ManEc 300
Day 1
Bryson
1. This daily outline is subject to revision
and upgrading. It might be wise to rely
on the syllabus as an agenda
2. Review syllabus
3. On the significance of economics.
Review Power Point presentation on the
methodology and power of
microeconomics
ManEc 300
Day 1
Bryson
(Cont’d)
3. Personal introduction and testimony
4. Feedback on concerns. What concerns do
you have about ManEc 300?
Course Objective I: Help you understand the firm
in its competitive environment and its internal
organization by mastering these concepts.
My objectives will be
achieved by
understanding.
 Bounded rationality and
private information
 Central economic
planning vs. markets.
 Competitive markets
 Competitive advantage
 How markets work
 Elasticities
 Isoquants and Isocost
curves
 Industrial regulation
 Isoquants and isocosts
 Coordination and
motivation in
organizations
Course Objective II: Help you gain the conviction
through class activities that all these concepts are
useful in application.
 Mathematics and Micro-economics
 Market models: competition and imperfect
comp.
 Contracting and opportunistic behavior
 Performance Incentives
 Porter’s five competitive forces. Strategy and
Economics
 Production and Costs
 Property Rights and Ownership
For Tomorrow’s (Second) Session
 Look over syllabus
 Read Chap. 1, pp. 14-19, 34-39,
Chapter 3 and Chapter 4.
 Get accustomed to web site
 See online: Markets, 300.ppt
ManEc 300
Day 2
Bryson
1. Make seating chart
2. Discuss student presentations
(Review syllabus)
3. Introduce TA for the course,
Plarent Sinamati
sinamati@hotmail.com
4. Sign up for The Wall Street
Journal
ManEc 300
Day 2
Bryson
Discuss markets and the market
economy by reviewing concepts in
“Markets, 300”
Non-price variables
Substitute products
Change in supply
Equilibrium
Consumer surplus
Market automaticity
Demand curve
Ceteris paribus
Change in q supplied
Surplus/shortage
Producer Surplus
Government intervention
ManEc 300
Day 2
Bryson
 Review of first text reading assignment
and Markets, 300.ppt.
 Look at the end of Chapter 4, “Demand
Estimation.”
 Review Econometrics.ppt
For Tomorrow’s (Third) Session
Finish reading (or review) chapter 4 and
brush up on elasticities
No quizzes yet. Just do the homework
assignment due on Thursday.
TEAMS, Summer, 2004
Group 1: CEO Compensation
Scott Brinkerhoff, Jason Greenwood,
Rob Murtagh, Jonathan Nielsen
Group 2: Intellectual Property Rights
Hayden Arnold, Shaun Bailey, Sunne
Drinkwater, David Stevens
Group 3: K-Mart
Bryan Barney, Brian Cooley, Andrea Everts,
David Jensen
TEAMS, Summer, 2004
Group 4: Microsoft as a Monopoly
Nathan Palki, Travy Ka Ying Wong, Sabrina Wu,
Sandra Woodruff
Group 5: Apple Computers and Technology
Corey Davis, Aubrey Duncan, Rich Hamilton, Will
Kearl
Team Organization
 Introductions. Choose team
spokesman. Exchange phone
numbers, etc.
 Team meeting time.
 Team name?
Team Organization
Choose three issues your team would
like to present. If there are no
conflicts, you will be assigned your
first preference.
o Choose a major firm and explain its
strategies and describe its
performance,
o Describe the problems of an entire
industry,
o Talk about an important problem in
the environment of the economy or
Team Organization




Spokesman.
Meeting time.
Team name?
Select presentation topic priorities:
Choose three issues to present. If there
are no conflicts, you will be assigned
your first choice.
o A major firm
o An industry,
o An important micro problem
ManEc 300
Day 3
Bryson
 Elasticity, Alfred Marshall
• Consumer response to price
change
• ($1 off on gum/washing machine)
 ∆p0, ceteris paribus
 The Definition
%∆Quantity
%∆Price
ManEc 300
Day 3
Bryson
 Another way to write that
 ∆Q x 100
Q (mean)
∆P x 100
P (mean)
 or, point elasticity is: η = (P/Q)(dq/dp)
%∆Quantity
%∆Price
∆Q x 100
Q (mean)
∆P x 100
P (mean)
 = -[∆Q/(Q1+Q2)/2] /
[∆P/P1+P2)/2]
P2=40
=-[-67/(200+133)/2] /
[10/(30+40)/2]
P1=30
= 1.4
Q1=133
Q2=200
or, point  = (P/Q)(dq/dp)
ManEc 300
Day 3
Bryson
4. Elasticity and revenues
 >1
P TR 
Inelastic  <1
P TR 
5. Elastic
Unitary
 =1 TR max
*Diagrams showing each as well as
summary diagram
“Elastic”:  >1
P TR 
“Inelastic”:  <1 P TR 
Unitary:  =1
TR max
Summary diagram
s, Elasticity of Supply
%∆ in Q supplied
%∆ in price
(∆Q/Q)/(∆P/P) Note positive sign
Cross  of Demand
(∆Qx/Qx)
% change in Q of X
% change in P of Y
(∆Py/Py)
+ sign: substitutes
- sign: complements
Closer relationships indicated by higher  coefficient
Income  of Demand
(∆Qx/Qx)
% change in Q of X
% change in income
I
neg
(∆I/I)
zero
low
unit
High (i>1)
Q
For tomorrow’s (fourth) session
1. Review Power Point Presentation:
Markets vs. Hierarchies (“Hierarchies”)
2. Complete first homework assignment, which
is due tomorrow.
3. For subscribers, the Journal is available
on line.
When it starts to come, get on line and go to
http://services.wsj.com/ Enter your account
number, which is on the address sticker.
ManEc 300
Day 4
Bryson
See Power Point Presentation:
Markets vs. Hierarchies
(“Hierarchies”)
Day 4
For the next (5th) Session
 See Power Point presentation:
The Firm’s Coordination of Plans and
Activities (“Firm Coordination”)
Be prepared in class to discuss or take a quiz
on the following:
Should there be market coordination within the
corporation?
What are design attributes?
Firms don’t always have dispatchers or
coxswains, so what organizational problem
do they have?
Day 4 (Cont’d)
Preparation for next session
What problems of information flow does the
firm have in its planning? What is
brittleness?
When can the firm not rely on organizational
routine for proper functioning of productive
processes?
How do economies of scale and scope affect
the firm’s coordination?
ManEc 300, Day 5
Review Questions from Session 4
What problems of information flow does the firm have
in its planning? What is brittleness?
When can the firm not rely on organizational routine
for proper functioning of productive processes?
How do economies of scale and scope affect the
firm’s coordination?
What problems of information flow does the firm have
in its planning? What is brittleness?
When can the firm not rely on organizational routine
for proper functioning of productive processes?
How do economies of scale and scope affect the
firm’s coordination?
ManEc 300
Day 5, cont.
 Review “The Principle-Agent Problem”
 For tomorrow, you should be well into
the reading of Chapter 5 of the text.
When you get a chance, review Coase
and transactions costs. (See the last
part of Chapter 4 and the ppt, “Markets
vs. Hierarchies”).
ManEc 300
Day 6
Bryson
The Neo-classical Theory of the Firm,
Part II, Production and costs.
Start with an unspecified production
function:
Q = f(a,b,...n) = f(X1, X2,…Xn)
ManEc 300
Day 6
Bryson
A specific production function may
appear as suggested in the text.
Q = S1/2 A1/2,
where S = steel and A = Aluminum.
Reminder: S1/2 =S and S1/n = n S
Production Functions and costs.
Law of Diminishing Returns: holding all
inputs constant but one, increasing
variable inputs will give rise first to
increasing returns, but ultimately,
additional units of the input will bring less
than proportional returns.
Production Functions and costs.
Diminishing returns can be shown by
exponents that add to less than one.
S1/2(S 1/2) = S
S1/3(S 1/3) = S2/3
Stages of Production
 Begin with a Total Product (TP) curve.
With two geometric “tricks,” find
Average Product (AP) and Marginal
Product (MP) curves. Discuss these
concepts.
 Relationship between average and
marginal values.
Stages of Production
 At boundary of stages I/II, AP = MP, at
boundary of stage II/III, MP = 0. Discuss
other characteristics.
 Why we produce in stage II of
production.
Geometric Trick 1
Holding land constant and adding labor
leads to a growth of TP until diminishing
returns set in. APL = TP/labor. MPL = the
change in TP when labor (a) increases by
1 unit. Geometrically, APL = TP/a or the
slope of a ray from the origin, intersecting
the TP curve at some level of output.
Geometric Trick 1
Land Labor TP
1
1
1
1
1
1
1
1
1
1
0
1
2
3
4
5
6
7
8
9
APL
0
0
2
2
5
2 /2
9
3
12
3
14
2 4/5
15
2 1/2
15
2 1/7
14
1
12 3/4
1
1/3
MPL
..
2
3
4
3
2
1
0
-1
-2
Geometric Trick 1, the old ray from
the origin trick.
 Slope = rise/run =
T/a
 APL = TP/a
 Draw a ray from O
through the relevant
point on the TP
curve.
 Notice that this
slope rises to point
E, then falls again at
larger outputs.
Geometric Trick 2,
the old tangency trick.
MPa = ∆TP when we
use one more unit of a.
MPa = ∆TP/∆Q
Geometric Trick 2,
the old tangency trick.
Find the slope of TP at
a given output to
determine the MPa at
at that output.. Find the
slope geometrically by
drawing a tangent line
to the TP curve at the
interesting output.
The Stages of Production
Let us
 draw these and
 conclude by showing why we operate in
Stage II of production. In stage I, we
keep going for more inputs because it
results in growing average and marginal
productivity. In stage III we are
experiencing diminishing returns
(negative MPa)
ManEc 300
Day 7
Bryson
Review of Costs
1. Show: TVC, TFC, TC
What are these?
What are their slopes?
ManEc 300
Day 7
Bryson
2. Review two geometric tricks:
1. Find SR: AVC, AFC, AC,
2. Find MC.
3. Relationship between average and
marginal values.
Total Costs
At first, TVC and TC
rise gradually, Q rises
faster than cost
because of increasing
returns.
Then, TVC and TC
rise rapidly. Costs rise
faster than output
because of diminishing
returns.
Average variable, average total costs
We can find the average
costs from the totals,
using geometric trick #1,
the old ray trick.
Draw a ray from the
origin through a point on
the TC or TVC curve.
The slope of the ray is
the average cost
Average variable,
average total costs
(Rise/Run = TC/Q =
AC.
First it declines
(increasing returns,
then rises
(diminishing returns.
Marginal Costs
Marginal cost is the
change in TC or TVC
when output is
increased by one unit.
Or, it is the slope of TC
or TVC. Therefore, we
can find it by taking the
derivative of a TC
function.
Marginal Costs
Or, we can use geometric
trick #2, the old tangency
trick. Draw a tangency to
the TC (or TVC) curve.
The slope of the tangent
is MC. First, MC declines
(increasing returns), but
ultimately rises
(decreasing returns).
Relate AVC to APP
 Note that the APP rises and falls in
correspondence with the decline, then
increase of AVC. AP increases (AVC)
falls as increasing returns to the
variable factor occurs.
 But as diminishing returns set in, APP
falls, which means that AVC rises.
ManEc 300
Day 7
Prof. Bryson
(Cont’d)
Discuss LR Costs
1. No fixed factors
2. Unlimited number of conceptual
SRAC curves
ManEc 300
Day 7
Prof. Bryson
(Cont’d)
Discuss LR Costs
3. Envelope curve
4. “For any output, min cost by using
the scale of plant whose SRAC curve is
tangent to the LRAC curve.”
ManEc 300
Day 7
Bryson
(Cont’d)
5. Why is it U-shaped?
Economies of scale vs. Law of
diminishing returns
Economies of scale: division and
specialization of labor, advanced
technology, large machines, digitalization
and electronics.
Diseconomies of scale: control and
coordination problems
ManEc 300
Day 7
Bryson
(Cont’d)
6. Learning curve 7.
7. Four LRAC curves
Textbook U
(Range of) constant returns
Constant returns through replication
Continually increasing returns
ManEc 300
Day 7
Bryson
(Cont’d)
For the next session, review pp.
111-117 on Isoquants and
Isocost lines.
ManEc 300
Episode 8
Bryson
Isoquant/Isocost approach to
production, trade, equilibrium and
efficiency.
ManEc 300
Episode 8
Bryson
Isoquants--purpose for use
Get up to speed on diagrams.
Tight logic (and math) vs.
Scientists prize
-- skepticism,
-- rigorous reasoning, and
-- empirical experimentation.)
Learning Objectives
Appreciate and understand
Tradeoffs
Budget constraints
Logic of maximization
Representation of efficiency
Get ready for a quiz next session on the
production box.
ManEc 300 Day 8 (Cont’d)
The analysis
1. Intuition on isoquants:
Movement NE = improvement.
Discovering substitutability of inputs.
MRTSlk = ∆ K/ ∆ L
one unit of L will compensate.
ManEc 300 Day 8 (Cont’d)
The analysis
2. Characteristics of isoquants
a. No intersection
b. Downward slope
MRTSlk = amount of K lost for which
one unit of L will compensate.
Budget line
Total Cost = C = wL + rK
Rewrite:
rK = C - wL
K = C/r - (w/r)L
Intercept 

ratio of factor
prices = slope of
budget line
Budget line
Slope of isoquant =
MRTSlk = MPl/MPk = ∆ K/ ∆L
Discuss diminishing MRTSlk Notion
of tradeoff
∆Q = MPl(∆L) ∆Q = MPk(∆K)
ManEc 300
Day 8
Bryson
On the isoquant
MPl (∆ L) + MPk(∆K) = 0
At equilibrium
Slope of Isoquant = Slope of isocost
ManEc 300
Day 8
Bryson
Mpl /MPk = w/r
Mpl /w = MPk/r
(Mpl /Pl = Mpk/Pk)
4. Show changing slope of isocost line
5. Show changing isocost line (shift when
budget changes)
ManEc 300
Day 9
Bryson
Preparation for quiz on isoquants and
the Edgeworth Box:
1. Review the effect of price changes
2. Explain the Edgeworth-Bowley Box
Trading from any point off the
contract curve to a point on the contract
curve.
ManEc 300
Day 9
Bryson
Preparation for quiz on isoquants and
the Edgeworth Box:
3. Gains of trade.
Efficiency is being on the contract
curve.
ManEc 300
Day 9
Bryson
(Cont’d)
4. How does one move on the
contract curve?
Theft, violence, opportunism-Elaborate according to time on
“economic man” as rational
optimizer vs. more modern
problem of opportunism.
ManEc 300
Day 9
Bryson
(Cont’d)
Contrast utility maximization to
opportunism
5. Show connection of points on
the contract curve to points on
PPF.
Begin with a Total Product (TP) curve. With
two geometric “tricks,” find Average Product
(AP) and Marginal Product (MP) curves.
Discuss these concepts.
Relationship between average and
marginal values.
Show TP, AP, and MP Diagram
At boundary of stages I/II, AP = MP, at
boundary of stage II/III, MP = 0. Discuss
other characteristics.
Why we produce in stage II of production.
Geometric Trick 1
Holding land constant and adding labor leads to a
growth of TP until diminishing returns set in.
APL = TP/labor. MPL = the change in TP when
labor (a) increases by 1 unit. Geometrically,
APL = TP/a or the slope of a ray from the origin,
intersecting the TP curve at some level of output.
Geometric Trick 1
Land Labor
1
1
1
1
1
1
1
1
1
1
0
1
2
3
4
5
6
7
8
9
TP
0
2
5
9
12
14
15
15
14
12
APL
0
2
2 1/2
3
3
2 4/5
2½
2 1/7
1 3/4
1 1/3
MPL
..
2
3
4
3
2
1
0
-1
-2
Geometric Trick 1, the old ray from
the origin trick.




Slope = rise/run =
T/a
APL = TP/a
Draw a ray from O
through the relevant
point on the TP
curve.
Notice that this
slope rises to point
E, then falls again at
larger outputs.
Geometric Trick 2,
the old tangency trick.
MPa = ∆TP when
we use one
more unit of a.
MPa = ∆TP/∆Q
Geometric Trick 2,
the old tangency trick.
Find the slope of TP
at a given output to
determine the MPa
at that output.
Find the slope
geometrically by
drawing a tangent
line to the TP curve
at the interesting
output.
Draw the stages of production
why
operate
in more
Stage II
InShow
stage I,
we we
keep
going for
inputs because it results in growing
average and marginal productivity. In
stage III we are experiencing
diminishing returns (negative MPa).
Show: TVC, TFC, TC
and their slopes
Total Costs
At first, TVC and TC
rise gradually, Q rises
faster than cost
because of increasing
returns.
Then, TVC and TC
rise rapidly. Costs rise
faster than output
because of
diminishing returns.
Average variable, average total costs
We can find the average
costs from the totals, using
geometric trick #1, the old
ray trick.
Average variable, average total costs
Draw a ray from the origin
through a point on the TC or
TVC curve. The slope of the
ray is the average cost
(Rise/Run = TC/Q = AC.
First it declines (increasing
returns, then rises
(diminishing returns).
Marginal Costs
Marginal cost is the change
in TC or TVC when output is
increased by one unit.
Or, it is the slope of TC or
TVC. Therefore, we can find
it by taking the derivative of
a TC function.
Marginal Costs
Or, we can use geometric
trick #2, the old tangency
trick. Draw a tangency to the
TC (or TVC) curve.
The slope of the tangent is
MC.
First, MC declines
(increasing returns), but
ultimately rises (decreasing
returns).
Find SR: AVC, AFC, AC, and MC,
using two geometric tricks.
Note that the APP rises and falls in
correspondence with the decline,
then increase of AVC.
AP increases (AVC) falls as increasing
returns to the variable factor occurs.
But as diminishing returns set in, APP
falls, which means that AVC rises
Discuss LR Costs
1. No fixed factors
2. Unlimited number of conceptual
SRAC curves. Choose your output,
then the SRAC that produces it at the
lowest cost.
Discuss LR Costs
3. Envelope curve
4. “For any output, min cost by using
the scale of plant whose SRAC curve is
tangent to the LRAC curve.”
Why is it U-shaped?
Economies of scale vs. Law of
diminishing returns
Economies of scale: division and
specialization of labor, advanced
technology, large machines, digitalization
and electronics.
Diseconomies of scale: control and
coordination problems
Learning curve.
Four LRAC curves
Textbook U
(Range of) constant returns
Constant returns through replication
Continually increasing returns
Isoquant/Isocost approach to
production, trade, equilibrium and
efficiency.
Isoquants--purpose for use
Get up to speed on diagrams.
Tight logic (and math) vs.
Isoquant/Isocost approach to
production, trade, equilibrium and
efficiency.
Scientists prize
-- skepticism,
-- rigorous reasoning, and
-- empirical experimentation.)
Appreciate and understand
Tradeoffs
Budget constraints
Logic of maximization
Representation of efficiency
Get ready for a quiz next session on
the production box.
1. Intuition on isoquants:
Movement NE = improvement.
Discovering substitutability of inputs.
MRTSlk = ∆ K/ ∆ L
2. Characteristics of isoquants
a. No intersection
b. Downward slope
MRTSlk = amount of K lost for which
one unit of L will compensate.
Total Cost = C = wL + rK
Rewrite:
rK = C - wL
K = C/r - (w/r)L
Intercept 
 ratio of factor
prices (or slope of
budget line)
Slope of isoquant:
MRTSlk = MPl/MPk = ∆ K/ ∆L
Discuss diminishing MRTSlk (and tradeoffs)
∆Q = MPl(∆L)
∆Q = MPk( ∆ K)
On the isoquant
MPl(∆ L) + MPk(∆K) = 0
At equilibrium
Slope of Isoquant = Slope of isocost
Mpl /MPk = w/r
Mpl/w = MPk/r
(Mpl/Pl = Mpk/Pk)
4. Show isocost line
Preparation for quiz on isoquants and
the
Edgeworth Box:
1. Start with the two-producer barter
case of production: the EdgeworthBowley Box
Gains of trade.
Efficiency is being on the contract curve.
Trading from any point off the contract
curve to a point on the contract curve.
Labor
(Clothing Producer Origin)
0
Capital
Capital
C
O
Labor
(Food Producer Origin)
Labor
(Clothing Producer Origin)
0
Capital
B
C
O
Labor
(Food Producer Origin)
Capital
Observe a movement from
point A to a point on the
A Contract Curve.
here?
IsWho
this ahas
netgained
social gain?
Labor
(Clothing Producer Origin)
0
Capital
Capital
Observe a different movement
from point A to a point on the
A Contract Curve.
here?
IsWho
this ahas
netgained
social gain?
D
C
O
Labor
(Food Producer Origin)
Labor
(Clothing Producer Origin)
0
Capital
Capital
Observe a more reasonable
movement from point A to
A point D on the Contract Curve.
here?
IsWho
this ahas
netgained
social gain?
D
C
O
Labor
(Food Producer Origin)
Movement along the contract curve
To move to the contract curve is to achieve
efficiency. What does movement along the
curve represent?
Theft, violence, opportunism–
“economic man” as rational optimizer
vs. opportunism.
The market production case.
Isoquants and Isocost lines.
TC = Pl(L) + Pk(K).
The easy way to draw it.
Say we have a budget of $100,
Pl = $.50 and Pk = $1
$100 = .50L + K
K = 100 – 0.5L 100 is the Y intercept,
the slope is -1 times
the ratio of the two prices (Pl/Pk).
Show input prices varying
and resultant isocost lines.
ManEc 300
Day 10
Bryson
Ownership and Property Rights.ppt,
1. Review slide (power point)
presentation for chapter 5.
2. The ppt presentation reviews
Millgrom & Roberts notes.
ManEc 300
Day 11
Bryson
Ownership and Property Rights, II
1. Complete property rights discussion
(& “tragedy of commons”)
Coase Theorem
2. Read about government actions and
other solutions to externalities problem.
A. Cooperation and Group Ownership
B. Reputation
C. Taxes and Subsidies
ManEc 300
Day 11
Bryson
(Cont’d)
2. a. Discuss overhead “The Nature of
Profits”.
b. Millgrom & Roberts on “Ownership
of Complex Assets”.
ManEc 300
Prof. Bryson
Day 12
The Profit Motive
 Definition
 I. Normal Profit (as
opposed to accounting
profits) assumes a return
high enough to include:
 A. Normal (opportunity
cost) return to
stockholders
ManEc 300
Prof. Bryson
 B. Normal
(opportunity cost)
return to
management (and all
other factors).
 II. Economic Profit or
“Pure” Profit is any
profit in excess of
normal profit.
Day 12
The Profit Motive
The Function of Profit
 Pure or Economic Profit permits:
1. Higher than normal returns (dividends)
to owners
2. Increase in value of owners’ holdings
(Or, profits “plowed back” into
investments)
The Function of Profit
3. Higher than normal (opportunity cost)
returns for other factors of production.
Profit can be a vitally important market
signal of great social benefit.
The Origins of Profit
 Profits may result from
 -- the exploitation of a
monopoly position,
 -- from innovative
entrepreneurship and
the effective introduction
of new technologies
(cost-cutting or revenue
generating) in the face of
risk, or
The Origins of Profit
 Profits may result from
 --from a new and
superior means of
satisfying consumer
demands
Profit Maximization and Other Theories
 1. Profit maximization, say most
economists, is the best general theory. It
has to work in pure competition.
 2. Where a firm has little competition, or
competitive “slack”, it may be at liberty to
pursue other objectives, while “satisficing”
profits.

Profit Maximization and Other Theories
Other objectives might include:





A. Maximizing Sales Revenues
B. Maximizing Market Share
C. Ensuring Long-term Survival
D. Pursuing growth and
Diversification for the firm
E. Pursuing Social Objectives
The Simple Mathematics of Micro
 Production theory. Begin with a
production function:
showing output, Q, a function of the
variable input, labor, a.
 Marginal product of labor (MPa) is
a) the addition to total product resulting
from the use of one more unit of a.
The Simple Mathematics of Micro
 Marginal product of labor (MPa) is
b) the slope of the total product curve,
and
c) the first derivative of a total product,
TP, function, thus,
dQ/da = MPa = 21 + 18a - 3a2*
_______________________
Taking Derivatives
 *You will remember about first
derivatives that:
to get the derivative of a constant,
dQ/da = 0.
For example, in the expression
Q = 21 + 7a - a2 + 3a3,
the number 21 is a constant, for which
dQ/da = 0.
Taking Derivatives
 To get the derivative of a variable “a”
preceded by a coefficient m, or ma,
dQ/da = m.
 For example, in the expression
Q = 21 + 7a - a2 + 3a3,
the term 7a consists of the coefficient 7
and the variable a, for which dQ/da = 7.
Taking Derivatives
 To get the derivative of a
variable with an exponent, an,
dQ/da = nan-1.
 For example, in the expression
Q = 21 + 7a - a2 + 3a3,
the term a2 consists of the
variable a and the exponent 2,
for which dQ/da = 2a.

Taking Derivatives
 (By the formula, this would
read 2a1, but any number or
variable taken to the first power,
i.e., having an exponent of 1, is
not changed. So we need not
write the 1.)
Taking Derivatives
 To get the derivative of a variable with
both coefficient m and exponent n, such
as man, we have dQ/da = n(m)an-1
 For example, in the expression
Q = 21 + 7a - a2 + 3a3,
the term 3a3 consists of the variable a
with the coefficient 3 and exponent 3,
for which
dQ/da = 9a2.
Taking Derivatives
For the entire expression,
Q = 21 + 7a - a2 + 3a3, we get the derivative
dQ/da = 7 - 2a + 9a2.
For average product, AP, we have
APa = (TP/a) = (21a + 9a2 - a3)/a
= 21 + 9a - a2
Cost Analysis
 Now consider costs, using the same
kind of analysis. We recall the simple
short-run relationships, specifically that
total cost, TC, equals total fixed costs
(TFC) plus total variable costs (TVC) or
TC = TFC + TVC
Cost Analysis
TC = TFC + TVC
 Dividing both sides by Q, or quantity of
output, we have
TC/Q = TFC/Q + TVC/Q, or
AC = AFC + AVC.
Cost Analysis
 For total cost, consider the expression
TC = 128 + 69Q - 14Q2 + Q3.
Here, TFC = 128
and TVC = 69Q - 14Q2 + Q3.
Cost Analysis

MC = dTC/dQ = dTVC/dQ =
69 - 28Q + 3Q2

AVC =
TVC/Q = (69Q - 14Q2 + Q3)/Q
= 69 - 14Q + Q2
The Demand Function
 Consider now a demand
function such as
P = 3200 - 13Q.
 It will be recalled that demand
= average revenue, AR, so we
also have
AR = 3200 - 13Q
The Demand Function
 Note that in this expression of
a linear demand function,
3200 is the intercept, -13 the
slope.
 To get total revenue, TR, we
observe that TR = P x Q, so
TR = 3200Q - 13Q2
Marginal Revenue
 Marginal revenue, MR, is
simply the slope of a total
revenue curve, or the first
derivative of a TR function,
 so from P = 3200-13Q.
TR = PQ = 3200Q – 13Q2
MR = dTR/dQ = 3200 26Q.
Marginal Revenue
 It will be noticed that the MR
has the same intercept
(3200) as the demand or
average revenue curve,
while the slope
(-26 rather than -13) of MR
is twice as great as the
slope of AR, i.e., the MR
curve falls twice as fast as
the demand curve.
Maximizing Profits
Now, maximizing the firm’s profits.
TR = PQ = 3200Q - 13Q2
MR = 3200 - 26Q.
Assume:
TC= 24,000 + 500Q - 13Q2 + Q3,
MC = 500 - 26Q + 3Q2.
Maximizing Profits
To get profit maximization, we simply
equate MC and MR, so MC = MR
3200 - 26Q = 500 - 26Q + 3Q2
2700 = 3Q2
900 = Q2
Q = 30
Optimal Price with Quantity = 30
 Looking back at the
demand function again, we
have
P = 3200 - 13(30)
P = 3200 - 390
P = 2810.
This is the right price to
charge for sales of 30 units
of output in the pursuit of
maximal profit.
FOR THE NEXT SESSION
Don’t forget the group math homework
due next session.
1. Math assignment Hints:
Problem 3: plug value of Q into formula
up front, not after you have
differentiated.
FOR THE NEXT SESSION
Note that dp/dq = 1/(dQ/dP),
dQ/dP = 1/(dP/dQ)
No quadratic equation used.
Follow problem 4's hint. Factor Q2 so
(...Q)(...Q)
ManEc 300
Conclusion, Day 12
Prof Bryson
As soon as the next discussion (on
competition) Is complete, we will have
a quiz on that topic.
Please look at the reading for the next
session..
Pure Competition
 The assumptions of pure competition.
– A large number of buyers and sellers
– Product homogeneity
– Free entry and exit
 The assumption that makes for perfect
competition
– Rapid dissemination of low-cost, accurate
information
Pure Competition
 Discuss the standard, market/firm,
double diagram of competition.
 Short-term profits lead to entry, which
can impact costs: constant, increasing,
decreasing.
ManEc 300
Prof. Bryson
Day 13
Pure Competition
3. Review of pure competition.
a. TC, TR and NR diagrams for
NR>0, NR=0, NR<0.
b. When making losses? When shut
down? (Go fishing)
ManEc 300
Prof. Bryson
Day 13
Pure Competition
3. Review of pure competition.
c. Why is perfect competition
efficient?
d. Show constant & increasing (then
decreasing) costs.
4. Why all cost curves are equal in
competition
As soon as the next discussion (on
competition) Is complete, we will have
a quiz on that topic.
Please look at the reading for the next
session..

The assumptions of pure competition.
 A large number of buyers and sellers
 Product homogeneity
 Free entry and exit
The assumption that makes for perfect
competition
 Rapid dissemination of low-cost,
accurate information

P
Discuss the standard, market/firm, double
diagram of competition.
Q
q
q
q

Short-term profits lead to entry.
P
S
P
S’
P=MR=AR
D
0
Q
q
Entry can impact costs: constant,
increasing, decreasing.
First, consider an increasing cost
industry in pure competition
Demand Increases
Price rises
Entry Occurs, pushing S out to the right
Costs change as a result of entry, here
they rise
1.
2.
3.
4.
P
S
P=MR=AR
D
0
q
Consider now a decreasing-cost
industry in pure competition
Demand Increases
Price rises
Entry Occurs, pushing S out to the right
Costs change as a result of entry, here
they fall
1.
2.
3.
4.
P
S
P=MR=AR
D
0
q
Finally, consider a constant-cost industry
Demand Increases
Price rises
Entry Occurs, pushing S out to the right
Costs usually change as a result of entry,
but here they remain the same
1.
2.
3.
4.
P
S
P=MR=AR
D
0
q
TC, TR and NR diagrams for NR>0,
NR=0, NR<0.
TC
TC
TC
TR
NR
NR
NR
When making losses?
TC When shut
down? (Go fishing)
TR
Total Fishing Costs!
TFC
If we shut down, we
must pay?
If we produce, we
suffer only our operating
losses
NR
Why is perfect competition efficient?
The consumer pays only the minimal
average costs of production.
All factors of production get normal
opportunity cost returns.
Why all cost curves are equal in competition
Firm
B and Firm
manyAothers
will try to bid
that that
factor
Assume
has a production
factor
away
from A.
If A doesn’t
paylowering
that factor
more,
reduces
production
costs,
cost
curves
It will leave. So A’s cost curves go back up.
Firm A
Firm B
ManEc 300
Day 14
Bryson
(Cont’d)
Quiz on competition
Begin monopoly
See Power Point presentation
Day 15
Review session before midterm.
Day 16
Midterm at Testing Center.
ManEc 300
Day 17
Bryson
1. PowerPoint presentation of
monopoly.
2. There will be a multiple choice quiz
next class session on monopoly.
ManEc 300
Days 18, 19
Prof. Bryson
Discussion on monopoly regulation and
contestable markets.
Announcements:
In the File Directory, see “Practice
Multiple Choice Questions.doc.” At
the bottom of the file are references
to on-line multiple choice questions
for practice and tips on doing them.
ManEc 300
Day 19
Bryson
Competition from a spiritual
perspective.
.
Discussion on
 Price discrimination
 Monopolistic competition
ManEc 300
Day 20
Bryson
Begin oligopoly, which will cover
 The Kinked Demand Curve (see
ppt)
 Baumol’s model of Sales
Maximization with a profit
constraint, and
 Game theory
Profit constrained sales maximization
 Goal: maximize total revenue (dollar
sales, not physical volume), while
making sufficient profit.
 Sufficient profit
– Pays satisfactory dividends
– Provides net investment for growth
– Ensures financial safety, and
– Retains capital market confidence.
Baumol on Sales Maximization
 Oligopoly and the real world
$
TC
TR
We used this
model for
Monopoly, and
it Aapplies
= NR orhere.
Π max
C = Sales max, but
with big losses.
NR
0
A B
C
B = greatest sales
that still yield
Min Π sufficient and
X
minimally required
profit.
Baumol: conclusions
 This is not really like cost-plus pricing,
which produces some output, figures
the cost and adds a profit markup.
Baumol’s model pre-determines output
B as the greatest one that yields
sufficient profit.
Baumol: conclusions
 This model incorporates
interdependence, which can shift
around the TR curve greatly.
 Lack of emphasis on profit here may
help avoid anti-trust action and entry.
ManEc 300
Day 20
Bryson
2. Kinked Demand Curve
PowerPoint presentation
ManEc 300
Session 22
Bryson
Conclusion of Oligopoly. Power Point
Presentation on Game Theory
ManEc 300
Session 22
Bryson
BOUNDED RATIONALITY AND CONTRACTING
 The motivation problem.
 The question here is
motivation. Management
must assure that the various
actors and contract
participants actually do their
parts, both acting and
reporting appropriately.
ManEc 300
Session 22
Bryson
BOUNDED RATIONALITY AND CONTRACTING
 Incentive Compatibility
 People will do only what they
perceive to be in their
interests. Affairs need to be
arranged so that while
pursuing their own interests,
peoples’ actions also
promote the interests of the
corporation and (from the
standpoint of the economist)
the interests of the society
as well.
BOUNDED RATIONALITY
 Perfect, complete contracts.
 Contracts (or at least voluntary agreements)
are the means by which mutual interests are
pursued.
 The motivation problem: all relevant plans
cannot be completely described in
enforceable contracts. To write a perfect
contract, parties would have to foresee all
contingencies, then agree on an efficient
course of action responding to each one.
BOUNDED RATIONALITY
 Perfect, complete contracts.
 But we must contract with bounded rationality,
i.e.,
– limited foresight,
– imprecise language,
 In the face of bounded rationality, people act
in an intentionally rational manner, doing the
best they can given these limitations.
Contingency Responses
 Especially when unforeseen contingencies
arise, parties often adapt opportunistically.
 Incomplete and unenforceable contracts lead
to problems of imperfect commitment.
Contingency Responses
 Where contingencies are foreseen, impacts
and probability of occurrence may be
misperceived, so they may not be included in
the contract.
 Contracts usually relatively inflexible,
covering many provisions very broadly.
Contingency Responses
 Relational contracting avoids comprehensive
contracts
– agreement about goals and objectives
– general provisions broadly applicable.
– Procedures are outlined for making
decisions and mechanisms for appeal.
Private Information and Adverse Selection
 In contracting, private information may
prohibit a value-maximizing agreement.
 If private information held by one party we
can incur an adverse selection problem.
Private Information and Adverse Selection
The most famous example
of asymmetric information
and adverse selection:
if the seller of a used car
knows it is a lemon, the
selection of products
(cars) offered in a market
is determined in a manner
adverse to the buyers’
interests.
Pre-contractual Opportunism
Adverse Selection
Cases of Asymmetric Information
 Used Cars
 Insurance
(Maternity)
 Gifthorse, or
gifthamster
Courtship
 Auto air-conditioner
– (Nissan/CalsonicHarrison Co.
A JV no. of Tokyo)
Market vs. Government Solutions
 Where AS is strong enough, the price of
insurance can be driven so high that
nobody can afford it, so that market
collapses. No insurer, facing costs of
insurance payments, plus overhead,
can afford to serve the set of customers
who wish to buy insurance.
Market vs. Government Solutions
 George Akerloff (“lemon markets”)
showed that the volume of trade in
markets with AS is inefficiently low. As
we have seen, the market can also fail.
That failure often leads to clever
alternative arrangements and practices
in the private sector. Too often, some
advocate that the government jump in
with subsidies before seeing what the
private market will come up with.
Adverse Selection in Bank Loans
 AS in Bank Loans. The interest rates
that a bank charges can affect the
selection of customers who apply for
loans: when there is excess demand for
loans, a bank may be inclined to raise
its interest rates.
Adverse Selection in Bank Loans
But at high rates, only those
customers with very risky
investments may be seeking
loans. The bank should
ration credit in cases of
excess demand, rather than
raising the interest rate.
Signaling and Screening
 Signaling is an attempt to communicate
private information credibly.
 Example:
– Talented workers may gain additional
education as much for the value of
credentials as to enhance their actual
productivity.
Signaling and Screening
 Screening is done to attract only
desirable potential customers,
workers, etc. Or, at least to sort
groups into quality categories.
Signaling and Screening
 Example:
– offering some jobs with incentive pay
schemes and others with fixed wages
may tend to sort the workers. The
most productive ones will tend to
select the incentive pay jobs.
ManEc 300
Session 22
Bryson
Alert!
For tomorrow, go through the scheduled
Power Point on Moral Hazard. We will
have a quiz on it.
ManEc 300
Session 22
Bryson
Contract
Incomplete,
Bounded Rationality
Imperfect Commitment
Reneging
Holdup Problem
 specific assets
 co-specialized assets
Commitment and Reneging

One of the parties to an
imperfect contract may
try to renege -- payment
won’t be made or the
product won’t be
delivered.
Commitment and Reneging
 Contract ambiguity may
make it difficult even to
know who is reneging.
 Fear of reneging may
cause a contract not to
be completed in the first
place.
Contract Renegotiation
 A second commitment problem is that
sometimes it becomes necessary to
engage in ex post renegotiation of the
contract.
Contract Renegotiation
 Example:
–
Some firms provide incentives to
executives by issuing stock options
stating they can purchase stock at a
specific price on future dates. The
managers are supposed to work to
get the stock price higher giving them
a windfall gain.
Contract Renegotiation
 Example:
– But if after the options are issued a
firm’s stock price falls drastically, the
options are worthless and won’t
provide incentives. So it will pay to
renegotiate.
The Hold-up Problem
 Where both parties to a contract need to
worry about being forced to accept
disadvantageous terms later, after it has
sunk resources into an investment,
there is a hold-up problem.
The Hold-up Problem
 The problem: specific use of particular
assets in imperfect contracting.
 Fearing that a big investment may lead
to later vulnerability can lead to a
refusal to make the efficient investment.
The Hold-up Problem: Example
 If a coal mine supplies a
local power plant (as its
only customer) and a big
investment is required,
will the relationship
continue after the
expensive investment?
What will the price of
coal be in the future?
The Hold-up Problem: Example
 Post-contractual
opportunism may
result, so parties can
exploit loopholes to gain
unfair advantage. A
common response to a
cospecialized assets
problem is for the same
party or firm ultimately to
own both assets.
We should critically evaluate
opportunistic behavior
Is this acceptable business behavior?
Is this fair behavior?
Is this OK behavior?
Is this behavior we all engage in?
Is this moral behavior?
Read George Q. Cannon Statement
George Q. Cannon
on Informational Asymmetry
 Collected Discourses, Vol.5, George
Q. Cannon, October 6, 1895
I might go on and speak about stealing,
and dishonesty, and many other sins. I
believe that the Latter-day Satins as a
people are a more honest people, that
they respect their obligations more than
other people.
George Q. Cannon
on Informational Asymmetry
 Collected Discourses, Vol.5, George
Q. Cannon, October 6, 1895
We show this in our business
associations and dealing. We have the
credit for it everywhere. Men who have
found fault with our religion frequently
acknowledge that we are an honest
people, and our credit is "gilt edged."
But there are some things that we are
still guilty of.
George Q. Cannon
on Informational Asymmetry
I believe, however, that the young and
rising generation will outgrow them. It is
a strong temptation for a man, when he
has got a piece of property and he has
a chance to trade or sell it, to let the
buyer think it is better than it is.
George Q. Cannon
on Informational Asymmetry
Now, if we were strictly honest, we
would tell exactly the character of that
which we have to sell. We would not
allow a man to deceive himself; we
would tell him the facts. But I know that
we are all under the influence of the old
traditions.
George Q. Cannon
on Informational Asymmetry
 The old traditions were that a man
should have his own eyesight, and that
the seller should not furnish him with
anything to aid his perception or to
enable him to perceive something that
he would not otherwise see. It is a hard
thing for men who have grown up under
that system of things to refrain from it.
George Q. Cannon
on Informational Asymmetry
 You see everywhere where things are
for sale the endeavor to make them
appear better in the eyes of the
purchaser than they are. We have got
to change in this respect. Whenever a
man yields to do a dishonest thing he
yields to Satan, and Satan has influence
and power over him to that extent. We
have got to learn to overcome these
things, and to have Satan bound.
Suggestion: Begin Reviewing for Final
 In just a few days we will have an in-
class review for the final. Please bring
your questions to that session for
discussion.
 Tomorrow there will be a quiz on moral
hazard.
Post-contractual Opportunism:
Moral Hazard, Session 24
 The definition:
 MH is the form of post-contractual
opportunism that arises because actions
that have efficiency consequences are not
freely observable and so the person taking
them may choose to pursue his or her
private interests at others’ expense.
Post-contractual Opportunism:
Moral Hazard, Session 24
The term originated in the insurance
industry, where the tendency of people
was observed to change their behavior in
a way that led to larger claims against the
insurance company (e.g., being lax about
taking precautions to avoid or minimize
losses).
ManEc 300
Bryson
Day 24
Commitment vs. Monitoring
Shirking, Fraud/Deceit
.
In the case of the residual claimant, who
monitors the monitor?
South African Hosp
AMA, Doctors vs. Litigation
ManEc 300
Day 24
Bryson
Principle-agent relationship
Case of US Savings & Loan Crisis
S&L’s borrow from savers, loan for
mortgages-- low interest rates
FSLIC Insurance
1980’s Fed Interest Rates
Deregulation (cease monitoring)
ManEc 300
Day 24
Bryson
S&LS CONTINUED:
Fraud (25% of S&L bankruptcies)
Depositors didn’t monitor (insured)
Politicians wouldn’t monitor
ManEc 300
Day 24
Bryson
Note public insurance examples:
• Gov. Nat’l Mortgage Association
(GNMA)-- insurance against default
• Student Loans
ManEc 300
Day 25
Bryson
Economic Strategy and Michael Porter
See and discuss Power Point, “Bryson on
Porter”
The firm’s competitive advantage
2.The Gershwin-playing hamster
ManEc 300
Days 26, 27
Bryson
 Discussion of
 Organizational Architecture.ppt
 Review for final.
A little final math practice
Suppose a firm’s TR is given as TR = 500Q - 4Q2
 When output is 100, TR is
a. $2,000. b. $20,000.
c. $10,000.
d. $49,600. e. None of the above.
Suppose a firm’s TR is given as TR = 500Q - 4Q2
 When output is 10 units, AR is
a. $460.
b. $560
c. More than $500
d. $360
e. None of the above
When TR = 500Q - 4Q2
At an output level equal to 20, MR is
a. $440.
b. $340 c. More than 500.
d. None of the above.


Marginal revenue
a. always exceeds marginal cost.
b. always equals marginal cost.
c. is the tangent of the average revenue
curve.
d. is the slope of the total revenue curve.
e. is the distance between total revenue
and total cost curves at optimal output.
When TR = 500Q - 4Q2
Marginal revenue and average revenue are
equal when
a. Q = 10. b. Q = 0.
c. Q > 0.
d. Q < 0.
e. None of the above.