibrium.
13. Illustrate graphically the effect the credit market crisis in the United States in 2008 had in the
market for existing single-family homes. Assuming the demand for existing single-family
homes is relatively inelastic, what is likely to happen to the total revenues of home sellers as
a result of the credit market crisis?
14. Briefly describe the three key points managers must consider when using expert opinion,
consumer surveys, test marketing, and price experiments in analyzing consumer behavior.
15. Florence is considering going into business for herself and has developed the following
estimates of monthly costs and revenues to aid her in her decision-making process. She has
decided to house the business in a building that she already owns, although she could rent the
building to someone else for $1,000 per month. Estimated payments for utilities (electricity,
natural gas, water, and telephone) are $475 per month. She will hire one employee at a total
cost of $1,100 per month. Inventory is estimated to cost $2,800 per month. Finally, Florence
earns $3,000 a month in her current job.
a. How much monthly revenue would Florence have to take in to earn 0 economic profit?
b. Assume that Florence has estimated her monthly revenue to be $9,000. In this case,
Florence would earn an accounting profit (loss) of ________, and an economic profit
(loss) of ________.
c. Assume instead that Florence does not own a building, and that she will have to rent a
building for $1,000 per month (all other estimates remain the same). In this case
(assuming estimated monthly revenue is still $9,000), Florence would earn an accounting
profit (loss) of ________, and an economic profit (loss) of ________.
16. What are the two primary factors that influence a firm manager's choice between a laborintensive and a capital-intensive method of production? How does each factor influence the
17. Explain why a firm should continue to operate in the short run so long as market price is
greater the firm's average variable cost at the profit-maximizing level of output.
18. Describe the basic characteristics of the monopoly model and explain how these
characteristics affect the ability of a monopolist to earn positive economic profits, both in the
short run and over time.
PART 1 Microeconomic Analysis
Managers and Economics
hy should managers study economics? Many of you are
probably asking yourself this question as you open this text.
Students in Master of Business Administration (MBA) and
Executive MBA programs usually have some knowledge of
the topics that will be covered in their accounting, marketing, finance, and
management courses. You may have already used many of those skills on
the job or have decided that you want to concentrate in one of those areas in
your program of study.
But economics is different. Although you may have taken one or two introductory economics courses at some point in the past, most of you are not
going to become economists. From these economics classes, you probably
have vague memories of different graphs, algebraic equations, and terms such
as elasticity of demand and marginal propensity to consume. However, you
may have never really understood how economics is relevant to managerial
decision making. As you’ll learn in this chapter, managers need to understand the insights of both microeconomics, which focuses on the behavior of
individual consumers, firms, and industries, and macroeconomics, which analyzes issues in the overall economic environment. Although these subjects are
typically taught separately, this text presents the ideas from both approaches
and then integrates them from a managerial decision-making perspective.
As in all chapters in this text, we begin our analysis with a case study. The
case in this chapter, which focuses on the global automobile industry, provides an overview of the issues we’ll discuss throughout this text. In particular, the case illustrates how the automobile industry is influenced by both the
microeconomic issues related to production, cost, and consumer demand and
the larger macroeconomic issues including the uncertainty in global economic
activity, particularly in Europe, and the value of various countries’ currencies
relative to the U.S. dollar.
11/08/14 5:17 PM
Case for Analysis
Micro- and Macroeconomic Influences on the Global Automobile Industry
In September 2012, U.S. automobile sales increased to 1.19
million cars and light trucks per month, a 12.8 percent increase
from a year earlier. This increase represented an annualized rate
of 14.94 million vehicles, the highest sales rate since March
2008 before the recession began in the United States. Much of
the increase was driven by passenger car sales at Toyota Motor
Corp., Honda Motor Co., and Chrysler Group LLC. There was
a significant increase in sales for Toyota and Honda from the
previous year, as both companies were recovering from the
earthquake that hit Japan in March 2011.1 Analysts noted similar increases in August 2012 that were attributed to pent-up
consumer demand for replacing aging vehicles and the lowinterest financing and other incentives Japanese auto makers
offered to regain market share lost in 2011 due to the lack of
availability of their cars.2
Automobile production in the United States had expanded
in 2012, given favorable foreign exchange rates and a plentiful supply of affordable labor. Toyota, Honda, and Nissan
Motor Co. all increased their production capacity in the
United States with the goal of shipping automobiles to
Europe, Korea, the Middle East, and other countries. The
strong value of the yen, and conversely the weak U.S. dollar,
gave Japanese producers the incentive to produce cars in the
United States for export around the world. This investment
by foreign automobile producers helped the U.S. economy
that was still struggling to recover from the recession of
2007–2009. Automobile industry employment in the United
States was estimated to increase from 566,400 in 2010 to
756,800 in 2015. Although these estimates were well below
the 1.1 million automobile workers employed in 1999, they
indicated that the economic recovery was moving forward.
General Motors Co., which had once encouraged auto parts
Jeff Bennett, “Corporate News: Passenger Cars Lift U.S. Sales—
Big Gains for Toyota, Honda, Chrysler: Pickup Weakness Weighs
on GM, Ford,” Wall Street Journal (Online), October 3, 2012.
Christina Rogers, “August U.S. Car Sales Surge,” Wall Street
Journal (Online), September 4, 2012.
suppliers to relocate in low-wage countries, now encouraged
them to locate near U.S. auto plants.3
U.S. auto producers, who had once essentially lost the competition to their Japanese rivals in the 1980s and 1990s and
who went through government-backed (GM and Chrysler)
or private (Ford) restructurings during the U.S. recession,
regained profitability and invested in the engineering and redesign of their cars. Several Fords were designed with a voiceoperated Sync entertainment system, and the Chevrolet Cruze
that was launched in 2010 came with 10 air bags compared
with 6 for the Toyota Corolla. As the U.S. economy recovered,
Americans also began purchasing more trucks and sport-utility
vehicles (SUVs), which helped to restore profits and market
share for the Detroit auto makers. Trucks and SUVs made up
47.3 percent of the U.S. market in 2009, 50.2 percent in 2010,
and 50.8 percent in 2011. This segment of the market had been
hit particularly hard during the U.S. recession.4
As the U.S. automobile industry revived, the competition
between Ford and GM again became more intense. In 2008,
Ford supported the government bailout for GM and Chrysler
because Ford was worried that a collapse of these companies
would also impact the auto parts industry. As the domestic
auto industry recovered, Ford, which had often focused just
on Toyota as its key competitor, began developing strategies to
counter GM. Ford realized that customers who had long been
loyal to Asian brands were again looking at U.S. cars, given the
generally perceived quality increases in the U.S. auto industry.5
Joseph B. White, Jeff Bennett, and Lauren Weber, “Car Makers’
U-Turn Steers Job Gains,” Wall Street Journal (Online),
January 23, 2012; Neal Boudette, “New U.S. Car Plants Signal
Renewal for Manufacturing,” Wall Street Journal (Online),
January 26, 2012.
Mike Ramsey and Sharon Terlep, “Americans Embrace SUVs
Again,” Wall Street Journal (Online), December 2, 2011; Jeff
Bennett and Neal E. Boudette, “Revitalized Detroit Makes Bold
Bets on New Models,” Wall Street Journal (Online), January 9,
Sharon Terlep and Mike Ramsey, “Ford and GM Renew a Bitter
Rivalry,” Wall Street Journal (Online), November 23, 2011.
11/08/14 5:17 PM
PART 1 Microeconomic Analysis
Japanese auto makers in 2011 and 2012 faced managerial
decisions that were influenced both by the nature of the competition from their rivals and by macroeconomic conditions,
most importantly the value of the exchange rate between the
yen and the U.S. dollar.6 Production by both Toyota and Honda
was hit by the earthquake and tsunami in Japan in March 2011
and by subsequent flooding in Thailand that disrupted the supply of electronics and other auto parts made there. Toyota sales
were also influenced by the recall and quality issues in 2010
related to the gas pedal and floor mat design. Honda’s redesigned 2012 Civic was criticized for its technology and lessthan-luxurious interior. The car was dropped from Consumer
Reports’ recommended list in August 2011. Honda officials
acknowledged that they had underestimated the competition
from U.S. producers.
The strong yen, which made exports from Japan less price
competitive, also gave the Japanese producers the incentive
to produce their cars in the United States. Honda, which had
produced 1.29 million vehicles in North America in 2010,
planned to open a new plant in Mexico and expand production in all seven of its existing assembly plants to 2 million
cars and trucks per year. Production abroad was a particular issue for Toyota, which made half of its automobiles
in Japan, compared to Honda and Nissan, which produced
about one-third of their output in Japan. The president of
Toyota, Akio Toyoda, grandson of the company founder, had
made a public commitment to build at least 3 million cars
in Japan annually, half of which would be for export. Some
company officials argued for streamlining production in
Japan by decreasing production without raising costs, essentially redefining the economies of scale in the company’s
production process. These officials believed the company
could meet domestic goals with high-precision production,
cost-cutting, and collaboration on new technology with parts
Auto producers also focused on China during this period,
although there was concern about the slowing Chinese economy.7 Auto sales in China increased only 2.5 percent in 2011
compared with increases of 46 percent in 2009 and 32 percent
The following discussion is based on Jeff Bennett and Neal
E. Boudette, “Revitalized Detroit Makes Bold Bets on New
Models”; Mike Ramsey and Yoshio Takahashi, “Car Wreck:
Honda and Toyota,” Wall Street Journal (Online), November 1,
2011; Chester Dawson, “For Toyota, Patriotism and Profits May
Not Mix,” Wall Street Journal (Online), November 29, 2011;
Mike Ramsey and Neal E. Boudette, “Honda Revs Up Outside
Japan,” Wall Street Journal (Online), December 21, 2011; and
Yoshio Takahashi and Chester Dawson, “Japan Auto Makers on
a Roll,” Wall Street Journal (Online), April 22, 2012.
This discussion is based on Andrew Galbraith, “Car Makers
Still Look to China,” Wall Street Journal (Online), April 19,
2012; Sharon Terlep and Mike Ramsey, “Ford Bets $5 Billion on
Made in China,” Wall Street Journal (Online), April 20, 2012;
Chester Dawson and Sharon Terlep, “China Ramps Up Auto
Exports,” Wall Street Journal (Online), April 24, 2012; and
Sharon Terlep, “Balancing the Give and Take in GM’s Chinese
Partnership,” Wall Street Journal (Online), August 19, 2012.
in 2010. However, the size of the Chinese economy continued to be the major incentive for expansion in that country. In
April 2012, Ford announced that it would build its fifth factory in eastern China as part of its plan to double its production capacity and sales outlets in the country by 2015. This
production increase would make the company capable of
producing 1.2 million passenger cars in China, approximately
half of the number of cars it built in North America in 2011.
Ford lagged behind other major auto producers in entering
the world’s largest car market. Ford’s strategy was to build
cars from platforms developed elsewhere to minimize costs.
However, these platforms might not provide enough space
in the back seats to appeal to affluent Chinese, who often
employed drivers. General Motors developed a partnership
with Chinese SAIC Motor Corp. to become the dominant foreign competitor in China. This partnership resulted in production changes such as designing Cadillacs with softer corners,
dashboards with more gadgets, and increasing the comfort of
the rear seats to appeal to Chinese consumers. The challenge
for GM was that SAIC could also use GM’s expertise and
technology to make itself a major competitor with the U.S.
company. In 2012, the Chinese automobile industry began
increasing exports, although these were not thought to be a
threat in developed markets in the United States and Europe,
given perceived quality issues including lack of air-conditioning and power windows. However, Chinese producers were
making inroads into emerging markets in Africa, Asia, and
The other major influence on the global auto industry in
2011 and 2012 was the recession and economic crisis in
Europe.8 In October 2012, Ford announced a plan to cut its
operating losses in Europe by closing three auto-assembly and
parts factories in the region, reduce its workforce by 13 percent, and decrease automobile production by 18 percent. Ford
predicted a loss of $1.5 billion in Europe in 2012 and a similar
loss in 2013. The cost-cutting in Europe was combined with
the introduction of several new commercial vans and SUVs and
the introduction of the Mustang sports car for the first time. All
European auto makers faced decreased car sales and chronic
overcapacity at this time. Daimler AG, maker of MercedesBenz automobiles, announced that it would not achieve its
profit targets, while PSA Peugeot Citroen SA announced a
government bailout of its financing arm and a cost-sharing
pact with General Motors. There had been a smaller decrease
in auto-producing capacity in Europe since the 2008 financial
crisis compared with that during the restructuring of the U.S.
auto industry that was influenced by the federal government
This discussion is based on Sharon Terlep and Sam
Schechner, “GM, Peugeot Take Aim at Europe Woes,” Wall
Street Journal (Online), July 12, 2012; Mike Ramsey, David
Pearson, and Matthew Curtin, “Daimler Warns as Europe Car
Makers Cut Back,” Wall Street Journal (Online), October 24,
2012; and Marietta Cauchi and Mike Ramsey, “Ford to Shut
3 Europe Plants,” Wall Street Journal (Online), October 25,
11/08/14 5:17 PM
CHAPTER 1 Managers and Economics
Two Perspectives: Microeconomics
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