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Lecture Notes - Copyright c 2008 by Benjamin E Hermalin All...

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Copyright c circlecopyrt 2008 by Benjamin E. Hermalin. All rights reserved.
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Contents List of Tables v List of Figures vii List of Examples ix Preface xi I Review 1 Purpose 3 1 Cost 5 1.1 Opportunity Cost . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 1.2 Sunk Expenditure . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 1.3 Imputed Cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 1.4 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 2 Pricing 9 2.1 Demand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 2.2 Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 2.3 Profits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 2.4 Setting Price to Maximize Profit . . . . . . . . . . . . . . . . . . . 13 2.5 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 II Strategy 21 Overview 23 3 Assessing the Firm’s Situation 27 3.1 SWOT Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 3.2 The 5 + 2 Forces Model . . . . . . . . . . . . . . . . . . . . . . . 30 3.3 The AURA Model . . . . . . . . . . . . . . . . . . . . . . . . . . . 50 3.4 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54 i
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ii CONTENTS 4 Game Theory 57 4.1 Introduction to Game Theory . . . . . . . . . . . . . . . . . . . . 57 4.2 The Bertrand Trap . . . . . . . . . . . . . . . . . . . . . . . . . . . 62 4.3 Avoiding the Bertrand Trap . . . . . . . . . . . . . . . . . . . . . 64 4.4 Repeated Interactions . . . . . . . . . . . . . . . . . . . . . . . . . 70 4.5 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79 III International Business 81 Overview 83 5 International Trade 85 5.1 Comparative Advantage . . . . . . . . . . . . . . . . . . . . . . . 85 5.2 Comparative Advantage and the Gains to Trade . . . . . . . . . 87 5.3 Trade as Market Expansion . . . . . . . . . . . . . . . . . . . . . 90 5.4 Criticisms of International Trade . . . . . . . . . . . . . . . . . . 91 5.5 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93 6 Currency Exchange 95 6.1 Foreign Exchange Market . . . . . . . . . . . . . . . . . . . . . . 95 6.2 Quoting Exchange Rates . . . . . . . . . . . . . . . . . . . . . . . 95 6.3 What Determines Exchange Rates? . . . . . . . . . . . . . . . . . 96 6.4 Foreign Exchange Risk . . . . . . . . . . . . . . . . . . . . . . . . 99 6.5 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101 7 Doing Business Abroad 103 7.1 Dealing with Trade Rules . . . . . . . . . . . . . . . . . . . . . . 103 7.2 Different Protections for Property . . . . . . . . . . . . . . . . . . 106 7.3 Different Legal Systems . . . . . . . . . . . . . . . . . . . . . . . 107 7.4 Different Cultures and Cultural Sensitivities . . . . . . . . . . . 109 7.5 Domestic Repercussions . . . . . . . . . . . . . . . . . . . . . . . 111 7.6 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111 IV Entrepreneurship 113 Overview 115 8 How Firms are Organized: The Corporation 117 8.1 What is a Corporation? . . . . . . . . . . . . . . . . . . . . . . . . 119 8.2 Corporations: A Legal Perspective . . . . . . . . . . . . . . . . . 120 8.3 The Basics of Securities and Financing . . . . . . . . . . . . . . . 121 8.4 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 122
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CONTENTS iii 9 Strategy for the Entrepreneur 125 9.1 A Good Idea negationslash = Success . . . . . . . . . . . . . . . . . . . . . . . . 125 9.2 AURA Analysis for the Entrepreneur . . . . . . . . . . . . . . . . 125 9.3 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 127 10 Funding the New Venture 129 10.1 Draw up a Business Plan . . . . . . . . . . . . . . . . . . . . . . . 129 10.2 Incorporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 129 10.3 Raising Funds from Friends and Family . . . . . . . . . . . . . . 130 10.4 Angel and Venture Capital Funding . . . . . . . . . . . . . . . . 130 10.5 The Initial Public Offering . . . . . . . . . . . . . . . . . . . . . . 130 10.6 One Last Consideration . . . . . . . . . . . . . . . . . . . . . . . 131 10.7 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 131 Index 132
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iv CONTENTS
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List of Tables 1.1 Hotel Room Financials . . . . . . . . . . . . . . . . . . . . . . . . 6 1.2 PDA Financials . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 1.3 Jeweler’s Financials . . . . . . . . . . . . . . . . . . . . . . . . . . 7 2.1 Checking that $3/unit is profit-maximizing price . . . . . . . . . 19 5.1 Trade between Ruritania and Pannonia . . . . . . . . . . . . . . 90 8.1 Organizational Forms . . . . . . . . . . . . . . . . . . . . . . . . . 118 v
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vi LIST OF TABLES
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List of Figures 2.1 Demand curve . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 2.2 Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 2.3 Unit cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 2.4 Total cost of q units . . . . . . . . . . . . . . . . . . . . . . . . . . 14 2.5 Revenue and cost . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 2.6 Profit is revenue minus cost . . . . . . . . . . . . . . . . . . . . . 16 2.7 Profits at two different prices . . . . . . . . . . . . . . . . . . . . 16 2.8 Effect of a small price change . . . . . . . . . . . . . . . . . . . . 17 A The Strategic Process . . . . . . . . . . . . . . . . . . . . . . . . . . 24 3.1 SWOT Brainstorming Figure . . . . . . . . . . . . . . . . . . . . . 29 3.2 The 5 + 2 Forces Model . . . . . . . . . . . . . . . . . . . . . . . . . 31 3.3 Average Cost and Minimum Efficient Scale . . . . . . . . . . . . 36 3.4 AURA Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51 4.1 Advertising Game . . . . . . . . . . . . . . . . . . . . . . . . . . . 58 4.2 3 × 3 game . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60 4.3 Dominated strategy removed . . . . . . . . . . . . . . . . . . . . 61 5.1 Pannonian Production Possibility Frontier . . . . . . . . . . . . . 88 6.1 Adjustment of exchange rate . . . . . . . . . . . . . . . . . . . . 99 8.1 Payoffs to debt and equity . . . . . . . . . . . . . . . . . . . . . . 122 9.1 AURA and Entrepreneurship . . . . . . . . . . . . . . . . . . . . 126 vii
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viii LIST OF FIGURES
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List of Examples Hotel Room Example . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Replacing Old Technology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 Rise in Price of Commodity Input . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 Farming in Tokyo . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 Depreciation Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 A Profit-Maximizing Price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 Average Cost and Minimum Efficient Scale . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 A Holdup Example . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42 AURA and growth of Chinese market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52 AURA and off-patent pharmaceutical . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53 Advertising game . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57 Mildred & Nathan — Comparative Advantage . . . . . . . . . . . . . . . . . . . . . . . . 85
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