, Solution manual for Managerial Economics A
Problem Solving Approach , 6th Edition Luke M.
Froeb
Notes
1- The file is chapter after chapter.
2- We have shown you 10 or five pages.
3- The file contains all Appendix and Excel
sheet if it exists.
4- We have all what you need, we make
update at every time. There are many
new editions waiting you.
5- If you think you purchased the wrong file
You can contact us at every time, we can
replace it with true one.
Our email:
, Instructor Manual: Froeb/McCann/Ward/Shor, Managerial Economics: A Problem-Solving Approach, CY23, 9780357748237;
Chapter 1: Solving Problems with Economics
Instructor Manual
Froeb/McCann/Ward/Shor, Managerial Economics: A Problem-Solving Approach,
CY23, 9780357748237; Chapter 1: Solving Problems with Economics
TABLE OF CONTENTS
Purpose and Perspective of the Chapter..................................................................................2
Chapter Objectives......................................................................................................................2
Cengage Supplements................................................................................................................3
What's New in This Chapter....................................................................................................... 3
Chapter Outline ........................................................................................................................... 3
Teaching Notes......................................................................................................................4
Discussion Questions.................................................................................................................5
Additional Resources ................................................................................................................. 6
Cengage MindTap Videos ......................................................................................................... 6
Additional Anecdotes.................................................................................................................6
© 2022 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a 1
publicly accessible website, in whole or in part.
, Instructor Manual: Froeb/McCann/Ward/Shor, Managerial Economics: A Problem-Solving Approach, CY23, 9780357748237;
Chapter 1: Solving Problems with Economics
PURPOSE AND PERSPECTIVE OF THE CHAPTER
Chapter 1 covers:
Problem solving
Ethics and economics
Economics in job interviews
Main points in this chapter:
Problem solving requires two steps: First, figure out why mistakes are being made; and
then figure out how to make them stop.
The rational-actor paradigm assumes that people act rationally, optimally, and self-
interestedly. To change behavior, you have to change incentives.
Good incentives are created by rewarding good performance.
A well-designed organization is one in which employee incentives are aligned with
organizational goals. By this we mean that employees have enough information to make
good decisions, and the incentive to do so.
It follows that you can analyze problems by asking three questions: (1) Who is making
the bad decision?; (2) Does the decision maker have enough information to make a
good decision?; and (3) the incentive to do so?
Answers to these questions will suggest solutions centered on (1) letting someone else
make the decision, someone with better information or incentives; (2) giving the decision
maker more information; or (3) changing the decision maker’s incentives.
CHAPTER OBJECTIVES
The following objectives are addressed in this chapter:
01.01 Identify the steps in problem solving.
01.02 Explain the rational-actor paradigm.
01.03 Identify the components of an incentive.
01.04 Define a well-designed organization.
01.05 Analyze and solve problems by asking and answering questions.
[return to top]
CENGAGE SUPPLEMENTS
The following product-level supplements provide additional information that may help you in
preparing your course. They are available in the Instructor Resource Center.
PowerPoint Slides
Test Bank
© 2022 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a 2
publicly accessible website, in whole or in part.
, Instructor Manual: Froeb/McCann/Ward/Shor, Managerial Economics: A Problem-Solving Approach, CY23, 9780357748237;
Chapter 1: Solving Problems with Economics
[return to top]
WHAT'S NEW IN THIS CHAPTER
See the Transition Guide for information on changes that have been made to this chapter
[return to top]
CHAPTER OUTLINE
The following outline organizes activities and assessments by chapter (and therefore by topic),
so that you can see how all the content relates to the topics covered in the text.
Chapter Introduction (PPT slide 4)
1.1 Using Economics to Solve Problems (PPT slides 5-14)
1.2 Incentive Misalignment at an Auction House (PPT slides 15-19)
1.3 Ethics and Economics (PPT slides 20-25)
1.4 Economics in Job Interviews (PPT slides 26-27)
Summary & Homework Problems
Summary of Main points
Multiple Choice Questions
Individual Problems
Teaching Notes
You can open with a business problem, like the over-bidding in the introduction, the Kidder-
Peabody anecdote, or any of the anecdotes in the concluding chapter “you be the consultant,”
and then ask the students to assume that they are a consultant brought in to the company to
figure out what is wrong. Play 20 questions, and make them ask questions that have “yes” or
“no” answers until they figure out what is wrong. Students will invariably use the rational actor
paradigm to do this. Point this out to them. Tell them that this class is trying to show them how
to use this paradigm more formally.
Reinforce their problem solving skills by asking them to solve a specific problem. The trick is to
dribble out the information, bit by bit, to engage the students and keep them guessing what the
problem is.
Note that some students will typically define the problem as the lack of a particular solution.
When this happens, use the opportunity to point out how this approach locks you into
a particular solution. Show them how not to do this.
Formally introduce the rational actor paradigm and show how it can be used to both identify why
problems occur and what can be done to change behavior. Tell them that the key step in
solving problems is to bring it down to an individual decision level. First, find out who made a
bad decision. Under the rational actor paradigm there are only two reasons for making
mistakes: not enough information or bad incentives. Find out which it is. Bottom line is that
problems can be identified by asking three questions:
© 2022 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a 3
publicly accessible website, in whole or in part.
, Instructor Manual: Froeb/McCann/Ward/Shor, Managerial Economics: A Problem-Solving Approach, CY23, 9780357748237;
Chapter 1: Solving Problems with Economics
1. Who made the bad decision?
2. Did they have enough information to make a good decision?
3. Did they have the incentive to make a good decision?
Tell them that incentives have two pieces: a performance evaluation metric and a way to reward
good performance, or punish bad performance. The Brickley, Smith, and Zimmerman article is a
good reference for this. Various solutions to the problem will likewise center on:
1. Changing decision rights (letting someone else make the decision)
2. Changing information flows; or
3. Changing incentives
i. Performance evaluation
ii. Compensation linking performance to rewards.
The “goal” is to align the incentives of employees with the goals of the organization. After giving
students this paradigm, ask them to fix the problem. Solicit suggestions, and ask other students
what they like or don’t like about the various proposed solutions. The message is that there are
only tradeoffs and no universal solutions, i.e., the answer to every question is “it depends.” The
point of the class is to teach students to recognize and evaluate the tradeoffs.
[return to top]
DISCUSSION QUESTIONS
One of the best ways to engage the class is by posing in-class problem. Pose the question to
the students, give them five minutes to do it; and then ask them to turn to the person sitting next
to them and explain the answer. Tell them that the two best ways to learn economics are doing
problems and verbally explaining the answers to someone else. When enough time has
elapsed and you want to move on, tell the students to “stop learning.”
In-class problem
If you do not assign it, the following question is a good one to motivate problem solving. Tell
them to put themselves in the role of the newly hired manager. Ask them what the problem is;
and then how to solve it.
Goal Alignment at a Small Manufacturing Concern
The owners of a small manufacturing concern have hired a manager to run the company with
the expectation that he will buy the company after five years. Compensation of the new vice
president is a flat salary plus 75% of first $150,000 of profit, and then 10% of profit over
$150,000. Purchase price for the company is set as 4½ times earnings (profit), computed as
average annual profitability over the next five years. Does this contract align the incentives of
the new vice president with the goals of the owners?
Answer: No. Both the purchase price and the profit sharing create perverse incentives. The VP
keeps $0.75 of each dollar earned up to $150,000, but only $0.10 of each dollar earned after
© 2022 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a 4
publicly accessible website, in whole or in part.
, Instructor Manual: Froeb/McCann/Ward/Shor, Managerial Economics: A Problem-Solving Approach, CY23, 9780357748237;
Chapter 1: Solving Problems with Economics
$150K. Since earning more requires more effort (increasing marginal effort), the VP has little
incentive to earn more than $150,000. And every dollar the VP earns raises the price that he will
eventually pay for the company by $4.50, effectively penalizing him for increasing company
profitability.
[return to top]
ADDITIONAL RESOURCES
CENGAGE MINDTAP VIDEOS
Chapter 01: Lecture Videos
Chapter 01: Problem Walk-Through
ADDITIONAL ANECDOTES
In telling the anecdotes, you can give students just enough information to recognize that there is
a problem. Play “20 questions” with the students where they have to ask yes-or-no questions
until they figure out what the problem is, and then ask them how to fix it. Students may
unconsciously begin using the rational actor paradigm. After you get the right answer,
summarize the analysis for them to reinforce the benefits of using the rational actor paradigm to
diagnose and solve problems: any problem can be analyzed by asking three questions:
1. Who is making the bad decision;
2. Do they have enough information to make a good decision; and
3. The incentive to do so?
Tell students that incentives have two pieces, a performance evaluation scheme and a link
between compensation and performance.
Answers to the questions will suggest solutions centered on:
1. Changing decision rights (letting someone else make the decision);
2. Changing the information flow; or
3. Changing incentives (performance evaluation+compensation).
Tell them that the art of business is figuring out why mistakes are made and then how to fix
them. Econ can teach them only to recognize the tradeoffs, but they have to figure out which
solution is most profitable by balancing the costs against the benefits.
Note that this is related to Michael Jensen’s famous 3-legged stool, popularized by Brickley,
Smith, and Zimmerman in their textbook. You can assign a shorter version of their approach as
outside reading James Brickley, Clifford Smith, Jerold Zimmerman, “The Economics of
Organizations,” Journal of Financial Economics, Vol. 8:2 (Summer, 1995) pp. 19-31. The
difference is that Brickley, et al. focus on (i) Decision rights, (ii) Performance evaluation, and (iii)
Compensation schemes, and just assume that if the incentives are there, individuals will find the
relevant information. It may be more useful to focus on information and incentives as sometimes
changing the decision rights, e.g., on pricing.
© 2022 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a 5
publicly accessible website, in whole or in part.
, Instructor Manual: Froeb/McCann/Ward/Shor, Managerial Economics: A Problem-Solving Approach, CY23, 9780357748237;
Chapter 1: Solving Problems with Economics
I. KIDDER-PEABODY:
In 1992 Joseph Jett became a star bond trader for Kidder-Peabody, earning a two-
million-dollar bonus. As his monthly profits grew, he was allowed to risk more and
more capital in his trading portfolio, and was eventually promoted to head of the
Government Trading Desk. By the end of 1993, Jett had been promoted to
managing director. He also received the “Chairman’s Award” for outstanding
performance, in addition to a $9 million year-end bonus.
Joseph Jett traded “strips,” which involved separating the interest payments from the
principal on a government bond. He specialized in putting interest payments back
together with the stripped bonds, thus reconstructing original bond. This activity
earns profits by taking advantage of yield differences between zero-coupon bonds
(no interest payments) and interest-bearing bonds.
However, at Kidder-Peabody, this activity seemed to earn profits—even in the
absence of any yield differences. The antiquated information system at Kidder-
Peabody tracked zero-coupon bonds by price instead of yield, which overstated their
value once they entered the system. The information system rewarded Jett
contemporaneously for sales of five-day forward contracts on reconstructed bonds.
This allowed Jett to realize contemporaneous profits that would disappear in five
days, when the computer recorded the future reconstruction. However, by rolling the
contracts forward, Jett was able to keep these profits on the books. In order to make
this work, Jett had to continuously increase the size of his portfolio.
Early in 1994, the information system at Kidder began having trouble keeping up with
Jett’s trading activity. From 1992-1994, Jett had traded about $1.7 trillion in
government securities, about half of all outstanding government debt. When the
source of the profits was uncovered, Kidder liquidated Jett’s positions, and the
company was sold to Paine-Webber for under-performing the market.
Joseph Jett was fired for refusing to cooperate with the resulting internal
investigation but was cleared of criminal fraud charges in 1996. Kidder’s civil suit to
collect $9 million from Jett was rejected by the NASD (National Association of
Securities Dealers). He was fined by an SEC administrative judge but was allowed
to keep $3.7 million in compensation earned while at Kidder.
Jett’s boss, Edward Cerullo, was forced to resign in 1994. The Securities and
Exchange Commission charged him with failing to supervise Jett’s trading activities.
He was suspended from working in the industry for one year, but walked away with
$9 million in severance pay and deferred compensation.
[return to top]
© 2022 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a 6
publicly accessible website, in whole or in part.
, Instructor Manual: Froeb/McCann/Ward/Shor, Managerial Economics: A Problem-Solving Approach, CY23, 9780357748237;
Chapter 2: The One Lesson of Business
Instructor Manual
Froeb/McCann/Ward/Shor, Managerial Economics: A Problem-Solving Approach,
CY23, 9780357748237; Chapter 2: The One Lesson of Business
TABLE OF CONTENTS
Purpose and Perspective of the Chapter..................................................................................2
Chapter Objectives......................................................................................................................2
Cengage Supplements................................................................................................................3
What's New in This Chapter....................................................................................................... 3
Chapter Outline ........................................................................................................................... 3
Teaching Notes......................................................................................................................4
Discussion Questions.................................................................................................................5
Additional Resources ................................................................................................................. 6
Cengage MindTap Videos ......................................................................................................... 6
Additional Anecdotes.................................................................................................................6
© 2022 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a 1
publicly accessible website, in whole or in part.
, Instructor Manual: Froeb/McCann/Ward/Shor, Managerial Economics: A Problem-Solving Approach, CY23, 9780357748237;
Chapter 2: The One Lesson of Business
PURPOSE AND PERSPECTIVE OF THE CHAPTER
Chapter 2 covers:
Capitalism & Wealth
Do Mergers Move Assets to Higher-Valued Uses?
Does the Government Create Wealth?
Economics versus Business
Wealth Creation in Organizations
Main points in this chapter:
Voluntary transactions create wealth by moving assets from lower- to higher-valued uses.
Anything that impedes the movement of assets to higher-valued uses, like taxes,
subsidies, or price controls, destroys wealth.
The art of business consists of identifying assets in low-valued uses and devising ways to
profitably move them to higher-valued ones.
A company can be thought of as a series of transactions. A well-designed organization
rewards employees who identify and consummate profitable transactions or who stop
unprofitable ones.
CHAPTER OBJECTIVES
The following objectives are addressed in this chapter:
02.01 Understand how voluntary transactions create wealth.
02.02 Describe factors impeding the movement of assets to higher-valued uses.
02.03 Infer how efficiency helps business.
02.04 Identify transactions that create money-making opportunities.
02.05 Interpret the role of marketing in collecting and transmitting information between
buyers and sellers.
02.06 Interpret the role of design of an organization in its wealth creation.
[return to top]
CENGAGE SUPPLEMENTS
The following product-level supplements provide additional information that may help you in
preparing your course. They are available in the Instructor Resource Center.
PowerPoint Slides
Test Bank
[return to top]
© 2022 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a 2
publicly accessible website, in whole or in part.
Problem Solving Approach , 6th Edition Luke M.
Froeb
Notes
1- The file is chapter after chapter.
2- We have shown you 10 or five pages.
3- The file contains all Appendix and Excel
sheet if it exists.
4- We have all what you need, we make
update at every time. There are many
new editions waiting you.
5- If you think you purchased the wrong file
You can contact us at every time, we can
replace it with true one.
Our email:
, Instructor Manual: Froeb/McCann/Ward/Shor, Managerial Economics: A Problem-Solving Approach, CY23, 9780357748237;
Chapter 1: Solving Problems with Economics
Instructor Manual
Froeb/McCann/Ward/Shor, Managerial Economics: A Problem-Solving Approach,
CY23, 9780357748237; Chapter 1: Solving Problems with Economics
TABLE OF CONTENTS
Purpose and Perspective of the Chapter..................................................................................2
Chapter Objectives......................................................................................................................2
Cengage Supplements................................................................................................................3
What's New in This Chapter....................................................................................................... 3
Chapter Outline ........................................................................................................................... 3
Teaching Notes......................................................................................................................4
Discussion Questions.................................................................................................................5
Additional Resources ................................................................................................................. 6
Cengage MindTap Videos ......................................................................................................... 6
Additional Anecdotes.................................................................................................................6
© 2022 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a 1
publicly accessible website, in whole or in part.
, Instructor Manual: Froeb/McCann/Ward/Shor, Managerial Economics: A Problem-Solving Approach, CY23, 9780357748237;
Chapter 1: Solving Problems with Economics
PURPOSE AND PERSPECTIVE OF THE CHAPTER
Chapter 1 covers:
Problem solving
Ethics and economics
Economics in job interviews
Main points in this chapter:
Problem solving requires two steps: First, figure out why mistakes are being made; and
then figure out how to make them stop.
The rational-actor paradigm assumes that people act rationally, optimally, and self-
interestedly. To change behavior, you have to change incentives.
Good incentives are created by rewarding good performance.
A well-designed organization is one in which employee incentives are aligned with
organizational goals. By this we mean that employees have enough information to make
good decisions, and the incentive to do so.
It follows that you can analyze problems by asking three questions: (1) Who is making
the bad decision?; (2) Does the decision maker have enough information to make a
good decision?; and (3) the incentive to do so?
Answers to these questions will suggest solutions centered on (1) letting someone else
make the decision, someone with better information or incentives; (2) giving the decision
maker more information; or (3) changing the decision maker’s incentives.
CHAPTER OBJECTIVES
The following objectives are addressed in this chapter:
01.01 Identify the steps in problem solving.
01.02 Explain the rational-actor paradigm.
01.03 Identify the components of an incentive.
01.04 Define a well-designed organization.
01.05 Analyze and solve problems by asking and answering questions.
[return to top]
CENGAGE SUPPLEMENTS
The following product-level supplements provide additional information that may help you in
preparing your course. They are available in the Instructor Resource Center.
PowerPoint Slides
Test Bank
© 2022 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a 2
publicly accessible website, in whole or in part.
, Instructor Manual: Froeb/McCann/Ward/Shor, Managerial Economics: A Problem-Solving Approach, CY23, 9780357748237;
Chapter 1: Solving Problems with Economics
[return to top]
WHAT'S NEW IN THIS CHAPTER
See the Transition Guide for information on changes that have been made to this chapter
[return to top]
CHAPTER OUTLINE
The following outline organizes activities and assessments by chapter (and therefore by topic),
so that you can see how all the content relates to the topics covered in the text.
Chapter Introduction (PPT slide 4)
1.1 Using Economics to Solve Problems (PPT slides 5-14)
1.2 Incentive Misalignment at an Auction House (PPT slides 15-19)
1.3 Ethics and Economics (PPT slides 20-25)
1.4 Economics in Job Interviews (PPT slides 26-27)
Summary & Homework Problems
Summary of Main points
Multiple Choice Questions
Individual Problems
Teaching Notes
You can open with a business problem, like the over-bidding in the introduction, the Kidder-
Peabody anecdote, or any of the anecdotes in the concluding chapter “you be the consultant,”
and then ask the students to assume that they are a consultant brought in to the company to
figure out what is wrong. Play 20 questions, and make them ask questions that have “yes” or
“no” answers until they figure out what is wrong. Students will invariably use the rational actor
paradigm to do this. Point this out to them. Tell them that this class is trying to show them how
to use this paradigm more formally.
Reinforce their problem solving skills by asking them to solve a specific problem. The trick is to
dribble out the information, bit by bit, to engage the students and keep them guessing what the
problem is.
Note that some students will typically define the problem as the lack of a particular solution.
When this happens, use the opportunity to point out how this approach locks you into
a particular solution. Show them how not to do this.
Formally introduce the rational actor paradigm and show how it can be used to both identify why
problems occur and what can be done to change behavior. Tell them that the key step in
solving problems is to bring it down to an individual decision level. First, find out who made a
bad decision. Under the rational actor paradigm there are only two reasons for making
mistakes: not enough information or bad incentives. Find out which it is. Bottom line is that
problems can be identified by asking three questions:
© 2022 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a 3
publicly accessible website, in whole or in part.
, Instructor Manual: Froeb/McCann/Ward/Shor, Managerial Economics: A Problem-Solving Approach, CY23, 9780357748237;
Chapter 1: Solving Problems with Economics
1. Who made the bad decision?
2. Did they have enough information to make a good decision?
3. Did they have the incentive to make a good decision?
Tell them that incentives have two pieces: a performance evaluation metric and a way to reward
good performance, or punish bad performance. The Brickley, Smith, and Zimmerman article is a
good reference for this. Various solutions to the problem will likewise center on:
1. Changing decision rights (letting someone else make the decision)
2. Changing information flows; or
3. Changing incentives
i. Performance evaluation
ii. Compensation linking performance to rewards.
The “goal” is to align the incentives of employees with the goals of the organization. After giving
students this paradigm, ask them to fix the problem. Solicit suggestions, and ask other students
what they like or don’t like about the various proposed solutions. The message is that there are
only tradeoffs and no universal solutions, i.e., the answer to every question is “it depends.” The
point of the class is to teach students to recognize and evaluate the tradeoffs.
[return to top]
DISCUSSION QUESTIONS
One of the best ways to engage the class is by posing in-class problem. Pose the question to
the students, give them five minutes to do it; and then ask them to turn to the person sitting next
to them and explain the answer. Tell them that the two best ways to learn economics are doing
problems and verbally explaining the answers to someone else. When enough time has
elapsed and you want to move on, tell the students to “stop learning.”
In-class problem
If you do not assign it, the following question is a good one to motivate problem solving. Tell
them to put themselves in the role of the newly hired manager. Ask them what the problem is;
and then how to solve it.
Goal Alignment at a Small Manufacturing Concern
The owners of a small manufacturing concern have hired a manager to run the company with
the expectation that he will buy the company after five years. Compensation of the new vice
president is a flat salary plus 75% of first $150,000 of profit, and then 10% of profit over
$150,000. Purchase price for the company is set as 4½ times earnings (profit), computed as
average annual profitability over the next five years. Does this contract align the incentives of
the new vice president with the goals of the owners?
Answer: No. Both the purchase price and the profit sharing create perverse incentives. The VP
keeps $0.75 of each dollar earned up to $150,000, but only $0.10 of each dollar earned after
© 2022 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a 4
publicly accessible website, in whole or in part.
, Instructor Manual: Froeb/McCann/Ward/Shor, Managerial Economics: A Problem-Solving Approach, CY23, 9780357748237;
Chapter 1: Solving Problems with Economics
$150K. Since earning more requires more effort (increasing marginal effort), the VP has little
incentive to earn more than $150,000. And every dollar the VP earns raises the price that he will
eventually pay for the company by $4.50, effectively penalizing him for increasing company
profitability.
[return to top]
ADDITIONAL RESOURCES
CENGAGE MINDTAP VIDEOS
Chapter 01: Lecture Videos
Chapter 01: Problem Walk-Through
ADDITIONAL ANECDOTES
In telling the anecdotes, you can give students just enough information to recognize that there is
a problem. Play “20 questions” with the students where they have to ask yes-or-no questions
until they figure out what the problem is, and then ask them how to fix it. Students may
unconsciously begin using the rational actor paradigm. After you get the right answer,
summarize the analysis for them to reinforce the benefits of using the rational actor paradigm to
diagnose and solve problems: any problem can be analyzed by asking three questions:
1. Who is making the bad decision;
2. Do they have enough information to make a good decision; and
3. The incentive to do so?
Tell students that incentives have two pieces, a performance evaluation scheme and a link
between compensation and performance.
Answers to the questions will suggest solutions centered on:
1. Changing decision rights (letting someone else make the decision);
2. Changing the information flow; or
3. Changing incentives (performance evaluation+compensation).
Tell them that the art of business is figuring out why mistakes are made and then how to fix
them. Econ can teach them only to recognize the tradeoffs, but they have to figure out which
solution is most profitable by balancing the costs against the benefits.
Note that this is related to Michael Jensen’s famous 3-legged stool, popularized by Brickley,
Smith, and Zimmerman in their textbook. You can assign a shorter version of their approach as
outside reading James Brickley, Clifford Smith, Jerold Zimmerman, “The Economics of
Organizations,” Journal of Financial Economics, Vol. 8:2 (Summer, 1995) pp. 19-31. The
difference is that Brickley, et al. focus on (i) Decision rights, (ii) Performance evaluation, and (iii)
Compensation schemes, and just assume that if the incentives are there, individuals will find the
relevant information. It may be more useful to focus on information and incentives as sometimes
changing the decision rights, e.g., on pricing.
© 2022 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a 5
publicly accessible website, in whole or in part.
, Instructor Manual: Froeb/McCann/Ward/Shor, Managerial Economics: A Problem-Solving Approach, CY23, 9780357748237;
Chapter 1: Solving Problems with Economics
I. KIDDER-PEABODY:
In 1992 Joseph Jett became a star bond trader for Kidder-Peabody, earning a two-
million-dollar bonus. As his monthly profits grew, he was allowed to risk more and
more capital in his trading portfolio, and was eventually promoted to head of the
Government Trading Desk. By the end of 1993, Jett had been promoted to
managing director. He also received the “Chairman’s Award” for outstanding
performance, in addition to a $9 million year-end bonus.
Joseph Jett traded “strips,” which involved separating the interest payments from the
principal on a government bond. He specialized in putting interest payments back
together with the stripped bonds, thus reconstructing original bond. This activity
earns profits by taking advantage of yield differences between zero-coupon bonds
(no interest payments) and interest-bearing bonds.
However, at Kidder-Peabody, this activity seemed to earn profits—even in the
absence of any yield differences. The antiquated information system at Kidder-
Peabody tracked zero-coupon bonds by price instead of yield, which overstated their
value once they entered the system. The information system rewarded Jett
contemporaneously for sales of five-day forward contracts on reconstructed bonds.
This allowed Jett to realize contemporaneous profits that would disappear in five
days, when the computer recorded the future reconstruction. However, by rolling the
contracts forward, Jett was able to keep these profits on the books. In order to make
this work, Jett had to continuously increase the size of his portfolio.
Early in 1994, the information system at Kidder began having trouble keeping up with
Jett’s trading activity. From 1992-1994, Jett had traded about $1.7 trillion in
government securities, about half of all outstanding government debt. When the
source of the profits was uncovered, Kidder liquidated Jett’s positions, and the
company was sold to Paine-Webber for under-performing the market.
Joseph Jett was fired for refusing to cooperate with the resulting internal
investigation but was cleared of criminal fraud charges in 1996. Kidder’s civil suit to
collect $9 million from Jett was rejected by the NASD (National Association of
Securities Dealers). He was fined by an SEC administrative judge but was allowed
to keep $3.7 million in compensation earned while at Kidder.
Jett’s boss, Edward Cerullo, was forced to resign in 1994. The Securities and
Exchange Commission charged him with failing to supervise Jett’s trading activities.
He was suspended from working in the industry for one year, but walked away with
$9 million in severance pay and deferred compensation.
[return to top]
© 2022 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a 6
publicly accessible website, in whole or in part.
, Instructor Manual: Froeb/McCann/Ward/Shor, Managerial Economics: A Problem-Solving Approach, CY23, 9780357748237;
Chapter 2: The One Lesson of Business
Instructor Manual
Froeb/McCann/Ward/Shor, Managerial Economics: A Problem-Solving Approach,
CY23, 9780357748237; Chapter 2: The One Lesson of Business
TABLE OF CONTENTS
Purpose and Perspective of the Chapter..................................................................................2
Chapter Objectives......................................................................................................................2
Cengage Supplements................................................................................................................3
What's New in This Chapter....................................................................................................... 3
Chapter Outline ........................................................................................................................... 3
Teaching Notes......................................................................................................................4
Discussion Questions.................................................................................................................5
Additional Resources ................................................................................................................. 6
Cengage MindTap Videos ......................................................................................................... 6
Additional Anecdotes.................................................................................................................6
© 2022 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a 1
publicly accessible website, in whole or in part.
, Instructor Manual: Froeb/McCann/Ward/Shor, Managerial Economics: A Problem-Solving Approach, CY23, 9780357748237;
Chapter 2: The One Lesson of Business
PURPOSE AND PERSPECTIVE OF THE CHAPTER
Chapter 2 covers:
Capitalism & Wealth
Do Mergers Move Assets to Higher-Valued Uses?
Does the Government Create Wealth?
Economics versus Business
Wealth Creation in Organizations
Main points in this chapter:
Voluntary transactions create wealth by moving assets from lower- to higher-valued uses.
Anything that impedes the movement of assets to higher-valued uses, like taxes,
subsidies, or price controls, destroys wealth.
The art of business consists of identifying assets in low-valued uses and devising ways to
profitably move them to higher-valued ones.
A company can be thought of as a series of transactions. A well-designed organization
rewards employees who identify and consummate profitable transactions or who stop
unprofitable ones.
CHAPTER OBJECTIVES
The following objectives are addressed in this chapter:
02.01 Understand how voluntary transactions create wealth.
02.02 Describe factors impeding the movement of assets to higher-valued uses.
02.03 Infer how efficiency helps business.
02.04 Identify transactions that create money-making opportunities.
02.05 Interpret the role of marketing in collecting and transmitting information between
buyers and sellers.
02.06 Interpret the role of design of an organization in its wealth creation.
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CENGAGE SUPPLEMENTS
The following product-level supplements provide additional information that may help you in
preparing your course. They are available in the Instructor Resource Center.
PowerPoint Slides
Test Bank
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© 2022 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a 2
publicly accessible website, in whole or in part.
