Etextbook 978 1305506381 Managerial Economics Applications Strategies and Tactics

eTextbook 978-1305506381 Managerial
Economics: Applications, Strategies

and Tactics
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Brief
Table of Contents
Preface xix 13 Best-Practice Tactics: Game Theory 446
About the Authors xxiii 13A Entry Deterrence and Accommodation
Games 497
14 Pricing Techniques and Analysis 508
PART I 14A The Practice of Revenue Management 545
INTRODUCTION 1
1 Introduction and Goals of the Firm 2
PART V
2 Fundamental Economic Concepts 28
ORGANIZATIONAL ARCHITECTURE
AND REGULATION 557
PART II 15 Contracting, Governance, and
DEMAND AND FORECASTING 63 Organizational Form 558
15A Auction Design and Information
3 Demand Analysis 64
Economics 594
4 Estimating Demand 101
16 Government Regulation 623
4A Problems in Applying the Linear
17 Long-Term Investment Analysis 660
Regression Model 129
5 Business and Economic Forecasting 141
APPENDICES
6 Managing in the Global Economy 178
6A Foreign Exchange Risk Management 232 A The Time Value of Money A-1
B Differential Calculus Techniques
in Management B-1
PART III C Tables C-1
D Check Answers to Selected
PRODUCTION AND COST 235 End-of-Chapter Exercises D-1
7 Production Economics 236 Glossary G-1
7A Production Economics of Renewable and Index I-1
Exhaustible Natural Resources, Advanced Notes
Material 272
8 Cost Analysis 282 WEB APPENDICES
9 Applications of Cost Theory 307 A Consumer Choice Using Indifference
Curve Analysis
B International Parity Conditions
PART IV C Linear-Programming Applications
D Capacity Planning and Pricing against a
PRICING AND OUTPUT DECISIONS: Low-Cost Competitor: A Case Study of
STRATEGY AND TACTICS 333 Piedmont Airlines and People Express
10 Prices, Output, and Strategy: Pure and E Pricing of Joint Products and Transfer Pricing
Monopolistic Competition 334 F Decisions under Risk and Uncertainty
11 Price and Output Determination: G Maximization of Production Output Subject
Monopoly and Dominant Firms 384 to a Cost Constraint, Advanced Material
12 Price and Output Determination: H Long-Run Costs with a Cobb-Douglas
Oligopoly 411 Production Function, Advanced Material
vii
Contents
Preface xix Case Exercise: Designing a Managerial
About the Authors xxiii Incentives Contract 23
Case Exercise: Shareholder Value of Renewable
Energy from Wind Power at Hydro Co.:
PART I Is RE < C? 24
INTRODUCTION 1 2 Fundamental Economic Concepts 28

Chapter Preview 28
1 Introduction and Goals of the Firm 2 Managerial Challenge: Why Charge
Chapter Preview 2 $25 per Bag on Airline Flights? 28
Managerial Challenge: How to Achieve 2-1 Demand and Supply: A Review 29
Sustainability: Southern Company 2-1a The Diamond-Water Paradox and the
Electric Power Generation 2 Marginal Revolution 31
1-1 What Is Managerial Economics? 4 2-1b Marginal Utility and Incremental Cost
1-2 The Decision-Making Model 5 Simultaneously Determine Equilibrium
1-2a The Responsibilities of Management 5 Market Price 32
2-1c Individual and Market Demand Curves 33
What Went Right/What Went Wrong: 2-1d The Demand Function 34
Saturn Corporation 6 2-1e Import-Export Traded Goods 36
1-2b Moral Hazard in Teams 6
1-3 The Role of Profits 8 International Perspectives: Exchange Rate
1-3a Risk-Bearing Theory of Profit 8 Impacts on Demand: Cummins Engine
1-3b Temporary Disequilibrium Theory of Profit 9 Company 36
1-3c Monopoly Theory of Profit 9 2-1f Individual and Market Supply Curves 37
1-3d Innovation Theory of Profit 9 2-1g Equilibrium Market Price of Gasoline 38
1-3e Managerial Efficiency Theory of Profit 9 2-2 Marginal Analysis 43
1-4 Objective of the Firm 9 2-2a Total, Marginal, and Average Relationships 44
1-4a The Shareholder Wealth-Maximization 2-3 The Net Present Value Concept 48
Model of the Firm 10 2-3a Determining the Net Present Value of an
1-5 Separation of Ownership and Control: Investment 48
The Principal-Agent Problem 11 2-3b Sources of Positive Net Present Value
1-5a Divergent Objectives and Agency Conflict 11 Projects 50
1-5b Agency Problem 13 2-3c Risk and the NPV Rule 51
1-6 Implications of Shareholder Wealth 2-4 Meaning and Measurement of Risk 52
Maximization 15 2-4a Probability Distributions 52
2-4b Expected Values 53
What Went Right/What Went Wrong: Eli 2-4c Standard Deviation: An Absolute
Lilly Depressed by Loss of Prozac Patent 15 Measure of Risk 54
1-6a Caveats to Maximizing Shareholder Value 17 2-4d Normal Probability Distribution 54
1-6b Residual Claimants 19 2-4e Coefficient of Variation: A Relative
1-6c Goals in the Public Sector and Measure of Risk 56
Not-for-Profit Enterprises 19
What Went Right/What Went Wrong:
1-6d Not-for-Profit Objectives 20
1-6e The Efficiency Objective in Long-Term Capital Management (LTCM) 56
Not-for-Profit Organizations 20 2-5 Risk and Required Return 57
Summary 21 Summary 59
Exercises 22 Exercises 59
ix
x Contents
Case Exercise: Revenue Management at 4-2 A Simple Linear Regression Model 105
American Airlines 61 4-2a Assumptions Underlying the Simple
Linear Regression Model 106
4-2b Estimating the Population Regression
PART II Coefficients 107
4-3 Using the Regression Equation to Make
DEMAND AND FORECASTING 63 Predictions 110
4-3a Inferences about the Population
3 Demand Analysis 64 Regression Coefficients 112
Chapter Preview 64 4-3b Correlation Coefficient 115
4-3c The Analysis of Variance 116
Managerial Challenge: Health Care 4-4 Multiple Linear Regression Model 118
Reform and Cigarette Taxes 64 4-4a Use of Computer Programs 118
3-1 Demand Relationships 66 4-4b Estimating the Population Regression
3-1a The Demand Schedule Defined 66 Coefficients 118
3-1b Constrained Utility Maximization and 4-4c Using the Regression Model to Make
Consumer Behavior 67 Forecasts 118
What Went Right/What Went Wrong: 4-4d Inferences about the Population
Chevy Volt 71 Regression Coefficients 119
3-2 The Price Elasticity of Demand 72 4-4e The Analysis of Variance 121
3-2a Price Elasticity Defined 73 Summary 122
3-2b Interpreting the Price Elasticity: The Exercises 122
Relationship between the Price Elasticity Case Exercise: Soft Drink Demand Estimation 126
and Sales Revenue 76
3-2c The Importance of Elasticity-Revenue 4A Problems in Applying the Linear
Relationships 82 Regression Model 129
3-2d Factors Affecting the Price Elasticity of 4A-1 Introduction 129
Demand 84 4A-1a Autocorrelation 129
4A-1b Heteroscedasticity 131
International Perspectives: Free Trade 4A-1c Specification and Measurement Errors 132
and the Price Elasticity of Demand: 4A-1d Multicollinearity 133
Nestlé Yogurt 86 4A-1e Simultaneous Equation Relationships
3-3 The Income Elasticity of Demand 87 and the Identification Problem 133
3-3a Income Elasticity Defined 87 4A-2 Nonlinear Regression Models 136
3-4 Cross Elasticity of Demand 90 4A-2a Semilogarithmic Transformation 136
3-4a Cross Price Elasticity Defined 90 4A-2b Double-Log Transformation 136
3-4b Interpreting the Cross Price Elasticity 90 4A-2c Reciprocal Transformation 137
3-4c Antitrust and Cross Price Elasticities 90 4A-2d Polynomial Transformation 137
3-4d An Empirical Illustration of Price, Summary 138
Income, and Cross Elasticities 92 Exercises 138
3-5 The Combined Effect of Demand
Elasticities 92 5 Business and Economic Forecasting 141
Summary 93 Chapter Preview 141
Exercises 94 Managerial Challenge: Excess Fiber Optic
Case Exercise: Polo Golf Shirt Pricing 97 Capacity at Global Crossing Inc. 141
Case Exercise: Fifty Years of Sales 5-1 The Significance of Forecasting 143
Maximization at Volkswagen 98 5-2 Selecting a Forecasting Technique 143
5-2a Hierarchy of Forecasts 143
4 Estimating Demand 101 5-2b Criteria Used to Select a Forecasting
Chapter Preview 101 Technique 144
Managerial Challenge: Demand for 5-2c Evaluating the Accuracy of Forecasting
Models 144
Whitman’s Chocolate Samplers 101
4-1 Statistical Estimation of the Demand What Went Right/What Went Wrong:
Function 102 Crocs Shoes 144
Specification
4-1a Copyright of the Model 103 5-3 Alternative Forecasting Techniques
2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-203
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Contents xi
5-4 Deterministic Trend Analysis 145 6-5a Import-Export Flows and Transaction
5-4a Components of a Time Series 145 Demand for a Currency 192
5-4b Some Elementary Time-Series Models 146 6-5b The Equilibrium Price of the U.S. Dollar 193
5-4c Secular Trends 147 6-5c Speculative Demand, Government
5-4d Seasonal Variations 150 Transfers, and Coordinated Intervention 193
5-5 Smoothing Indicators 152 6-5d Short-Term Exchange Rate Fluctuations 194
5-5a Moving Averages 153 6-6 Determinants of Long-Run Trends in
5-5b First-Order Exponential Smoothing 155 Exchange Rates 195
5-6 Barometric Techniques 158 6-6a The Role of Real Growth Rates 195
5-6a Leading, Lagging, and Coincident 6-6b The Role of Real Interest Rates 198
Indicators 158 6-6c The Role of Expected Inflation 198
5-7 Survey and Opinion-Polling Techniques 159 6-7 Purchasing Power Parity 199
5-7a Forecasting Macroeconomic Activity 160 6-7a PPP Offers a Better Yardstick of
5-7b Sales Forecasting 161 Comparative Size of Business Activity 200
5-8 Macroeconometric Models 161 What Went Right/What Went Wrong:
5-8a Advantages of Econometric Forecasting Big Box U.S. Retailers in China 202
Techniques 161 6-7b Relative Purchasing Power Parity 202
5-8b Single-Equation Models 161 6-7c Qualifications of PPP 203
5-8c Multi-Equation Models 163 6-7d The Appropriate Use of PPP: An
5-8d Consensus Forecasts: Livingston and Overview 204
Blue Chip Forecaster Surveys 164
What Went Right/What Went Wrong: GM,
5-9 Forecasting with Input-Output Tables 165
Toyota, and the Celica GT-S Coupe 205
International Perspectives: Long-Term 6-7e Trade-Weighted Exchange Rate Index 206
Sales Forecasting by General Motors 6-8 International Trade: A Managerial
in Overseas Markets 165 Perspective 209
5-10 Advanced Material: Stochastic 6-8a Shares of World Trade and Regional
Time-series Analysis 166 Trading Blocs 209
Summary 169 6-8b Comparative Advantage and Free Trade 211
Exercises 169 6-8c Import Controls and Protective Tariffs 214
Case Exercise: Cruise Ship Arrivals in Alaska 173 6-8d The Case for Strategic Trade Policy 215
Case Exercise: Lumber Price Forecast 174 6-8e Increasing Returns 218
Case Exercise: Forecasting in the Global 6-8f Network Externalities 218
Financial Crisis 175 6-9 Free Trade Areas: The European Union
and NAFTA 219
6 Managing in the Global Economy 178 6-9a Optimal Currency Areas 219
Chapter Preview 178 6-9b Intraregional Trade 220
6-9c Mobility of Labor 220
Managerial Challenge: The Role of the 6-9d Correlated Macroeconomic Shocks 221
FX Rate in Assessing Foreign Business 6-10 Largest U.S. Trading Partners:
Opportunity 178 The Role of NAFTA 222
6-1 Introduction 181 6-10a A Comparison of the EU and NAFTA 224
What Went Right/What Went Wrong: 6-10b Gray Markets, Knockoffs, and Parallel
Export Market Pricing at Toyota 181 Importing 225
6-2 Import-Export Sales and Exchange What Went Right/What Went Wrong:
Rates 182 Ford Motor Co. and Exide Batteries:
6-2a Foreign Exchange Risk 183 Are Country Managers Here to Stay? 226
International Perspectives: Collapse 6-11 Perspectives on the U.S. Trade Deficit 227
of Export and Domestic Sales Summary 229
at Cummins Engine 184 Exercises 230
6-3 Outsourcing 185 Case Exercise: Predicting the Long-Term
6-4 China Trade Blossoms 187 Trends in Value of the U.S. Dollar and
6-4a China Today 189 the Euro 231
6-5 The Market for U.S. Dollars as Foreign Case Exercise: Elaborate the Debate on
Exchange 191 NAFTAin whole or in part. WCN 02-200-203
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xii Contents
6A Foreign Exchange Risk Management 232 7-8d Empirical Studies of the Cobb-Douglas
International Perspectives: Toyota and Production Function in Manufacturing 263
Honda Buy U.S. Assembly Capacity 233 7-8e A Cross-Sectional Analysis of U.S.
Manufacturing Industries 263
Summary 266
PART III Exercises 267
Case Exercise: The Production Function
PRODUCTION AND COST 235 for Wilson Company 270
7 Production Economics 236 7A Production Economics of Renewable and

Chapter Preview 236 Exhaustible Natural Resources, Advanced
Managerial Challenge: Green Power Material 272
Initiatives Examined: What Went 7A-1 Renewable Resources 272
Wrong in California’s Deregulation 7A-2 Exhaustible Natural Resources 276
of Electricity? 236 Exercises 281
7-1 The Production Function 238
7-1a Fixed and Variable Inputs 239 8 Cost Analysis 282
7-2 Production Functions with One Chapter Preview 282
Variable Input 241 Managerial Challenge: Can a Leaner
7-2a Marginal and Average Product Functions 241 General Motors Compete Effectively? 282
7-2b The Law of Diminishing Marginal 8-1 The Meaning and Measurement of Cost 283
Returns 242 8-1a Accounting versus Economic Costs 284
What Went Right/What Went Wrong: 8-1b Three Contrasts between Accounting
Factory Bottlenecks at a Boeing and Economic Costs 284
Assembly Plant 243 8-2 Short-Run Cost and Product Functions 288
7-2c Increasing Returns with Network Effects 243 8-2a Average and Marginal Cost Functions 288
7-2d Producing Information Services under 8-3 Long-Run Cost Functions 293
Increasing Returns 245 8-3a Optimal Capacity Utilization: Three
7-2e The Relationship between Total, Concepts 293
Marginal, and Average Product 246 8-4 Economies and Diseconomies of Scale 294
7-3 Determining the Optimal Use of the 8-4a The Percentage of Learning 295
Variable Input 248 8-4b Diseconomies of Scale 298
7-3a Marginal Revenue Product 249 8-4c The Overall Effects of Scale Economies
7-3b Marginal Factor Cost 249 and Diseconomies 298
7-3c Optimal Input Level 249 International Perspectives: How Japanese
7-4 Production with Multiple Variable Inputs 250 Companies Deal with the Problems
7-4a Production (Output Constant) Isoquants 250 of Size 299
7-4b The Marginal Rate of Technical Summary 301
Substitution 252 Exercises 302
7-5 Determining the Optimal Combination Case Exercise: Cost Analysis of Patio Furniture 304
of Inputs 254 Case Exercise: Profit Margins on the
7-5a Isocost Lines 255
Amazon Kindle 306
7-5b Minimizing Cost Subject to an Output
Constraint 256
9 Applications of Cost Theory 307
7-6 A Fixed Proportions Optimal
Chapter Preview 307
Production Process 257
7-6a Production Processes and Process Rays 258 Managerial Challenge: How Exactly Have
7-7 Measuring the Efficiency of a Computerization and Information
Production Process 259 Technology Lowered Costs at Chevron,
7-8 Returns to Scale 260 Timken, and Merck? 307
7-8a Measuring Returns to Scale 261 9-1 Estimating Cost Functions 308
7-8b Increasing and Decreasing Returns to 9-1a Issues in Cost Definition and
Scale 262 Measurement 309
The Cobb-Douglas
7-8c Copyright Production
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All Rights Reserved. 262 9-1b orControlling
May not be copied, scanned, for Other
duplicated, in whole Variables
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Contents xiii
9-1c The Form of the Empirical Cost-Output 10-3c The Power of Buyers and Suppliers 346
Relationship 310 10-3d The Intensity of Rivalrous Tactics 347
What Went Right/What Went Wrong: 10-3e The Myth of Market Share 351
Boeing: The Rising Marginal Cost 10-4 A Continuum of Market Structures 351
10-4a Pure Competition 352
of Wide-Bodies 311 10-4b Monopoly 353
9-1d Statistical Estimation of Short-Run 10-4c Monopolistic Competition 354
Cost Functions 312 10-4d Oligopoly 354
9-1e Statistical Estimation of Long-Run 10-5 Price-Output Determination under
Cost Functions 313 Pure Competition 355
9-1f Determining the Optimal Scale of an 10-5a Short Run 355
Operation 313 10-5b Profit Maximization under Pure
9-1g Economies of Scale versus Economies Competition (Short Run): Adobe
of Scope 316 Corporation 358
9-1h Engineering Cost Techniques 316 10-5c Long Run 359
9-1i The Survivor Technique 318 10-6 Price-Output Determination under
9-1j A Cautionary Tale 318
Monopolistic Competition 362
9-2 Break-Even Analysis 319
9-2a Graphical Method 320 What Went Right/What Went Wrong:
9-2b Algebraic Method 320 The Dynamics of Competition at
9-2c Some Limitations of Break-Even Analysis 323 Amazon.com 363
9-2d Doing a Break-Even versus a 10-6a Short Run 363
Contribution Analysis 323 10-6b Long Run 363
9-2e A Limitation of Contribution Analysis 325 10-7 Selling and Promotional Expenses 365
9-2f Operating Leverage 325 10-7a Determining the Optimal Level
9-2g Inherent Business Risk 327 of Selling and Promotional Outlays 366
Summary 327 10-7b Optimal Advertising Intensity 367
10-7c The Net Value of Advertising 368
Exercises 328
10-8 Competitive Markets under
Case Exercise: Cost Functions 329
Asymmetric Information 369
Case Exercise: Charter Airline Operating
10-8a Incomplete versus Asymmetric
Decisions 330 Information 369
10-8b Search Goods versus Experience Goods 370
PART IV 10-8c Adverse Selection and the Notorious
Firm 370
PRICING AND OUTPUT DECISIONS: 10-8d Insuring and Lending under Asymmetric
STRATEGY AND TACTICS 333 Information: Another Lemons Market 372
10-9 Solutions to the Adverse Selection
10 Prices, Output, and Strategy: Pure and Problem: Advanced Material 373
Monopolistic Competition 334 10-9a Mutual Reliance: Hostage Mechanisms
Chapter Preview 334 Support Asymmetric Information
Managerial Challenge: Resurrecting Exchange 373
10-9b Brand-Name Reputations as Hostages 374
Apple in the Tablet World 334
10-9c Price Premiums with Non-Redeployable
10-1 Introduction 335 Assets 376
10-2 Competitive Strategy 336
Summary 378
What Went Right/What Went Wrong: Exercises 379
Xerox 337 Case Exercise: Netflix and Redbox Compete
10-2a Generic Types of Strategies 338 for Movie Rentals 381
10-2b Product Differentiation Strategy 338 Case Exercise: Saving Sony Music 382
10-2c Cost-Based Strategy 338
10-2d Information Technology Strategy 339 1 1 Price and Output Determination:
10-2e The Relevant Market Concept 341 Monopoly and Dominant Firms 384
10-3 Porter’s Five Forces Strategic Chapter Preview 384
Framework 341 Managerial Challenge: Dominant
10-3a The Threat of Substitutes 342 Microprocessor Company Intel
10-3b2017The
Copyright Threat
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Learning. All Rights Reserved. May not be343 Adapts intowhole
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or inTrend
part. WCN 02-200-203 384
xiv Contents
11-1 Monopoly Defined 385 12-2 Interdependencies in Oligopolistic

11-2 Sources of Market Power for a Industries 418
Monopolist 386 12-2a The Cournot Model 420
11-2a Increasing Returns from Network 12-3 Cartels and Other Forms of Collusion 421
Effects 386 12-3a Factors Affecting the Likelihood of
What Went Right/What Went Wrong: Successful Collusion 423
12-3b Cartel Profit Maximization and the
Pilot Error at Palm 389
Allocation of Restricted Output 424
11-3 Price and Output Determination for a
Monopolist 390 International Perspectives: The OPEC
11-3a Spreadsheet Approach: Profit versus Cartel 426
Revenue Maximization for Polo Golf 12-3c Cartel Analysis: Algebraic Approach 431
Shirts 390 12-4 Price Leadership 433
11-3b Graphical Approach 391 12-4a Barometric Price Leadership 433
11-3c Algebraic Approach 392 12-4b Dominant Firm Price Leadership 434
11-3d The Importance of the Price Elasticity 12-5 The Kinked Demand Curve Model 437
of Demand 393 12-6 Avoiding Price Wars 438
11-4 The Optimal Markup, Contribution What Went Right/What Went Wrong:
Margin, and Contribution Margin Good-Better-Best Product Strategy at
Percentage 395 Marriott Corporation and Kodak 441
11-4a Gross Profit Margins 397
Summary 443
11-4b Components of the Margin 397
11-4c Monopolists and Capacity Investments 398
Exercises 444
11-4d Limit Pricing 399 13 Best-Practice Tactics: Game Theory 446
11-4e Using Limit Pricing to Hamper the Chapter Preview 446
Sales of Generic Drugs 400
Managerial Challenge: Large-Scale Entry
What Went Right/What Went Wrong: Deterrence of Low-Cost Discounters:
Pfizer Sustains Sales of Off-Patent Southwest Airline/AirTran 446
Lipitor 401 13-1 Oligopolistic Rivalry and Game Theory 448
11-5 Regulated Monopolies 402
11-5a Electric Power Companies 402 What Went Right/What Went Wrong:
Nintendo’s Wii U 448
What Went Right/What Went Wrong: 13-1a A Conceptual Framework for Game
The Public Service Company of Theory Analysis 449
New Mexico 402 13-1b Components of a Game 450
11-5b Natural Gas Companies 403 13-1c Cooperative and Noncooperative Games 452
11-6 The Economic Rationale for Regulation 403 13-1d Other Types of Games 452
11-6a Natural Monopoly Argument 403 13-2 Analyzing Simultaneous Games 453
Summary 405 13-2a The Prisoner’s Dilemma 453
Exercises 405 13-2b Dominant Strategy Defined 455
Case Exercise: Differential Pricing of 13-3 Nash Equilibrium Strategy Defined 457
Pharmaceuticals: The HIV/AIDS Crisis 409 13-3a Mixed Nash Equilibrium Strategy 460
Case Exercise: Limit Pricing as Strategic 13-4 The Escape from Prisoner’s Dilemma 463
Entry Deterrence: Ace Inhibitor 410 13-4a Multiperiod Punishment and Reward
Schemes in Repeated Play Games 463
12 Price and Output Determination: 13-4b Unraveling and the Chain Store Paradox 464
Oligopoly 411 13-4c Mutual Forbearance and Cooperation
Chapter Preview 411 in Repeated Prisoner’s Dilemma Games 466
Managerial Challenge: Google’s Android 13-4d Winning Strategies in Evolutionary
Computer Tournaments: Tit for Tat 467
and Apple’s iPhone Displace Nokia in 13-4e Bayesian Reputation Effects 467
Smart phones? 411 13-4f Price-Matching Guarantees 469
12-1 Oligopolistic Market Structures 413 13-5 Analyzing Sequential Games 471
12-1a Oligopoly in the United States: 13-5a Industry Standards as Coordination
Relative Market Shares 413 Devices 471
Contents xv
13-5b Importance of the Order of Play 473 14-2c Multiple-Product Pricing Decision 516
13-5c A Sequential Coordination Game 474 14-2d Differential Pricing and the Price
13-5d Subgame Perfect Equilibrium in Elasticity of Demand 517
Sequential Games 476 What Went Right/What Went Wrong:
13-6 Business Rivalry as a Self-Enforcing Two-Part Pricing at Disney World 522
Sequential Game 477 14-3 Differential Pricing in Target Market
13-6a First-Mover and Fast-Second Segments 522
Advantages 478 14-3a Direct Segmentation with “Fences” 523
13-7 Credible Threats and Commitments 480 14-3b Optimal Two-Part Tariffs 526
13-8 Mechanisms for Establishing What Went Right/What Went Wrong:
Credibility 481 Unlimited Data at Verizon Wireless 526
13-9 Replacement Guarantees 483 14-3c Couponing 527
13-9a Hostages Support the Credibility of
Commitments 484 What Went Right/What Went Wrong:
13-9b Credible Commitments of Durable Price-Sensitive Customers Redeem 528
Goods Monopolists 485 14-3d Bundling 528
13-9c Planned Obsolescence 486 14-3e Price Discrimination 531
13-9d Post-Purchase Discounting Risk 487 14-4 Pricing in Practice 533
13-9e Lease Prices Reflect Anticipated Risks 489 14-4a Product Life Cycle Framework 533
14-4b Full-Cost Pricing versus Incremental
Summary 489 Contribution Analysis 535
Exercises 490 14-4c Pricing on the Internet 537
Case Exercise: International Perspectives: Summary 540
The Superjumbo Dilemma 495 Exercises 541
Case Exercise: Partitoning the Price of the
13A Entry Deterrence and Accommodation Chevy Volt 543
Games 497
13A-1 Excess Capacity as a Credible 14A The Practice of Revenue Management 545
Threat 497 14A-1 A Cross-Functional Systems
13A-2 Precommitments Using Non- Management Process 546
Redeployable Assets 497 14A-2 Sources of Sustainable Price
13A-3 Customer Sorting Rules 500 Premiums 548
13A-3a A Role for Sunk Costs in Decision 14A-3 Revenue Management Decisions,
Making 501 Advanced Material 548
13A-3b Perfectly Contestable Markets 502 14A-3a Proactive Price Discrimination 549
13A-3c Brinkmanship and Wars of Attrition 503 14A-3b Capacity Reallocation 550
13A-4 Tactical Insights about Slippery 14A-3c Optimal Overbooking 553
Slopes 505 Summary 556
Summary 506 Exercises 556
Exercises 507
PART V
14 Pricing Techniques and Analysis 508
ORGANIZATIONAL ARCHITECTURE
Chapter Preview 508
AND REGULATION 557
Managerial Challenge: Pricing the
Chevy Volt 508 15 Contracting, Governance, and
14-1 A Conceptual Framework for Proactive, Organizational Form 558
Systematic-Analytical, Value-Based Chapter Preview 558
Pricing 509 Managerial Challenge: Controlling the
What Went Right/What Went Wrong: Vertical: Microsoft WebTV versus
Zerex Anticorrosive Antifreeze 510 Google Fiber 558
14-2 Optimal Differential Price Levels 513 15-1 Introduction 559
14-2a Graphical Approach 513 15-2 The Role of Contracting in
14-2b Algebraic Approach 515 Cooperative Games 560
xvi Contents
15-2a Vertical Requirements Contracts 561 Case Exercise: Designing a Managerial

15-2b The Function of Commercial Incentive Contract 592
Contracts 562 Case Exercise: The Division of Investment
15-2c Incomplete Information, Incomplete Banking Fees in a Syndicate 593
Contracting, and Post-Contractual
Opportunism 565 15A Auction Design and Information
15-3 Corporate Governance and the Economics 594
Problem of Moral Hazard 565 15A-1 Optimal Mechanism Design 594
15A-1a Queue Service Rules 594
What Went Right/What Went Wrong:
15A-2 First-Come, First-Served versus
Forecasting the Great Recession with
Last-Come, First-Served 595
Workouts and Rollovers 567
15A-2a Stratified Lotteries for Concerts 596
15-3a The Need for Governance
Mechanisms 568 15A-3 Auctions 597
15A-3a Types of Auctions 597
What Went Right/What Went Wrong: 15A-3b Winner’s Curse in Asymmetric
Moral Hazard and Holdup at Enron Information Bidding Games 598
and WorldCom 569 15A-3c Information Revelation in
15-4 The Principal-Agent Model 569 Common-Value Auctions 600
15-4a The Efficiency of Alternative Hiring 15A-3d Bayesian Strategy with Open
Arrangements 569 Bidding Design 601
15-4b Creative Ingenuity and the Moral 15A-3e Strategic Underbidding in Private-
Hazard Problem in Managerial Value Auctions 603
Contracting 571 15A-3f Second-Highest Sealed-Bid
15-4c Formalizing the Principal-Agent Auctions: A Revelation Mechanism 605
Problem 573 15A-3g Revenue Equivalence of Alternative
15-4d Screening and Sorting Managerial Auction Types 607
Talent with Optimal Incentives 15A-3h Contractual Approaches to
Contracts 574 Asymmetric Information in Online
What Went Right/What Went Wrong: Auctions 609
Why Have Restricted Stock Grants 15A-4 Incentive-Compatible Revelation
Replaced Executive Stock Options at Mechanisms 611
Microsoft? 575 15A-4a Cost Revelation in Joint Ventures
15-5 Choosing the Efficient Organizational and Partnerships 611
15A-4b Cost Overruns with Simple
Form 577
Profit-Sharing Partnerships 612
What Went Right/What Went Wrong: 15A-4c Clarke-Groves Incentive-Compatible
Cable Allies Refuse to Adopt Microsoft’s Revelation Mechanism 614
WebTV as an Industry Standard 580 15A-4d An Optimal Incentives Contract 614
International Perspectives: Economies International Perspectives: Joint Venture
of Scale and International Joint in Memory Chips: IBM, Siemens, and
Ventures in Chip Making 581 Toshiba 615
15-6 Prospect Theory Motivates Full-Line 15A-4e Implementation of IC Contracts 616
Forcing 582 International Perspectives: Whirlpool’s
15-7 Vertical Integration 584 Joint Venture in Appliances Improves
What Went Right/What Went Wrong: upon Maytag’s Outright Purchase of
Dell Replaces Vertical Integration Hoover 617
with Virtual Integration 587 Summary 618
15-7a The Dissolution of Assets in a Exercises 619
Partnership 588 Case Exercise: Spectrum Auction 620
Summary 589 Case Exercise: Debugging Computer
Exercises 591 Software: Versioning at Intel 621
Case Exercise: Borders Books and
Amazon.com Decide to Do Business 16 Government Regulation 623
Together 592 Chapter Preview 623
Contents xvii
Managerial Challenge: Cap and Trade, What Went Right/What Went Wrong:
Deregulation, and the Coase Technology Licenses Cost Palm Its
Theorem 623 Lead in PDAs 652
16-1 The Regulation of Market Structure What Went Right/What Went Wrong:
and Conduct 624 Motorola: What They Didn’t Know
16-1a Market Performance 625
Hurt Them 653
16-1b Market Conduct 625
16-7b Conclusion on Licensing 653
16-1c Contestable Markets 626
Summary 654
16-2 Antitrust Statutes and Their
Exercises 655
Regulatory Enforcement 627
16-2a The Sherman Act (1890) 627
Case Exercise: Do Luxury Good
16-2b The Clayton Act (1914) 627 Manufacturers Have a Legitimate
16-2c The Robinson-Patman Act (1936) 628 Interest in Minimum Resale Price
16-2d The Hart-Scott-Rodino Antitrust Maintenance: Leegin v. Kay’s Kloset? 657
Improvement Act (1976) 629 Case Exercise: Microsoft Tying
16-3 Antitrust Prohibition of Selected Arrangements 658
Business Decisions 630 Case Exercise: Music Recording Industry
16-3a Collusion: Price Fixing 630 Consolidating 659
16-3b Mergers That Substantially Lessen
Competition 632 17 Long-Term Investment Analysis 660
16-3c Merger Guidelines (2010) 633 Chapter Preview 660
16-3d Monopolization 633 Managerial Challenge: Industrial
16-3e Wholesale Price Discrimination 635
Renaissance in America: Insourcing
16-3f Refusals to Deal 636
16-3g Resale Price Maintenance of GE Appliances 660
Agreements 636 17-1 The Nature of Capital Expenditure
16-4 Command and Control Regulatory Decisions 661
Constraints: An Economic Analysis 637 17-2 A Basic Framework for Capital
16-4a The Deregulation Movement 639 Budgeting 662
What Went Right/What Went Wrong: 17-3 The Capital Budgeting Process 662
The Need for a Regulated 17-3a Generating Capital Investment
Projects 663
Clearinghouse to Control Counterparty 17-3b Estimating Cash Flows 663
Risk at AIG 639 17-3c Evaluating and Choosing the
16-5 Regulation of Externalities 640 Investment Projects to Implement 665
16-5a Coasian Bargaining for Reciprocal
17-4 Estimating the Firm’s Cost of
Externalities 641
16-5b Qualifications of the Coase Theorem 642 Capital 668
16-5c Impediments to Bargaining 643 17-4a Cost of Debt Capital 669
16-5d Resolution of Externalities by 17-4b Cost of Internal Equity Capital 669
Regulatory Directive 644 17-4c Cost of External Equity Capital 671
16-5e Resolution of Externalities by Taxes 17-4d Weighted Cost of Capital 671
and Subsidies 645 17-5 Cost-Benefit Analysis 672
16-5f Resolution of Externalities by Sale of 17-5a Accept-Reject Decisions 673
Pollution Rights: Cap and Trade 647 17-5b Program-Level Analysis 674
16-6 Governmental Protection of Business 647 17-6 Steps in Cost-Benefit Analysis 674
16-6a Licensing and Permitting 647 17-7 Objectives and Constraints in
16-6b Patents 648 Cost-Benefit Analysis 676
16-7 The Optimal Deployment Decision: 17-8 Analysis and Valuation of Benefits
To License or Not 648 and Costs 677
16-7a Pros and Cons of Patent Protection 17-8a Direct Benefits 677
and Licensure of Trade Secrets 649 17-8b Direct Costs 677
What Went Right/What Went Wrong: 17-8c Indirect Costs or Benefits and
Intangibles 677
Delayed Release at Aventis 650
xviii Contents
17-8d The Appropriate Rate of Discount 678 D Check Answers to Selected

17-9 Cost-Effectiveness Analysis 679 End-of-Chapter Exercises D-1
17-9a Least-Cost Studies 679 Glossary G-1
17-9b Objective-Level Studies 680 Index I-1
Summary 680 Notes
Exercises 681
Case Exercise: Industrial WEB APPENDICES
Development Tax Relief and A Consumer Choice Using Indifference Curve
Incentives 684 Analysis
Case Exercise: Multigenerational Effects B International Parity Conditions
of Ozone Depletion and Greenhouse C Linear-Programming Applications
Gases 685 D Capacity Planning and Pricing against a Low-Cost
Case Exercise: Can Tidal Power Be Competitor: A Case Study of Piedmont Airlines
Harnessed in the Bay of Fundy 688 and People Express
E Pricing of Joint Products and Transfer Pricing
APPENDICES F Decisions under Risk and Uncertainty
A The Time Value of Money A-1 G Maximization of Production Output Subject to a
B Differential Calculus Techniques in Cost Constraint, Advanced Material
Management B-1 H Long-Run Costs with a Cobb-Douglas Production
C Tables C-1 Function, Advanced Material
Preface
ORGANIZATION OF THE TEXT
The 14th edition has been thoroughly updated with 45 new applications and dozens of new
figures and tables.
We continue to expand the review of microeconomic fundamentals in Chapters 2 and
3, employing a wide-ranging discussion of the equilibrium price of crude oil and gasoline
as well as the marginal analysis of long-lasting lightbulbs. This new emphasis supports
the use of the book for pre-experience MA in Management and specialized MS programs
in business schools.
The text is structured, like many others, around demand, production, cost and pric-
ing theory in context, but the difference here is the context. We believe students are
motivated to learn analytical tools by first becoming immersed in and motivated by
deep fact situation contexts. Consequently, in each of the first 12 chapters we teach
the students why a new technique is important by first demonstrating what it can be
used to accomplish in business practice. Only then, do we delve into the theory that
applies.
Another distinctive feature of the book is the extensive treatment in Chapter 6 of
global business, import-export trade, exchange rates, free trade areas, and trade policy.
There is more comprehensive material on applied game theory in Chapters 13, 13A, 15,
15A, and the Web Appendix Case Study than in any other managerial economics text-
book. And a unique treatment of revenue (yield) management appears in Chapter 14A.
Part V includes the hot topics of corporate governance, information economics, auction
design, and the choice of organizational architecture. Chapter 16 on Regulation includes
an extensive discussion of market mechanisms for addressing externalities. Chapter 17
now leads off with a capital budgeting decision by GE to return appliance manufacturing
to the United States.
By far the most distinctive feature of the book is its 300 boxed examples, Managerial
Challenges, What Went Right/What Went Wrong explorations of corporate practice,
and mini-case examples on every other page demonstrating what each analytical concept
is used for in practice. This list of concept applications is highlighted on the inside front
and back covers.
STUDENT PREPARATION
The text is designed for use by upper-level undergraduates and first-year graduate stu-
dents in business schools, departments of economics, and professional schools of man-
agement, public policy, and information science as well as in executive training
programs. Students are presumed to have a background in the basic principles of micro-
economics, although Chapter 2 offers an extensive review of those topics. No prior
work in statistics is assumed; development of all the quantitative concepts employed is
self-contained. The book makes occasional use of elementary concepts of differential
xix
xx Preface
calculus. In all cases where calculus is employed, at least one alternative approach, such as
graphical, algebraic, or tabular analysis, is also presented. Spreadsheet applications have
become so prominent in the practice of managerial economics that we now address
optimization in that context.
PEDAGOGICAL FEATURES OF THE

14TH EDITION
The 14th edition of Managerial Economics makes extensive use of pedagogical aids to
enhance individualized student learning. The key features of the book are:
1. Managerial Challenges. Each chapter opens with a Managerial Challenge (MC) illumi-
nating a real-life problem faced by managers that is closely related to the topics covered
in the chapter. Instructors can use the discussion questions following each MC to
“hook” student interest at the start of the class or in conjunction with MindTap preclass
preparation assignments.
2. What Went Right/What Went Wrong. This feature allows students to relate
business mistakes and triumphs to what they have just learned, and helps build
that elusive goal of managerial insight.
3. Extensive Use of Boxed Examples. More than 300 real-world applications and
examples derived from actual corporate practice are highlighted throughout the
text. These applications help the analytical tools and concepts to come alive
and thereby enhance student learning. They are listed on the inside front and
back covers to highlight the prominence of this feature of the book.
4. Sustainability and the Environment Symbol. A wind vane symbol highlights
numerous passages that address environmental effects and sustainability issues
throughout the book.
5. Exercises. Each chapter contains a large problem analysis set. Check answers to
selected problems color-coded in blue type are provided in Appendix D at the
end of the book. Problems that can be solved using Excel are highlighted with an
Excel icon. The book’s Web site (www.cengage.com/economics/mcguigan) has
answers to all the other textbook problems.
6. Case Exercises. Most chapters include mini-cases that extend the concepts and
tools developed into a deep fact situation context of a real-world company, allow-
ing the students to practice what they encounter on every other page in the 300
boxed examples and applications.
7. Chapter Glossaries. In the margins of the text, new terms are defined as they are
introduced. The placement of the glossary terms next to the location where the
term is first used reinforces the importance of these new concepts and aids in
later studying.
8. International Perspectives. Throughout the book, special International Perspec-
tives sections that illustrate the application of managerial economics concepts
to an increasingly global economy are provided. A globe symbol highlights this
internationally relevant material.
9. Point-by-Point Summaries. Each chapter ends with a detailed, point-by-point
summary of important concepts from the chapter.
10. Diversity of Presentation Approaches. Important analytical concepts are
presented in several different ways, including tabular, spreadsheet, graphical, and
algebraic analysis to individualize the learning process.
Preface xxi
ANCILLARY MATERIALS
A complete set of ancillary materials is available to adopters to supplement the text,
including the following:
Instructor’s Manual and Test Bank

The instructor’s manual and test bank that accompany the book contain suggested
answers to the end-of-chapter exercises and cases. The authors have taken great care to
provide an error-free manual for instructors to use. The manual is available to instruc-
tors on the book’s Web site. The test bank, containing a large collection of true-false,
multiple-choice, and numerical problems, is available to adopters and is also available
on the Web site in Word format, as well as on the IRCD.
MindTap
MindTap is an extensive online learning system that includes the ebook, assignments
that bring course concepts to life, supplemental readings, video and discussions ques-
tions, and practice and apply exercises. This cloud-based platform integrates learning
applications (“apps”) into an easy-to-use and easy-to-access tool that supports a person-
alized learning experience. MindTap combines student learning tools—readings, multi-
media, activities and assessments—into a singular Learning Path that guides students
through the course.
Mindtap Support Web Site

When you adopt Managerial Economics: Applications, Strategy, and Tactics, 14e, you and
your students will have access to a rich array of teaching and learning resources that you
won’t find anywhere else. Located at www.CengageBrain.com, this outstanding site features
additional instructor and student resources.
PowerPoint Presentation
Available on the product companion Web site, this comprehensive package provides an
excellent lecture aid for instructors. These slides cover many of the most important
topics from the text, and they can be customized by instructors to meet specific course
needs.
ACKNOWLEDGMENTS
A number of reviewers, users, and colleagues have been particularly helpful in providing
us with many worthwhile comments and suggestions at various stages in the development
of this and earlier editions of the book. Included among these individuals are:
William Beranek, J. Walter Elliott, William J. Kretlow, William Gunther, J. William
Hanlon, Robert Knapp, Robert S. Main, Edward Sussna, Bruce T. Allen, Allen Moran,
Edward Oppermann, Dwight Porter, Robert L. Conn, Allen Parkman, Daniel Slate, Richard
L. Pfister, J. P. Magaddino, Richard A. Stanford, Donald Bumpass, Barry P. Keating, John
Wittman, Sisay Asefa, James R. Ashley, David Bunting, Amy H. Dalton, Richard D. Evans,
Gordon V. Karels, Richard S. Bower, Massoud M. Saghafi, John C. Callahan, Frank Falero,
Ramon Rabinovitch, D. Steinnes, Jay Damon Hobson, Clifford Fry, John Crockett, Marvin
Frankel, James T. Peach, Paul Kozlowski, Dennis Fixler, Steven Crane, Scott L. Smith,
Edward Miller, Fred Kolb, Bill Carson, Jack W. Thornton, Changhee Chae, Robert
B. Dallin, Christopher J. Zappe, Anthony V. Popp, Phillip M. Sisneros, George Brower,
xxii Preface
Carlos Sevilla, Dean Baim, Charles Callahan, Phillip Robins, Bruce Jaffee, Alwyn du Plessis,
Darly Winn, Gary Shoesmith, Richard J. Ward, William H. Hoyt, Irvin Grossack, William
Simeone, Satyajit Ghosh, David Levy, Simon Hakim, Patricia Sanderson, David P. Ely, Albert
A. O’Kunade, Doug Sharp, Arne Dag Sti, Walker Davidson, David Buschena, George
M. Radakovic, Harpal S. Grewal, Stephen J. Silver, Michael J. O’Hara, Luke M. Froeb, Dean
Waters, Jake Vogelsang, Lynda Y. de la Viña, Audie R. Brewton, Paul M. Hayashi, Lawrence
B. Pulley, Tim Mages, Robert Brooker, Carl Emomoto, Charles Leathers, Marshall Medoff,
Gary Brester, Stephan Gohmann, L. Joe Moffitt, Christopher Erickson, Antoine El Khoury,
Steven Rock, Rajeev K. Goel, Lee S. Redding, Paul J. Hoyt, Bijan Vasigh, Cheryl A. Casper,
Semoon Chang, Kwang Soo Cheong, Barbara M. Fischer, John A. Karikari, Francis
D. Mummery, Lucjan T. Orlowski, Dennis Proffitt, and Steven S. Shwiff.
People who were especially helpful in the preparation of the 14th edition include
Robert F. Brooker, Kristen E. Collett-Schmitt, Simon Medcalfe, Dr. Paul Stock, Shahab
Dabirian, James Leady, Stephen Onyeiwu, and Karl W. Einoff. A special thanks to
B. Ramy Elitzur of Tel Aviv University for suggesting the exercise on designing a manage-
rial incentive contract and to Bob Hebert, Business Librarian at Wake Forest School of
Business, for his tireless pursuit of reference material.
We are also indebted to Wake Forest University and the University of Louisville for the
support they provided and owe thanks to our faculty colleagues for the encouragement and
assistance provided on a continuing basis during the preparation of the manuscript. We wish
to express our appreciation to the members of the Cengage Learning staff for their help in
the preparation and promotion of this book, especially Chris Rader. We are grateful to the
Literary Executor of the late Sir Ronald A. Fisher, F.R.S.; to Dr. Frank Yates, F.R.S.; and to
Longman Group, Ltd., London, for permission to reprint Table III from their book Statistical
Tables for Biological, Agricultural, and Medical Research (6th ed., 1974).
James R. McGuigan
R. Charles Moyer
Frederick H. deB. Harris
About the Authors
James R. McGuigan
James R. McGuigan owns and operates his own numismatic investment firm. Prior to this
business, he was Associate Professor of Finance and Business Economics in the School of
Business Administration at Wayne State University. He also taught at the University of
Pittsburgh and Point Park College. McGuigan received his undergraduate degree from
Carnegie Mellon University. He earned an M.B.A. at the Graduate School of Business at
the University of Chicago and his Ph.D. from the University of Pittsburgh. In addition to
his interests in economics, he has coauthored books on financial management.
His research articles on options have been published in the Journal of Financial and
Quantitative Analysis.
R. Charles Moyer
R. Charles Moyer earned his B.A. in Economics from Howard University and his M.B.A.
and Ph.D. in Finance and Managerial Economics from the University of Pittsburgh.
Professor Moyer is Dean Emeritus and Professor of Finance and Entrepreneurship at
the College of Business, University of Louisville. Previously, he was GMAC Chair of
Finance and Dean, Babcock Graduate School of Management, Wake Forest University.
He was also Professor of Finance and Chairman of the Department of Finance at Texas
Tech University. Professor Moyer also has taught at the University of Houston, Lehigh
University, and the University of New Mexico, and spent a year at the Federal Reserve
Bank of Cleveland. Professor Moyer has taught extensively abroad in Germany, France,
and Russia. In addition to this text, Moyer has coauthored two other financial management
texts. He has been published in many leading journals, including Financial Management,
Journal of Financial and Quantitative Analysis, Journal of Finance, Financial Review, Journal
of Financial Research, International Journal of Forecasting, Strategic Management Journal and
Journal of Economics and Business. Professor Moyer is a member of the Board of Directors
of Capitala Finance Corporation, US WorldMeds, and Summit Biosciences.
Frederick H. deB. Harris

Frederick H. deB. Harris is Professor of Managerial Economics and Finance at the School of
Business, Wake Forest University. His specialties are pricing tactics and capacity planning.
Professor Harris has taught managerial economics core courses and B.A., B.S., M.S., M.B.A.,
and Ph.D. electives in business schools and economics departments in the United States,
Germany, France, Italy, and Australia. He has won two school-wide Professor of the Year
teaching awards and two Researcher of the Year awards. Other recognitions include Out-
standing Faculty by Inc. magazine (1998), Most Popular Courses by Business Week Online
2000–2001, and Outstanding Faculty by BusinessWeek’s Guide to the Best Business Schools,
5th to 9th eds., 1997–2004.
Professor Harris has published widely in leading journals, including the Review of Eco-
nomics and Statistics, Journal of Financial and Quantitative Analysis, Journal of Operations
Management, Journal of Industrial Economics, Journal of Banking and Finance, Journal of
Business Ethics, and Journal of Financial Markets. From 1988 through 1993, Professor
Harris served on the Board of Associate Editors of the Journal of Industrial Economics.
xxiii
xxiv About the Authors
His path breaking work on price discovery has been frequently cited in leading academic
journals, and several articles with practitioners have been published in the Journal of
Trading from Institutional Investor Journals. In addition, he often benchmarks the pricing,
order processing, and capacity planning functions of large companies against state-of-the-
art techniques in revenue management and writes about his findings in journals such as
the AMA’s Marketing Management and INFORMS’s Journal of Revenue and Pricing
Management.
PART I
Introduction
ECONOMIC ANALYSIS AND ECONOMIC, POLITICAL, AND

DECISIONS SOCIAL ENVIRONMENT
1. Demand Analysis 1. Business Conditions (Trends,
2. Production and Cost Analysis Cycles, and Seasonal Effects)
3. Product, Pricing, and Output 2. Factor Market Conditions
Decisions (Capital, Labor, and Raw
4. Capital Expenditure Analysis Materials)
3. Competitors’ Reactions and
Tactical Response
4. Organizational Architecture
and Regulatory Constraints
Cash Flows Risk
Firm Value
(Shareholders’ Wealth)
1
CHAPTER
1 Introduction and Goals

of the Firm
CHAPTER PREVIEW
Managerial economics is the application of microeconomics to decision problems faced in the private and
public sectors. Managerial economics assists managers in efficiently allocating scarce resources, planning
organizational strategy, and executing effective tactics. In this chapter, the meaning of economic profit is
explored, and the role of profits in allocating resources in a free enterprise system is examined. The
primary goal of the firm to maximize shareholder wealth is developed along with a full discussion of
critical resources and feedback effects attributable to stakeholders. Management’s role in resolving
problems associated with the separation of ownership and control, moral hazard in teams, and principal-
agent relationships is explored.
MANAGERIAL CHALLENGE
How to Achieve Sustainability: Southern Company Electric
Power Generation1
In the second decade of the twenty-first century, compa- downwind hundreds of miles away to trees, painted and
nies all across the industrial landscape are seeking to stone surfaces, and asthmatics. The Clean Air Act
achieve sustainability. Sustainability is a powerful meta- (CAA) of 1990, amended in 1997 and 2003, granted
phor but an elusive goal. It means much more than tradable pollution allowances (TPAs) to known pollu-
aligning oneself with a commitment to environmental ters. The CAA also authorized an auction market for
sensitivity, which tests higher in opinion polling of the these TPA assets. The Environmental Protection Agency
latent preferences of Americans and Europeans than any Web site (www.epa.gov) displays on a daily basis the
other response. Sustainability also implies renewability equilibrium, market-clearing price of these new TPAs
and longevity of business plans that are adaptable to on the balance sheet. Most importantly, the cap-
changing circumstances. But what exactly should man- and-trade system literally identified for the first time a
agement pursue as a set of objectives to achieve this price for the use of what had previously been unpriced
goal? common property resources—namely, acid-free air and
Management response to pollution abatement illus- rainwater. As a result, large point-source polluters like
trates one type of sustainability challenge. At the insis- power plants and steel mills now incur an actual cost
tence of the prime minister of Canada during the Reagan per ton for the SOx and NOx–laden soot by-products
Administration, the U.S. Congress enacted a bipartisan of burning lots of high sulfur coal. These amounts
cap-and-trade bill to address smokestack emissions. Sul- were promptly placed in spreadsheets designed to find
fur dioxide and nitrous oxide (SOx and NOx) emissions ways of minimizing the sum of operating plus pollution
precipitate as acid rain, mist, and ice, imposing damage by-product costs.2 Thereafter, each polluter felt powerful
Cont.
2 Copyright 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-203
Chapter 1: Introduction and Goals of the Firm 3
MANAGERIAL CHALLENGE Continued

Figure 1.1). Although TPAs “grandfathered” a substan-
tial amount of pollution, the gradual transition provided
by cap-and-trade legislation was pivotally important to
its widespread success. Industries such as steel and elec-
tric power were given five years to comply with the reg-
ulated emissions requirements, and then in 1997, the
initial allowances were cut in half. Duke Power initially
AP Images/Stephen Morton
bought 19,146 allowances for Belews Creek at prices
ranging from $131 to $480 per ton and then in 2003
built two 30-story smokestack scrubbers that reduced
the NOx emissions by 75 percent.
Another major electric utility, Southern Company, ana-
incremental incentives to reduce compliance cost by abat- lyzed three compliance choices on a least-cost cash flow
ing pollution. And an entire industry devoted to develop- basis: (1) buying allowances, (2) installing smokestack
ing pollution abatement technology sprang up. scrubbers, or (3) adopting fuel-switching technology to
The TPAs granted were set at approximately 80 per- burn low-sulfur coal or even cleaner natural gas. In a widely
cent of the known pollution taking place at each plant in studied case, the Southern Company found its huge Bowen
1990. For example, Duke Power’s Belews Creek power plant in North Georgia would require a $657 million scrub-
plant, generating 120,085 tons of nitrous oxide acidic ber that after tax deductions for capital equipment depreci-
soot annually from burning 400 train carloads of coal ation and offsets from excess allowance revenue implied
every day, was granted 96,068 tons of allowances (see a $476 million cost. Alternatively, continuing to burn
FIGURE 1.1 Nitrous Oxide from Coal-Fired Power Plants (Daily Emissions in Tons, pre Clean Air Act)
329 tons
NOx
194
164 Mayo
55 CP&L
13
Buck
Duke 14 Dan Roxboro
44 River CP&L
59 24 17
Asheville 39 Duke 27
Marshall Cape
CP&L Duke Belews
Fear Lee
Riverbend Creek CP&L CP&L
Duke Duke
Cliffside 13 55
Allen
Duke Duke Weatherspoon
CP&L
Sutton
CP&L
Source: NC Division of Air Quality.
Cont.
4 Part I: Introduction
MANAGERIAL CHALLENGE Continued

high-sulfur coal from the nearby Appalachian Mountains
and purchasing the requisite allowances in the cap- Discussion Questions
and-trade market was projected to cost $266 million. And n What is the basic externality problem with
finally, switching to low-sulfur coal while adopting fuel- acid rain? What objectives should manage-
switching technology was found to cost $176 million. All ment serve in responding to the acid rain
these analyses were performed on a present value basis problem?
with cost projections over 25 years. Chapter 2 offers a n How did the Clean Air Act’s cap-and-trade
quick primer on the net present value concept. approach to air pollution affect the Southern
Southern Company’s decision to switch to low-sulfur Company’s analysis of the previously unpriced
coal was hailed far and wide as environmentally sensitive common property air and water resources
and sustainable. Many electric utilities support cap- damaged by smokestack emissions?
and-trade policies and actively pursue the mandate of n How should management comply with the
the states in which they operate to derive 15 percent of Clean Air Act, or should the Southern Com-
their power from renewable energy (RE). In a Case pany simply pay the EPA’s fines? Why? How
Study at the end of the chapter, we analyze wind and would you decide?
tidal power RE alternatives for generating electricity. n Which among Southern Company’s three
The choice of fuel-switching technology to abate alternatives for compliance offered the most
smokestack emissions was a shareholder value- strategic flexibility? Explain.
maximizing choice for Southern Company for two rea-
sons. First, switching to low-sulfur coal minimized their
projected cash flow compliance costs under the CAA
1
but, in addition, the fuel-switching technology created Based on Frederick Harris, Alternative Energy Symposium, Wake Forest
Schools of Business (September 2008); and “Acid Rain: The Southern Com-
a strategic flexibility (a “real option”) and that in itself pany,” Harvard Business School Publishing, HBS: 9-792-060.
created additional shareholder value. In this chapter, we 2
EPA fines for noncompliance of $2,000 per ton often exceed the auction
will see what maximizing capitalized value of equity market price of tradeable pollution allowances by a factor of 10.
(shareholder value) entails and what is does not.
1-1 WHAT IS MANAGERIAL ECONOMICS?

Managerial economics extracts from microeconomic theory those concepts and techni-
ques that enable managers to select strategic direction, to allocate efficiently the resources
available to the organization, and to respond effectively to tactical issues. All such mana-
gerial decision making seeks to do the following:
1. identify the alternatives,
2. select the choice that accomplishes the objective(s) in the most efficient manner,
3. taking into account the constraints,
4. and the likely actions and reactions of rival decision makers.
For example, consider the following stylized decision problem:
Example
Capacity Expansion at Honda, N.A., and
Toyota Motors, N.A.
Honda and Toyota are attempting to expand their already substantial assembly opera-
tions in North America. Both companies face increasing demand for their
U.S.-manufactured vehicles, especially Toyota Camrys and Honda Accords. Camrys
and Accords rate extremely highly in consumer reports of durability and reliability.
(continued)
The demand for used Accords is so strong that they depreciate only 45 percent in their
first four years. Other competing vehicles may depreciate as much as 65 percent in the
same period. Toyota and Honda have identified two possible strategies (S1NEW and
S2USED) to meet the growing demand for Camrys and Accords. Strategy S1NEW
involves an internal expansion of capacity at Toyota’s $700 million Princeton, Indiana,
plant and Honda’s Marysville, Ohio, plant. Strategy S2USED involves the purchase and
renovation of assembly plants now owned by General Motors. The new plants will likely
receive substantial public subsidies through reduced property taxes. The older plants
already possess an enormous infrastructure of local suppliers and regulatory relief.
The objective of Toyota’s managers is to maximize the value today (present value)
of the expected future profit from the expansion. This problem can be summarized as
follows:
Objective function: Maximize the present value (P.V.) of profit
(S1NEW, S2USED)
Decision rule: Choose strategy S1NEW if P.V. (Profit S1NEW)
> P.V. (Profit S2USED)
Choose strategy S2USED if the reverse.
This simple illustration shows how resource-allocation decisions of managers

attempt to maximize the value of their firms across forward-looking dynamic strate-
gies for growth while respecting all ethical, legal, and regulatory constraints.
1-2 THE DECISION-MAKING MODEL

The ability to make good decisions is the key to successful managerial performance. All
decision making shares several common elements. First, the decision maker must estab-
lish the objectives. Next, the decision maker must identify the problem. For example, the
CEO of electronics retailer Best Buy may note that the profit margin on sales has been
decreasing. This could be caused by pricing errors, declining labor productivity, or the
use of outdated retailing concepts. Once the source or sources of the problem are identi-
fied, the manager can move to an examination of potential solutions. The choice between
these alternatives depends on an analysis of the relative costs and benefits, as well as other
organizational and societal constraints that may make one alternative preferable to
another.
The final step in the decision-making process, after all alternatives have been evalu-
ated, is to analyze the best available alternative under a variety of changes in the assump-
tions before making a recommendation. This crucial final step is referred to as a
sensitivity analysis. Knowing the limitations of the planned course of action as the deci-
sion environment changes, the manager can then proceed to an implementation of the
decision, monitoring carefully any unintended consequences or unanticipated changes
in the market. The case problem at the end of the chapter highlights the role of sensitiv-
ity analysis in analyzing wind turbines as a renewable energy source of electricity.
1-2a The Responsibilities of Management

In a free enterprise system, managers are responsible for a number of goals. Managers
are responsible for proactively solving problems in the current business model before
WHAT WENT RIGHT • WHAT WENT WRONG

Saturn Corporation3 other divisions. Consequently, cash flow was not reinvested
When General Motors (GM) rolled out their “different kind in the Saturn division, products were not updated, and the
of car company,” J.D. Powers rated product quality 8 percent models stagnated. By 1997, sales were slumping at −9 percent
ahead of Honda, and customers liked the no-haggle selling and in 1998 they fell an additional 20 percent. In 2009, GM
process. Saturn achieved the 200,000 unit sales enjoyed by announced it was permanently closing the Saturn division.
the Honda Civic and the Toyota Corolla in two short years GM managers had not established the next Saturn busi-
and caught the 285,000 volume of the Ford Escort in ness model which would have transferred young childless
Saturn’s fourth year. Making interpersonal aspects of cus- couples to more profitable GM divisions as their lifecycle
tomer service the number-one priority and possessing super- called for bigger sedans, minivans, and SUVs. Rather than
ior inventory and MIS systems, Saturn dealerships proved trading up to Buick, middle-aged loyal Saturn owners
very profitable and quickly developed a reputation for sought to trade up within Saturn, and finding no sporty
some of the highest customer loyalty in the industry. larger models available, they switched to larger Japanese
However, with pricing of the base Saturn model $1,200 imports like the Honda Accord and Toyota Camry. After
below the $12,050 rival Japanese compact cars, the GM parent almost collapsing, Saturn introduced a sport wagon, an
earned only a $400 gross profit margin per vehicle. In a typical efficient SUV, and a high-profile sports coupe. GM ulti-
year, this meant GM was recovering only about $100 million mately abandoned the brand in 2009.
of its $3 billion capital investment, a paltry 3 percent return. 3
Based on M. Cohen, “Saturn’s Supply-Chain Innovation,” Sloan Manage-
Netting out GM’s 11 percent cost of capital, each Saturn was ment Review (Summer 2000), pp. 93–96; “Small Car Sales Are Back” and
losing approximately $1,000. These figures compare to a “Why Didn’t GM Do More for Saturn?” BusinessWeek, September 22,
$3,300 gross profit margin per vehicle in some of GM’s 1997, pp. 40–42, and March 16, 1998, p. 62.
they become crises and for selecting strategies to assure the more likely success of the
next business model. Research In Motion built the world’s best international cell phone
(the Blackberry) but missed the market as customer demand evolved to web-enabled
smart phones with 500,000 and then millions of apps. In addition, managers create orga-
nizational structure and culture based on the organization’s mission. Senior management
especially is responsible for establishing a vision of new business directions and setting
stretch goals to get there. In addition, managers coordinate the integration of marketing,
operations, and finance functions. If plant managers don’t know the realized margins
from particular segments targeted by the sales team, then they will often expedite and
fulfill orders to the wrong customers. Finally, managers undertake the critical responsi-
bility of motivating and monitoring teamwork.
1-2b Moral Hazard in Teams

Teamwork skills and the ability to motivate teams is widely acknowledged as the single
most critical trait of effective managers. This applies equally to Navy Seal teams, factory
work cell teams, brand management teams, or consulting teams. Why is that? Why is
teamwork so important, and why is attaining good teamwork so hard? The essence of
teamwork is synergistic value creation in excess of the sum of the parts. As individuals
on a team, we can each “pull our own weight” or contribute more than that and com-
pound our extra effort with the extraordinary efforts of those around us. Just as in
sports, 110 percent effort on company teams often defeats more skilled opponents and
sometimes even those with better resources. But how does a manager attain the commit-
ment from a team to put forth 110 percent effort when doing less would not impose as
much personal sacrifice, and when individual shirking on one’s effort may not be trans-
parently obvious? This constitutes the so-called moral hazard problem in team-making.
If penalties and sanctions are few and far between, only a sense of moral duty induces
full-effort teamwork rather than the reduced effort associated with free-riding.
Consider the following example of the teamwork involved in bringing a product to
market. Mack and Myer are collaborating on a product launch. Each has specialized
skills that are required to achieve the maximum output and a gross profit of $100 if
they each “Pull Hard,” devoting their best effort to the project. In that event, $25 per-
sonal cost for each leaves $25 net profit available to each of them. If either shirks and
reduces effort unilaterally, the output is reduced and gross profit declines by 30 percent
to $70 to be divided between them, but the shirker reduces his or her personal cost to $0,
thereby yielding a $35 net profit to the free rider and only $10 to the dutiful teammate
who Pulled Hard. If both shirk and fail to provide best effort, then output collapses,
gross profit falls to $30, yielding each just $15 net profit. These payoffs are depicted in
the normal form game matrix Figure 1.2, Panel A.
What if this is a one-time-only situation, and each player must decide simultaneously
without knowing the choice of his or her teammate? One of the insights of game theory
is that in the absence of repeated games involving the same teammates, rational players
in such situations will ignore reputation effects and select the action whose payoff dom-
inates all others. In this case, that means each player will choose to Shirk since the $35
outcome exceeds $25, and the $15 outcome exceeds $10. In short, the outcomes from the
action Shirk in the right-hand column dominate those in the Pull Hard column (and so
too in the rows of the payoff matrix). Each team member therefore prefers to defect (by
choosing Shirk), whatever the choice of his or her teammate; Shirk is said to be a domi-
nant strategy. Therefore, {Shirk, Shirk} emerges as a dominant strategy outcome with
great predictability.
But if they both do so, a tragic dilemma arises. In the southeast {Shirk, Shirk} cell, the
payoff to each player is just $15, and total value added is only $30. Both teammates
FIGURE 1.2
Payoffs from Team
Panel A No Supervisor
Production with Mack
and without a
Pull Hard Shirk
Supervisor
Pull Hard
$25 $35
Meyer $25 $10
Shirk
$10 $15
$35 $15
Panel B Supervisor Present. A $10 Manager is Hired as a Monitor of Shirking for which
A $15 Penalty is Imposed.
Mack
Pull Hard Shirk
$20 $15
Pull Hard $20 $5
Meyer
Shirk $5 $–5
$15 $–5
realize, however, that if they had just found a way to elicit cooperation from one another,
$50 net profit would have been available in the northwest {Pull Hard, Pull Hard} cell.
Their individually optimal decision-making (reflected by the dominant strategy to defect
from cooperative arrangements) leaves $20 foregone profits until the players them-
selves organize their team-making differently. As a result, we might well expect that the
players would evolve mechanisms for contracting around the moral hazard problem in
order to capture the foregone value. How can this be accomplished?
What if the team hired a manager as project supervisor to monitor the teamwork and
punish shirking fairly? Splitting the cost of paying a manager $10 leaves $40 gross profit
in the {Pull Hard, Pull Hard} cell, to be divided evenly between Mack and Meyer. In the
diagonal cells, the manager now penalizes whichever teammate shirks their duty $15.
The payoff for this unilateral defector now becomes ð$70=2 ¼ $35Þ $15 $5 ¼ $15,
less than the ð$100=2 ¼ $50Þ $25 $5 ¼ $20 associated with the cooperative decision
to Pull Hard. And this is a symmetric payoff game, so both players now conclude the
same thing—that is, it pays to adopt mutually cooperative teamwork and deliver full
effort. Since each player will receive only ð$30=2 ¼ $15Þ $15 $5 ¼ $15 in the
event they both shirk their duties, and ð$70=2 ¼ $35Þ $25 $5 ¼ $5 in the event
their Hard Pull is unilaterally defected upon, each decides to Pull Hard. Indeed, examin-
ing the new payoff matrix in Figure 1.2, Panel B the choice pair {Pull Hard, Pull Hard}
has now become the dominant strategy. So, in conclusion, moral hazard in teams can be
avoided. What is needed is a manager as supervisor who imposes sanctions for the shirk-
ing behavior of teammates that decide to free ride.
Managers in a capitalist economy are motivated to monitor teamwork ultimately
because of their overarching goal to maximize returns to the owners of the business—
that is, economic profits.
economic profit The Economic profit is the difference between total sales revenue (price times units sold)
difference between and total economic cost. The economic cost of any activity may be thought of as the
total revenue and total highest valued alternative opportunity that is forgone. To attract labor, capital, intellec-
economic cost. Eco- tual property, land, and matériel, the firm must offer to pay a price that is sufficient to
nomic cost includes a convince the owners of these resources to forego other alternative activities and commit
“normal” rate of return
their resources to this use. Thus, economic costs should always be thought of as oppor-
on the capital contri-
butions of the firm’s
tunity costs—that is, the costs of attracting a resource such as investment capital from its
partners. next best alternative use.
1-3 THE ROLE OF PROFITS

In a free enterprise system, economic profits play an important role in guiding the deci-
sions made by the thousands of competing independent resource owners. The existence
of profits determines the type and quantity of goods and services that are produced and
sold, as well as the resulting derived demand for resources. Several theories of profit indi-
cate how this works.
1-3a Risk-Bearing Theory of Profit

Economic profits arise in part to compensate the owners of the firm for the risk they
assume when making their investments. Because a firm’s shareholders are not entitled
to a fixed rate of return on their investment—that is, they are claimants to the firm’s
residual cash flows after all other contractual payments have been made—they need to
be compensated for this risk in the form of a higher rate of return.
The risk-bearing theory of profits is explained in the context of normal profits, where
normal is defined in terms of the relative risk of alternative investments. Normal profits
for a high-risk firm, such as Las Vegas hotels and casinos, a biotech pharmaceutical
company, or an oil field exploration well operator, should be higher than normal profits
for firms of lesser risk, such as water utilities. For example, in 2005, the industry average
return on net worth for the casino hotel/gaming industry was 12.6 percent, compared to
9 percent for the water utility industry.
1-3b Temporary Disequilibrium Theory of Profit

Although there exists a long-run equilibrium normal rate of profit (adjusted for risk) that
all firms should tend to earn, at any point in time, firms may find themselves earning a
rate of return above or below this long-run normal return level. This can occur because
of temporary dislocations (shocks) in various sectors of the economy. Rates of return in
the oil industry rose substantially when the price of crude oil doubled from $75 in mid-
2007 to $146 in July 2008. However, those high returns declined sharply in 2014–2015,
when oil market conditions led to excess supplies and the price of crude oil fell to $45.
1-3c Monopoly Theory of Profit

In some industries, one firm is effectively able to dominate the market and persistently
earn above-normal rates of return. This ability to dominate the market may arise from
economies of scale (a situation in which one large firm, such as Boeing, can produce
additional units of 747 aircraft at a lower cost than can smaller firms), control of essen-
tial natural resources (crude oil), control of critical patents (biotech pharmaceutical
firms), or governmental restrictions that prohibit competition (cable franchise owners).
The conditions under which a monopolist can earn above-normal profits are discussed
in greater depth in Chapter 11.
1-3d Innovation Theory of Profit

The innovation theory of profit suggests that above-normal profits are the reward for
successful innovations. Firms that develop high-quality products (such as Porsche) or
successfully identify unique market opportunities (such as Apple) are rewarded with the
potential for above-normal profits. Indeed, the U.S. patent system is designed to ensure
that these above-normal return opportunities furnish strong incentives for continued
innovation.
1-3e Managerial Efficiency Theory of Profit

Closely related to the innovation theory is the managerial efficiency theory of profit.
Above-normal profits can arise because of the exceptional managerial skills of well-
managed firms. No single theory of profit can explain the observed profit rates in each
industry, nor are these theories necessarily mutually exclusive. Profit performance is
invariably the result of many factors, including differential risk, innovation, managerial
skills, the existence of monopoly power, and chance occurrences.
1-4 OBJECTIVE OF THE FIRM

These theories of simple profit maximization as an objective of management are insight-
ful, but they do not quantify the timing and risk of profit streams. Shareholder wealth
maximization as an objective overcomes both these limitations.
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DANCE ON STILTS AT THE GIRLS’ UNYAGO, NIUCHI
Newala, too, suffers from the distance of its water-supply—at least

the Newala of to-day does; there was once another Newala in a lovely
valley at the foot of the plateau. I visited it and found scarcely a trace
of houses, only a Christian cemetery, with the graves of several
missionaries and their converts, remaining as a monument of its
former glories. But the surroundings are wonderfully beautiful. A
thick grove of splendid mango-trees closes in the weather-worn
crosses and headstones; behind them, combining the useful and the
agreeable, is a whole plantation of lemon-trees covered with ripe
fruit; not the small African kind, but a much larger and also juicier
imported variety, which drops into the hands of the passing traveller,
without calling for any exertion on his part. Old Newala is now under
the jurisdiction of the native pastor, Daudi, at Chingulungulu, who,
as I am on very friendly terms with him, allows me, as a matter of
course, the use of this lemon-grove during my stay at Newala.
FEET MUTILATED BY THE RAVAGES OF THE “JIGGER”
(Sarcopsylla penetrans)
The water-supply of New Newala is in the bottom of the valley,

some 1,600 feet lower down. The way is not only long and fatiguing,
but the water, when we get it, is thoroughly bad. We are suffering not
only from this, but from the fact that the arrangements at Newala are
nothing short of luxurious. We have a separate kitchen—a hut built
against the boma palisade on the right of the baraza, the interior of
which is not visible from our usual position. Our two cooks were not
long in finding this out, and they consequently do—or rather neglect
to do—what they please. In any case they do not seem to be very
particular about the boiling of our drinking-water—at least I can
attribute to no other cause certain attacks of a dysenteric nature,
from which both Knudsen and I have suffered for some time. If a
man like Omari has to be left unwatched for a moment, he is capable
of anything. Besides this complaint, we are inconvenienced by the
state of our nails, which have become as hard as glass, and crack on
the slightest provocation, and I have the additional infliction of
pimples all over me. As if all this were not enough, we have also, for
the last week been waging war against the jigger, who has found his
Eldorado in the hot sand of the Makonde plateau. Our men are seen
all day long—whenever their chronic colds and the dysentery likewise
raging among them permit—occupied in removing this scourge of
Africa from their feet and trying to prevent the disastrous
consequences of its presence. It is quite common to see natives of
this place with one or two toes missing; many have lost all their toes,
or even the whole front part of the foot, so that a well-formed leg
ends in a shapeless stump. These ravages are caused by the female of
Sarcopsylla penetrans, which bores its way under the skin and there
develops an egg-sac the size of a pea. In all books on the subject, it is
stated that one’s attention is called to the presence of this parasite by
an intolerable itching. This agrees very well with my experience, so
far as the softer parts of the sole, the spaces between and under the
toes, and the side of the foot are concerned, but if the creature
penetrates through the harder parts of the heel or ball of the foot, it
may escape even the most careful search till it has reached maturity.
Then there is no time to be lost, if the horrible ulceration, of which
we see cases by the dozen every day, is to be prevented. It is much
easier, by the way, to discover the insect on the white skin of a
European than on that of a native, on which the dark speck scarcely
shows. The four or five jiggers which, in spite of the fact that I
constantly wore high laced boots, chose my feet to settle in, were
taken out for me by the all-accomplished Knudsen, after which I
thought it advisable to wash out the cavities with corrosive
sublimate. The natives have a different sort of disinfectant—they fill
the hole with scraped roots. In a tiny Makua village on the slope of
the plateau south of Newala, we saw an old woman who had filled all
the spaces under her toe-nails with powdered roots by way of
prophylactic treatment. What will be the result, if any, who can say?
The rest of the many trifling ills which trouble our existence are
really more comic than serious. In the absence of anything else to
smoke, Knudsen and I at last opened a box of cigars procured from
the Indian store-keeper at Lindi, and tried them, with the most
distressing results. Whether they contain opium or some other
narcotic, neither of us can say, but after the tenth puff we were both
“off,” three-quarters stupefied and unspeakably wretched. Slowly we
recovered—and what happened next? Half-an-hour later we were
once more smoking these poisonous concoctions—so insatiable is the
craving for tobacco in the tropics.
Even my present attacks of fever scarcely deserve to be taken
seriously. I have had no less than three here at Newala, all of which
have run their course in an incredibly short time. In the early
afternoon, I am busy with my old natives, asking questions and
making notes. The strong midday coffee has stimulated my spirits to
an extraordinary degree, the brain is active and vigorous, and work
progresses rapidly, while a pleasant warmth pervades the whole
body. Suddenly this gives place to a violent chill, forcing me to put on
my overcoat, though it is only half-past three and the afternoon sun
is at its hottest. Now the brain no longer works with such acuteness
and logical precision; more especially does it fail me in trying to
establish the syntax of the difficult Makua language on which I have
ventured, as if I had not enough to do without it. Under the
circumstances it seems advisable to take my temperature, and I do
so, to save trouble, without leaving my seat, and while going on with
my work. On examination, I find it to be 101·48°. My tutors are
abruptly dismissed and my bed set up in the baraza; a few minutes
later I am in it and treating myself internally with hot water and
lemon-juice.
Three hours later, the thermometer marks nearly 104°, and I make
them carry me back into the tent, bed and all, as I am now perspiring
heavily, and exposure to the cold wind just beginning to blow might
mean a fatal chill. I lie still for a little while, and then find, to my
great relief, that the temperature is not rising, but rather falling. This
is about 7.30 p.m. At 8 p.m. I find, to my unbounded astonishment,
that it has fallen below 98·6°, and I feel perfectly well. I read for an
hour or two, and could very well enjoy a smoke, if I had the
wherewithal—Indian cigars being out of the question.
Having no medical training, I am at a loss to account for this state
of things. It is impossible that these transitory attacks of high fever
should be malarial; it seems more probable that they are due to a
kind of sunstroke. On consulting my note-book, I become more and
more inclined to think this is the case, for these attacks regularly
follow extreme fatigue and long exposure to strong sunshine. They at
least have the advantage of being only short interruptions to my
work, as on the following morning I am always quite fresh and fit.
My treasure of a cook is suffering from an enormous hydrocele which
makes it difficult for him to get up, and Moritz is obliged to keep in
the dark on account of his inflamed eyes. Knudsen’s cook, a raw boy
from somewhere in the bush, knows still less of cooking than Omari;
consequently Nils Knudsen himself has been promoted to the vacant
post. Finding that we had come to the end of our supplies, he began
by sending to Chingulungulu for the four sucking-pigs which we had
bought from Matola and temporarily left in his charge; and when
they came up, neatly packed in a large crate, he callously slaughtered
the biggest of them. The first joint we were thoughtless enough to
entrust for roasting to Knudsen’s mshenzi cook, and it was
consequently uneatable; but we made the rest of the animal into a
jelly which we ate with great relish after weeks of underfeeding,
consuming incredible helpings of it at both midday and evening
meals. The only drawback is a certain want of variety in the tinned
vegetables. Dr. Jäger, to whom the Geographical Commission
entrusted the provisioning of the expeditions—mine as well as his
own—because he had more time on his hands than the rest of us,
seems to have laid in a huge stock of Teltow turnips,[46] an article of
food which is all very well for occasional use, but which quickly palls
when set before one every day; and we seem to have no other tins
left. There is no help for it—we must put up with the turnips; but I
am certain that, once I am home again, I shall not touch them for ten
years to come.
Amid all these minor evils, which, after all, go to make up the
genuine flavour of Africa, there is at least one cheering touch:
Knudsen has, with the dexterity of a skilled mechanic, repaired my 9
× 12 cm. camera, at least so far that I can use it with a little care.
How, in the absence of finger-nails, he was able to accomplish such a
ticklish piece of work, having no tool but a clumsy screw-driver for
taking to pieces and putting together again the complicated
mechanism of the instantaneous shutter, is still a mystery to me; but
he did it successfully. The loss of his finger-nails shows him in a light
contrasting curiously enough with the intelligence evinced by the
above operation; though, after all, it is scarcely surprising after his
ten years’ residence in the bush. One day, at Lindi, he had occasion
to wash a dog, which must have been in need of very thorough
cleansing, for the bottle handed to our friend for the purpose had an
extremely strong smell. Having performed his task in the most
conscientious manner, he perceived with some surprise that the dog
did not appear much the better for it, and was further surprised by
finding his own nails ulcerating away in the course of the next few
days. “How was I to know that carbolic acid has to be diluted?” he
mutters indignantly, from time to time, with a troubled gaze at his
mutilated finger-tips.
Since we came to Newala we have been making excursions in all
directions through the surrounding country, in accordance with old
habit, and also because the akida Sefu did not get together the tribal
elders from whom I wanted information so speedily as he had
promised. There is, however, no harm done, as, even if seen only
from the outside, the country and people are interesting enough.
The Makonde plateau is like a large rectangular table rounded off
at the corners. Measured from the Indian Ocean to Newala, it is
about seventy-five miles long, and between the Rovuma and the
Lukuledi it averages fifty miles in breadth, so that its superficial area
is about two-thirds of that of the kingdom of Saxony. The surface,
however, is not level, but uniformly inclined from its south-western
edge to the ocean. From the upper edge, on which Newala lies, the
eye ranges for many miles east and north-east, without encountering
any obstacle, over the Makonde bush. It is a green sea, from which
here and there thick clouds of smoke rise, to show that it, too, is
inhabited by men who carry on their tillage like so many other
primitive peoples, by cutting down and burning the bush, and
manuring with the ashes. Even in the radiant light of a tropical day
such a fire is a grand sight.
Much less effective is the impression produced just now by the
great western plain as seen from the edge of the plateau. As often as
time permits, I stroll along this edge, sometimes in one direction,
sometimes in another, in the hope of finding the air clear enough to
let me enjoy the view; but I have always been disappointed.
Wherever one looks, clouds of smoke rise from the burning bush,
and the air is full of smoke and vapour. It is a pity, for under more
favourable circumstances the panorama of the whole country up to
the distant Majeje hills must be truly magnificent. It is of little use
taking photographs now, and an outline sketch gives a very poor idea
of the scenery. In one of these excursions I went out of my way to
make a personal attempt on the Makonde bush. The present edge of
the plateau is the result of a far-reaching process of destruction
through erosion and denudation. The Makonde strata are
everywhere cut into by ravines, which, though short, are hundreds of
yards in depth. In consequence of the loose stratification of these
beds, not only are the walls of these ravines nearly vertical, but their
upper end is closed by an equally steep escarpment, so that the
western edge of the Makonde plateau is hemmed in by a series of
deep, basin-like valleys. In order to get from one side of such a ravine
to the other, I cut my way through the bush with a dozen of my men.
It was a very open part, with more grass than scrub, but even so the
short stretch of less than two hundred yards was very hard work; at
the end of it the men’s calicoes were in rags and they themselves
bleeding from hundreds of scratches, while even our strong khaki
suits had not escaped scatheless.
NATIVE PATH THROUGH THE MAKONDE BUSH, NEAR

MAHUTA
I see increasing reason to believe that the view formed some time
back as to the origin of the Makonde bush is the correct one. I have
no doubt that it is not a natural product, but the result of human
occupation. Those parts of the high country where man—as a very
slight amount of practice enables the eye to perceive at once—has not
yet penetrated with axe and hoe, are still occupied by a splendid
timber forest quite able to sustain a comparison with our mixed
forests in Germany. But wherever man has once built his hut or tilled
his field, this horrible bush springs up. Every phase of this process
may be seen in the course of a couple of hours’ walk along the main
road. From the bush to right or left, one hears the sound of the axe—
not from one spot only, but from several directions at once. A few
steps further on, we can see what is taking place. The brush has been
cut down and piled up in heaps to the height of a yard or more,
between which the trunks of the large trees stand up like the last
pillars of a magnificent ruined building. These, too, present a
melancholy spectacle: the destructive Makonde have ringed them—
cut a broad strip of bark all round to ensure their dying off—and also
piled up pyramids of brush round them. Father and son, mother and
son-in-law, are chopping away perseveringly in the background—too
busy, almost, to look round at the white stranger, who usually excites
so much interest. If you pass by the same place a week later, the piles
of brushwood have disappeared and a thick layer of ashes has taken
the place of the green forest. The large trees stretch their
smouldering trunks and branches in dumb accusation to heaven—if
they have not already fallen and been more or less reduced to ashes,
perhaps only showing as a white stripe on the dark ground.
This work of destruction is carried out by the Makonde alike on the
virgin forest and on the bush which has sprung up on sites already
cultivated and deserted. In the second case they are saved the trouble
of burning the large trees, these being entirely absent in the
secondary bush.
After burning this piece of forest ground and loosening it with the
hoe, the native sows his corn and plants his vegetables. All over the
country, he goes in for bed-culture, which requires, and, in fact,
receives, the most careful attention. Weeds are nowhere tolerated in
the south of German East Africa. The crops may fail on the plains,
where droughts are frequent, but never on the plateau with its
abundant rains and heavy dews. Its fortunate inhabitants even have
the satisfaction of seeing the proud Wayao and Wamakua working
for them as labourers, driven by hunger to serve where they were
accustomed to rule.
But the light, sandy soil is soon exhausted, and would yield no
harvest the second year if cultivated twice running. This fact has
been familiar to the native for ages; consequently he provides in
time, and, while his crop is growing, prepares the next plot with axe
and firebrand. Next year he plants this with his various crops and
lets the first piece lie fallow. For a short time it remains waste and
desolate; then nature steps in to repair the destruction wrought by
man; a thousand new growths spring out of the exhausted soil, and
even the old stumps put forth fresh shoots. Next year the new growth
is up to one’s knees, and in a few years more it is that terrible,
impenetrable bush, which maintains its position till the black
occupier of the land has made the round of all the available sites and
come back to his starting point.
The Makonde are, body and soul, so to speak, one with this bush.
According to my Yao informants, indeed, their name means nothing
else but “bush people.” Their own tradition says that they have been
settled up here for a very long time, but to my surprise they laid great
stress on an original immigration. Their old homes were in the
south-east, near Mikindani and the mouth of the Rovuma, whence
their peaceful forefathers were driven by the continual raids of the
Sakalavas from Madagascar and the warlike Shirazis[47] of the coast,
to take refuge on the almost inaccessible plateau. I have studied
African ethnology for twenty years, but the fact that changes of
population in this apparently quiet and peaceable corner of the earth
could have been occasioned by outside enterprises taking place on
the high seas, was completely new to me. It is, no doubt, however,
correct.
The charming tribal legend of the Makonde—besides informing us
of other interesting matters—explains why they have to live in the
thickest of the bush and a long way from the edge of the plateau,
instead of making their permanent homes beside the purling brooks
and springs of the low country.
“The place where the tribe originated is Mahuta, on the southern
side of the plateau towards the Rovuma, where of old time there was
nothing but thick bush. Out of this bush came a man who never
washed himself or shaved his head, and who ate and drank but little.
He went out and made a human figure from the wood of a tree
growing in the open country, which he took home to his abode in the
bush and there set it upright. In the night this image came to life and
was a woman. The man and woman went down together to the
Rovuma to wash themselves. Here the woman gave birth to a still-
born child. They left that place and passed over the high land into the
valley of the Mbemkuru, where the woman had another child, which
was also born dead. Then they returned to the high bush country of
Mahuta, where the third child was born, which lived and grew up. In
course of time, the couple had many more children, and called
themselves Wamatanda. These were the ancestral stock of the
Makonde, also called Wamakonde,[48] i.e., aborigines. Their
forefather, the man from the bush, gave his children the command to
bury their dead upright, in memory of the mother of their race who
was cut out of wood and awoke to life when standing upright. He also
warned them against settling in the valleys and near large streams,
for sickness and death dwelt there. They were to make it a rule to
have their huts at least an hour’s walk from the nearest watering-
place; then their children would thrive and escape illness.”
The explanation of the name Makonde given by my informants is
somewhat different from that contained in the above legend, which I
extract from a little book (small, but packed with information), by
Pater Adams, entitled Lindi und sein Hinterland. Otherwise, my
results agree exactly with the statements of the legend. Washing?
Hapana—there is no such thing. Why should they do so? As it is, the
supply of water scarcely suffices for cooking and drinking; other
people do not wash, so why should the Makonde distinguish himself
by such needless eccentricity? As for shaving the head, the short,
woolly crop scarcely needs it,[49] so the second ancestral precept is
likewise easy enough to follow. Beyond this, however, there is
nothing ridiculous in the ancestor’s advice. I have obtained from
various local artists a fairly large number of figures carved in wood,
ranging from fifteen to twenty-three inches in height, and
representing women belonging to the great group of the Mavia,
Makonde, and Matambwe tribes. The carving is remarkably well
done and renders the female type with great accuracy, especially the
keloid ornamentation, to be described later on. As to the object and
meaning of their works the sculptors either could or (more probably)
would tell me nothing, and I was forced to content myself with the
scanty information vouchsafed by one man, who said that the figures
were merely intended to represent the nembo—the artificial
deformations of pelele, ear-discs, and keloids. The legend recorded
by Pater Adams places these figures in a new light. They must surely
be more than mere dolls; and we may even venture to assume that
they are—though the majority of present-day Makonde are probably
unaware of the fact—representations of the tribal ancestress.
The references in the legend to the descent from Mahuta to the
Rovuma, and to a journey across the highlands into the Mbekuru
valley, undoubtedly indicate the previous history of the tribe, the
travels of the ancestral pair typifying the migrations of their
descendants. The descent to the neighbouring Rovuma valley, with
its extraordinary fertility and great abundance of game, is intelligible
at a glance—but the crossing of the Lukuledi depression, the ascent
to the Rondo Plateau and the descent to the Mbemkuru, also lie
within the bounds of probability, for all these districts have exactly
the same character as the extreme south. Now, however, comes a
point of especial interest for our bacteriological age. The primitive
Makonde did not enjoy their lives in the marshy river-valleys.
Disease raged among them, and many died. It was only after they
had returned to their original home near Mahuta, that the health
conditions of these people improved. We are very apt to think of the
African as a stupid person whose ignorance of nature is only equalled
by his fear of it, and who looks on all mishaps as caused by evil
spirits and malignant natural powers. It is much more correct to
assume in this case that the people very early learnt to distinguish
districts infested with malaria from those where it is absent.
This knowledge is crystallized in the
ancestral warning against settling in the
valleys and near the great waters, the
dwelling-places of disease and death. At the
same time, for security against the hostile
Mavia south of the Rovuma, it was enacted
that every settlement must be not less than a
certain distance from the southern edge of the
plateau. Such in fact is their mode of life at the
present day. It is not such a bad one, and
certainly they are both safer and more
comfortable than the Makua, the recent
intruders from the south, who have made USUAL METHOD OF
good their footing on the western edge of the CLOSING HUT-DOOR
plateau, extending over a fairly wide belt of
country. Neither Makua nor Makonde show in their dwellings
anything of the size and comeliness of the Yao houses in the plain,
especially at Masasi, Chingulungulu and Zuza’s. Jumbe Chauro, a
Makonde hamlet not far from Newala, on the road to Mahuta, is the
most important settlement of the tribe I have yet seen, and has fairly
spacious huts. But how slovenly is their construction compared with
the palatial residences of the elephant-hunters living in the plain.
The roofs are still more untidy than in the general run of huts during
the dry season, the walls show here and there the scanty beginnings
or the lamentable remains of the mud plastering, and the interior is a
veritable dog-kennel; dirt, dust and disorder everywhere. A few huts
only show any attempt at division into rooms, and this consists
merely of very roughly-made bamboo partitions. In one point alone
have I noticed any indication of progress—in the method of fastening
the door. Houses all over the south are secured in a simple but
ingenious manner. The door consists of a set of stout pieces of wood
or bamboo, tied with bark-string to two cross-pieces, and moving in
two grooves round one of the door-posts, so as to open inwards. If
the owner wishes to leave home, he takes two logs as thick as a man’s
upper arm and about a yard long. One of these is placed obliquely
against the middle of the door from the inside, so as to form an angle
of from 60° to 75° with the ground. He then places the second piece
horizontally across the first, pressing it downward with all his might.
It is kept in place by two strong posts planted in the ground a few
inches inside the door. This fastening is absolutely safe, but of course
cannot be applied to both doors at once, otherwise how could the
owner leave or enter his house? I have not yet succeeded in finding
out how the back door is fastened.
MAKONDE LOCK AND KEY AT JUMBE CHAURO

This is the general way of closing a house. The Makonde at Jumbe
Chauro, however, have a much more complicated, solid and original
one. Here, too, the door is as already described, except that there is
only one post on the inside, standing by itself about six inches from
one side of the doorway. Opposite this post is a hole in the wall just
large enough to admit a man’s arm. The door is closed inside by a
large wooden bolt passing through a hole in this post and pressing
with its free end against the door. The other end has three holes into
which fit three pegs running in vertical grooves inside the post. The
door is opened with a wooden key about a foot long, somewhat
curved and sloped off at the butt; the other end has three pegs
corresponding to the holes, in the bolt, so that, when it is thrust
through the hole in the wall and inserted into the rectangular
opening in the post, the pegs can be lifted and the bolt drawn out.[50]
MODE OF INSERTING THE KEY
With no small pride first one householder and then a second

showed me on the spot the action of this greatest invention of the
Makonde Highlands. To both with an admiring exclamation of
“Vizuri sana!” (“Very fine!”). I expressed the wish to take back these
marvels with me to Ulaya, to show the Wazungu what clever fellows
the Makonde are. Scarcely five minutes after my return to camp at
Newala, the two men came up sweating under the weight of two
heavy logs which they laid down at my feet, handing over at the same
time the keys of the fallen fortress. Arguing, logically enough, that if
the key was wanted, the lock would be wanted with it, they had taken
their axes and chopped down the posts—as it never occurred to them
to dig them out of the ground and so bring them intact. Thus I have
two badly damaged specimens, and the owners, instead of praise,
come in for a blowing-up.
The Makua huts in the environs of Newala are especially
miserable; their more than slovenly construction reminds one of the
temporary erections of the Makua at Hatia’s, though the people here
have not been concerned in a war. It must therefore be due to
congenital idleness, or else to the absence of a powerful chief. Even
the baraza at Mlipa’s, a short hour’s walk south-east of Newala,
shares in this general neglect. While public buildings in this country
are usually looked after more or less carefully, this is in evident
danger of being blown over by the first strong easterly gale. The only
attractive object in this whole district is the grave of the late chief
Mlipa. I visited it in the morning, while the sun was still trying with
partial success to break through the rolling mists, and the circular
grove of tall euphorbias, which, with a broken pot, is all that marks
the old king’s resting-place, impressed one with a touch of pathos.
Even my very materially-minded carriers seemed to feel something
of the sort, for instead of their usual ribald songs, they chanted
solemnly, as we marched on through the dense green of the Makonde
bush:—
“We shall arrive with the great master; we stand in a row and have
no fear about getting our food and our money from the Serkali (the
Government). We are not afraid; we are going along with the great
master, the lion; we are going down to the coast and back.”
With regard to the characteristic features of the various tribes here
on the western edge of the plateau, I can arrive at no other
conclusion than the one already come to in the plain, viz., that it is
impossible for anyone but a trained anthropologist to assign any
given individual at once to his proper tribe. In fact, I think that even
an anthropological specialist, after the most careful examination,
might find it a difficult task to decide. The whole congeries of peoples
collected in the region bounded on the west by the great Central
African rift, Tanganyika and Nyasa, and on the east by the Indian
Ocean, are closely related to each other—some of their languages are
only distinguished from one another as dialects of the same speech,
and no doubt all the tribes present the same shape of skull and
structure of skeleton. Thus, surely, there can be no very striking
differences in outward appearance.
Even did such exist, I should have no time
to concern myself with them, for day after day,
I have to see or hear, as the case may be—in
any case to grasp and record—an
extraordinary number of ethnographic
phenomena. I am almost disposed to think it
fortunate that some departments of inquiry, at
least, are barred by external circumstances.
Chief among these is the subject of iron-
working. We are apt to think of Africa as a
country where iron ore is everywhere, so to
speak, to be picked up by the roadside, and
where it would be quite surprising if the
inhabitants had not learnt to smelt the
material ready to their hand. In fact, the
knowledge of this art ranges all over the
continent, from the Kabyles in the north to the
Kafirs in the south. Here between the Rovuma
and the Lukuledi the conditions are not so
favourable. According to the statements of the
Makonde, neither ironstone nor any other
form of iron ore is known to them. They have
not therefore advanced to the art of smelting
the metal, but have hitherto bought all their
THE ANCESTRESS OF
THE MAKONDE
iron implements from neighbouring tribes.
Even in the plain the inhabitants are not much
better off. Only one man now living is said to
understand the art of smelting iron. This old fundi lives close to
Huwe, that isolated, steep-sided block of granite which rises out of
the green solitude between Masasi and Chingulungulu, and whose
jagged and splintered top meets the traveller’s eye everywhere. While
still at Masasi I wished to see this man at work, but was told that,
frightened by the rising, he had retired across the Rovuma, though
he would soon return. All subsequent inquiries as to whether the
fundi had come back met with the genuine African answer, “Bado”
(“Not yet”).
BRAZIER
Some consolation was afforded me by a brassfounder, whom I

came across in the bush near Akundonde’s. This man is the favourite
of women, and therefore no doubt of the gods; he welds the glittering
brass rods purchased at the coast into those massive, heavy rings
which, on the wrists and ankles of the local fair ones, continually give
me fresh food for admiration. Like every decent master-craftsman he
had all his tools with him, consisting of a pair of bellows, three
crucibles and a hammer—nothing more, apparently. He was quite
willing to show his skill, and in a twinkling had fixed his bellows on
the ground. They are simply two goat-skins, taken off whole, the four
legs being closed by knots, while the upper opening, intended to
admit the air, is kept stretched by two pieces of wood. At the lower
end of the skin a smaller opening is left into which a wooden tube is
stuck. The fundi has quickly borrowed a heap of wood-embers from
the nearest hut; he then fixes the free ends of the two tubes into an
earthen pipe, and clamps them to the ground by means of a bent
piece of wood. Now he fills one of his small clay crucibles, the dross
on which shows that they have been long in use, with the yellow
material, places it in the midst of the embers, which, at present are
only faintly glimmering, and begins his work. In quick alternation
the smith’s two hands move up and down with the open ends of the
bellows; as he raises his hand he holds the slit wide open, so as to let
the air enter the skin bag unhindered. In pressing it down he closes
the bag, and the air puffs through the bamboo tube and clay pipe into
the fire, which quickly burns up. The smith, however, does not keep
on with this work, but beckons to another man, who relieves him at
the bellows, while he takes some more tools out of a large skin pouch
carried on his back. I look on in wonder as, with a smooth round
stick about the thickness of a finger, he bores a few vertical holes into
the clean sand of the soil. This should not be difficult, yet the man
seems to be taking great pains over it. Then he fastens down to the
ground, with a couple of wooden clamps, a neat little trough made by
splitting a joint of bamboo in half, so that the ends are closed by the
two knots. At last the yellow metal has attained the right consistency,
and the fundi lifts the crucible from the fire by means of two sticks
split at the end to serve as tongs. A short swift turn to the left—a
tilting of the crucible—and the molten brass, hissing and giving forth
clouds of smoke, flows first into the bamboo mould and then into the
holes in the ground.
The technique of this backwoods craftsman may not be very far
advanced, but it cannot be denied that he knows how to obtain an
adequate result by the simplest means. The ladies of highest rank in
this country—that is to say, those who can afford it, wear two kinds
of these massive brass rings, one cylindrical, the other semicircular
in section. The latter are cast in the most ingenious way in the
bamboo mould, the former in the circular hole in the sand. It is quite
a simple matter for the fundi to fit these bars to the limbs of his fair
customers; with a few light strokes of his hammer he bends the
pliable brass round arm or ankle without further inconvenience to
the wearer.
SHAPING THE POT
SMOOTHING WITH MAIZE-COB
CUTTING THE EDGE

FINISHING THE BOTTOM
LAST SMOOTHING BEFORE

BURNING
FIRING THE BRUSH-PILE

LIGHTING THE FARTHER SIDE OF
THE PILE
TURNING THE RED-HOT VESSEL
NYASA WOMAN MAKING POTS AT MASASI

Pottery is an art which must always and everywhere excite the
interest of the student, just because it is so intimately connected with
the development of human culture, and because its relics are one of
the principal factors in the reconstruction of our own condition in
prehistoric times. I shall always remember with pleasure the two or
three afternoons at Masasi when Salim Matola’s mother, a slightly-
built, graceful, pleasant-looking woman, explained to me with
touching patience, by means of concrete illustrations, the ceramic art
of her people. The only implements for this primitive process were a
lump of clay in her left hand, and in the right a calabash containing
the following valuables: the fragment of a maize-cob stripped of all
its grains, a smooth, oval pebble, about the size of a pigeon’s egg, a
few chips of gourd-shell, a bamboo splinter about the length of one’s
hand, a small shell, and a bunch of some herb resembling spinach.
Nothing more. The woman scraped with the
shell a round, shallow hole in the soft, fine
sand of the soil, and, when an active young
girl had filled the calabash with water for her,
she began to knead the clay. As if by magic it
gradually assumed the shape of a rough but
already well-shaped vessel, which only wanted
a little touching up with the instruments
before mentioned. I looked out with the
MAKUA WOMAN closest attention for any indication of the use
MAKING A POT. of the potter’s wheel, in however rudimentary
SHOWS THE a form, but no—hapana (there is none). The
BEGINNINGS OF THE embryo pot stood firmly in its little
POTTER’S WHEEL
depression, and the woman walked round it in
a stooping posture, whether she was removing
small stones or similar foreign bodies with the maize-cob, smoothing
the inner or outer surface with the splinter of bamboo, or later, after
letting it dry for a day, pricking in the ornamentation with a pointed
bit of gourd-shell, or working out the bottom, or cutting the edge
with a sharp bamboo knife, or giving the last touches to the finished
vessel. This occupation of the women is infinitely toilsome, but it is
without doubt an accurate reproduction of the process in use among
our ancestors of the Neolithic and Bronze ages.
There is no doubt that the invention of pottery, an item in human
progress whose importance cannot be over-estimated, is due to
women. Rough, coarse and unfeeling, the men of the horde range
over the countryside. When the united cunning of the hunters has
succeeded in killing the game; not one of them thinks of carrying
home the spoil. A bright fire, kindled by a vigorous wielding of the
drill, is crackling beside them; the animal has been cleaned and cut
up secundum artem, and, after a slight singeing, will soon disappear
under their sharp teeth; no one all this time giving a single thought
to wife or child.
To what shifts, on the other hand, the primitive wife, and still more
the primitive mother, was put! Not even prehistoric stomachs could
endure an unvarying diet of raw food. Something or other suggested
the beneficial effect of hot water on the majority of approved but
indigestible dishes. Perhaps a neighbour had tried holding the hard
roots or tubers over the fire in a calabash filled with water—or maybe
an ostrich-egg-shell, or a hastily improvised vessel of bark. They
became much softer and more palatable than they had previously
been; but, unfortunately, the vessel could not stand the fire and got
charred on the outside. That can be remedied, thought our
ancestress, and plastered a layer of wet clay round a similar vessel.
This is an improvement; the cooking utensil remains uninjured, but
the heat of the fire has shrunk it, so that it is loose in its shell. The
next step is to detach it, so, with a firm grip and a jerk, shell and
kernel are separated, and pottery is invented. Perhaps, however, the
discovery which led to an intelligent use of the burnt-clay shell, was
made in a slightly different way. Ostrich-eggs and calabashes are not
to be found in every part of the world, but everywhere mankind has
arrived at the art of making baskets out of pliant materials, such as
bark, bast, strips of palm-leaf, supple twigs, etc. Our inventor has no
water-tight vessel provided by nature. “Never mind, let us line the
basket with clay.” This answers the purpose, but alas! the basket gets
burnt over the blazing fire, the woman watches the process of
cooking with increasing uneasiness, fearing a leak, but no leak
appears. The food, done to a turn, is eaten with peculiar relish; and
the cooking-vessel is examined, half in curiosity, half in satisfaction
at the result. The plastic clay is now hard as stone, and at the same
time looks exceedingly well, for the neat plaiting of the burnt basket
is traced all over it in a pretty pattern. Thus, simultaneously with
pottery, its ornamentation was invented.
Primitive woman has another claim to respect. It was the man,
roving abroad, who invented the art of producing fire at will, but the
woman, unable to imitate him in this, has been a Vestal from the
earliest times. Nothing gives so much trouble as the keeping alight of
the smouldering brand, and, above all, when all the men are absent
from the camp. Heavy rain-clouds gather, already the first large
drops are falling, the first gusts of the storm rage over the plain. The
little flame, a greater anxiety to the woman than her own children,
flickers unsteadily in the blast. What is to be done? A sudden thought
occurs to her, and in an instant she has constructed a primitive hut
out of strips of bark, to protect the flame against rain and wind.
This, or something very like it, was the way in which the principle
of the house was discovered; and even the most hardened misogynist
cannot fairly refuse a woman the credit of it. The protection of the
hearth-fire from the weather is the germ from which the human
dwelling was evolved. Men had little, if any share, in this forward
step, and that only at a late stage. Even at the present day, the
plastering of the housewall with clay and the manufacture of pottery
are exclusively the women’s business. These are two very significant
survivals. Our European kitchen-garden, too, is originally a woman’s
invention, and the hoe, the primitive instrument of agriculture, is,
characteristically enough, still used in this department. But the
noblest achievement which we owe to the other sex is unquestionably
the art of cookery. Roasting alone—the oldest process—is one for
which men took the hint (a very obvious one) from nature. It must
have been suggested by the scorched carcase of some animal
overtaken by the destructive forest-fires. But boiling—the process of
improving organic substances by the help of water heated to boiling-
point—is a much later discovery. It is so recent that it has not even
yet penetrated to all parts of the world. The Polynesians understand
how to steam food, that is, to cook it, neatly wrapped in leaves, in a
hole in the earth between hot stones, the air being excluded, and
(sometimes) a few drops of water sprinkled on the stones; but they
do not understand boiling.
To come back from this digression, we find that the slender Nyasa
woman has, after once more carefully examining the finished pot,
put it aside in the shade to dry. On the following day she sends me
word by her son, Salim Matola, who is always on hand, that she is
going to do the burning, and, on coming out of my house, I find her
already hard at work. She has spread on the ground a layer of very
dry sticks, about as thick as one’s thumb, has laid the pot (now of a
yellowish-grey colour) on them, and is piling brushwood round it.
My faithful Pesa mbili, the mnyampara, who has been standing by,
most obligingly, with a lighted stick, now hands it to her. Both of
them, blowing steadily, light the pile on the lee side, and, when the
flame begins to catch, on the weather side also. Soon the whole is in a
blaze, but the dry fuel is quickly consumed and the fire dies down, so
that we see the red-hot vessel rising from the ashes. The woman
turns it continually with a long stick, sometimes one way and
sometimes another, so that it may be evenly heated all over. In
twenty minutes she rolls it out of the ash-heap, takes up the bundle
of spinach, which has been lying for two days in a jar of water, and
sprinkles the red-hot clay with it. The places where the drops fall are
marked by black spots on the uniform reddish-brown surface. With a
sigh of relief, and with visible satisfaction, the woman rises to an
erect position; she is standing just in a line between me and the fire,
from which a cloud of smoke is just rising: I press the ball of my
camera, the shutter clicks—the apotheosis is achieved! Like a
priestess, representative of her inventive sex, the graceful woman
stands: at her feet the hearth-fire she has given us beside her the
invention she has devised for us, in the background the home she has
built for us.
At Newala, also, I have had the manufacture of pottery carried on
in my presence. Technically the process is better than that already
described, for here we find the beginnings of the potter’s wheel,
which does not seem to exist in the plains; at least I have seen
nothing of the sort. The artist, a frightfully stupid Makua woman, did
not make a depression in the ground to receive the pot she was about
to shape, but used instead a large potsherd. Otherwise, she went to
work in much the same way as Salim’s mother, except that she saved
herself the trouble of walking round and round her work by squatting
at her ease and letting the pot and potsherd rotate round her; this is
surely the first step towards a machine. But it does not follow that
the pot was improved by the process. It is true that it was beautifully
rounded and presented a very creditable appearance when finished,
but the numerous large and small vessels which I have seen, and, in
part, collected, in the “less advanced” districts, are no less so. We
moderns imagine that instruments of precision are necessary to
produce excellent results. Go to the prehistoric collections of our
museums and look at the pots, urns and bowls of our ancestors in the
dim ages of the past, and you will at once perceive your error.
MAKING LONGITUDINAL CUT IN
BARK
DRAWING THE BARK OFF THE LOG
REMOVING THE OUTER BARK

BEATING THE BARK
WORKING THE BARK-CLOTH AFTER BEATING, TO MAKE IT

SOFT
MANUFACTURE OF BARK-CLOTH AT NEWALA

To-day, nearly the whole population of German East Africa is
clothed in imported calico. This was not always the case; even now in
some parts of the north dressed skins are still the prevailing wear,
and in the north-western districts—east and north of Lake
Tanganyika—lies a zone where bark-cloth has not yet been
superseded. Probably not many generations have passed since such
bark fabrics and kilts of skins were the only clothing even in the
south. Even to-day, large quantities of this bright-red or drab
material are still to be found; but if we wish to see it, we must look in
the granaries and on the drying stages inside the native huts, where
it serves less ambitious uses as wrappings for those seeds and fruits
which require to be packed with special care. The salt produced at
Masasi, too, is packed for transport to a distance in large sheets of
bark-cloth. Wherever I found it in any degree possible, I studied the
process of making this cloth. The native requisitioned for the
purpose arrived, carrying a log between two and three yards long and
as thick as his thigh, and nothing else except a curiously-shaped
mallet and the usual long, sharp and pointed knife which all men and
boys wear in a belt at their backs without a sheath—horribile dictu!
[51]
Silently he squats down before me, and with two rapid cuts has
drawn a couple of circles round the log some two yards apart, and
slits the bark lengthwise between them with the point of his knife.
With evident care, he then scrapes off the outer rind all round the
log, so that in a quarter of an hour the inner red layer of the bark
shows up brightly-coloured between the two untouched ends. With
some trouble and much caution, he now loosens the bark at one end,
and opens the cylinder. He then stands up, takes hold of the free
edge with both hands, and turning it inside out, slowly but steadily
pulls it off in one piece. Now comes the troublesome work of
scraping all superfluous particles of outer bark from the outside of
the long, narrow piece of material, while the inner side is carefully
scrutinised for defective spots. At last it is ready for beating. Having
signalled to a friend, who immediately places a bowl of water beside
him, the artificer damps his sheet of bark all over, seizes his mallet,
lays one end of the stuff on the smoothest spot of the log, and
hammers away slowly but continuously. “Very simple!” I think to
myself. “Why, I could do that, too!”—but I am forced to change my
opinions a little later on; for the beating is quite an art, if the fabric is
not to be beaten to pieces. To prevent the breaking of the fibres, the
stuff is several times folded across, so as to interpose several
thicknesses between the mallet and the block. At last the required
state is reached, and the fundi seizes the sheet, still folded, by both
ends, and wrings it out, or calls an assistant to take one end while he
holds the other. The cloth produced in this way is not nearly so fine
and uniform in texture as the famous Uganda bark-cloth, but it is
quite soft, and, above all, cheap.
Now, too, I examine the mallet. My craftsman has been using the
simpler but better form of this implement, a conical block of some
hard wood, its base—the striking surface—being scored across and
across with more or less deeply-cut grooves, and the handle stuck
into a hole in the middle. The other and earlier form of mallet is
shaped in the same way, but the head is fastened by an ingenious
network of bark strips into the split bamboo serving as a handle. The
observation so often made, that ancient customs persist longest in
connection with religious ceremonies and in the life of children, here
finds confirmation. As we shall soon see, bark-cloth is still worn
during the unyago,[52] having been prepared with special solemn
ceremonies; and many a mother, if she has no other garment handy,
will still put her little one into a kilt of bark-cloth, which, after all,
looks better, besides being more in keeping with its African
surroundings, than the ridiculous bit of print from Ulaya.
MAKUA WOMEN

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eTextbook 978-1305506381 Managerial

Economics: Applications, Strategies

INTRODUCTION 1 2 Fundamental Economic Concepts 28

7 Production Economics 236 7A Production Economics of Renewable and

11-1 Monopoly Defined 385 12-2 Interdependencies in Oligopolistic

15-2a Vertical Requirements Contracts 561 Case Exercise: Designing a Managerial

17-8d The Appropriate Rate of Discount 678 D Check Answers to Selected

PEDAGOGICAL FEATURES OF THE

Instructor’s Manual and Test Bank

Mindtap Support Web Site

Frederick H. deB. Harris

ECONOMIC ANALYSIS AND ECONOMIC, POLITICAL, AND

Cash Flows Risk

1 Introduction and Goals

MANAGERIAL CHALLENGE Continued

Source: NC Division of Air Quality.

MANAGERIAL CHALLENGE Continued

1-1 WHAT IS MANAGERIAL ECONOMICS?

This simple illustration shows how resource-allocation decisions of managers

1-2 THE DECISION-MAKING MODEL

1-2a The Responsibilities of Management

WHAT WENT RIGHT • WHAT WENT WRONG

1-2b Moral Hazard in Teams

1-3 THE ROLE OF PROFITS

1-3a Risk-Bearing Theory of Profit

1-3b Temporary Disequilibrium Theory of Profit

1-3c Monopoly Theory of Profit

1-3d Innovation Theory of Profit

1-3e Managerial Efficiency Theory of Profit

1-4 OBJECTIVE OF THE FIRM

Newala, too, suffers from the distance of its water-supply—at least

The water-supply of New Newala is in the bottom of the valley,

NATIVE PATH THROUGH THE MAKONDE BUSH, NEAR

MAKONDE LOCK AND KEY AT JUMBE CHAURO

MODE OF INSERTING THE KEY

With no small pride first one householder and then a second

Some consolation was afforded me by a brassfounder, whom I

SMOOTHING WITH MAIZE-COB

CUTTING THE EDGE

LAST SMOOTHING BEFORE

FIRING THE BRUSH-PILE

TURNING THE RED-HOT VESSEL

NYASA WOMAN MAKING POTS AT MASASI

DRAWING THE BARK OFF THE LOG

REMOVING THE OUTER BARK

WORKING THE BARK-CLOTH AFTER BEATING, TO MAKE IT

MANUFACTURE OF BARK-CLOTH AT NEWALA

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