REVIEWER IN MANAGERIAL ECONOMICS

LESSON 1
Manager - A person who directs resources to achieve a stated goal.
Economics - The science of making decisions in the presence of scarce
resources
Managerial Economics - The study of how to direct scarce resources in
the way that most efficiently achieves a managerial goal.
Economic Profits - The difference between total revenue and total
opportunity cost
Opportunity Cost - The cost of the explicit and implicit resources that are
forgone when a decision is made.
Present Value - The amount that would have to be invested today at the
prevailing interest rate to generate the given future value
Net Present Value - The present value of the income stream generated by
a project minus the current cost of the project.
Marginal Analysis - states that optimal managerial decisions involve
comparing the marginal
Marginal Benefit - The change in total benefits arising from a change in
the managerial control variable Q.
Marginal Cost - The change in total costs arising from a change in the
managerial control variable Q.
Incremental Revenues - The additional revenues that stem from a
yes-or-no decision.
Incremental Costs - The additional costs that stem from a yes-or-no
decision.
LESSON 2
Market Demand Curve - A curve indicating the total quantity of a good all
consumers are willing and able to purchase at each possible price, holding
the prices of related goods, income, advertising, and other variables
constant.
Change in Quantity Demanded - Changes in the price of a good lead to a
change in the quantity demanded of that good. This corresponds to a
movement along a given demand curve
Change in Demand - Changes in variables other than the price of a good,
such as income or the price of another good, lead to a change in demand.
This corresponds to a shift of the entire demand curve.
Normal Good - A good for which an increase (decrease) in income leads
to an increase (decrease) in the demand for that good.
Inferior Good - A good for which an increase (decrease) in income leads
to a decrease (increase) in the demand for that good.
Substitutes - Goods for which an increase (decrease) in the price of one
good leads to an increase (decrease) in the demand for the other good.
Complements - Goods for which an increase (decrease) in the price of
one good leads to a decrease (increase) in the demand for the other good
Demand Function - A function that describes how much of a good will be
purchased at alternative prices of that good and related goods, alternative
income levels, and alternative values of other variables affecting demand.
Linear Demand Function - A representation of the demand function in
which the demand for a given good is a linear function of prices, income
levels, and other variables influencing demand.
Consumer Surplus - The value consumers get from a good but do not
have to pay for.
Market Supply Curve - A curve indicating the total quantity of a good that
all producers in a competitive market would produce at each price, holding
input prices, technology, and other variables affecting supply constant.
Change in Quantity Supplied - Changes in the price of a good lead to a
change in the quantity supplied of that good. This corresponds to a
movement along a given supply curve
Change in Supply - Changes in variables other than the price of a good,
such as input prices or technological advances, lead to a change in supply.
This corresponds to a shift of the entire supply curve.
Supply Function - A function that describes how much of a good will be
produced at alternative prices of that good, alternative input prices, and
alternative values of other variables affecting supply.
Linear Supply Function - A representation of the supply function in which
the supply of a given good is a linear function of prices and other variables
affecting supply.
Producer Surplus - The amount producers receive in excess of the
amount necessary to induce them to produce the good.
Price Ceiling - The maximum legal price that can be charged in a market.
Full Economic Price - The dollar amount paid to a firm under a price
ceiling, plus the nonpecuniary price.
Price Floor - The minimum legal price that can be charged in a market.

LESSON 3
Elasticity - A measure of the responsiveness of one variable to changes in
another variable; the percentage change in one variable that arises due to
a given percentage change in another variable.
Own Price Elasticity - A measure of the responsiveness of the quantity
demanded of a good to a change in the price of that good; the percentage
change in quantity demanded divided by the percentage change in the
price of the good.
Elastic Demand - Demand is elastic if the absolute value of the own price
elasticity is greater than 1.
Inelastic Demand - Demand is inelastic if the absolute value of the own
price elasticity is less than 1.
Unitary Elastic Demand - Demand is unitary elastic if the absolute value
of the own price elasticity is equal to 1.
Perfectly Elastic Demand - Demand is perfectly elastic if the own price
elasticity is infinite in absolute value. In this case the demand curve is
horizontal.
Perfectly Inelastic Demand - Demand is perfectly inelastic if the own price
elasticity is zero. In this case the demand curve is vertical.
Cross - Price Inelasticity - responsiveness of the demand for a good to
changes in the price of a related good; the percentage change in the
quantity demanded of one good divided by the percentage change in the
price of a related good.
Income Elasticity - A measure of the responsiveness of the demand for a
good to changes in consumer income; the percentage change in quantity
demanded divided by the percentage change in income.
Log - Linear Demand - Demand is log linear if the logarithm of demand is
a linear function of the logarithms of prices, income, and other variables.
Least Squares Regression - The line that minimizes the sum of squared
deviations between the line and the actual data points.
T - Static - The ratio of the value of a parameter estimate to the standard
error of the parameter estimate.

LESSON 4
Indifference Curve - A curve that defines the combinations of two goods
that give a consumer the same level of satisfaction.
Marginal Rate of Substitution - The rate at which a consumer is willing to
substitute one good for another good and still maintain the same level of
satisfaction
Budget Set - The bundles of goods a consumer can afford.
Budget Line - The bundles of goods that exhaust a consumer’s income.
Market Rate of Substitution - The rate at which one good may be traded
for another in the market; slope of the budget line
Consumer Equilibrium - The equilibrium consumption bundle is the
affordable bundle that yields the greatest satisfaction to the consumer.
Substitution Effect - The movement along a given indifference curve that
results from a change in the relative prices of goods, holding real income
constant.
Income Effect - The movement from one indifference curve to another that
results from the change in real income caused by a price change.

LESSON 5
Production Function - defines the maximum amount of output that can be
produced with a given set of inputs.
Fixed and Variable Factors of Production - Fixed factors are the inputs
the manager cannot adjust in the short run. Variable factors are the inputs a
manager can adjust to alter production.
Total Product - The maximum level of output that can be produced with a
given amount of inputs
Average Product - A measure of the output produced per unit of input.
Marginal Product - The change in total output attributable to the last unit
of an input.
Increasing Marginal Returns - Range of input usage over which marginal
product increases.
Decreasing (diminishing) Marginal Returns - Range of input usage over
which marginal product declines.
Negative Marginal Returns - Range of input usage over which marginal
product is negative.
Value Marginal Product - The value of the output produced by the last unit
of an input.
Linear Production Function - A production function that assumes a
perfect linear relationship between all inputs and total output.
Leontief Production Function - A production function that assumes that
inputs are used in fixed proportions
Cobb-Douglas Production Function - A production function that assumes
some degree of substitutability among inputs.
Isoquant - Defines the combinations of inputs that yield the same level of
output.
Marginal Rate of Technical Substitution (MRTS) - The rate at which a
producer can substitute between two inputs and maintain the same level of
output.
Law of Diminishing Marginal Rate of Technical Substitution - A
property of a production function stating that as less of one input is used,
increasing amounts of another input must be employed to produce the
same level of output.
Isocost Line - A line that represents the combinations of inputs that will
cost the producer the same amount of money.
Fixed Costs - Costs that do not change with changes in output; include the
costs of fixed inputs used in production
Variable Costs - Costs that change with changes in output; include the
costs of inputs that vary with output.
Short Run Cost Function - A function that defines the minimum possible
cost of producing each output level when variable factors are employed in
the cost-minimizing fashion.
Average Fixed Cost - Fixed costs divided by the number of units of output.
Average Variable Cost - Variable costs divided by the number of units of
output.
Marginal (Incremental) Cost - The cost of producing an additional unit of
output.
Sunk Cost - A cost that is forever lost after it has been paid.
Cubic Cost Function - Costs are a cubic function of output; provides a
reasonable approximation to virtually any cost function.
Long Run Average Cost Function - A curve that defines the minimum
average cost of producing alternative levels of output, allowing for optimal
selection of both fixed and variable factors of production.
Economics of Scale - Exist when long run average costs decline as output
is increased.
Diseconomies of Scale - Exist when long run average costs rise as output
is increased.
Constant Returns to Scale - Exist when long run average costs remain
constant as output is increased.
Multiproduct Cost Function - A function that defines the cost of producing
given levels of two or more types of outputs assuming all inputs are used
efficiently.
Economies of Scope - When the total cost of producing two types of
outputs together is less than the total cost of producing each type of output
separately.
Cost Complementarity - When the marginal cost of producing one type of
output decreases when the output of another good is increased.

LESSON 6
Spot Exchange - An informal relationship between a buyer and seller in
which neither party is obligated to adhere to specific terms for exchange.
Contract - A formal relationship between a buyer and seller that obligates
the buyer and seller to exchange at terms specified in a legal document.
Vertical Integration - A situation where a firm produces the inputs required
to make its final product.
Transaction Costs - Costs associated with acquiring an input that are in
excess of the amount paid to the input supplier.
Specialized Investment - An expenditure that must be made to allow two
parties to exchange but has little or no value in any alternative use.
Relationship Specific Exchange - A type of exchange that occurs when
the parties to a transaction have made specialized investments.
Profit Sharing - Mechanism used to enhance workers’ efforts that involves
tying compensation to the underlying profitability of the firm.
Revenue Sharing - Mechanism used to enhance workers’ efforts that
involves linking compensation to the underlying revenues of the firm.

LESSON 7
Market Structure - Factors that affect managerial decisions, including the
number of firms competing in a market, the relative size of firms,
technological and cost considerations, demand conditions, and the ease
with which firms can enter or exit the industry.
Four-Firm Concentration Ratio - The fraction of total industry sales
generated by the four largest firms in the industry
HerfindahlHirschman Index (HHI) - The sum of the squared market
shares of firms in a given industry multiplied by 10,000.
Rothschild Index - A measure of the sensitivity to price of a product group
as a whole relative to the sensitivity of the quantity demanded of a single
firm to a change in its price
Lerner Index - A measure of the difference between price and marginal
cost as a fraction of the product’s price.
Dansby-Willig Performance Index - Ranks industries according to how
much social welfare would improve if the output in an industry were
increased by a small amount.

LESSON 8
Perfectly Competitive Market - A market in which (1) there are many
buyers and sellers; (2) each firm produces a homogeneous product; (3)
buyers and sellers have perfect information; (4) there are no transaction
costs; and (5) there is free entry and exit.
Firm Demand Curve - The demand curve for an individual firm’s product;
in a perfectly competitive market, it is simply the market price.
Marginal Revenue - The change in revenue attributable to the last unit of
output; for a competitive firm, MR is the market price
Monopoly - A market structure in which a single firm serves an entire
market for a good that has no close substitutes.
Cost Complementarities - Exist when the marginal cost of producing one
output is reduced when the output of another product is increased.
Deadweight Loss of Monopoly - The consumer and producer surplus that
is lost due to the monopolist charging a price in excess of marginal cost.
Monopolistically Competitive Market - A market in which (1) there are
many buyers and sellers; (2) each firm produces a differentiated product;
and (3) there is free entry and exit.
Comparative Advertising - A form of advertising where a firm attempts to
increase the demand for its brand by differentiating its product from
competing brands
Brand Equity - The additional value added to a product because of its
brand.
Niche Marketing - A marketing strategy where goods and services are
tailored to meet the needs of a particular segment of the market.
Green Marketing - A form of niche marketing where firms target products
toward consumers who are concerned about environmental issues.
Brand Myopic - A manager or company that rests on a brand’s past laurels
instead of focusing on emerging industry trends or changes in consumer
preferences.

LESSON 9
Oligopoly - A market structure in which there are only a few firms, each of
which is large relative to the total industry.
Sweezy Oligopoly - An industry in which (1) there are few firms serving
many consumers; (2) firms produce differentiated products; (3) each firm
believes rivals will respond to a price reduction but will not follow a price
increase; and (4) barriers to entry exist.
Cournot Oligopoly - An industry in which (1) there are few firms serving
many consumers; (2) firms produce either differentiated or homogeneous
products; (3) each firm believes rivals will hold their output constant if it
changes its output; and (4) barriers to entry exist
Best-Response (or reaction) Function - A function that defines the profit
maximizing level of output for a firm for given output levels of another firm.
Cournot Equilibrium - A situation in which neither firm has an incentive to
change its output given the other firm’s output.
Isoprofit Curve - A function that defines the combinations of outputs
produced by all firms that yield a given firm the same level of profits.
Stackelberg Oligopoly - An industry in which (1) there are few firms
serving many consumers; (2) firms produce either differentiated or
homogeneous products; (3) a single firm (the leader) chooses an output
before rivals select their outputs; (4) all other firms (the followers) take the
leader’s output as given and select outputs that maximize profits given the
leader’s output; and (5) barriers to entry exist.
Bertrand Oligopoly - An industry in which (1) there are few firms serving
many consumers; (2) firms produce identical products at a constant
marginal cost; (3) firms compete in price and react optimally to competitors’
prices; (4) consumers have perfect information and there are no transaction
costs; and (5) barriers to entry exist.
Contestable Market - A market in which (1) all firms have access to the
same technology; (2) consumers respond quickly to price changes; (3)
existing firms cannot respond quickly to entry by lowering their prices; and
(4) there are no sunk costs.

LESSON 10
Simultaneous Move Game - Game in which each player makes decisions
without knowledge of the other players’ decisions.
Sequential-Move Game - Game in which one player makes a move after
observing the other player’s move.
Strategy - In game theory, a decision rule that describes the actions a
player will take at each decision point.
Normal-Form Game - A representation of a game indicating the players,
their possible strategies, and the payoffs resulting from alternative
strategies.
Dominant Strategy - A strategy that results in the highest payoff to a
player regardless of the opponent’s action.
Secure Strategy - A strategy that guarantees the highest payoff given the
worst possible scenario.
Nash Equilibrium - A condition describing a set of strategies in which no
player can improve her payoff by unilaterally changing her own strategy,
given the other players’ strategies.
Mixed (randomized) Strategy - A strategy whereby a player randomizes
over two or more available actions in order to keep rivals from being able to
predict his or her action
Infinitely Repeated Game - A game that is played over and over again
forever and in which players receive payoffs during each play of the game.
Trigger Strategy - A strategy that is contingent on the past play of a game
and in which some particular past action “triggers” a different action by a
player.
Extensive-Form Game - A representation of a game that summarizes the
players, the information available to them at each stage, the strategies
available to them, the sequence of moves, and the payoffs resulting from
alternative strategies.
Subgame Perfect Equilibrium - A condition describing a set of strategies
that constitutes a Nash equilibrium and allows no player to improve his own
payoff at any stage of the game by changing strategies.

LESSON 11
Price Discrimination - The practice of charging different prices to
consumers for the same good or service
Two-Part Pricing - Pricing strategy in which consumers are charged a
fixed fee for the right to purchase a product, plus a per-unit charge for each
unit purchased.
Block Pricing - Pricing strategy in which identical products are packaged
together in order to enhance profits by forcing customers to make an
all-or-none decision to purchase.
Commodity Bundling - The practice of bundling several different products
together and selling them at a single “bundle price.”
Peak-Load Pricing - Pricing strategy in which higher prices are charged
during peak hours than during off-peak hours.
Cross-Subsidy - Pricing strategy in which profits gained from the sale of
one product are used to subsidize sales of a related product.
Transfer Pricing - Pricing strategy in which a firm optimally sets the
internal price at which an upstream division sells an input to a downstream
division.
Price Matching - A strategy in which a firm advertises a price and a
promise to match any lower price offered by a competitor.
Randomized Pricing - Pricing strategy in which a firm intentionally varies
its price in an attempt to “hide” price information from consumers and rivals

LESSON 12
Mean (expected value) - The sum of the probabilities that different
outcomes will occur multiplied by the resulting payoffs.
Variance - The sum of the probabilities that different outcomes will occur
multiplied by the squared deviations from the mean of the random variable.
Standard Deviation - The square root of the variance.
Risk Averse - Preferring a sure amount of $M to a risky prospect with an
expected value of $M.
Risk Loving - Preferring a risky prospect with an expected value of $M to a
sure amount of $M
Risk Neutral - Indifferent between a risky prospect with an expected value
of $M and a sure amount of $M
Reservation Price - The price at which a consumer is indifferent between
purchasing at that price and searching for a lower price.
Asymmetric Information - A situation that exists when some people have
better information than others.
Hidden Characteristics - Things one party to a transaction knows about
itself but which are unknown by the other party.
Hidden Action - Action taken by one party in a relationship that cannot be
observed by the other party
Adverse Selection - Situation where individuals have hidden
characteristics and in which a selection process results in a pool of
individuals with undesirable characteristics.
Moral Hazard - Situation where one party to a contract takes a hidden
action that benefits him or her at the expense of another party.
Signaling - An attempt by an informed party to send an observable
indicator of his or her hidden characteristics to an uninformed party.
Screening - An attempt by an uninformed party to sort individuals
according to their characteristics.
Self - Selection Device - Mechanism in which informed parties are
presented with a set of options, and the options they choose reveal their
hidden characteristics to an uninformed party.
English Auction - An ascending sequential-bid auction in which bidders
observe the bids of others and decide whether or not to increase the bid.
The auction ends when a single bidder remains; this bidder obtains the
item and pays the auctioneer the amount of the bid.
First - Price, Sealed - Bid Auction - A simultaneous move auction in
which bidders simultaneously submit bids on pieces of paper. The
auctioneer awards the item to the high bidder, who pays the amount bid.
Second - Price, Sealed - Bid Auction - A simultaneous move auction in
which bidders simultaneously submit bids. The auctioneer awards the item
to the high bidder, who pays the amount bid by the second-highest bidder.
Dutch Auction - A descending sequential-bid auction in which the
auctioneer begins with a high asking price and gradually reduces the
asking price until one bidder announces a willingness to pay that price for
the item.
Independent Private Values - Auction environment in which each bidder
knows his own valuation of the item but does not know other bidders’
valuations, and in which each bidder’s valuation does not depend on other
bidders’ valuations of the object.
Affiliated (or correlated) Value Estimates - Auction environment in which
bidders do not know their own valuation of the item or the valuations of
others. Each bidder uses his or her own information to estimate their
valuation, and these value estimates are affiliated: The higher a bidder’s
value estimate, the more likely it is that other bidders also have high value
estimates.
Common Value - Auction environment in which the true value of the item is
the same for all bidders, but this common value is unknown. Bidders each
use their own (private) information to form an estimate of the item’s true
common value.
Winner’s Curse - The “bad news” conveyed to the winner that his or her
estimate of the item’s value exceeds the estimates of all other bidders.