Market for Organic Foods in the United States: Demand, Supply, and Price Dynamics

Learning Objectives

Prepare a report on the market for organic foods in the United States. The paper is to be a report on the market for organics, using the determinants of demand, determinants of supply, and how supply and demand determine price.

The focus of the paper should not be on the health benefits of generic goods, but on the demand, supply and price dynamics of the market for generic foods. Your paper should have an introduction, body and conclusion. There should be at least five (5) references at the end of the paper, using APA format.

The paper should be no fewer than three, but no more than five pages. Use one inch margins and the paper should be double spaced. Remember this is not just a report on organic food, but an economic analysis of the market for organic foods. The paper should discuss the demand for organic foods, the supply of organic foods, and then the resulting price of organics. 

Learning Objectives
Upon completion of this chapter, readers should be able to:
1. Define managerial economics and discuss briefly its relationship to microeconomics and other related fields of study such as finance, marketing, and statistics.
2. Cite the important types of decisions that managers must make concerning the allocation of a company’s scarce resources.
3. Cite and compare the three basic economic questions from the standpoint of both a country and a company.

1. What are the economic conditions in a particular market in which we are or could be competing? In particular:
a. Market structure?
b. Supply and demand conditions?

c. Technology?
d. Government regulations?
e. International dimensions?
f. Future conditions?
g. Macroeconomic factors?

2. Should our firm be in this business?

3. If so, what price and output levels should we set in order to maximize our economic profit or minimize our losses in the short run?

4. How can we organize and invest in our resources (land, labor, capital, managerial skills) in such a way that we maintain a competitive advantage over other firms in this market?
a. Cost leader?
b. Product differentiation?
c. Focus on market niche?
d. Outsourcing, alliances, mergers, acquisitions?
e. International dimension—regional or country focus or expansion?

5. What are the risks involved?

1. What goods and services should be produced and in what quantities?
2. How should these goods and services be produced?
3. For whom should these goods and services be produced?

The first question incorporates the “guns versus butter” decision. Should a country with scarce resources produce guns? Should it produce butter? If so, how much butter and how many guns? The same applies to the countless other goods and services or product groups that a country is capable of producing.

The Three Basic Economic Questions

The second question involves the allocation of a country’s resources in the production of a particular good or service. Suppose a country decides to produce a certain amount of butter. What amounts of land, labor, capital, and entrepreneurial efforts should it devote to this end? Should it use more workers than machinery (a labor-intensive process), or vice versa (a capital-intensive process)?

The meaning of the third question should be readily apparent. It is a decision that must be made about the distribution of a country’s output of goods and services among the members of its population.

1. What goods and services should be produced? 

2. How should these goods and services be produced?

3. For whom should these goods and services be produced?

Questions

1. Define scarcity and opportunity cost. What role do these two concepts play in the making of management decisions?
2. Elaborate on the basic economic questions of what, how, and for whom. Provide specific examples of these questions with respect to the use of a country’s scarce resources.
3. Following are examples of typical economic decisions made by the managers of a firm. Determine whether each is an example of what, how, or for whom.
a. Should the company make its own spare parts or buy them from an outside vendor?
b. Should the company continue to service the equipment that it sells or ask customers to use independent repair companies?
c. Should a company expand its business to international markets or concentrate on the domestic market?
d. Should the company replace its own communications network with a “virtual private network” that is owned and operated by another company?
e. Should the company buy or lease the fleet of trucks that it uses to transport its products to market?
4. Define the market process, the command process, and the traditional process. How does each process deal with the basic questions of what, how, and for whom?

5. Discuss the importance of the command process and the traditional process in the making of management decisions. Illustrate specific ways in which managers must take these two processes into account.
6. Explain the differences between management skills and entrepreneurship. Discuss how each factor contributes to the economic success of a business.
7. Compare and contrast microeconomics with macroeconomics. Although managerial economics is based primarily on microeconomics, explain why it is also important for managers to understand macroeconomics.
8. What do you think is the key to success in the soft drink industry? What chance do you think Global Foods has in succeeding in its new venture into the soft drink market? Explain. (Answer these questions on the basis of the information provided in the chapter and any other knowledge you might have about the food and beverage business.)
 9. (Optional) Have you been personally involved in the making of a decision for a business concerning what, how, or for whom? If so, explain your rationale for making such decisions. Were these decisions guided by the market process, the command process, or the traditional process? Explain.

Questions

Learning Objectives

Upon completion of this chapter, readers should be able to:
1. Understand the reasons for the existence of firms and the meaning of transaction costs.
2. Explain the economic goals of the firm and optimal decision making.
3. Describe the meaning of the “principal-agent” problem.
4. Distinguish between “profit maximization” and the “maximization of the wealth of shareholders.”
5. Demonstrate the usefulness of Market Value Added and Economic Value Added.

Questions

1. The following is a quote from a New York Times article: “If a company makes product donations to the school—computers for instance—then the image of a company goes up as graduate students use the company’s products.” Does such action square with a company’s objective of profit maximization? Discuss.
2. Is the maximization of profit margin (profit as a percentage of total sales) a valid financial objective of a corporation? Discuss.
3. “The growth of consumer information organizations, legal requirements, and warranty requirements has caused significant increases in the cost of customer satisfaction. Thus it is no longer useful to talk about profit maximization as a company objective.” Comment on
this quote.
4. Discuss the difference between profit maximization and shareholder wealth maximization. Which of these is a more comprehensive statement of a company’s economic objectives?
5. Explain the term satisfice as it relates to the operations of a large corporation.
6. Discuss the meaning of the term principal-agent problem. Why does this problem exist?
7. Why may corporate managers not specifically aim at profit (or wealth) maximization for their companies?
8. What are some of the forces that cause managers to act in the interest of shareholders?
9. Do you believe that profit (or shareholder wealth) maximization still represents the best overall economic objective for today’s corporation?
10. Because of inflation, a company must replace one of its (fully depreciated) machines at twice the nominal price paid for a similar machine 8 years ago. Based on present accounting rules, will the company have covered the entire cost of the new machine through depreciation charges? Explain by contrasting accounting and economic costs.
11. How do implicit costs lead to a difference between accounting and economic profits?

12. You have a choice of opening your own business or being employed by someone else in a similar type of business. What are some of the considerations in terms of opportunity costs that you would have to include in arriving at your decision?
13. Various depreciation methods can be used to arrive at an accounting profit number. From the viewpoint of the economist, how should annual depreciation be determined?
14. Do you believe that the profit maximization model can be applied to the activities of a multinational corporation? Explain.
15. What are transaction costs? How does opportunistic behavior tend to increase transaction costs?
16. The outsourcing of important parts of a company’s production has been growing in recent years. How would you explain these changes? How has the Internet contributed to these changes?
17. What are some reasons for companies internalizing transaction costs?
18. A company has 2 million shares outstanding. It paid a dividend of $2 during the past year, and expects that dividends will grow at 6 percent annually in the future. Stockholders require a rate of return of 13 percent. What would you expect the price of each share to be today, and what is the value of the company’s common stock?
19. Discuss the difference between the calculation of shareholder wealth and the concept of Market Value Added. Which of the two would appear to be more meaningful from the viewpoint of a shareholder?

Learning Objectives

Learning Objectives

Upon completion of this chapter, readers should be able to:
1. Define supply, demand, and equilibrium price.
2. List and provide specific examples of the nonprice determinants of supply and demand.
3. Distinguish between the short-run rationing function and the long-run guiding function of price.
4. Illustrate how the concepts of supply and demand can be used to analyze market conditions in which management decisions about price and allocations of resources must be made.
5. Use supply and demand diagrams to show how the determinants of supply and demand interact to determine market price in the short run and in the long run.

Questions

1. Define demand. Define supply. In your answers, explain the difference between demand and quantity demanded and between supply and quantity supplied.
2. List the key nonprice factors that influence demand and supply.
3. In defining demand and supply, why do you think economists focus on price while holding constant other factors that might have an impact on the behavior of buyers and sellers?
4. Define comparative statics analysis. How does it compare with sensitivity analysis or what-if analysis used in finance, accounting, and statistics?
5. Define the rationing function of price. Why is it necessary for price to serve this function in the market economy?
6. Define the guiding or allocating function of price.
7. Discuss the differences between the short run and the long run from the perspective of producers and from the perspective of consumers.
8. Explain the difference between shortages and scarcity. In answering this question, you should consider the difference between the short run and the long run in economic analysis.
9. Why do you think it is important for managers to understand the mechanics of supply and demand both in the short run and in the long run? Give examples of companies whose business was either helped or hurt by changes in supply or demand in the markets in which they were competing.
10. “If Congress levies an additional tax on luxury items, the prices of these items will rise. However, this will cause demand to decrease, and as a result the prices will fall back down, perhaps even to their original levels.” Do you agree with this statement? Explain.
11. Overheard at the water cooler in the corporate headquarters of a large manufacturing company: “The competition is really threatening us with their new product line. I think we should consider offering discounts on our current line in order to stimulate demand.” In this statement, is the term demand being used in a manner consistent with economic theory? Explain. Illustrate your answer using a line drawn to represent the demand for this firm’s product line.

Questions

12. Briefly list and elaborate on the factors that will be affecting the demand for the following products in the next several years. Do you think these factors will cause the demand to increase or decrease?
a. Convenience foods (sold in food shops and supermarkets)
b. Products purchased on the Internet
c. Fax machines
d. digital cameras
e. DVDs rented from retail outlets
f. Pay-per-view television programing
g. Airline travel within the United States; airline travel within Europe
h. Gasoline
13. Briefly list and elaborate on the factors that will be affecting the supply of the following products in the next several years. Do you think these factors will cause the supply to increase or decrease?
a. Crude oil
b. Beef
c. Computer memory chips
d. Hotel rooms
e. Fast food outlets in emerging markets
f. Credit cards issued by financial institutions
g. Laptop computers
h. PC servers

Learning Objectives

Upon completion of this chapter, readers should be able to:
1. Define and measure elasticity.
2. Apply the concepts of price elasticity, cross-elasticity, and income elasticity.
3. Understand the determinants of elasticity.
4. Show how elasticity affects revenue.

Questions

1. State the general meaning of elasticity as it applies to economics. Define the price elasticity of demand.
2. Explain the difference between point elasticity and arc elasticity. What problem can arise in the calculation of the latter, and how is it usually dealt with? In actual business situations, would you expect arc elasticity to be the more useful concept? Why or why not?
3. It has often been said that craft unions (electricians, carpenters, etc.) possess considerably greater power to raise wages than do industrial unions (automobile workers, steel workers, etc.). How would you explain this phenomenon in terms of demand elasticity?
4. Discuss the relative price elasticity of the following products:
a. Mayonnaise
b. A specific brand of mayonnaise
c. Chevrolet automobiles
d. Jaguar automobiles

e. Washing machines
f. Air travel (vacation)
g. Beer
h. Diamond rings
5. What would you expect to happen to spending on food at home and spending on food in restaurants during a decline in economic activity? How would income elasticity of demand help explain these changes?
6. Would you expect the cross-elasticity coefficients between each of the following pairs of products to be positive or negative? Why?
a. Personal computers and software
b. Electricity and natural gas
c. Apples and oranges
d. Bread and DVRs
7. Why is it unlikely that a firm would sell at a price and quantity where its demand curve is price inelastic?
8. Which products would exhibit a higher elasticity with respect to interest rates, automobiles or small appliances? Why?
9. The immediate effect of gasoline price increases in the aftermath of the Persian Gulf crisis in August 1990 on gasoline consumption was not very significant. Would you expect the consumption of gasoline to be more severely affected if these higher prices remained in effect for a year or more? Why or why not?
10. Suppose the federal tax on gasoline increased by 5 cents per gallon. Do you think that such an increase, reflected in the price of gasoline, would have a significant impact on gasoline consumption?
11. Why do you think that whenever governments (federal and state) want to increase revenues, they usually propose an increase in taxes on cigarettes and alcohol?
12. Could a straight-line demand curve ever have the same elasticity on all its points?
13. If a demand curve facing a firm is horizontal or nearly so, what does it say about this firm’s competition?
14. A company faced by an elastic demand curve will always benefit by decreasing price. True or false? Explain.
15. Discuss the income elasticities of the following consumer products:
a. Margarine
b. Fine jewelry
c. Living room furniture
d. Whole lobsters
16. If the income elasticity of tomatoes is estimated to approximate +0.25, what would you expect to happen to the consumption of tomatoes as personal income rises?
17. (Read the “The Market for Used Automobiles” section in Appendix 4A before answering the question.) When prices of used cars dropped about 10 percent in October 2001, their sales increased by 4.5 percent. Does this mean that the demand elasticity for used carsis 0.45?
18. The U.S. Postal Service has been raising postal rates on a regular basis. The service had been losing money. One of the reasons is increased competition from companies such as United Parcel Service and Federal Express. Another reason is the use of faxes and e-mail, as well as electronic bill payment. With this decrease in demand for postal services, why do you think that the Postal Service is seeking a rate increase?
19. A Canadian apparel company, Roots, agreed to provide the U.S. Olympic team at the 2002 Winter Olympics with various types of clothing, including berets, for free, and further, to turn over a portion of its profits on sales of this clothing to the U.S. Olympic Committee. The beret became an instant success, and Roots sold a large number of them. What type of elasticity does this arrangement represent?

Learning Objectives

Upon completion of this chapter, readers should be able to:
1. Specify the components of a regression model that can be used to estimate a demand equation.
2. Interpret the regression results (i.e., explain the quantitative impact that changes in the determinants have on the quantity demanded).
3. Explain the meaning of R2
4. Evaluate the statistical significance of the regression coefficients using the t-test and the statistical significance of R2 using the F-test.
5. Recognize the challenges of obtaining reliable cross-sectional and time series data on consumer behavior that can be used in regression models of demand.
6. Understand the importance of forecasting in business.
7. Describe six different forecasting techniques.
8. Show how to carry out least squares projections, and decompose them into trends, seasonal, cyclical, and irregular movements.
9. Explain basic smoothing methods of forecasting, such as the moving average and exponential smoothing.

Questions

Demand Estimation

1. Explain the difference between time series data and cross-sectional data. Provide examples of each type of data.
2. Would there be any differences in the set of variables used in a regression model of the demand for consumer durable goods (e.g., automobiles, appliances, furniture) and a regression model of the demand for “fast-moving consumer goods” (e.g., food, beverages, personal care products)? Explain.
3. Briefly explain the meaning of R2. A time series analysis of demand tends to result in a higher R2 than one using cross-sectional data. Why do you think this is the case?
4. Summarize the steps involved in conducting the t-test. What is the basis for using the “rule of 2” as a convenient method of evaluating t-ratios?
5. Briefly explain the meaning of the F-test. Why do you think this test is considered to be more important in multiple regression analysis than it is in simple regression analysis?
6. What is multicollinearity? How can researchers detect this problem? What is the impact of this problem on the regression estimates? What steps can be taken to deal with this problem?
7. What is the identification problem? What effect will this problem have on the regression estimates of a demand function? Explain.

Forecasting

1. “The best forecasting method is the one that gives the highest proportion of correct predictions.” Comment.
2. Enumerate methods of qualitative and quantitative forecasting. What are the major differences between the two?
3. Discuss the benefits and drawbacks of the following methods of forecasting:
a. Jury of executive opinion
b. The Delphi method
c. Opinion polls
Each method has its uses. What are they?
4. a. Why are manufacturers’ new orders, nondefense capital goods, an appropriate leading indicator?
b. Why is the index of industrial production an appropriate coincident indicator?
c. Why is the average prime rate charged by banks an appropriate lagging indicator?

5. Discuss some of the important criticisms of the forecasting ability of the leading economic indicators.
6. Manhattan was allegedly purchased from Native Americans in 1626 for $24. If the sellers had invested this sum at a 6 percent interest rate compounded semiannually, how much would it amount to today?
7. The compound growth rate is frequently used to forecast various quantities (sales, profits, and so on). Do you believe this is a good method? Should any cautions be exercised in making such projections?
8. Describe projections that use either moving averages or exponential smoothing. Under what conditions can these techniques be used? Which of the two appears to be the more useful?

9. How do econometric models differ from “naive” projection methods? Is it always advisable to use the former in forecasting?

10. You have been asked to produce a forecast for your company’s product, bottled water. Discuss the kind of information you would look for in order to make this forecast.

Learning Objectives

Upon completion of this chapter, readers should be able to:
1. Define the production function and explain the difference between a short-run and a long-run production function.
2. Explain the “law of diminishing returns” and how it relates to the Three Stages of Production.
3. Define the Three Stages of Production and explain why a rational firm always tries to operate in Stage II.
4. Provide examples of types of inputs that might go into a production function for a manufacturing company and for a service company.
5. Describe the various forms of a production function that are used in the statistical estimation of these functions.
6. Briefly describe the Cobb-Douglas function and cite a few statistical studies that used this particular functional form in their analysis.
7. Discuss the key differences between productivity in the production of goods vs. productivity in the production of services, and list important factors that can help to improve productivity in services.
8. Describe isoquant and isocost curves and explain how the tangency of these curves help to determine the optimal combination of inputs for a firm to utilize.
9. Use the tools of calculus to determine a firm’s optimal combination inputs.

Questions

1. Explain the difference between a short-run and long-run production function. Cite one example of this difference in a business situation.
2. Define the law of diminishing returns. Why is this law considered a short-run phenomenon?
3. What are the key points in a short-run production function that delineate the three stages of production? Explain the relationship between the law of diminishing returns and the three stages of production.
4. Explain why a firm’s adherence to the MRP 5 MLC rule enables it to find the optimal number of units of a variable input to use in the short-run production process.
5. Define returns to scale. Why is this considered a long-run phenomenon?
6. According to the rule for optimal input usage, a firm should hire a person as long as her marginal revenue product is greater than her marginal cost to the company. It is well known that many companies have management training programs in which new trainees are paid relatively high starting salaries and are not expected to make substantial contributions to the company until after the program is over (programs may run between 6 to 18 months). In offering such training programs, is a company violating the optimality rule? Explain.
7. Explain the relationship between marginal product and average product. Why can we expect marginal product to equal average product at average product’s maximum point?
8. Cite and discuss possible reasons a firm may actually find itself operating in Stage I or Stage III of the short-run production function.
9. Discuss the problems of measuring productivity in actual work situations. How might productivity be measured for each of the following industries?
a. Education (e.g., elementary and secondary education, higher education—undergraduate and graduate)
b. Government (e.g., the Social Security Office, the Internal Revenue Service)
c. Manufacturing (e.g., soap and toothpaste, computers, heavy machinery)
d. Finance and insurance (e.g., banks, insurance companies, brokerage houses)
10. For those of you with current or previous work experience, how is (was) productivity measured in your organization?
11. What are the two statistical methods most frequently used to estimate production functions? What are the advantages and disadvantages of each method?
12. Design a study of a production function for a steel mill and another one for a call center. Which variables would you use, and what statistical method would you select for each function? In general, compare and contrast the production function for a product and one for a service.

14. When a Cobb-Douglas function with at least two inputs shows the existence of constant returns to scale, it implies that the marginal product of each input is diminishing. True or false? Explain.
15. Write a production function equation that expresses the existence of diminishing marginal returns. How will this equation differ from one that shows both increasing and decreasing marginal returns?

Learning Objectives

Upon completion of this chapter, readers should be able to:
1. Define the cost function and explain the difference between a short-run and a long-run cost function.
2. Explain the linkages between the production function and the cost function.
3. Distinguish between economic cost and accounting cost.
4. Explain how the concept of relevant cost is used in the economic analysis of cost.
5. Define short-run total cost, short-run total variable cost, and total fixed cost and explain their relationship to each other.
6. Define average cost, average variable cost, and average fixed cost and explain their relationship to each other in the short run. Do the same for average cost and average variable cost in the long run.
7. Compare and contrast the short-run cost function and the long-run cost function and explain why economies of scale is considered to be a long-run phenomenon.
8. Provide at least four reasons for the existence of economies of scale.
9. Use calculus to derive marginal cost from total cost and to find the minimums of each per-unit cost curve, and use Excel to depict the per-unit cost curves graphically.
10. Cite several studies that have estimated the cost functions in actual market situations.
11. Explain how to conduct empirical cost studies and cite several studies.

Questions

1. Define and compare the following types of cost:
a. Sunk cost versus incremental cost
b. Fixed cost versus variable cost
c. Incremental cost versus marginal cost
d. Opportunity cost versus out-of-pocket cost
2. Point out which costs in the preceding question are considered “relevant” and which are considered “irrelevant” to a business decision. Explain why.
3. Explain the relationship between a firm’s short-run production function and its shortrun cost function. Focus on the marginal product of an input and the marginal cost of production.
4. “If it were not for the law of diminishing returns, a firm’s average cost and average variable cost would not increase in the short run.” Do you agree with this statement? Explain.
5. Explain the distinction made in economic analysis between the short run and the long run.
6. Define economies of scale. How does this relate to returns to scale? Cite and briefly discuss the main determinants of economies of scale.
7. Define diseconomies of scale. Cite and briefly discuss the main determinants of this phenomenon.

8. Define economies of scope. Is this concept related to economies of scale? Explain.
9. Explain the relationship between the learning curve and a firm’s cost function. Would economists consider the learning curve a short-run or a long-run phenomenon?
10. Define the experience curve. Compare its impact on a firm’s cost function with that of the learning curve.
11. “Because of economies of scale, it is sometimes more cost effective for a firm to operate a large plant at less than maximum efficiency than a small plant at maximum efficiency.” Do you agree with this statement? Explain.

12. Overheard at the water cooler: “I think our company should take advantage of economies of scale by increasing our output, thereby spreading out our overhead costs.” Would you agree with this statement (assuming this person is not your boss)? Explain. Refer to Appendix 7B for help in answering questions 14 through 16.
13. Discuss the estimation of short-run cost functions. Which regression method is most frequently used, and what are some of the problems a researcher will encounter? What adjustment factors may have to be employed?
14. Discuss the estimation of long-run cost functions. Which regression method is most frequently used, and what are some of the problems a researcher will encounter? What adjustment factors may have to be employed?
15. Comment briefly on the following methods of cost estimation:
a. Engineering costs
b. Survivorship principle
Discuss the strengths and shortcomings of these methods and the circumstances under which each can be applied.

Learning Objectives

Upon completion of this chapter, readers should be able to:
1. Describe the key characteristics of the four basic market types used in economic analysis.
2. Compare and contrast the degree of price competition among the four market types.
3. Provide specific actual examples of the four types of markets.
4. Explain why the P 5 MC rule leads firms to the optimal level of production in competitive markets.
5. Describe what happens in the long run in markets where firms are either incurring economic losses or are making economic profits. Explain why this happens with particular attention to the key assumptions used in this analysis.
6. Explain how and why the MR = MC rule helps a monopoly to determine the optimal level of price and output.
7. Explain the relationship between the MR = MC rule and the P = MC rule.
8. Use the tools of calculus to determine the optimal level of output for a firm in perfect competition and the optimal levels of price and output for a monopoly.
9. Explain how the fixed cost and variable cost help to determine a firm’s break-even level of output.
10. Explain the concept of operating leverage and how it can be used to better understand the challenges faced by firms with a high fixed cost relative to their variable cost.

Questions

1. What are the main characteristics of a perfectly competitive market that cause buyers and sellers to be price takers? Explain.
2. Explain the importance of free entry and exit in the perfectly competitive market. That is, if free entry and exit did not exist, what impact would this have on the allocation of resources and on the ability of firms to earn above-normal profits over time?
3. “The perfectly competitive model is not very useful for managers because very few markets in the U.S. economy are perfectly competitive.” Do you agree with this statement? Explain. Regardless of whether you agree, what lessons can managers learn by studying perfectly competitive markets?
4. Explain why the demand curve facing a perfectly competitive firm is assumed to be perfectly elastic (i.e., horizontal at the going market price).
5. Explain why the demand curve facing a monopolist is less elastic than one facing a firm that operates in a monopolistically competitive market (all other factors held constant).
6. Use the model of perfect competition described in this chapter to explain, illustrate, or elaborate on the following statements.
a. “Increasing competition from new firms entering the market is good because it means one is in a good business.”
b. “One important difference between an entrepreneur and a manager is that the former gets into a market before demand increases, while the latter gets into the market after the shift.”
7. Explain the relationship between P . AVC and a firm’s contribution margin.
8. Why do economists consider zero economic profit to be “normal”?
9. “Economic profit” is a theoretical concept used to help explain the behavior of firms in competitive markets. Suggest ways in which this concept can actually be measured.

10. Explain why the P 5 MC rule is the same as the MR 5 MC rule for perfectly competitive firms.
11. Explain why a price-setting firm will always set its revenue-maximizing price below the price that would maximize its profit.
12. Provide some examples of business cases that a typical firm must consider. If possible, use current examples reported in the business press.
13. How “perfectly” competitive do you think are the following markets: (1) stock market, (2) bond market, (3) foreign exchange market, (4) world sugar market, and (5) world oil market? Explain.
14. Explain how the concept of “economic profit” might help explain the rationale for the government’s granting of monopolies to those firms that protect their product with a patent.

Learning Objectives

Upon completion of the appendix, readers should be able to:
1. Understand the concept of break-even analysis.
2. Calculate the break-even point and break-even revenue.
3. Show how break-even analysis can be combined with demand analysis.
4. Explain and apply the concept of degree of operating leverage.
5. Describe the benefits and limitations of break-even analysis.

Questions

1. Although volume-cost-profit analysis uses graphs similar to those used by economists, the analysis differs in content. Discuss these differences.
2. Does the volume-cost-profit method analyze short-run or long-run situations? Why?
3. What is the difference between fixed costs and constant costs?
4. How realistic is the assumption of constant variable unit costs in volume-cost-profit analysis? Does it detract a great deal from the value of this analysis? Explain briefly.
5. What is the effect on break-even quantity of
a. A decrease in unit price?
b. A decrease in average variable cost?
c. A decrease in fixed cost?
Assume some numbers and illustrate the effect by drawing graphs showing the break-even point.

6. Business risk is usually defined in terms of variations of return (or profit) to a firm due to changes in activity resulting from changes in general economic activity. Can the degree of operating leverage therefore be described as a measure of business risk? Why?
7. Would you expect a company whose production is rather stable from period to period and growing slowly from year to year to have relatively high fixed costs?
8. How would you account for required profit in the break-even formula when
a. Profit is set as a requirement for a time period (e.g., a year)?
b. Profit is set as a specific monetary amount per unit?
9. Can the degree of operating leverage be measured at the break-even quantity point? Why or why not?
10. Is volume-cost-profit analysis a good planning tool? Discuss briefly.
11. What are some useful applications of volume-cost-profit analysis?

Learning Objectives

Upon completion of this chapter, readers should be able to:
1. Cite the main differences between monopolistic competition and oligopoly.
2. Describe the role that mutual interdependence plays in setting prices in oligopolistic markets.
3. Illustrate price rigidity in oligopoly markets using the “kinked demand curve.”
4. Elaborate on how nonprice factors help firms in monopolistic competition and oligopoly to differentiate their products and services.
5. Cite and briefly describe the five forces in Porter’s model of competition.

Questions

1. Explain the key difference between perfect competition and monopolistic competition.
2. Assume firms in the short run are earning above-normal profits. Explain what will happen to these profits in the long run for the following markets:
a. Pure monopoly
b. Oligopoly
c. Monopolistic competition
d. Perfect competition
3. In certain industries, firms buy their most important inputs in markets that are close to perfectly competitive and sell their output in imperfectly competitive markets. Cite as many examples as you can of these types of businesses. Explain why the profits of such firms tend to increase when there is an excess supply of the inputs they use in their production process.
4. In the short run, firms that seek to maximize their market share will tend to charge a lower price for their products than firms that seek to maximize their profit. Do you agree with this statement? Explain.
5. Explain why it is sometimes difficult to apply the MR 5 MC rule in actual business situations.
6. Define mutual interdependence.
7. Why do oligopolists often rely on a price leader to raise the market price of a product?
8. How does one determine whether a market is oligopolistic? Is it important for managers to recognize the existence of oligopolistic competitors in the markets in which their companies operate? Explain.
9. In the following list are a number of well-known companies and the products that they sell. Which of the four types of markets (perfect competition, monopoly, monopolistic competition, and oligopoly) best characterizes the markets in which they compete? Explain why.
a. McDonald’s—hamburgers
b. ExxonMobil—gasoline
c. Dell—personal computers
d. Heinz—ketchup
e. Procter & Gamble—disposable diapers
f. Starbucks—gourmet coffee
g. Domino’s—pizza
h. Intel—computer chip for the PC
10. Briefly explain the structure-conduct-performance approach to the study of industrial economics.
11. Compare and contrast Porter’s Five Forces model with the four basic types of markets first described in Chapter 8 in the section “Market Structure.”

12. In 2002, Philip Morris sold its Miller Brewing Division to South African Breweries.
a. What impact do you think this transaction had on the market structure of the beer industry in the United States? In world markets? Explain.
b. Using the economic concepts presented in Chapters 7, 8, and 9, discuss possible reasons why both parties agreed to this transaction.

Learning Objectives

Upon completion of this chapter, readers should be able to:
1. Analyze cartel pricing.
2. Illustrate price leadership.
3. Understand price discrimination, and explain how it affects production and prices.
4. Distinguish between marginal pricing and “cost-plus” pricing.
5. Discuss the various types of multiproduct pricing.
6. Explain the meaning of “transfer pricing,” and explain how a company should price products that pass from one operating division to another.

Questions

1. “If a company sets its prices on the basis of a cost-plus calculation, it cannot possibly suffer a loss on its products.” True or false? Comment.
2. Price discrimination is often defended on the basis of fairness. What is meant by this statement? Comment on its validity.
3. Which products in each pair would tend to have higher markups in a supermarket?
a. Cigarettes versus tomatoes
b. Potatoes versus orange juice
4. Many years ago, a neighborhood lunch counter charged 15 cents for a cup of coffee and 15 cents for a buttered hard roll. One day, a customer ordered the two items and was told that the total price was 35 cents. When the customer asked which of the two items had been raised by 5 cents, the owner’s condescending reply was, “Which do you think?” In your opinion, which of the two items was affected and why?
5. Differentiate barometric price leadership and dominant price leadership.
6. Is there a similarity between cartel pricing and monopoly pricing?
7. What conditions are favorable to the formation and maintenance of a cartel?
8. Can government be a potent force in the establishment and maintenance of monopolistic conditions? Name and describe such occurrences.
9. Describe the properties of the Baumol revenue maximization model. Do you consider this to be a good alternative to the profit maximization model?
10. Telephone companies charge different rates for calls during the day, in the evening, and at night or weekends. Do you consider this to be price discrimination?

11. Is cost-plus pricing necessarily inconsistent with marginal pricing?
12. Airline ticket prices may differ with respect to when the ticket is bought, how long a passenger remains on the trip (e.g., over a weekend) and other variables. Are these differences a case of price discrimination?
13. Does cost-plus pricing necessarily ignore the demand curve?
14. Define and describe (giving examples):
a. Transfer pricing
b. Psychological pricing
c. Price skimming
d. Penetration pricing
15. Under what circumstances would a discriminating monopolist produce a more socially optimal quantity than a nondiscriminating monopolist? Is there any situation under which a discriminating monopolist could produce the quantity that would be produced under competition? 

Learning Objectives

Upon completion of this chapter, readers should be able to:
1. Define game theory, and explain how it helps better understand mutually interdependent management decisions.
2. Explain the essential dilemma faced by participants in the prisoners’ dilemma game and explain why many oligopolistic situations resemble the prisoners’ dilemma.
3. Explain the circumstances when the prisoners’ dilemma is more of a dilemma for firms.
4. Explain the difference between cooperative and noncooperative games, and explain why many of the games played by firms are necessarily noncooperative in nature.
5. Explain the tactics used in bargaining, especially tacit bargaining.
6. Explain how focal points and limited war relate to oligopolistic interactions.
7. Explain the key problems that arise in a market where buyers and sellers do not have the same information about a product (i.e., when “asymmetric information” exists between buyers and sellers).
8. Briefly explain the concepts of “adverse selection” and “moral hazard” and why they exist in markets with asymmetric information.
9. Explain how the moral hazard problem relates to the principal-agent problem.
10. Explain the essential attribute of a signal as used by Michael Spence and explain how signals can help avoid the lemons problem discussed by George Akerlof.
11. Explain how parties that are at an informational disadvantage can sort those on the other side of a transaction into groups based voluntary action.

Questions

1. Is the prisoners’ dilemma more of a problem for a one-shot or a repeated game?
2. Is a prisoners’ dilemma game a zero sum or variable sum game?
3. Is a prisoners’ dilemma game more of a problem for cooperative or noncooperative games?
4. Is it easier for a rational or irrational person to make a credible threat?
5. Why must much of the bargaining in economic situations be done on a tacit basis?
6. Why are focal points important for noncooperative games?
7. Why is it particularly important to be the party who sets the agenda in situations involving tacit negotiation?
8. What attribute about a war makes it a limited war? How does the concept of limited war relate to oligopolistic rivalry?
9. Suppose you are asked to write down the name of a single card in a standard deck of playing cards. You cannot ask your neighbor what he or she is writing down, but you wish to write down the same card. What card would you write down?
10. The responses to Question 9 provide an example of what game theory concept?
11. Why might demand be downward sloping in a market with imperfect information even though the market is otherwise perfectly competitive?
12. Is there an informational asymmetry in the new car market?
13. If there is asymmetric information, do sellers always have better information than buyers do?
14. Which side has the informational advantage that is the key to the lemons model?
15. Why might demand be upward sloping in used car markets?
16. Which effect dominates, the price effect or the quality effect of a price change if demand is upward sloping?
17. What does Spence argue is required for a signal to be effective?
18. Who has more information in the job market: the job seeker or the potential employer?
19. How can education act as a separating device?

20. In Spence’s model, does the educated job seeker receive higher wages because education increases the worker’s productivity?
21. How do warranties and guarantees act as signals?
22. Does the buyer or seller of insurance typically have better information?
23. How is the menu of insurance contracts offered by an insurance company like the menu of wage choices available to individuals hired by a company?
24. Is an insurance policy with a high deductible aimed at low-risk or high-risk individuals?
25. Is the lemons model an example of the adverse selection problem?
26. Provide two examples of incentive-compatible mechanisms that reduce the principal-agent problem.
27. Does advertising have signaling value?