COMPLETE SOLUTION MANUAL FOR
Managerial Economics and Business Strategy 10th Edition
By Michael Baye, Jeff Prince
Chapter 1
The Fundamentals of Managerial Economics
Answers to Questions and Problems
1. This situation best represents producer-producer rivalry. Here, Southwest is a
producer attempting to steal customers away from other producers in the form of
lower prices.
2. The maximum you would be willing to pay for this asset is the present value, which is
250,000 250,000 250,000 250,000 250,000
𝑃𝑉 = + + + +
(1 + 0.08) (1 + 0.08)2 (1 + 0.08)3 (1 + 0.08)4 (1 + 0.08)5
= $998,177.51
3.
a. Net benefits are N(Q) = 20 + 24Q – 4Q2.
b. Net benefits when Q = 1 are N(1) = 20 + 24 – 4 = 40 and when Q = 5 they are
N(5) = 20 + 24(5) – 4(5)2 = 40.
c. Marginal net benefits are MNB(Q) = 24 – 8Q.
d. Marginal net benefits when Q 1 are MNB(1) = 24 – 8(1) = 16 and when Q 5
they are MNB(5) = 24 – 8(5) = -16.
e. Setting MNB(Q) = 24 – 8Q = 0 and solving for Q, we see that net benefits are
maximized when Q = 3.
f. When net benefits are maximized at Q = 3, marginal net benefits are zero. That is,
MNB(3) = 24 – 8(3) = 0.
4.
a. The value of the firm before it pays out current dividends is
1 + 0.06
𝑃𝑉𝑓𝑖𝑟𝑚 = $400,000 ( )
0.06 − 0.04
= $21.2 million.
b. The value of the firm immediately after paying the dividend is
Managerial Economics and Business Strategy, 10e Page 1
Copyright © 2022 by McGraw-Hill Education.
All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
, 1 + 0.04
𝑃𝑉𝐸𝑥−𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 = $400,000 ( )
𝑓𝑖𝑟𝑚
0.06 − 0.04
= $20.8 million.
5. The present value of the perpetual stream of cash flows. This is given by
𝐶𝐹 $120
𝑃𝑉𝑃𝑒𝑟𝑝𝑒𝑡𝑢𝑖𝑡𝑦 = = = $4,000
𝑖 0.03
6. The completed table looks like this:
Marginal
Control Total Total Net Marginal Marginal
Net
Variable Benefits Cost Benefits Benefit Cost
Benefit
Q B(Q) C(Q) N(Q) MB(Q) MC(Q)
MNB(Q)
100 1200 950 250 210 60 150
101 1400 1020 380 200 70 130
102 1590 1100 490 190 80 110
103 1770 1190 580 180 90 90
104 1940 1290 650 170 100 70
105 2100 1400 700 160 110 50
106 2250 1520 730 150 120 30
107 2390 1650 740 140 130 10
108 2520 1790 730 130 140 -10
109 2640 1940 700 120 150 -30
110 2750 2100 650 110 160 -50
a. Net benefits are maximized at Q = 107.
b. Marginal cost is slightly smaller than marginal benefit (MC = 130 and MB = 140).
This is due to the discrete nature of the control variable.
7.
a. The net present value of attending school is the present value of the benefits
derived from attending school (including the stream of higher earnings and the
value to you of the work environment and prestige that your education provides),
minus the opportunity cost of attending school. As noted in the text, the
opportunity cost of attending school is generally greater than the cost of books
and tuition. It is rational for an individual to enroll in graduate school when his or
her net present value is greater than zero.
b. Since this decreases the opportunity cost of getting an M.B.A., one would expect
more students to apply for admission into M.B.A. Programs.
8.
Page 2 Michael R. Baye & Jeffrey T. Prince
Copyright © 2022 by McGraw-Hill Education.
All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
, a. Her accounting profits are $170,000. These are computed as the difference
between revenues ($200,000) and explicit costs ($30,000).
b. By working as a painter, Jaynet gives up the $110,000 she could have earned
under her next best alternative. This implicit cost of $110,000 is in addition to the
$30,000 in explicit costs. Since her economic costs are $140,000, her economic
profits are $200,000 - $140,000 = $60,000.
9.
a. Total benefit when Q = 2 is B(2) = 20(2) – 2*22 = 32. When Q = 10, B(10) =
20(10) – 2*102 = 0.
b. Marginal benefit when Q = 2 is MB(2) = 20 – 4(2) = 12. When Q = 10, it is
MB(10) = 20 – 4(10) = -20.
c. The level of Q that maximizes total benefits satisfies MB(Q) = 20 – 4Q = 0, so Q
= 5.
d. Total cost when Q = 2 is C(2) = 4 + 2*22 = 12. When Q = 10 C(Q) = 4 + 2*102 =
204.
e. Marginal cost when Q = 2 is MC(Q) = 4(2) = 8. When Q = 10 MC(Q) = 4(10) =
40.
f. The level of Q that minimizes total cost is MC(Q) = 4Q = 0, or Q = 0.
g. Net benefits are maximized when MNB(Q) = MB(Q) - MC(Q) = 0, or 20 – 4Q –
4Q = 0. Some algebra leads to Q = 20/8 = 2.5 as the level of output that
maximizes net benefits.
10.
a. The present value of the stream of accounting profits is
(150,000 − 50,000) (150,000 − 50,000) (150,000 − 50,000)
𝑃𝑉 = + + = $262,431.60
1.07 (1.07)2 (1.07)3
b. The present value of the stream of economic profits is
(150,000 − 50,000 − 65,000) (150,000 − 50,000 − 65,000)
𝑃𝑉 = +
1.07 (1.07)2
(150,000 − 50,000 − 65,000)
+ = $91,851.06
(1.07)3
1+𝑖
11. First, recall the equation for the value of a firm: 𝑃𝑉𝑓𝑖𝑟𝑚 = 𝜋0 ( ). Next, solve this
𝑖−g
(1+𝑖)𝜋0
equation for g to obtain 𝑔 = 𝑖 − . Substituting in the known values implies a
𝑃𝑉𝑓𝑖r𝑚
(1+0.09)25,000
growth rate of: 𝑔 = 0.09 − = 0.0355 or 3.55 percent. This would seem
500,000
to be a reasonable rate of growth: 0.0355 < 0.09 (g < i).
Managerial Economics and Business Strategy, 10e Page 3
Copyright © 2022 by McGraw-Hill Education.
All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
, 12. Effectively, this question boils down to the question of whether it is a good
investment to spend an extra $250 on a refrigerator that will save you $40 at the end
of each year for five years. The net present value of this investment is
$40 $40 $40 $40 $40
𝑁𝑃𝑉 = + + + + − $250
1.06 (1.06)2 (1.06)3 (1.06)4 (1.06)5
= $168.49 − $250
= −$81.51.
You should buy the standard model, since doing so saves you $81.51 in present value
terms.
13. Under a flat hourly wage, employees have little incentive to work hard as working
hard will not directly benefit them. This adversely affects the firm, since its profits
will be lower than the $25,000 per store that is obtainable each day when employees
perform at their peak. Under the proposed pay structure, employees have a strong
incentive to increase effort, and this will benefit the firm. In particular, under the
fixed hourly wage, an employee receives $160 per day whether he or she works hard
or not. Under the new pay structure, an employee receives $330 per day if the store
achieves its maximum possible daily profit and only $80 if the store’s daily profit is
zero. This provides employees an incentive to work hard and to exert peer pressure on
employees who might otherwise goof off. By providing employees an incentive to
earn extra money by working hard, both the firm and the employees will benefit.
14.
a. Accounting costs equal $145,000 per year in overhead and operating expenses.
Her implicit cost is the $75,000 salary that must be given up to start the new
business. Her opportunity cost includes both implicit and explicit costs: $145,000
+ $75,000 = $220,000.
b. To earn positive accounting profits, the revenues per year should greater than
$145,000. To earn positive economic profits, the revenues per year must be
greater than $220,000.
15. First, note that the $200 million spent to date is irrelevant. It is a sunk cost that will be
lost regardless of the decision. The relevant question is whether the incremental
benefits (the present value of the profits generated from the drug) exceed the
incremental costs (the $60 million needed to keep the project alive). Since these costs
and benefits span time, it is appropriate to compute the net present value. Here, the
net present value of DAS’s R&D initiative is
12,000,000 13,400,000 17,200,000 20,700,000 22,450,000
𝑁𝑃𝑉 = + + + + − 60,000,00
(1 + 0.05)5 (1 + 0.05)6 (1 + 0.05)7 (1 + 0.05)8 (1 + 0.05)9
= $107,364.15
Page 4 Michael R. Baye & Jeffrey T. Prince
Copyright © 2022 by McGraw-Hill Education.
All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Managerial Economics and Business Strategy 10th Edition
By Michael Baye, Jeff Prince
Chapter 1
The Fundamentals of Managerial Economics
Answers to Questions and Problems
1. This situation best represents producer-producer rivalry. Here, Southwest is a
producer attempting to steal customers away from other producers in the form of
lower prices.
2. The maximum you would be willing to pay for this asset is the present value, which is
250,000 250,000 250,000 250,000 250,000
𝑃𝑉 = + + + +
(1 + 0.08) (1 + 0.08)2 (1 + 0.08)3 (1 + 0.08)4 (1 + 0.08)5
= $998,177.51
3.
a. Net benefits are N(Q) = 20 + 24Q – 4Q2.
b. Net benefits when Q = 1 are N(1) = 20 + 24 – 4 = 40 and when Q = 5 they are
N(5) = 20 + 24(5) – 4(5)2 = 40.
c. Marginal net benefits are MNB(Q) = 24 – 8Q.
d. Marginal net benefits when Q 1 are MNB(1) = 24 – 8(1) = 16 and when Q 5
they are MNB(5) = 24 – 8(5) = -16.
e. Setting MNB(Q) = 24 – 8Q = 0 and solving for Q, we see that net benefits are
maximized when Q = 3.
f. When net benefits are maximized at Q = 3, marginal net benefits are zero. That is,
MNB(3) = 24 – 8(3) = 0.
4.
a. The value of the firm before it pays out current dividends is
1 + 0.06
𝑃𝑉𝑓𝑖𝑟𝑚 = $400,000 ( )
0.06 − 0.04
= $21.2 million.
b. The value of the firm immediately after paying the dividend is
Managerial Economics and Business Strategy, 10e Page 1
Copyright © 2022 by McGraw-Hill Education.
All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
, 1 + 0.04
𝑃𝑉𝐸𝑥−𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 = $400,000 ( )
𝑓𝑖𝑟𝑚
0.06 − 0.04
= $20.8 million.
5. The present value of the perpetual stream of cash flows. This is given by
𝐶𝐹 $120
𝑃𝑉𝑃𝑒𝑟𝑝𝑒𝑡𝑢𝑖𝑡𝑦 = = = $4,000
𝑖 0.03
6. The completed table looks like this:
Marginal
Control Total Total Net Marginal Marginal
Net
Variable Benefits Cost Benefits Benefit Cost
Benefit
Q B(Q) C(Q) N(Q) MB(Q) MC(Q)
MNB(Q)
100 1200 950 250 210 60 150
101 1400 1020 380 200 70 130
102 1590 1100 490 190 80 110
103 1770 1190 580 180 90 90
104 1940 1290 650 170 100 70
105 2100 1400 700 160 110 50
106 2250 1520 730 150 120 30
107 2390 1650 740 140 130 10
108 2520 1790 730 130 140 -10
109 2640 1940 700 120 150 -30
110 2750 2100 650 110 160 -50
a. Net benefits are maximized at Q = 107.
b. Marginal cost is slightly smaller than marginal benefit (MC = 130 and MB = 140).
This is due to the discrete nature of the control variable.
7.
a. The net present value of attending school is the present value of the benefits
derived from attending school (including the stream of higher earnings and the
value to you of the work environment and prestige that your education provides),
minus the opportunity cost of attending school. As noted in the text, the
opportunity cost of attending school is generally greater than the cost of books
and tuition. It is rational for an individual to enroll in graduate school when his or
her net present value is greater than zero.
b. Since this decreases the opportunity cost of getting an M.B.A., one would expect
more students to apply for admission into M.B.A. Programs.
8.
Page 2 Michael R. Baye & Jeffrey T. Prince
Copyright © 2022 by McGraw-Hill Education.
All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
, a. Her accounting profits are $170,000. These are computed as the difference
between revenues ($200,000) and explicit costs ($30,000).
b. By working as a painter, Jaynet gives up the $110,000 she could have earned
under her next best alternative. This implicit cost of $110,000 is in addition to the
$30,000 in explicit costs. Since her economic costs are $140,000, her economic
profits are $200,000 - $140,000 = $60,000.
9.
a. Total benefit when Q = 2 is B(2) = 20(2) – 2*22 = 32. When Q = 10, B(10) =
20(10) – 2*102 = 0.
b. Marginal benefit when Q = 2 is MB(2) = 20 – 4(2) = 12. When Q = 10, it is
MB(10) = 20 – 4(10) = -20.
c. The level of Q that maximizes total benefits satisfies MB(Q) = 20 – 4Q = 0, so Q
= 5.
d. Total cost when Q = 2 is C(2) = 4 + 2*22 = 12. When Q = 10 C(Q) = 4 + 2*102 =
204.
e. Marginal cost when Q = 2 is MC(Q) = 4(2) = 8. When Q = 10 MC(Q) = 4(10) =
40.
f. The level of Q that minimizes total cost is MC(Q) = 4Q = 0, or Q = 0.
g. Net benefits are maximized when MNB(Q) = MB(Q) - MC(Q) = 0, or 20 – 4Q –
4Q = 0. Some algebra leads to Q = 20/8 = 2.5 as the level of output that
maximizes net benefits.
10.
a. The present value of the stream of accounting profits is
(150,000 − 50,000) (150,000 − 50,000) (150,000 − 50,000)
𝑃𝑉 = + + = $262,431.60
1.07 (1.07)2 (1.07)3
b. The present value of the stream of economic profits is
(150,000 − 50,000 − 65,000) (150,000 − 50,000 − 65,000)
𝑃𝑉 = +
1.07 (1.07)2
(150,000 − 50,000 − 65,000)
+ = $91,851.06
(1.07)3
1+𝑖
11. First, recall the equation for the value of a firm: 𝑃𝑉𝑓𝑖𝑟𝑚 = 𝜋0 ( ). Next, solve this
𝑖−g
(1+𝑖)𝜋0
equation for g to obtain 𝑔 = 𝑖 − . Substituting in the known values implies a
𝑃𝑉𝑓𝑖r𝑚
(1+0.09)25,000
growth rate of: 𝑔 = 0.09 − = 0.0355 or 3.55 percent. This would seem
500,000
to be a reasonable rate of growth: 0.0355 < 0.09 (g < i).
Managerial Economics and Business Strategy, 10e Page 3
Copyright © 2022 by McGraw-Hill Education.
All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
, 12. Effectively, this question boils down to the question of whether it is a good
investment to spend an extra $250 on a refrigerator that will save you $40 at the end
of each year for five years. The net present value of this investment is
$40 $40 $40 $40 $40
𝑁𝑃𝑉 = + + + + − $250
1.06 (1.06)2 (1.06)3 (1.06)4 (1.06)5
= $168.49 − $250
= −$81.51.
You should buy the standard model, since doing so saves you $81.51 in present value
terms.
13. Under a flat hourly wage, employees have little incentive to work hard as working
hard will not directly benefit them. This adversely affects the firm, since its profits
will be lower than the $25,000 per store that is obtainable each day when employees
perform at their peak. Under the proposed pay structure, employees have a strong
incentive to increase effort, and this will benefit the firm. In particular, under the
fixed hourly wage, an employee receives $160 per day whether he or she works hard
or not. Under the new pay structure, an employee receives $330 per day if the store
achieves its maximum possible daily profit and only $80 if the store’s daily profit is
zero. This provides employees an incentive to work hard and to exert peer pressure on
employees who might otherwise goof off. By providing employees an incentive to
earn extra money by working hard, both the firm and the employees will benefit.
14.
a. Accounting costs equal $145,000 per year in overhead and operating expenses.
Her implicit cost is the $75,000 salary that must be given up to start the new
business. Her opportunity cost includes both implicit and explicit costs: $145,000
+ $75,000 = $220,000.
b. To earn positive accounting profits, the revenues per year should greater than
$145,000. To earn positive economic profits, the revenues per year must be
greater than $220,000.
15. First, note that the $200 million spent to date is irrelevant. It is a sunk cost that will be
lost regardless of the decision. The relevant question is whether the incremental
benefits (the present value of the profits generated from the drug) exceed the
incremental costs (the $60 million needed to keep the project alive). Since these costs
and benefits span time, it is appropriate to compute the net present value. Here, the
net present value of DAS’s R&D initiative is
12,000,000 13,400,000 17,200,000 20,700,000 22,450,000
𝑁𝑃𝑉 = + + + + − 60,000,00
(1 + 0.05)5 (1 + 0.05)6 (1 + 0.05)7 (1 + 0.05)8 (1 + 0.05)9
= $107,364.15
Page 4 Michael R. Baye & Jeffrey T. Prince
Copyright © 2022 by McGraw-Hill Education.
All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
