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BSA CORE 1
MANAGERIAL ECONOMICS

MODULE 2
(Monday)

OPTIMAL DECISIONS USING MARGINAL ANALYSIS

Conflict in Fast-Food Franchising

The rapid growth in franchising during the last three decades can be explained in large
part by the mutual benefits the franchising partners receive. The franchiser (parent
company) increases sales via an ever-expanding network of franchisees. The parent
collects a fixed percentage of the revenue each franchise earns (as high as 15 to 20
percent, depending on the contract terms). The individual franchisee benefits from the
acquired know-how of the parent, from the parent’s advertising and promotional
support, and from the ability to sell a well-established product or service. Nonetheless,
economic conflicts frequently arise between the parent and an individual franchisee.
Disputes even occur in the loftiest of franchising realms: the fast-food industry. In the
1990s, there were ongoing conflicts between franchise operators and parent
management of McDonald’s and Burger King.
These conflicts were centered on a number of recurring issues.
1. The parent insisted on periodic remodeling of the premises; the franchisee
resisted.
2. The franchisee favored raising prices on best-selling items; the parent opposed
the change and wanted to expand promotional discounts.
3. The parent sought longer store hours and multiple express lines to cut down on
lunchtime congestion; many franchisees resisted both moves.
Beginning with a case on how to make a managerial decision, Module 2 will familiarize
you with the manager’s problem and think about how economic principles could be
applied in determining possible solutions and making a decision.
Managerial problems include the following:
1. How does one explain these conflicts?
2. What is their economic source?
3. What can the parent and the franchisee do to promote cooperation?
SITING A SHOPPING MALL
A real-estate developer is planning the construction of a large shopping mall in a coastal
county. The question is where to locate it. To help her in the decision, the developer has
gathered a wealth of information, including the stylized “map” of the region. The

Samuelson, Willian F. & Marks, Stephen G. 2012. Managerial Economics, 7th Edition. John Wiley and
Sons, Inc.
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county’s population centers run from west to east along the coast, with the ocean to the
north. Since available land and permits are not a problem, the developer judges that
she can locate the mall anywhere along the coast. In fact, the mall would be welcome in
any of the towns due to its potential positive impact on the local economy.
According to an old adage, “The three most important factors in the real estate business
are location, location, and location.” Accordingly, the developer seeks a site that is
proximate to as many potential customers as possible. A natural measure of locational
convenience is the total travel miles (TTM) between the mall and its customer
population. Thus, the developer’s key question is: Where along the coast should the
mall be located to minimize the total travel miles? We can use a basic decision-making
method, called marginal analysis, to identify the optimal site with much less
computational effort.
 Marginal analysis - process of considering small changes in a decision and
determining whether a given change will improve the ultimate objective.
SIMPLE MODEL OF THE FIRM
 The decision setting we will investigate can be described as follows:
o (1) A firm produces a single good or service for a single market with the
objective of maximizing profit.
o (2) Its task is to determine the quantity of the good to produce and sell and
to set a sales price.
o (3) The firm can predict the revenue and cost consequences of its price
and output decisions with certainty.

 Together these three statements fulfill the first four fundamental decision-making
steps.
o Statement 1 specifies the setting and objective.
o Statement 2 the firm’s possible decision alternatives.
o Statemen 3 along with some specific quantitative information supplied is
the link between actions and the ultimate objective, namely, profit.
REVENUE
 The analysis of revenue rests on the most basic empirical relationship in
economics: the law of demand.
 This law states that all other factors held constant, the higher the unit price of a
good, the fewer the number of units demanded by consumers and, consequently,
sold by firms.
 Total revenue function (or equation)
o TR = P x Q
 Where:
 TR = total revenue

Samuelson, Willian F. & Marks, Stephen G. 2012. Managerial Economics, 7th Edition. John Wiley and
Sons, Inc.
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 P = price
 Q = quantity

o Example:
Quantity (Q) Price (P) Total Revenue (TR)
(Lots) x ($000s) = ($000s)
0.0 170 0
1.0 150 150
2.0 130 260
3.0 110 330
4.0 90 360
5.0 70 350
6.0 50 300
7.0 30 210
8.0 10 80
8.5 0 0

 Total revenue curve

Samuelson, Willian F. & Marks, Stephen G. 2012. Managerial Economics, 7th Edition. John Wiley and
Sons, Inc.
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 Profit function
o π = TR – TC
 where:
 π = profit
 TR = total revenue
 TC = total cost
o Where: TC = FC + VC
 Where:
 FC = fixed cost
 VC = variable cost

 Marginal revenue (MR) - extra profit the firm earns from producing and selling
an additional unit of output

MR = Δ TR = change in total revenue (TR)

ΔQ change in quantity (Q)
Example
Quantity (Q) Price (P) Total Revenue (TR) Marginal Revenue (MR)
(Lots) x ($000s) = ($000s) ($000s)_______
0.0 170 0 -
1.0 150 150 150 – 0/1 – 0 = 150
2.0 130 260 260 – 150/2 – 1 = 110
3.0 110 330 ___________________
4.0 90 360 ___________________
5.0 70 350 ___________________
6.0 50 300 ___________________
7.0 30 210 ___________________
8.0 10 80 ____________________

Samuelson, Willian F. & Marks, Stephen G. 2012. Managerial Economics, 7th Edition. John Wiley and
Sons, Inc.
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Samuelson, Willian F. & Marks, Stephen G. 2012. Managerial Economics, 7th Edition. John Wiley and
Sons, Inc.