The best way to become acquainted with managerial economics is to come face to face with real-world decision-making problems.The seven examples that follow represent the different kinds of decisions that private and public-sector managers face. All of them are revisited and examined in detail in later chapters. The examples follow a logical progression. In the first example, a global carmaker faces the most basic problem in managerial economics: determining prices and outputs to maximize profit. making decisions requires a careful analysis of revenues and costs.

The second example highlights competition between firms, Here, two large bookstore chains are battling for market share in a multitude of regional markets. Each is trying to secure a monopoly, but when both build superstores in the same city, they frequently become trapped in price wars. The next two examples illustrate public-sector decisions: The first concerns funding a public project, the second is a regulatory decision. Here, a shift occurs both in the decision maker—from private to public manager—and in the objectives. , government decisions are guided by the criterion of benefit-cost analysis rather than by profit considerations.

The final three examples involve decision making under uncertainty. In the fifth example, the failure of BP to identify and manage exploration risks culminated in the 2010 explosion of its Deepwater Horizon drilling rig in the Gulf of Mexico and the resulting massive oil spill in the gulf that took so long to stop. In the next example, a pharmaceutical company is poised between alternative risky research and development (R&D) programs. Decision making under uncertainty is the focus of Chapters 12 and 13. In the final example,David Letterman and two rival television networks are locked in a high-stakes negotiation as to which company will land his profitable late-night show.Almost all firms face the problem of pricing their products. Consider a U.S.multinational carmaker that produces and sells its output in two geographic regions. It can produce cars in its home plant or in its foreign subsidiary. It sells cars in the domestic market and in the foreign market. For the next year, it must determine the prices to set at home and abroad, estimate sales for each market, and establish production quantities in each facility to supply those sales. It recognizes that the markets for vehicles at home and abroad differ with respect to demand (that is, how many cars can be sold at different prices). Also, the production facilities have different costs and capacities. Finally, at a cost, it can ship vehicles from the home facility to help supply the foreign market, or vice versa. Based on the available information, how can the company determine a profitmaximizing pricing and production plan for the coming year? For 20 years, the two giants of the book business—Barnes & Noble and Borders Market Entry Group—engaged in a cutthroat retail battle. In major city after major city, the rivals opened superstores, often within sight of each other. By the mid-1990s, more books were sold via chain stores than by independent stores, and both companies continued to open new stores at dizzying rates. The ongoing competition raises a number of questions: How did either chain assess the profitability of new markets? Where and when should each enter new markets? What if a region’s book-buying demand is sufficient to support
only one superstore? What measures might be taken by an incumbent to erect entry barriers to a would-be entrant? On what dimensions—number of titles, pricing, personal service—did the companies most vigorously compete? In view of accelerating book sales via the Internet and the emerging e-book market, can mega “bricks and mortar” bookstores survive? Building a New Bridge As chief city planner of a rapidly growing Sun Belt city, you face the single biggest decision of your tenure: whether to recommend the construction of a new harbor bridge to connect downtown with the surrounding suburbs located on a northern peninsula. Currently, suburban residents commute to the city via a ferry or by driving a long-distance circular route. Preliminary studies have shown that there is considerable need and demand for the bridge. Indeed, the
bridge is expected to spur economic activity in the region as a whole. The projected cost of the bridge is $75 million to $100 million. Part of the money would be financed with an issue of municipal bonds, and the remainder would be contributed by the state. Toll charges on commuting automobiles and particularly on trucks would be instituted to recoup a portion of the bridge’s costs.But, if bridge use falls short of projections, the city will be saddled with a very expensive white elephant. What would you recommend?
A Regulatory Problem Environmental regulations have a significant effect on business decisions and consumer behavior. Charles Schultze, former chairperson of the
President’s Council of Economic Advisers, describes the myriad problems associated with the regulations requiring electric utilities to convert from oil to coal.Petroleum imports can be conserved by switching [utilities] from oilfired to coal-fired generation. But barring other measures, burning highsulfur Eastern coal substantially increases pollution. Sulfur can be “scrubbed” from coal smoke in the stack, but at a heavy cost, with devices that turn out huge volumes of sulfur wastes that must be disposed of and about whose reliability there is some question. Intermittent control techniques (installing high smoke stacks and turning off burners when meteorological conditions are adverse) can, at a lower cost, reduce local concentrations of sulfur oxides in the air, but cannot cope with the growing problem of sulphates and widespread acid rainfall. Use of low-sulfur
Western coal would avoid many of these problems, but this coal is obtained by strip mining. Strip-mine reclamation is possible but substantially hindered in large areas of the West by lack of rainfall. Moreover,in some coal-rich areas the coal beds form the underlying aquifer, and their removal could wreck adjacent farming or ranching economies.
Large coal-burning plants might be located in remote areas far from highly populated urban centers in order to minimize the human effects of pollution. But such areas are among the few left that are unspoiled by pollution, and both environmentalists and the residents (relatively few in number compared to those in metropolitan localities but large among the voting populations in the particular states) strongly object to this policy. Fears, realistic or imaginary, about safety and accumulation of radioactive waste have increasingly hampered the nuclear option.1Schultze’s points apply directly to today’s energy and environmental tradeoffs. Actually, he penned this discussion in 1977! Important questions persist.How, when, and where should the government intervene to achieve and balance its energy and environmental objectives? How would one go about quantifying the benefits and costs of a particular program of intervention?

BP (known as British Petroleum prior to 2001) is in the business of taking risks. As the third largest energy company in the world, its main operations involve oil exploration, refining, and sale. The risks it faces begin with the uncertainty about where to find oil deposits (including drilling offshore more than a mile under the ocean floor), mastering the complex, risky methods of extracting petroleum, cost-effectively refining that oil, and selling those refined products at wildly fluctuating world prices. In short, the company runs the whole gamut of risk: geological, technological, safety, regulatory, legal, and market related Priding itself on 17 straight years of 100 percent oil reserve replacement, BP
is an aggressive and successful oil discoverer. But the dark side of its strategic aspirations is its troubling safety and environmental record, culminating in the explosion of its Deepwater Horizon drilling rig in the Gulf of Mexico in April 2010. This raises the question: What types of decisions should oil companies like BP take to identify, quantify, manage, and hedge against the inevitable risks they face? A five-year-old pharmaceutical company faces a major research and development decision. It already has spent a year of preliminary research toward producing a protein that dissolves blood clots. Such a drug would be of tremendous value in the treatment of heart attacks, some 80 percent of which are caused by clots. The primary method the company has been pursuing relies on conventional, state-of-the-art biochemistry. Continuing this approach will
require an estimated $10 million additional investment and should lead to a commercially successful product, although the exact profit is highly uncertain. Two of the company’s most brilliant research scientists are aggressively advocating a second R&D approach. This new biogenetic method relies on gene splicing to create a version of the human body’s own anticlotting agent and is considerably riskier than the biochemical alternative. It will require a $20 million investment and has only a 20 percent chance of commercial success.However, if the company accomplishes the necessary breakthroughs, the anticlotting agent will represent the first blockbuster, genetically engineered drug. In January 1993, David Letterman made it official—he would be leaving Late Night on NBC for a new 11:30 P.M. show on CBS beginning in the fall. A tangled web of negotiations preceded the move. In 1992 NBC chose the comedian Jay Leno, instead of Letterman, to succeed Johnny Carson as the host of The Tonight Show in an effort to keep its lock on late-night programming. Accordingly, CBS, a nonentity in late-night television, saw its chance to woo David Letterman.After extensive negotiations, CBS offered Letterman a $14 million salary to do the new show (a $10 million raise over his salary at NBC). In addition,Letterman’s own production company would be paid $25 million annually to produce the show. However, NBC was unwilling to surrender Letterman to CBS without a fight. The network entered into secret negotiations with Letterman’s
representative, Michael Ovitz, exploring the possibility of dumping Leno and giving The Tonight Show to Letterman. One group of NBC executives stood firmly behind Leno. Another group preferred replacing Leno to losing Letterman to CBS. In the end, NBC offered The Tonight Show to Letterman—but with the condition that he wait a year until
Leno’s current contract was up. David Letterman faced the most difficult decision of his life. Should he make up and stay with NBC or take a new path with CBS? In the end, he chose to leave. The Letterman negotiations raise a number of questions. How well did Michael Ovitz do in squeezing the most out of CBS on behalf of Letterman? In its negotiations, what (if anything) could NBC have done differently to keep its star?