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
to be a reasonable rate of 500,000
growth:q1 0.0355q1<q10.09q1(gq1<q1i).
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,q1thisq1questionq1boilsq1downq1toq1theq1questionq1ofq1whetherq1itq1isq1aq1
goodq1investmentq1toq1spendq1anq1extraq1$250q1onq1aq1refrigeratorq1thatq1willq1saveq1
youq1$40q1atq1theq1endq1ofq1eachq1yearq1forq1fiveq1years.q1Theq1netq1presentq1valueq1
ofq1thisq1investmentq1is
$40 $40 $40 $40 $40
𝑁𝑃𝑉q 1 =q1 +q1 +q1 +q1 +q1 −q1$250
1.06q1 (1.06) q1
2 (1.06) q1
3 (1.06) q1
4 (1.06)5q1
=q1 $168.49q1−q1$250
=q1 −$81.51.
Youq1shouldq1buyq1theq1standardq1model,q1sinceq1doingq1soq1savesq1youq1$81.51q1inq1p
resentq1valueq1terms.
13. Underq1aq1flatq1hourlyq1wage,q1employeesq1haveq1littleq1incentiveq1toq1workq1hardq1as
q1workingq1hardq1willq1notq1directlyq1benefitq1them.q1Thisq1adverselyq1affectsq1theq1fir
m,q1sinceq1itsq1profitsq1willq1beq1lowerq1thanq1theq1$25,000q1perq1storeq1thatq1isq1obtai
nableq1eachq1dayq1whenq1employeesq1performq1atq1theirq1peak.q1Underq1theq1propose
dq1payq1structure,q1employeesq1haveq1aq1strongq1incentiveq1toq1increaseq1effort,q1andq1
thisq1willq1benefitq1theq1firm.q1Inq1particular,q1underq1theq 1 fixedq1hourlyq1wage,q1anq1
employeeq1receivesq1$160q1perq1dayq1whetherq1heq1orq1sheq1worksq1hardq1orq1not.q1U
nderq1theq1newq1payq1structure,q1anq1employeeq1receivesq1$330q1perq1dayq1ifq1theq1sto
req1achievesq1itsq1maximumq1possibleq1dailyq1profitq1andq1onlyq1$80q1ifq1theq1store’sq
1dailyq1profitq1isq1zero.q1Thisq1providesq1employeesq1anq1incentiveq1toq1workq1hardq1a
ndq1toq1exertq1peerq1pressureq1onq1employeesq1whoq1mightq1otherwiseq1goofq1off.q1By
q1providingq1employeesq1anq1incentiveq1toq1earnq1extraq1moneyq1byq1workingq1hard,q1
bothq1theq1firmq1andq1theq1employeesq1willq1benefit.
14.
a. Accountingq1costsq1equalq1$145,000q1perq1yearq1inq1overheadq1andq1operatingq1e
xpenses.q1Herq1implicitq1costq1isq1theq1$75,000q1salaryq1thatq1mustq1beq1givenq1u
pq1toq1startq1theq1newq1business.q1Herq1opportunityq1costq1includesq1bothq1implicit
q1andq1explicitq1costs:q1$145,000
+q1$75,000q1=q1$220,000.
b. Toq1earnq1positiveq1accountingq1profits,q1theq1revenuesq1perq1yearq1shouldq1greaterq1than
$145,000.q1Toq1earnq1positiveq1economicq1profits,q1theq1revenuesq1perq1yearq1mus
tq1beq1greaterq1thanq1$220,000.
15. First,q1noteq1thatq1theq1$200q1millionq1spentq1toq1dateq1isq1irrelevant.q1Itq1isq1aq1sunkq1c
ostq1thatq1willq1beq1lostq1regardlessq1ofq1theq1decision.q1Theq1relevantq1questionq1isq1
whetherq1theq1incrementalq1benefitsq1(theq1presentq1valueq1ofq1theq1profitsq1generated
q1fromq1theq1drug)q1exceedq1theq1incrementalq1costsq1(theq1$60q1millionq1neededq1toq1
keepq1theq1projectq1alive).q1Sinceq1theseq1costsq1andq1benefitsq1spanq1time,q1itq1isq1ap
propriateq1toq1computeq1theq1netq 1 presentq1value.q1Here,q1theq1netq1presentq1valueq1of
Pageq14 Michaelq1R.q1Bayeq1&q1Jeffreyq1T.q1
Prince
Copyrightq1©q12022q1byq1McGraw-Hillq1Education.
Allq1rightsq1reserved.q1Noq1reproductionq1orq1distributionq1withoutq1theq1priorq1writtenq1consentq1ofq1
McGraw-Hillq1Education.
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
to be a reasonable rate of 500,000
growth:q1 0.0355q1<q10.09q1(gq1<q1i).
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,q1thisq1questionq1boilsq1downq1toq1theq1questionq1ofq1whetherq1itq1isq1aq1
goodq1investmentq1toq1spendq1anq1extraq1$250q1onq1aq1refrigeratorq1thatq1willq1saveq1
youq1$40q1atq1theq1endq1ofq1eachq1yearq1forq1fiveq1years.q1Theq1netq1presentq1valueq1
ofq1thisq1investmentq1is
$40 $40 $40 $40 $40
𝑁𝑃𝑉q 1 =q1 +q1 +q1 +q1 +q1 −q1$250
1.06q1 (1.06) q1
2 (1.06) q1
3 (1.06) q1
4 (1.06)5q1
=q1 $168.49q1−q1$250
=q1 −$81.51.
Youq1shouldq1buyq1theq1standardq1model,q1sinceq1doingq1soq1savesq1youq1$81.51q1inq1p
resentq1valueq1terms.
13. Underq1aq1flatq1hourlyq1wage,q1employeesq1haveq1littleq1incentiveq1toq1workq1hardq1as
q1workingq1hardq1willq1notq1directlyq1benefitq1them.q1Thisq1adverselyq1affectsq1theq1fir
m,q1sinceq1itsq1profitsq1willq1beq1lowerq1thanq1theq1$25,000q1perq1storeq1thatq1isq1obtai
nableq1eachq1dayq1whenq1employeesq1performq1atq1theirq1peak.q1Underq1theq1propose
dq1payq1structure,q1employeesq1haveq1aq1strongq1incentiveq1toq1increaseq1effort,q1andq1
thisq1willq1benefitq1theq1firm.q1Inq1particular,q1underq1theq 1 fixedq1hourlyq1wage,q1anq1
employeeq1receivesq1$160q1perq1dayq1whetherq1heq1orq1sheq1worksq1hardq1orq1not.q1U
nderq1theq1newq1payq1structure,q1anq1employeeq1receivesq1$330q1perq1dayq1ifq1theq1sto
req1achievesq1itsq1maximumq1possibleq1dailyq1profitq1andq1onlyq1$80q1ifq1theq1store’sq
1dailyq1profitq1isq1zero.q1Thisq1providesq1employeesq1anq1incentiveq1toq1workq1hardq1a
ndq1toq1exertq1peerq1pressureq1onq1employeesq1whoq1mightq1otherwiseq1goofq1off.q1By
q1providingq1employeesq1anq1incentiveq1toq1earnq1extraq1moneyq1byq1workingq1hard,q1
bothq1theq1firmq1andq1theq1employeesq1willq1benefit.
14.
a. Accountingq1costsq1equalq1$145,000q1perq1yearq1inq1overheadq1andq1operatingq1e
xpenses.q1Herq1implicitq1costq1isq1theq1$75,000q1salaryq1thatq1mustq1beq1givenq1u
pq1toq1startq1theq1newq1business.q1Herq1opportunityq1costq1includesq1bothq1implicit
q1andq1explicitq1costs:q1$145,000
+q1$75,000q1=q1$220,000.
b. Toq1earnq1positiveq1accountingq1profits,q1theq1revenuesq1perq1yearq1shouldq1greaterq1than
$145,000.q1Toq1earnq1positiveq1economicq1profits,q1theq1revenuesq1perq1yearq1mus
tq1beq1greaterq1thanq1$220,000.
15. First,q1noteq1thatq1theq1$200q1millionq1spentq1toq1dateq1isq1irrelevant.q1Itq1isq1aq1sunkq1c
ostq1thatq1willq1beq1lostq1regardlessq1ofq1theq1decision.q1Theq1relevantq1questionq1isq1
whetherq1theq1incrementalq1benefitsq1(theq1presentq1valueq1ofq1theq1profitsq1generated
q1fromq1theq1drug)q1exceedq1theq1incrementalq1costsq1(theq1$60q1millionq1neededq1toq1
keepq1theq1projectq1alive).q1Sinceq1theseq1costsq1andq1benefitsq1spanq1time,q1itq1isq1ap
propriateq1toq1computeq1theq1netq 1 presentq1value.q1Here,q1theq1netq1presentq1valueq1of
Pageq14 Michaelq1R.q1Bayeq1&q1Jeffreyq1T.q1
Prince
Copyrightq1©q12022q1byq1McGraw-Hillq1Education.
Allq1rightsq1reserved.q1Noq1reproductionq1orq1distributionq1withoutq1theq1priorq1writtenq1consentq1ofq1
McGraw-Hillq1Education.
