Contents in Brief Preface Page v PART 1 INTRODUCTION 1 Chapter 1 Nature and Scope of Managerial Economics and Finance 3 Chapter 2 Equations, Graphs and Optimisation Techniques 21 Chapter 3 Demand, Supply and the Market 39 Appendix: Review of Basic Economic Concepts 127 PART 2 DEMAND ANALYSIS AND ITS APPLICATIONS 57 Chapter 4 Consumer Behaviour 59 Appendix A: Consumer and Producer Surplus 127 Appendix B: Marshallian & Hicksian Demand Curves 127 Chapter 5 Elasticity of Demand 89 Chapter 6 Demand Estimation 111 Chapter 7 Demand Forecasting 111 PART 3 THE FIRM AND PRODUCTION DECISIONS 131 Chapter 8 Theory of the Firm and Profits 133 Appendix A: Entrepreneurs and Entrepreneurship 147 Appendix B: Business Ethics and Corporate Social Responsibility 147 Chapter 9 Production Theory and Estimation 151 Chapter 10 Cost Theory and Estimation 151 Appendix: Supply Chain Management 171 PART 4 PRICING DECISIONS & STRATEGY IN VARIOUS MARKET STRUCTURES 179 Chapter 11 Profit Maximisation: The Basic Rules 181 Chapter 12 Perfect Competition and Monopoly 193 Chapter 13 Monopolistic Competition and Oligopoly 215 Chapter 14 Models of Oligopoly Behaviour 171 Chapter 15 Special Pricing Practices 233 Chapter 16 Game Theory & Competitive Business Strategy 233 PART 5 ISSUES IN MANAGERIAL FINANCE 251 Chapter 17 Time Value of Money 269 Chapter 18 Capital Budgeting 253 Chapter 19 Cost of Capital and Valuation Methods 269 Chapter 20 Financial Ratio Analysis 253 Chapter 21 Decisions under Risk and Uncertainty 253 INTEGRATING CASE STUDIES 570 Case Study 1 Managing Football Clubs in Cyprus 571 Case Study 2 Managing in the Digital Domain 571 Appendixes 575 Present Value Statistical Tables 576 Answers to Odd-Numbered True-False Questions 579 Answers to Odd-Numbered Multiple Choice Questions 581 Glossary of Economic/Financial Terms 585 Subject Index 588
Preface About the Author Contents in Detail Page v xi PART 1 INTRODUCTION 1 Chapter 1 Nature and Scope of Managerial Economics & Finance 3 Learning outcomes 3 Preview 3 Lessons from the recent economic recession 4 Current economic issues 4 Managerial economics and finance 6 Economic theory 7 Finance theory 8 Management theory 9 Integrating economics with finance and management 7 Economic models and tools of analysis 8 The role of profits Profit maximisation 8 Maximisation of shareholder value 9 Structured framework for decision making 9 The integrating nature of managerial economics 10 Study Questions 15 Chapter 2 Equations, Graphs and Optimisation Techniques 21 Learning outcomes 21 Preview 21 Working with Models, Equations & Graphs 39 Models and theories 21 The role of mathematics in managerial economics 22 Plotting pairs of numbers 23 Expressing economic relationships 26 Algebraic functions and equations 26 Tables (or schedules) 26 Graphs 26 Inverting linear demand equations 29 The slope of a linear curve 29 Deriving a linear equation from data 29 Linear and non-linear functions 29 Slope of a non-linear curve 29 Percentage changes 29 Ratios 29 Scatter diagrams 29 Total, average and marginal values 29 Solving quadratic equations 29 Solving systems of equations 29 Optimisation Techniques 39 The slope and the derivative 32 Rules of differentiation 32 Constant function rule 32 Power function rule 32
Sums and differences rule 32 Product rule 32 Finding a maximum or a minimum 33 Distinguishing between maxima and minima 33 Partial derivatives 33 Constrained optimisation 33 Substitution method 33 Lagrangean method 33 Study Questions 33 Chapter 3 Demand, Supply and the Market 59 Learning outcomes 59 Preview 59 The market 59 Modern markets 59 An overview of market structures 60 The Law of Demand 61 Definition of the law of demand 62 Distinction between willingness to buy and ability to pay 62 Distinction between demand and quantity demanded 62 The ceteris paribus concept 62 The individual demand schedule 62 Drawing the individual demand curve 62 The substitution and income effects 63 The market demand 63 The market demand schedule 63 Deriving the demand equation from demand schedule/curve 63 Inverting the demand equation 63 Drawing the market demand curve 64 Non-price determinants of demand 65 Shift of the market demand curve 67 Changes in demand vs. changes in quantity demanded 68 The Law of Supply 69 The market supply schedule 69 The market supply curve 69 Non-price determinants of supply 70 Shifts in the supply curve 71 Market Equilibrium 72 The simple math of equilibrium 73 Disequilibrium situations 73 Situations of surplus 73 Situations of shortage 73 Changes in demand causing disequilibrium 76 Changes in supply causing disequilibrium 77 Simultaneous changes in demand and supply 77 Market interventions by governments 78 Minimum prices: EU farm support programmes 78 Maximum prices: Rent controls programmes 78 Study Questions 80
PART 2 DEMAND ANALYSIS AND ITS APPLICATIONS 57 Chapter 4 Consumer Behaviour 111 Learning outcomes 111 Preview 111 The Consumption Preferences 112 Utility analysis 112 Marginal utility 113 Law of diminishing marginal utility 114 The Consumption Possibilities 115 The budget line (income constraint) 115 Budget equation 116 Real income and slope 116 Changes in income 116 Changes in prices 117 Utility maximisation 118 Substitution and income effects 119 Derivation of the consumer s demand curve 120 Derivation of the market demand curve 121 Indifference Curve Analysis 127 Indifference curves 127 Assumptions about rational choice 127 Marginal rate of substitution 127 Consumer equilibrium 128 Perfect substitutes and perfect complements 128 Study Questions 122 Appendix A: Consumer and Producer Surplus 147 Consumer Surplus 147 Reservation price 147 Utility gains (money equivalent) 147 Consumer surplus 147 Changes in consumer surplus 147 Impact on consumer surplus due to monopolist intervention 147 Impact on consumer surplus due to government intervention 147 Producer surplus 147 Changes in producer surplus 147 Study Questions 122 Appendix B: Marshallian and Hicksian Demand Curves 147 The alternative approaches by Marshall and Hicks 147 Derivation of the Marshallian demand curve 147 Derivation of the Hicksian demand curve 147 Study Questions 122 Chapter 5 Elasticity of Demand 89 Learning outcomes 89 Preview 89 Price Elasticity of Demand 89 Calculating price elasticity 90 Elastic and inelastic demand 90 Arc price elasticity 93 Point price elasticity 94
Point price elasticity using the derivative form 94 Real world price elasticities 94 Determinants of price elasticity 94 Price elasticity and total revenue 96 Price reduction in elastic region of demand curve 96 Price reduction in inelastic region of demand curve 96 Optimal pricing policy 96 Income Elasticity 99 Income elasticity using the derivative form 94 Normal, luxury and inferior goods 94 Cross-Price Elasticity 100 Business applications of demand elasticity 100 Study Questions 103 Chapter 6 Demand Estimation 89 Learning outcomes 89 Preview 89 Correlation analysis and dependence 90 Correlation coefficient 93 Dependent and independent variables 94 Regression Analysis 94 A first approximation: Scatter plots 94 An improvement: Line of best fit 94 Formal estimation method: Regression analysis 94 Regression results 94 Interpretation of regression results 94 Parameter estimates 94 Intercept and slope 94 Tests of significance 94 t-statistic 94 p-value 94 Coefficient of determination (R 2 ) 94 Coefficient of correlation 94 F-statistic 94 Prediction based on regression results 94 Price elasticity and total revenue 96 Multiple Regression Analysis 99 Interpretation of results 99 Dummy Variables 100 Problems in regression analysis 100 Steps in estimating economic relationships 100 Functional forms of regression equations 101 Marketing approaches to demand equation 101 Study Questions 103 Chapter 7 Demand Forecasting 89 Learning outcomes 89 Preview 89 Estimation vs. Forecasting 89 Level / hierarchy of forecasts 90 Forecasting Techniques 93 Qualitative forecasting techniques 94 Quantitative forecasting techniques 94
Linear trend method 94 Seasonality adjustment methods 94 Seasonal adjustment with dummy variables 96 Smoothing Techniques 99 Moving averages 99 Exponential smoothing 99 Forecasting with Business Cycles Indicators 100 Econometric Forecasting 100 Study Questions 103 PART 3 THE FIRM AND PRODUCTION DECISIONS 131 Chapter 8 Theory of the Firm and Profits 133 Learning outcomes 133 Preview 133 Business organisations 133 Limited and unlimited liability companies 133 Some accounting concepts 134 Stocks vs. flows 134 The firm and its functions 135 The rational firm 135 Objectives of the firm 136 Maximisation theories 136 Profit maximisation 136 Revenue maximisation 136 Maximisation of shareholder value 136 Non-maximisation theories 137 Satisficing behaviour of the firm 137 Profit as part of a set of goals 137 Corporate social responsibility (CSR) 137 Summary evaluation of profit maximisation theories 137 Economic profits vs. accounting profits 138 Diverse profitability indicators 138 Theories of Profit 140 Risk-bearing theory of profit 140 Frictional theory of profit 140 Market power theory of profit 140 Innovation theory of profit 140 The role of profits in the economy 141 Study Questions 142 Appendix A: Entrepreneurs and Entrepreneurship 147 Learning outcomes 147 Introduction 147 Defining entrepreneur and entrepreneurship 147 Personality characteristics of entrepreneurs 149 Appendix B: Business Ethics and Corporate Social Responsibility 147 Learning outcomes 147 Preview 147 Business ethics 147 Ethical responsibilities of businesses 149
Corporate social responsibility (CSR) 149 The CSR debate 149 The case against CSR 149 The case in favour of CSR 149 Mechanisms and practices to promote ethical behaviour 149 Chapter 9 Production Analysis and Estimation 151 Learning outcomes 151 Preview 151 The production function 152 The short run (SR) and the long run (LR) 152 The SR production function: One variable input 153 The law of diminishing marginal returns 155 Stages of production 155 Optimal use of the variable input 156 Long-run production function: Two variable inputs 156 Isoquant analysis 156 Marginal rate of technical substitution 171 Isocosts 172 Isocost equation 173 Optimal combination of inputs 175 Optimisation rule 159 Study Questions 164 Chapter 10 Cost Analysis and Estimation 151 Learning outcomes 151 Preview 151 Relevant costs 156 Incremental and sunk costs 156 Implicit and explicit costs 156 Short run costs 157 Graphical representation of costs functions 159 Functional forms of costs equations and curves 159 Linear cost functions 159 Quadratic cost functions 159 Empirical cost functions 159 Putting production and costs curves together 159 Long run costs & optimal input combination 159 Returns to scale 159 Reasons for economies and diseconomies of scale 160 Minimum efficient scale 161 Measuring efficiency and input productivity 161 Economies of Scope 161 The Learning Curve 162 Strategic cost analysis and cost minimisation 162 Study Questions 164 Appendix: Supply Chain Management 171 Business change drivers 171 Supply chain 171 Supply chain management (SCM) 172 SCM objectives and efficiency 173 Benefits of supply chain management 175 Study Questions 176
PART 4 BUSINESS DECISIONS & STRATEGY IN DIFFERENT MARKET STRUCTURES 179 Chapter 11 Profit Maximisation: The Basic Rules 181 Learning outcomes 181 Preview 181 Profit Maximisation 181 Revenue variables 181 Relationship between AR and MR 181 Cost variables 181 Assumptions of the basic profit maximisation model 181 Profit maximisation using total revenue and total cost 182 Profit maximisation using marginal revenue and marginal cost 183 Shutdown points 185 Revenue Maximisation 185 Break-even Analysis 186 Algebraic form of break-even analysis 186 Scenario analysis 188 Margin of safety 188 Break-even analysis with a targeted level of profits 189 Application of break-even analysis to retail shops 189 Managerial uses of break-even analysis 189 Degree of operating leverage 189 Study Questions 189 Chapter 12 Decisions in Perfect Competition and Monopoly 193 Learning outcomes 193 Preview 193 Overview of Characteristics of Market Structures 193 PERFECT COMPETITION 195 Output Determination under Perfect Competition 195 Determination of market equilibrium price 196 The horizontal demand curve of the firm in perfect competition 196 Profit maximisation in the short run 199 Profit maximisation using TR & TC 199 Profit maximisation using MR & MC 199 Loss-making firm in perfect competition 199 Shut down for loss making firm in the SR 201 Deriving the firm s short run supply curve 201 Long Run Equilibrium in perfect competition 201 MONOPOLY 203 Barriers to entry 203 Demand conditions under monopoly 203 Profit maximisation under monopoly 205 Loss-minimisation under monopoly 205 Comparison of perfect competition with monopoly 206 Study Questions 207
Chapter 13 Decisions in Monopolistic Competition and Oligopoly 215 Learning outcomes 215 Preview 215 MONOPOLISTIC COMPETITION 216 Product differentiation 216 Profit maximisation in monopolistic competition 216 Market efficiency and excess capacity 218 OLIGOPOLY 219 Barriers to entry 219 Market concentration 223 Interdependent actions and strategies 220 Non-price competition 222 Cartels: Collusive oligopoly 224 Joint-profit maximisation by a cartel 226 Contestable markets 226 Strategic entry deterrents 226 Globalisation 226 Study Questions 226 Chapter 14 Models of Oligopoly Behaviour 215 Learning outcomes 215 Preview 215 The Kinked-Demand Curve Model 220 Short run profit maximisation in Oligopoly 221 The Cournot Model of Duopoly 216 Assumptions of the Cournot model 216 Outcome of the Cournot duopoly 216 Cournot-Nash equilibrium 216 General equilibrium condition of the Cournot model 216 Comparing outcomes in perfect competition, monopoly and duopoly 216 The Bertrand Model of Duopoly 216 Bertrand equilibrium 216 Brief comment about the Stackelberg model 218 Study Questions 226 Chapter 15 Special Pricing Practices 233 Learning outcomes 233 Preview 233 Mark-up pricing (Cost-plus pricing) 236 Comparison of marginal pricing with mark-up pricing 236 Price Discrimination 234 Examples of price discrimination 235 Degrees of price discrimination 234 a) First degree price discrimination 234 b) Second degree price discrimination 234 c) Third degree price discrimination 234 Prerequisite conditions for third-degree price discrimination 235 Price leadership model 238 Limit pricing 238 Predatory pricing 238 Life-Cycle pricing strategies 237 Other pricing practices 239 a) Tying and Bundling 239
b) Peak Load pricing 239 c) Two-Part Tariff 239 Study Questions 226 Chapter 16 Game Theory and Business Strategy 241 Learning outcomes 233 Preview 233 Game theory conceptual framework 233 Payoff matrix and dominant strategy 241 Nash equilibrium 242 Competition, cooperation and prisoners dilemmas 242 Repeated games and tit-for-tat 244 Credible threats and commitment 244 Strategic entry deterrents 244 Study Questions 245 PART 5 ISSUES IN MANAGERIAL FINANCE 251 Chapter 17 Time Value of Money 253 Learning outcomes 253 Preview 253 Interest rates, compound and future value of money 254 Discounting and the present value 255 Present value of an annuity 255 Indirect method 256 Direct method 256 Present value of perpetuity 257 Study Questions 263 Chapter 18 Capital Budgeting 269 Learning outcomes 269 Preview 269 Business situations for capital investments 270 Capital budgeting 270 The capital budgeting process 270 Projecting cash flows 271 Time value of money 273 Present value 274 Net present value (NPV) 274 Capital rationing and the profitability index 276 Internal rate of return (IRR) 276 Payback period method 277 Risk-adjusted valuation method 278 Certainty-equivalent valuation method 278 Study Questions 287 Chapter 19 Cost of Capital & Valuation Models 295 Learning outcomes 295 Preview 295 Cost of debt capital 296 Cost of equity capital 296
DIVIDEND DISCOUNT MODEL (DDM) 297 (a) Constant growth model 300 (b) Multi-stage non-constant growth model 301 Weaknesses of the dividend discount models 302 Weighted average cost of capital (WACC) 302 WACC with tax deductibility of interest 302 EARNINGS VALUATION MODELS 302 (1) Combined earnings and dividend model 303 (2) Price-earnings (PE) model 304 ASSET VALUATION MODELS 304 Estimating the returns of individual securities 306 Estimating the value of beta 307 The capital asset pricing model (CAPM) 309 Arbitrage pricing theory (APT) 310 Study Questions 312 Chapter 20 Financial Analysis 321 Learning outcomes 321 Preview 321 The Financial Reports 327 Income statement 322 Balance sheet 322 The asset section 322 The liabilities section 322 The shareholders equity section 324 The statement of cash flows 324 Financial Ratio Analysis 327 (1) Liquidity ratios 327 (2) Profitability and use of assets ratios 328 (3) Financial risk ratios 329 (4) Evaluation of earnings to shareholders ratios 329 Study Questions 334 Chapter 21 Decisions under Risk and Uncertainty 347 Learning outcomes 347 Preview 347 Risk and uncertainty 348 Probability 348 Measurement of risk 349 (1) Standard deviation 353 (2) Variance 353 (3) Coefficient of variation 353 (4) Covariance of returns 353 Calculating the expected rate of return 353 Probability and probability distributions 354 Individual choice, utility and risk aversion 354 Individuals and their risk tolerance 355 Marginal utility of money 356 Risk and expected utility 356 Trade-off between current and future consumption 356 Determinants of the required rate of return 357 Risk premium 357
Risk-adjusted valuation model 358 Risk and diversification 359 Study Questions 362 INTEGRATING CASE STUDIES 570 Case Study 1 Managing Football Clubs in Cyprus 571 Case Study 2 Managing in the Digital Domain` 571 Appendixes 575 Present Value Statistical Tables 576 Answers to Odd-Numbered True-False Questions 579 Answers to Odd-Numbered Multiple Choice Questions 581 Glossary of Economic/Financial Terms 585 Subject Index 588