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NINTH EDITION

Managerial Economics
and Business Strategy
The McGraw-Hill Series Economics
ESSENTIALS OF ECONOMICS Slavin ADVANCED ECONOMICS
Economics, Microeconomics, and
Brue, McConnell, and Flynn Romer
Macroeconomics
Essentials of Economics Advanced Macroeconomics
Eleventh Edition
Third Edition Fourth Edition

Mandel ECONOMICS OF SOCIAL ISSUES MONEY AND BANKING

M: Economics: The Basics
Third Edition Guell Cecchetti and Schoenholtz
Issues in Economics Today Money, Banking, and Financial Markets
Schiller and Gebhardt Eighth Edition Fifth Edition
Essentials of Economics
Tenth Edition Register and Grimes
URBAN ECONOMICS
Economics of Social Issues
PRINCIPLES OF ECONOMICS Twenty-First Edition O’Sullivan
Urban Economics
Asarta and Butters Eighth Edition
Connect Master: Principles of Economics ECONOMETRICS
First Edition Gujarati and Porter LABOR ECONOMICS
Colander Basic Econometrics
Borjas
Economics, Microeconomics, and Fifth Edition
Labor Economics
Macroeconomics Hilmer and Hilmer Seventh Edition
Tenth Edition Practical Econometrics
McConnell, Brue, and Macpherson
Frank, Bernanke, Antonovics, and Heffetz First Edition
Contemporary Labor Economics
Principles of Economics, Principles Eleventh Edition
of Microeconomics, Principles of MANAGERIAL ECONOMICS
Macroeconomics
Baye and Prince PUBLIC FINANCE
Sixth Edition
Managerial Economics and Business Rosen and Gayer
Frank, Bernanke, Antonovics, and Heffetz Strategy Public Finance
A Streamlined Approach for: Principles of Ninth Edition Tenth Edition
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Third Edition Managerial Economics Public Finance
and Organizational Architecture First Edition
Karlan and Morduch Sixth Edition
Economics, Microeconomics, and
Thomas and Maurice ENVIRONMENTAL ECONOMICS
Macroeconomics
Second Edition Managerial Economics Field and Field
Twelfth Edition Environmental Economics: An Introduction
McConnell, Brue, and Flynn Seventh Edition
Economics, Microeconomics, and INTERMEDIATE ECONOMICS
Macroeconomics INTERNATIONAL ECONOMICS
Twenty-First Edition Bernheim and Whinston
Microeconomics Appleyard and Field
Samuelson and Nordhaus Second Edition International Economics
Economics, Microeconomics, and Ninth Edition
Macroeconomics Dornbusch, Fischer, and Startz
Nineteenth Edition Macroeconomics Pugel
Twelfth Edition International Economics
Schiller and Gebhardt Sixteenth Edition
The Economy Today, The Micro Economy Frank
Today, and The Macro Economy Today Microeconomics and Behavior
Fourteenth Edition Ninth Edition
NINTH EDITION

Managerial Economics
and Business Strategy

Michael R. Baye
Bert Elwert Professor of Business Economics & Public Policy
Kelley School of Business
Indiana University

Jeffrey T. Prince
Associate Professor of Business Economics & Public Policy
Harold A. Poling Chair in Strategic Management
Kelley School of Business
Indiana University
MANAGERIAL ECONOMICS AND BUSINESS STRATEGY, NINTH EDITION
Published by McGraw-Hill Education, 2 Penn Plaza, New York, NY 10121. Copyright © 2017 by McGraw-Hill
Education. All rights reserved. Printed in the United States of America. Previous editions © 2014, 2010, 2008
and 2006. No part of this publication may be reproduced or distributed in any form or by any means, or stored in
a database or retrieval system, without the prior written consent of McGraw-Hill Education, including, but not
limited to, in any network or other electronic storage or transmission, or broadcast for distance learning.
Some ancillaries, including electronic and print components, may not be available to customers outside the
United States.
This book is printed on acid-free paper.
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DEDICATION
To my former students.
—Michael R. Baye
To Annie, Kate, and Elise.
—Jeffrey T. Prince
 About the Authors

Michael R. Baye is the Bert Elwert Professor of Business Economics & Public Policy at
Indiana University’s Kelley School of Business, and served as the Director of the Bureau of
Economics at the Federal Trade Commission from July 2007 to December 2008. He received
his BS in economics from Texas A&M University in 1980 and earned a PhD in economics
from Purdue University in 1983. Prior to joining Indiana University, he taught graduate
and undergraduate courses at The Pennsylvania State University, Texas A&M University,
and the University of Kentucky. He has held a variety of editorial posts in economics, mar-
keting, and business, and currently serves as a co-editor for the Journal of Economics and
Management Strategy.
Professor Baye has won numerous awards for his outstanding teaching and research,
and teaches courses in managerial economics and industrial organization at the undergrad-
uate, MBA, and PhD levels. His research has been published in the American Economic
Review, Journal of Political Economy, Econometrica, Review of Economic Studies, Economic
Journal, and Management Science. It has also been featured in The Wall Street Journal, Forbes,
the New York Times, and numerous other outlets. When he is not teaching or engaged in research,
Mike enjoys activities ranging from camping to shopping for electronic gadgets.

Jeffrey T. Prince is Associate Professor of Business Economics & Public Policy at Indiana
University’s Kelley School of Business. He is also the Harold A. Poling Chair in Strategic
Management. He received his BA in economics and BS in mathematics and statistics from
Miami University in 1998 and earned a PhD in economics from Northwestern University in
2004. Prior to joining Indiana University, he taught graduate and undergraduate courses at
Cornell University.
Professor Prince has won top teaching honors as a faculty member at both Indiana
University and Cornell, and as a graduate student at Northwestern. He has a broad research
agenda within applied economics, having written and published on topics that include demand
in technology markets, Internet diffusion, regulation in health care, risk aversion in insurance
markets, and quality competition among airlines. He is one of a small number of economists
to have published in both the top journal in economics (American Economic Review) and
the top journal in management (Academy of Management Journal). He currently serves as a
co-editor for the Journal of Economics and Management Strategy and on the editorial board
for Information Economics and Policy. In his free time, Jeff enjoys activities ranging from
poker and bridge to running and racquetball.

vi
Preface

Thanks to feedback from users around the world, Managerial Economics and Business
Strategy remains the best-selling managerial text in the market. We are grateful to all of you
for allowing us to provide this updated and improved edition. Before highlighting some of
the new features of the ninth edition, we would like to stress that the fundamental goal of
the book—providing students with the tools from intermediate microeconomics, game the-
ory, and industrial organization that they need to make sound managerial decisions—has not
changed. What has changed are the examples used to make managerial economics come to
life for this generation of students and the utilization of new technologies (such as Connect)
for enhancing the teaching and learning experiences of instructors and their students.
This book begins by teaching managers the practical utility of basic economic tools such
as present value analysis, supply and demand, regression, indifference curves, isoquants, pro-
duction, costs, and the basic models of perfect competition, monopoly, and monopolistic com-
petition. Adopters and reviewers also praise the book for its real-world examples and because
it includes modern topics not contained in any other single managerial economics textbook:
oligopoly, penetration pricing, multistage and repeated games, foreclosure, contracting, ver-
tical and horizontal integration, networks, bargaining, predatory pricing, principal–agent
problems, raising rivals’ costs, adverse selection, auctions, screening and signaling, search,
limit pricing, and a host of other pricing strategies for firms enjoying market power. This
balanced coverage of traditional and modern microeconomic tools makes it appropriate for a
wide variety of managerial economics classrooms. An increasing number of business schools
are adopting this book to replace (or use alongside) managerial strategy texts laden with anec-
dotes but lacking the microeconomic tools needed to identify and implement the business
strategies that are optimal in a given situation.
This ninth edition of Managerial Economics and Business Strategy has been revised to
include updated examples and problems, but it retains all of the basic content that made pre-
vious editions a success. The basic structure of the textbook is unchanged to ensure a smooth
transition to this edition.

KEY PEDAGOGICAL FEATURES

The ninth edition retains all of the class-tested features of previous editions that enhance
students’ learning experiences and make it easy to teach from this book. But this edition
includes a number of new features available to those using McGraw-Hill’s wonderful interac-
tive learning products, Connect and SmartBook. McGraw-Hill Connect® offers hundreds of
variations of end-of-chapter problems that may be electronically graded and provide students
with immediate, detailed, feedback. SmartBook® provides an adaptive reading experience.
Students and instructors can access these and other powerful resources directly from their
laptops, tablets, and phones. We know how important quality and accuracy is for both instruc-
tors and students when utilizing these enhanced features. For this reason, and unlike many
vii
viii Preface

competing books, we are directly involved in the generation and editing of material offered
through both Connect and SmartBook.

Headlines
As in previous editions, each chapter begins with a Headline that is based on a real-world
economic problem—a problem that students should be able to address after completing the
chapter. These Headlines are essentially hand-picked “mini-cases” designed to motivate stu-
dents to learn the material in the chapter. Each Headline is answered at the end of the relevant
chapter—when the student is better prepared to deal with the complications of real-world prob-
lems. Reviewers as well as users of previous editions praise the Headlines not only because
they motivate students to learn the material in the chapter, but also because the answers at the
end of each chapter help students learn how to use economics to make business decisions.

Learning Objectives
Each chapter includes learning objectives designed to enhance the learning experience. End-
of-chapter problems are denoted with the learning objective(s) to which they relate.

Demonstration Problems
The best way to learn economics is to practice solving economic problems. So, in addition
to the Headlines, each chapter contains many Demonstration Problems sprinkled throughout
the text, along with detailed answers. This provides students with a mechanism to verify that
they have mastered the material, and reduces the cost to students and instructors of having
to meet during office hours to discuss answers to problems. Some of the more challenging
demonstration problems have an accompanying video tutorial that walks through the solution
step-by-step. These videos are available via Connect and at www.mhhe.com/baye9e.

Inside Business Applications

Most chapters contain boxed material (called Inside Business applications) to illustrate how
theories explained in the text relate to a host of different business situations. As in previous
editions, we have tried to strike a balance between applications drawn from the current eco-
nomic literature and the popular press.

Calculus and Non-Calculus Alternatives

Users can easily include or exclude calculus-based material without losing content or con-
tinuity. That’s because the basic principles and formulae needed to solve a particular class
of economic problems (e.g., MR = MC) are first stated without appealing to the notation of
calculus. Immediately following each stated principle or formula is a clearly marked Calculus
Alternative. Each of these calculus alternatives states the preceding principle or formula in
calculus notation, and explains the relation between the calculus-based and non-calculus-
based formula. More detailed calculus derivations are relegated to chapter Appendices. Thus,
the book is designed for use by instructors who want to integrate calculus into managerial
economics and by those who do not require students to use calculus.

Variety of End-of-Chapter Problems

Three types of problems are offered. Highly structured but nonetheless challenging Conceptual
and Computational Questions stress fundamentals. These are followed by Problems and
 Preface ix

Applications, which are far less structured and, like real-world decision environments, may
contain more information than is actually needed to solve the problem. Many of these applied
problems are based on actual business events.
Additionally, the Time Warner Cable case that follows Chapter 14 includes 13 problems
called Memos that have a “real-world feel” and complement the text. All of these case-based
problems may be assigned on a chapter-by-chapter basis as specific skills are introduced, or
as part of a capstone experience.
Detailed answers to all problems can be found among the instructor resource material
available via Connect.

Case Study
A case study in business strategy—Time Warner Cable—follows Chapter 14 and was pre-
pared especially for this text. It can be used either as a capstone case for the course or to
supplement individual chapters. The case allows students to apply core elements from man-
agerial economics to a remarkably rich business environment. Instructors can use the case
as the basis for an “open-ended” discussion of business strategy, or they can assign specific
“memos” (contained at the end of the case) that require students to apply specific tools from
managerial economics to the case. Teaching notes, as well as solutions to all of the memos,
are provided among the instructor resource material available via Connect.

Flexibility
Instructors of managerial economics have genuinely heterogeneous textbook needs. Reviewers
and users continue to praise the book for its flexibility, and they assure us that sections or
even entire chapters can be excluded without losing continuity. For instance, an instructor
wishing to stress microeconomic fundamentals might choose to cover Chapters 2, 3, 4, 5, 8,
9, 10, 11, and 12. An instructor teaching a more applied course that stresses business strategy
might choose to cover Chapters 1, 2, 3, 5, 6, 7, 8, 10, 11, and 13. Each may choose to include
additional chapters (for example, Chapter 14 or the Time Warner Cable case) as time permits.
More generally, instructors can easily omit topics such as present value analysis, regression,
indifference curves, isoquants, or reaction functions without losing continuity.

CHANGES IN THE NINTH EDITION

We have made every effort to update and improve Managerial Economics and Business
Strategy while assuring a smooth transition to the ninth edition. Following is a summary of
the pedagogical improvements, enhanced supplements, and content changes that make the
ninth edition an even more powerful tool for teaching and learning managerial economics and
business strategy.
∙ A brand new Case Study—Time Warner Cable—which introduces a whole new set of
managerial challenges beyond those posed in our previous case, Challenges at Time
Warner.
∙ New and updated end-of-chapter problems.
∙ Learning objective labels for each end-of-chapter problem, to help foster targeted
learning.
∙ New and updated Headlines.
∙ New and updated Inside Business applications.
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x Preface

Chapter-by-Chapter Changes
∙ Chapter 1 contains new and updated examples, several updated end-of-chapter prob-
lems, and a new end-of-chapter problem that carefully distinguishes total benefits and
total costs from marginal benefits and marginal costs in an applied setting.
∙ Chapter 2 contains updated demonstration problems and an expanded discussion of
price floors in the text and demonstration problems.
∙ Chapter 3 contains a new Headline and an updated table with accompanying discus-
sion. It also has several updated end-of-chapter problems.
∙ Chapter 4 contains an updated Headline and updated Inside Business applications. It
also has several updated end-of-chapter problems.
∙ Chapter 5 contains an updated Inside Business application with details about the
Affordable Care Act. It also includes a formal definition of the law of diminishing
marginal returns and has several updated end-of-chapter problems.
∙ Chapter 6 offers a new Inside Business on the duration of franchise contracts,
updated examples, and several updated end-of-chapter problems.
∙ Chapter 7 contains a new Headline, updated examples and industry data, as well as
several updated end-of-chapter problems.
∙ Chapter 8 contains an updated Inside Business concerning automobile competition in
China, updated examples, and several updated end-of-chapter problems.
∙ Chapter 9 contains an updated end-of-chapter problem, as well as a new end-of-
chapter problem looking at contestability within airline markets.
∙ Chapter 10 contains a new Inside Business application examining airline competition,
as well as improved Demonstration Problem exposition. It also has several updated
end-of-chapter problems.
∙ Chapter 11 contains a new Inside Business application discussing the use of fuel points
by major U.S. grocery chains. It also has several updated end-of-chapter problems.
∙ Chapter 12 includes a new discussion of online reviews as a means of attracting risk-
averse customers. It also includes a new Inside Business application, as well as several
updated end-of-chapter problems.
∙ Chapter 13 contains a new Inside Business on limit pricing and the “Southwest
Effect.” It also has two updated end-of-chapter problems.
∙ Chapter 14 contains a new Inside Business application discussing the Small Business
Act for Europe as a key distinction in competition policy between Europe and the
United States. In addition, it has two updated end-of-chapter problems, including one
discussing the Trans-Pacific Partnership (TPP).

ORGANIZED LEARNING IN THE NINTH EDITION

Chapter Learning Objectives
Students and instructors can be confident that the organization of each chapter reflects com-
mon themes outlined by four to seven learning objectives listed on the first page of each
chapter. These objectives, along with AACSB and Bloom’s taxonomy learning categories, are
connected to all end-of-chapter material and test bank questions to offer a comprehensive and
thorough teaching and learning experience.
 Preface xi

Assurance of Learning Ready

Many educational institutions today are focused on the notion of assurance of learning, an
important element of some accreditation standards. Managerial Economics and Business
Strategy is designed specifically to support your assurance of learning initiatives with a sim-
ple, yet powerful solution.
Instructors can use Connect to easily query for learning outcomes/objectives that directly
relate to the learning objectives of the course. You can then use the reporting features of
Connect to aggregate student results in similar fashion, making the collection and presenta-
tion of assurance of learning data simple and easy.

AACSB Statement
McGraw-Hill Global Education is a proud corporate member of AACSB International.
Understanding the importance and value of AACSB accreditation, Managerial Economics and
Business Strategy, 9/e, has sought to recognize the curricula guidelines detailed in the AACSB
standards for business accreditation by connecting questions in the test bank and end-of-chapter
material to the general knowledge and skill guidelines found in the AACSB standards.
It is important to note that the statements contained in Managerial Economics and
Business Strategy, 9/e, are provided only as a guide for the users of this text. The AACSB
leaves content coverage and assessment within the purview of individual schools, the mission
of the school, and the faculty. While Managerial Economics and Business Strategy, 9/e, and
the teaching package make no claim of any specific AACSB qualification or evaluation, we
have labeled questions according to the general knowledge and skill areas.

ACKNOWLEDGMENTS
We thank the many users of Managerial Economics and Business Strategy who provided both
direct and indirect feedback that has helped improve your book. This includes thousands of
students at Indiana University’s Kelley School of Business and instructors worldwide who
have used this book in their own classrooms, colleagues who unselfishly gave up their own
time to provide comments and suggestions, and reviewers who provided detailed suggestions
to improve this and previous editions of the book. We especially thank the following profes-
sors, past and present, for enlightening us on the market’s diverse needs and for providing
suggestions and constructive criticisms to improve this book.

Contributing reviewers for this edition:

Narine Badasyan, Murray State University Anand Jha, Texas A&M International
Cristanna Cook, Husson University University
Robert Daffenbach, University of Harlan Platt, Northeastern University
Oklahoma Stefan Ruediger, Arizona State University
Jeffrey Edwards, North Carolina A&T Charles Sebuhara, Virginia Technical
University University
Silke Forbes, Case Western Reserve Thomas White, Fontbonne University
University Keith Willett, Oklahoma State University,
Martin Heintzelman, Clarkson University Stillwater
Craig Hovey, Brenau University, Gainesville Laura Youderian, Xavier University
xii Preface

Contributing reviewers for previous editions:

Fatma Abdel-Raouf, Goldey-Beacom Wilffrid W. Csaplar Jr., Bethany College
College Shah Dabirian, California State University,
Burton Abrams, University of Delaware Long Beach
Rashid Al-Hmoud, Texas Tech University Joseph DaBoll-Lavioe, Nazareth College of
Anthony Paul Andrews, Governors State Rochester
University George Darko, Tusculum College
Sisay Asefa, Western Michigan University Tina Das, Elon University
Simon Avenell, Murdoch University Ron Deiter, Iowa State University
Joseph P. Bailey, University of Maryland Jonathan C. Deming, Seattle Pacific
Dale G. Bails Christian Brothers University University
Dean Baim, Pepperdine University Casey Dirienzo, Appalachian State
University
Sheryl Ball, Virginia Polytechnic University
Eric Drabkin, Hawaii Pacific University
Klaus Becker, Texas Tech University
Martine Duchatelet, Barry University
Richard Beil, Auburn University
Keven C. Duncan, University of Southern
Barbara C. Belivieu, University of Colorado
Connecticut
Yvonne Durham, Western Washington
Dan Black, University of Chicago University
Louis Cain, Northwestern University Eugene F. Elander, Brenau University
Kerem Cakirer, Indiana University Ibrahim Elsaify, Goldey-Beacom College
Leo Chan, University of Kansas David Ely, San Diego State University
Robert L. Chapman, Florida Metropolitan Mark J. Eschenfelder, Robert Morris
University University
Joni Charles, Texas State University—San Li Feng, Texas State University–San Marcos
Marcos David Figlio, University of Florida
Basanta Chaudhuri, Rutgers University— Ray Fisman, Graduate School of Business,
New Brunswick Columbia University
Shuo Chen, State University of New York at Silke Forbes, University of California—San
Geneseo Diego
Xiujian Chen, State University of New David Gerard, Carnegie Mellon University
York—Binghamton University Sharon Gifford, Rutgers University
Kwang Soo Cheong, Johns Hopkins Lynn G. Gillette, Northeast Missouri State
University University
Christopher B. Colburn, Old Dominion Otis Gilley, Louisiana Tech University
University
Roy Gobin, Loyola University
Daniel Patrick Condon, Dominican
Stephan Gohmann, University of Louisville
University
Steven Gold, Rochester Institute of
Michael Conlin, Syracuse University Technology
Cristanna Cook, Husson University Julie Hupton Gonzalez, University of
Keith Crocker, Penn State University California—Santa Cruz
Ian Cromb, University of Western Ontario Thomas A. Gresik, Mendoza College of
Dean Croushore, Federal Reserve Business (University of Notre Dame)
 Preface xiii

Andrea Mays Griffith, California State Dick Leiter, American Public University
University Canlin Li, University of
Madhurima Gupta, University of Notre California—Riverside
Dame Chung-Ping Loh, University of North
Carl Gwin, Pepperdine University Florida
Gail Heyne Hafer, Lindenwood College Vahe Lskavyan, Ohio University—Athens
Karen Hallows, George Mason University Heather Luea, Newman University
William Hamlen Jr., SUNY Buffalo Nancy L. Lumpkin, Georgetown
Shawkat Hammoudeh, Drexel University College
Mehdi Harian, Bloomsburg University Thomas Lyon, University of Michigan
Nile W. Hatch, Marriott School (Brigham Richard Marcus, University of
Young University) Wisconsin—Milwaukee
Clifford Hawley, West Virginia University Vincent Marra, University of Delaware
Wade Martin, California State University,
Ove Hedegaard, Copenhagen Business
Long Beach
School
Catherine Matraves, Michigan State
Steven Hinson, Webster University
University—East Lansing
Hart Hodges, Western Washington
John Maxwell, Indiana University
University
David May, Oklahoma City University
Robert L. Holland, Purdue University
Alan McInnes, California State University,
Jack Hou, California State University—
Fullerton
Long Beach
Christopher McIntosh, University of
Lowel R. Jacobsen, William Jewell
Minnesota Duluth
College
Kimberly L. Merritt, Oklahoma Christian
Thomas D. Jeitschko, Michigan State
University
University
Edward Millner, Virginia Commonwealth
Jaswant R. Jindia, Southern University
University
Russell Kashian, University of
John Moran, Syracuse University
Wisconsin—Whitewater
Shahriar Mostashari, Campbell University
Paul Kattuman, Judge Business School
(Cambridge University) John Morgan, Haas Business School
(University of California—Berkeley)
Brian Kench, University of Tampa
Ram Mudambi, Temple University
Kimberley L. Kinsley, University of Mary
Washington Francis Mummery, California State
University—Fullerton
Peter Klein, University of Georgia,
University of Missouri—Columbia Inder Nijhawan, Fayetteville State University
Audrey D. Kline, University of Louisville Albert A. Okunade, University of Memphis
Robert A. Krell, George Mason Walton M. Padelford, Union University
University Darrell Parker, Georgia Southern University
Paul R. Kutasovic, New York Institute of Stephen Pollard, California State University,
Technology Los Angeles
W. J. Lane, University of New Orleans Dwight A. Porter, College of St. Thomas
Daniel Lee, Shippensburg University Stanko Racic, University of Pittsburgh
xiv Preface

Eric Rasmusen, Indiana University Ed Steinberg, New York University

Matthew Roelofs, Western Washington Barbara M. Suleski, Cardinal Stritch
University College
Christian Roessler, National University Caroline Swartz, University of North
of Singapore Carolina Charlotte
Bansi Sawhney, University of Baltimore Joseph K. Tanimura, San Diego State
George L. Schatz, Maine Maritime University
Academy Bill Taylor, New Mexico Highlands
Craig Schulman, University of Arkansas University
Karen Schultes, University of Roger Tutterow, Kennesaw State College
Michigan—Dearborn Nora Underwood, University of Central
Peter M. Schwartz, University of North Florida
Carolina Lskavyan Vahe, Ohio University
Richard Alan Seals Jr., Oklahoma City Lawrence White, Stern School of Business
University (New York University)
Edward Shinnick, University College Leonard White, University of Arkansas
Ireland Keith Willett, Oklahoma State
Dean Showalter, Southwest Texas State University—Stillwater
University Mike Williams, Bethune Cookman College
Chandra Shrestha, Virginia Commonwealth Richard Winkelman, Arizona State
University University
Karen Smith, Columbia Southern University Eduardo Zambrano, University of Notre Dame
John Stapleford, Eastern University Rick Zuber, University of North Carolina,
Mark Stegeman, University of Arizona Charlotte

We thank Katie Hoenicke, Christina Kouvelis, James Heine, and Doug Ruby at McGraw-
Hill for all they have done to make this project a success. We also thank Mitchell Baye, Patrick
Scholten, Eric Schmidbauer, Susan Kayser, Kyle Anderson, and Vikram Ahuja for sugges-
tions and assistance during various stages of the revision, and Ellie Mafi-Kreft, Haizhen Lin,
and Steven Kreft, who graciously agreed to class test the Connect features in their classrooms.
Finally, we thank our families for their continued love and support.
As always, we welcome your comments and suggestions for the next edition. Please feel
free to write to us directly at mbaye@indiana.edu or jeffprin@indiana.edu.

Michael R. Baye
Jeffrey T. Prince
 Preface xv

SUPPLEMENTS
We know the content and reliability of new editions and book supplements are of utmost impor-
tance to users of our book. Because of this, and unlike most other managerial economics books,
we personally are involved in crafting and accuracy checking virtually every content update and
supplement for our book. Below we discuss popular features of some of the supplements that
have been greatly expanded for this edition. The following ancillaries are available for quick
download and convenient access via the instructor resource material available through Connect.

Cases
In addition to the Time Warner Cable case, nearly a dozen full-length cases were updated and
prepared to accompany Managerial Economics and Business Strategy. These cases comple-
ment the textbook by showing how real-world businesses use tools like demand elasticities,
markup pricing, third-degree price discrimination, bundling, Herfindahl indices, game the-
ory, and predatory pricing to enhance profits or shape business strategies. The cases are based
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problems, all of which have been class-tested for accuracy.

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 Brief Contents

1 The Fundamentals of Managerial Economics 1

2 Market Forces: Demand and Supply 30

3 Quantitative Demand Analysis 64

4 The Theory of Individual Behavior 101

5 The Production Process and Costs 135

6 The Organization of the Firm 175

7 The Nature of Industry 203

8 Managing in Competitive, Monopolistic, and Monopolistically

Competitive Markets 229

9 Basic Oligopoly Models 270

10 Game Theory: Inside Oligopoly 302

11 Pricing Strategies for Firms with Market Power 340

12 The Economics of Information 372

13 Advanced Topics in Business Strategy 406

14 A Manager’s Guide to Government in the Marketplace 435

Case Study Time Warner Cable 468

Glossary 497

Appendix Additional Readings and References 505

Name Index 525

General Index 534

xviii
Contents

INSIDE BUSINESS 1–1: The Goals of Firms in Our Global

CHAPTER 1
Economy 6
The Fundamentals of Managerial INSIDE BUSINESS 1–2: Profits and the Evolution of the
Economics 1 Computer Industry 9
HEADLINE: Amcott Loses $3.5 Million; Manager INSIDE BUSINESS 1–3: Joining the Jet Set 16
Fired 1
INTRODUCTION 2
The Manager 2
CHAPTER 2
Economics 3 Market Forces: Demand and Supply 30
Managerial Economics Defined 3
HEADLINE: Samsung and Hynix Semiconductor to Cut
THE ECONOMICS OF EFFECTIVE MANAGEMENT 4
Chip Production 30
Identify Goals and Constraints 4
INTRODUCTION 31
Recognize the Nature and Importance
of Profits 4 DEMAND 31
Economic versus Accounting Profits 4 Demand Shifters 33
The Role of Profits 5 Income 33
The Five Forces Framework and Industry Prices of Related Goods 34
Profitability 7 Advertising and Consumer Tastes 35
Understand Incentives 10 Population 35
Understand Markets 11 Consumer Expectations 36
Consumer–Producer Rivalry 11 Other Factors 36
Consumer–Consumer Rivalry 11 The Demand Function 36
Producer–Producer Rivalry 11 Consumer Surplus 38
Government and the Market 12 SUPPLY 39
Recognize the Time Value of Money 12 Supply Shifters 40
Present Value Analysis 12 Input Prices 40
Present Value of Indefinitely Lived Assets 14 Technology or Government Regulations 40
Use Marginal Analysis 16 Number of Firms 40
Discrete Decisions 17 Substitutes in Production 41
Continuous Decisions 19 Taxes 41
Incremental Decisions 20 Producer Expectations 42
LEARNING MANAGERIAL ECONOMICS 21 The Supply Function 43
Producer Surplus 44
ANSWERING THE HEADLINE 22
MARKET EQUILIBRIUM 45
KEY TERMS AND CONCEPTS 23 / CONCEPTUAL AND
COMPUTATIONAL QUESTIONS 23 / PROBLEMS AND PRICE RESTRICTIONS AND MARKET
APPLICATIONS 25 / SELECTED READINGS 28 / EQUILIBRIUM 47
APPENDIX: THE CALCULUS OF MAXIMIZING NET Price Ceilings 47
BENEFITS 29 Price Floors 51

xix
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Other documents randomly have
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spoke a word during the meal, and scarcely touched a mouthful; she
seemed buried in thought.

"What is the matter with you, Ella?" asked Mrs. Carlyon, noticing
this. "Surely you are not going to be ill!"

"I was never better in all my life, Aunt Gertrude, than I am this
morning," answered Ella, with her sweet, serious smile. "Only I do
not seem to be in the humour for talking."

"Nor for eating either, apparently," said Mrs. Carlyon with a shake of
her cap-strings. "I don't like the symptoms; and if you have not
recovered your appetite at luncheon I shall think it time to send for
Dr. Spreckley." At which Ella laughed.

By-and-by, Ella put on her hat and shawl and went out, strolling
across the garden towards the way in which she might expect the
approach of her lover. He was already in sight. Drawing her hand
within his arm when they met, he and she paced about for the best
part of an hour, talking eagerly. It was the day subsequent to the
gipsy's visit to the kitchen, when she had told the fortunes of the
maids and--perhaps--of Dorothy Stone, and this conversation ran on
that event. The reader will very probably have divined that the
gipsy's visit had been a ruse; a thing planned by Conroy, to get
some information out of Dorothy.

Going indoors, Ella and Mr. Conroy proceeded to the old Squire's
sitting-room, which had not been used since his death. A fire,
ordered in it this morning, burnt brightly on the hearth. Ella paused
for a moment on the threshold. There was her uncle's big leathern
high-backed chair, with the screen behind it, as in the days that were
gone. There was the little old-fashioned table with the twisted legs
that used to stand at his elbow. It needed but a slight stretch of
imagination to fancy that presently the Squire's heavy footstep
would be heard, that he would come in with his curt "good-morrow,"
and begin at once to poke the fire, which was a thing that he
believed no one could do as well as himself. Ella's eyes filled with
tears.

"Courage, my dear," whispered Conroy. "Think of the present just

now, not of the past."

She brushed away her tears and nodded, as she rang the bell. It
was answered by one of the maids, Phemie; who was desired to
inform Aaron Stone that his mistress waited for him in the Squire's
old room.

Aaron received the message with an incredulous stare.

"You must be dreaming," he said wrathfully. "The missus in that cold

room--and wanting to see me in it! Be off with your tales."

"Is it cold!" retorted Phemie. "There's a wood fire blazing in it up to

the top of the chimney. And the mistress is there, sir, with Mr.
Conroy, and she is waiting for you."

Aaron obeyed slowly, fuming a little. He did not like being sent for by
Miss Winter and talked to before Mr. Conroy. With all his heart he
wished Mr. Conroy well away from Heron Dyke; he was the only man
whom Aaron feared. His look of cold, dark, grave scrutiny always
disconcerted the old man. What he and Dorothy should do when Mr.
Conroy married the mistress and became master of Heron Dyke,
which would undoubtedly be the case before long, was a thought
that had troubled him a good deal of late.

Aaron paused when he opened the door, and shivered as he looked

in. What could he be wanted for in that room, of all others? Had
anything been found out?

"Come in, Aaron," said Miss Winter. "Shut the door, and sit down."

She was leaning back in one of the smaller chairs. Mr. Conroy stood
against the old-fashioned mantelpiece. The old man took a chair
near the door with a sinking heart.

"Some considerable time ago, Aaron," began his mistress in a grave

but not unkindly voice, "I put certain questions to you bearing
reference to my uncle's illness and death. I had been led to suppose
that some mystery attached to that time, and that, whatever it was,
it had been kept, and was intended to be kept, from me. You denied
it; you told me I was mistaken."

"No, no, Miss Ella, I kept nothing back from you; I didn't indeed,"
answered the old man, in a trembling, beseeching voice, his
agitation pitiable to see.

"But I now know that you did, Aaron. I know that while my uncle
was said to have died in the middle of May, he really died weeks and
weeks before that date! Will you tell me why you induced me to
believe that it was my uncle whom John Tilney and the choristers
from Nullington saw on the evening of his birthday, and whom Mr.
Plackett, the lawyer from London, saw a day or two later, and whom
Mr. Daventry's partner saw--when you knew quite well that it was
you yourself, dressed up so as to personate your master, whom each
and all of them beheld?"

Aaron's teeth began to chatter.

"The truth is known to me at last," continued Ella. "Do not make any
further attempts to deceive me; they will be useless."

"Quite useless," struck in Conroy, a sternness in his tone that Miss

Winter's had lacked. "We know all."

What little tinge of colour had been in Aaron's rugged face fled from
it; he looked like a man suddenly stricken with some mortal sickness.
He turned his affrighted eyes from his mistress to Conroy, and from
Conroy to her again.

"Better make a clean breast of it," said Conroy, quietly.

"I will," at length spoke Aaron, in a husky whisper, probably seeing
that no other course remained to him. "The Squire did die afore
May; long afore his birthday too, the twenty-fourth of April."

"It was a dreadful fraud!" gasped Ella.

"Ay, 'twas a fraud," assented Aaron. "It was not me, though, that set
it agate; I only helped to carry it out."

"Who did set it agate?" asked Conroy.

"Hubert: my grandson Hubert. Him and the Squire between them."

"The Squire!" cried Ella, reproachfully. "Aaron!"

"It's true, ma'am. He couldn't rest for fear of dying before his
birthday; old Spreckley let him know that he'd not live to see it,
except by a miracle, and it a'most killed him. Hubert thought of
something. He had been reading just then in one of his French
books of a gentleman in France who died and was kept alive for
months afterwards--leastways was said to be kept alive, to deceive
the world. He told the Squire of this, and the Squire caught at it
eagerly; and they spoke to Jago, and he helped to carry it out."

"And you helped too," said Conroy.

"I did it for the best--for the best," sighed Aaron, the tears starting
to his eyes as he slightly lifted his wrinkled hands. "Moreover, the
Squire ordered me: and when did I ever disobey him? 'Twas in this
very room, Miss Ella"--looking across at her--"that he first spoke to
me. I had come in to get him ready for bed, and he told me about it.
At the first blush I felt frightened to death; I said to him, 'Master, it
can't be done.' 'It can be done, and shall be done; how dare you
dissent!' he answered me angrily, and I didn't dare to say more."

What could Ella answer?

"'Twas all for you, Miss Ella; all for you," shivered the faithful old
servant--for faithful he was, despite this wrong-doing. "How could
you have inherited Heron Dyke had the master not lived over his
birthday? 'Twould have gone right away to the other people. A nice
thing for that other Denison to have come in to the old place!
Swindlers and spies, all the lot of 'em! If----"

"Be silent!" sternly struck in Conroy. "How dare you presume so to

speak of your master's kinsman?"

Aaron looked up with a gasp.

"Mr. Denison of Nunham Priors is every whit as honourable as the

late Mr. Denison of Heron Dyke. Take care how you speak of him in
future. And remember that he is Mr. Denison of Heron Dyke now--
and would have been so ever since last April but for your plotting."

Never had Conroy been so moved--so stern.

Ella, though assenting in her heart to every word, looked at him in

surprise. Aaron felt checked and mortified; he thought this was
pretty assumption for a man who was but a newspaper reporter, and
would have liked to say so.

"Mistress," he stammered in a husky voice, "how did you come to

know about the Squire?"

"That I must decline to tell you," spoke Miss Winter. "It is enough
that I do know it. Had you but told me the truth when I first
questioned you, what annoyance it would have saved both myself
and you!"

But the aged retainer could only reiterate, "I did it for the best."

Mr. Conroy spoke.

"I want you to tell me, Aaron, the real date of the Squire's death."
Aaron threw a quick, sour, suspicious look at his interlocutor.

"Am I to answer that question, Miss Ella? he asked, in an aggrieved

tone.

"Certainly."

"Well, then, if you must know, sir, he died on the 19th of February,"
was the answer, grudgingly given.

"The 19th of February. What did you do then?"

"Why, what should we do but put the body into a coffin that had
been ordered from London two months before by the Squire's own
directions. Hubert ordered it, and it was sent down in a packing-
case, and the servants were told that it was a new sort of invalid-
chair for the master."

"Oh. And this coffin, nailed down, I suppose, was kept in the room?"

"In the lumber-room off the bed-room; nobody had ever thought o'
going in there. We kept the room locked mostly after that."

"Just one moment," interposed Ella. "Was the account you gave me
of my uncle's death--what happened the evening it took place--a
true one?"

"Every word," answered the old man. "Save that it was in February
'stead o' May, ma'am."

"Whose idea was it that you should personate your master after his
death?" resumed Conroy.

Aaron did not answer at once. His eyes had taken a dull far-away
expression, as though he were lost in the past.

"Such a lot o' things had to be done that wasn't at first thought of,"
he presently said. "Nobody can foresee what ins and outs a matter
will take when it be first planned. Hubert saw that it might not be
enough to say the Squire lived over his birthday; people might
clamour to see him and convince theirselves of it; and Jago, he saw
it also."

"Yes. Go on."

"They thought there was nothing for it but that I must be dressed up
to personate him. I fought against it; I did indeed, Miss Ella," lifting
his eyes to his mistress, "but 'twas o' no manner o' use my holding
out; for, as they pointed out to me, all might have been discovered
unless I gave in."

"So they dressed you up!" cried Conroy.

"Hubert did it--the whole scheme was carried out by Hubert. Oh, but
he was a clever lad; an amazing clever lad! Jago was deep and
cunning, but he had not the talent of Hubert. Who but he got me a
wig to imitate the Squire's long white hair, and a velvet skull-cap? I
had to put them and the dressing-gown on every day and be drilled
for an hour, till I used sometimes to half fancy that I had been
transmogrified into the Squire himself. It took in Daventry's partner,
and them lawyer rascals from London, finely!--and the band from
Nullington and John Tilney and his wife! I had on the cat's-eye ring
that the Squire had worn for thirty years."

"Dr. Jago was in the secret from the first.

"Of course he was, sir. He was just the man for a job of that sort,
and it couldn't have been done without a doctor."

Mr. Conroy had been jotting down a few notes in his pocket-book.

"I think that is all for the present," he said to Aaron. "If any other
questions should occur to me, I can ask them later."
Aaron rose stiffly from his chair. To his ears there seemed an
assumption of authority, of power in Conroy, excessively distasteful
to him. But the cloud vanished from his countenance and his rugged
features softened as his eyes rested on his mistress. No anger, no
haughty condemnation sat on that fair young face; only a sort of
sweet, patient sadness.

"Miss Ella, you know everything now," he whispered, moving a step

or two nearer to her. "But what of that? The world's none the wiser
and never need be. The secret's as safe now as ever it was."

"Yes, Aaron, I know everything," answered Ella, a little wearily. "I

know that I am no longer the mistress of Heron Dyke. I know that
the dear old home no longer belongs to me but to another! But I
also know that he will be a worthy inheritor."

Aaron gasped--as if demented.

"But, Miss Ella, you have only to hold your tongue and nobody will
ever be a bit the wiser. The Squire bound us all not to tell you, but
now that you've found it out for yourself, there's no harm done. You
surely would not tell--no, no! not that--not that!"

"I have no alternative, Aaron. I would do that which is right. This

home is not mine: it must be given up to him to whom it rightly
belongs."

"Oh, ma'am!--Miss Ella! My master would turn in his grave if he

could hear your words. Give up the old place? No--no! And not a
soul who knows the secret but ourselves and Jago--and the nurse:
and their mouths are sealed!"

"If my uncle, out of that larger knowledge which I doubt not is now
his, were permitted to counsel me, do you not think he would urge
me to do that which is just and honourable?" said Ella,
condescending to reason with him, in pity for his evident
wretchedness. "Your master sees now with other eyes than those he
saw with when on earth; he would not ask me to keep what is not,
and never has been, mine; that which he would have me do, could
he speak to me, is the thing I must do, and no other."

Aaron listened, but he was not convinced.

"To think of the estate going to them that the master hated so!
Sneaks and spies----"

"Not another word!" severely spoke Miss Winter. "You forget

yourself, Aaron."

The old man bowed his head and let his arms fall by his side with a
gesture of despair. Turning, he hobbled slowly from the room.

"Poor, faithful old soul!" cried Ella, as she gazed after him. "Wrongly
though he has acted, it was done in loyalty to my uncle and me. And
so, Edward," she added, bravely smiling through her tears, "you see
that you will not have a well-dowered bride."

"So much the better, sweet one," answered Conroy, stealing his arm
round her. "You will then owe something to me, instead of my owing
so much to you. Nobody can now call me a fortune-hunter."

"They have not called you one."

"Have they not! Ask that old man, now gone out, what he thinks of
me in his private thoughts. Ask your Aunt Gertrude; ask Mrs.
Toynbee--ask the world."

"I am sure you have never been that."

"I don't think I have. But, Ella, it will be a sore parting--this of yours
from Heron Dyke."

"I try not to think of it yet. When the day shall come I shall try to
bear it as I best may."
"Who knows but that old gentleman at Nunham Priors will give it up
to you to live in?" suggested Conroy. "Has he not said something of
the kind to you?"

"And do you think I would impose upon his generosity by staying?

No, no. This is the place of his ancestors, and it must be his--his
entirely; and his son's after him. You forget he has a son, Edward."

"One Master Frank, I believe. A graceless young fellow, by all

accounts."

"That may be; but he is still a Denison, and the heir after his father.
Besides--you have indeed been speaking without thought, Edward!--
how could poor people, such as we shall be, speaking comparatively,
live at a grand old place like this? It requires a grand income to keep
it up."

"Dear me! So it does."

"You had better give me up, perhaps, Edward, now things have
turned out for the worse," she suggested, her voice slightly
trembling. "I shall only be a clog upon your ambition, and keep you
down."

"Do you think so?" he rejoined gravely. "You will be afraid to venture
on marriage with a man so poor as I? Well, there's little doubt you
might marry a rich one. Many a man high in the world's favour might
be glad to woo and win you. Young ladies with only a tithe of your
good looks make rich marriages every season; why should not you?
You have always be enused to the luxuries and refinements of life; it
would be a misery to me not to be able to afford you them still. Had
we not better part?"

Ella was looking at him with a startled expression in her eyes, as if

she were half afraid he might be in earnest, and was taking her at
her word. Edward Conroy's pleasant laugh rang out. He drew her to
him and kissed her tenderly.
"Why, what a great goose you are to-day!" he said. "As if you did
not know that our love was altogether independent of either poverty
or riches, and that neither one nor the other of them could affect it
in any way. You are mine and I am yours, and no caprices of worldly
fortune can come between us. And now let us fling our cares to the
wind for a little while, and forget everything except that we do love
each other, and that the sun is shining, and that Rover and Caprice
are waiting to be saddled. Put on your riding-habit and let us go for
a long gallop in the sweet January sunshine. If we are not to have
many more rides together, it were wise to enjoy them while we
may."

When Aaron Stone quitted the presence of his mistress he was like a
man utterly dazed and confounded. It was not merely the shock of
finding that the elaborate house of cards which he and others had
helped to build had tumbled to pieces so suddenly about his ears
that dismayed him: it was the fact of Miss Winter's having succeeded
in unravelling a plot which had been so patiently planned and so
carefully guarded from discovery, that nonplussed the old retainer.
So far as he was aware, the secret of the Squire's death could be
known to three people alone: to himself, to Dr. Jago, and to Mrs.
Dexter: Hubert was no longer living. Both Jago and Mrs. Dexter had
been well paid for their share in the affair, and neither of them
would be likely to speak of what would render themselves liable to a
criminal prosecution. From what unknown source, then, could Miss
Winter have obtained her information? Aaron could not answer: and
the oftener he asked himself the question, the more puzzled and
bewildered he became. As to that bumptious Conroy--one might
think the whole place belonged to him to see him and hear his
tones!

"There's witchcraft in it, altogether; that's what there is," concluded

the dazed old man.

And witchcraft there was in it, but of a kind different from that
imagined by Aaron Stone.
Convinced that Dorothy Stone knew more than she dared tell, that
the clue to the secret might be got from her by stratagem, though
perhaps never by a straightforward examination, Edward Conroy set
his wits to work. She was so full of superstitious fancies and beliefs,
it seemed to him something might be effected by playing upon
them. At first Miss Winter objected, but she grew to see that if the
means used were not perfectly legitimate, the end to be obtained
certainly was. In fact there seemed to be no other way, and they
could not go on living in their present state of uncertainty.

During a recent visit of Conroy to London, he had witnessed a

representation of the play of "Guy Mannering," and had been much
struck by the powerful way in which the character of Meg Merrilies
was portrayed. The actress who played the part was known to the
public under the name of Miss Murcott. She was a lady of
irreproachable character; and Mr. Conroy had been introduced to
her, after the play was over, by one of his newspaper friends. In
furtherance of the object he had now in view, he went up to London
again, sought an interview with the actress, and enlisted her
sympathy. The result was that Miss Murcott went down to
Nullington, and took up her abode for a night at Mrs. Keen's, who
had been prepared to receive her by Mr. Conroy. In the disguise of a
gipsy, and under pretence of telling the maids of Heron Dyke their
fortunes, she obtained access to Dorothy Stone, Aaron's absence
having been secured by his mistress. Using the information
confidentially given her by Conroy, she whispered words into
Dorothy's ear that so startled her, as to render her pliable as a lamb.

"Give me your hand," said the sham gipsy: and the dazed and
trembling woman held it out without a dissenting word.

Holding the withered palm in her own, the gipsy proceeded to scan
it closely, tracing the different lines with her forefinger.

"This indicates a coffin," she said; and Dorothy groaned. "And this--
why what is this? It seems to point to a hale old man with long
white hair, who wears something dark on his head, and is put into
the coffin before----"

"Oh, don't, don't!" shrieked Dorothy, trying in vain to withdraw her

hand from the gipsy's firm grasp.

"What have we here?" continued the fortune-teller. "A darkened

room where people walk with hushed footsteps; green doors that
open and shut without noise; a little white-faced man with a black
moustache and evil eyes!----And this dark line must be a secret--a
secret with a crime in it that might drive you forth from your grave
at midnight had you committed it----"

"I didn't commit it," moaned Dorothy. "They never let me know of
it."

"No, but you found it out; you hold the secret; this line shows me
that. You must disclose it. Tell it at once before it be too late--too
late!"

"What shall I do?" sobbed Dorothy: "What shall I do?"

"What I bid you," said the woman, sternly. "Tell me all you know--or
there will be no peace for you living or dead."

It needed no more to induce Dorothy to do as she was bidden. With

many sighs, and groans, and hesitations, her story came out little by
little. It appeared that in those past days the housekeeper's curiosity
was aroused, and to a certain extent her anger also, at being kept in
ignorance of what was going on behind the green baize doors, and
at not being allowed to penetrate beyond them herself. "They treat
me as if I was a common pantry-maid," she would say with
bitterness. The position also that Mrs. Dexter took up in the
household by no means tended to soothe these ruffled feelings. "I've
helped to nurse the master for the last twenty years when he has
been ill, and now I've got to make room for a strange woman!" she
said to Aaron; and all the answer Dorothy got from him was an
order to concern herself with her own business. "There's something
going on behind those doors that they are afeard to be let known,"
concluded the shrewd old woman in her mind.

Dorothy determined to go beyond the doors, if she could get a

chance of it, and tell her wrongs to the Squire himself; and she
watched for an opportunity. It came at last. One afternoon when
Aaron had gone to Nullington, he came home all the worse for the
pints of strong ale he had taken. Not often did he transgress in this
way; and, with the view of hiding it from the household, he went
straight to bed, saying the sun had given him a headache, and fell
asleep. Dorothy filched the key of the green baize doors from his
pocket. Mrs. Dexter, who rarely left the house, had gone this
afternoon to the railway-station, to send off some private telegram
that she would not trust to anybody else; and Hubert Stone was out
riding. In a perfect flutter of excitement, Dorothy took the key to the
green baize doors; she ventured to open them both, and went on.
Knocking at the door of the Squire's sitting-room, she waited for the
answering "Come in." It did not reach her ears. She thought he
might be dozing, and opened the door, all in a twitter of eagerness
to ask and hear from her master why she was excluded. The room
was empty. He is in bed, thought Dorothy, and went to the chamber.
That also was empty. She stood bewildered; what could be the
meaning of it? Perhaps the Squire had stepped into the lumber-room
for something--she opened its door gently, and gave one glance
around. That one brief look was quite enough. A low scream broke
from her lips; then, hardly knowing what she was about, she closed
the door, and fled back by the way she had come. What she saw in
the third room was a closed coffin--the very coffin which she saw
carried out of the Hall some two months later on the day of Mr.
Denison's funeral.

The Squire must be dead; she saw that: but why were they
concealing it? Watching and prying about after this, Dorothy, without
seeming to see anything, saw enough to convince her that, after the
death was really announced to the world, it was no other than her
own husband who personated the dead Squire. She stole into the
garden the night the musicians were playing, and distinguished
Aaron's features in his master's clothes. The day Mr. Charles Plackett
was expected from London, Dorothy watched and saw her husband
turn back privately, and go stealing into the Squire's rooms, instead
of proceeding on his pretended walk to Nullington. All this was
confessed to the gipsy woman, who in her turn related it to Miss
Winter and Mr. Conroy.

CHAPTER XI.

CONVERGING THREADS

Events now began to follow quickly on the steps of each other.

Philip Cleeve had not yet engaged in any active business. After his
return home he had had a slight relapse, and Dr. Spreckley said
business must wait. Old Mr. Marjoram, hearing of this in London, for
Maria often wrote to him, sent a peremptory mandate for Philip to
go back to his house to be nursed. But Philip was getting better
now.

Matters were arranged with Mr. Tiplady: and that gentleman had
already ordered a new brass plate for his office-door--"Messrs.
Tiplady and Cleeve; Architects and Surveyors." The necessary money
had been paid by Maria: and the Vicar did not withhold his sanction.
Philip would take a fair income for a year or two, then become full
partner, and succeed to the whole whenever it should please Mr.
Tiplady to retire. It was a very fair prospect, and the Reverend Mr.
Kettle saw no cause to grumble at it.

One little clause, known only to Mr. Daventry, who drew it up, to Mr.
Tiplady, and to Philip, was inserted in the deed of partnership. It was
to the effect that Philip could not come upon the firm for any money
whatever beyond his salary; if he contracted debts, Mr. Tiplady was
secured from the fear of having to pay them.

"It is only a matter of precaution, Cleeve, inserted as much for your

own sake as for mine," Mr. Tiplady said to him in private. "I have not
much fear that you will be playing cards for high stakes again, or
betting at billiards. Or," added the architect, with a grim smile,
"investing your spare cash in silver mines."

"Never again; never again," whispered Philip, tears of emotion filling

his eyes, as he clasped the hand of his good friend.

The paying of the money had been a surprise to Mr. Tiplady,

knowing, as he did, Philip's penniless state. Without saying a word to
her husband, Maria had gone to Mr. Tiplady, and had made over to
him the twelve hundred pounds which, long before, he had agreed
with Lady Cleeve should be the amount of premium to be paid him
in consideration of taking Philip into partnership. How gratifying to
Philip it was to know that his mother was never to hear the truth of
his folly; that she was to be left in the belief that the money she had
made him a loving present of on his birthday, had all gone in the
silver mine! In her fond eyes Philip always remained the most
peerless of sons. What a weight was lifted off the young man's heart
by this generous act of his wife! From that day forward his health
improved rapidly; he grew again like the merry, light-hearted Philip
Cleeve of old times, his laugh a pleasure to hear. But the lesson
taught him was not one to be readily forgotten. And there would be
one sweet presence ever by his side to see that his footsteps did not
falter, and to cheer him onward whenever the road before him
seemed hard and difficult to travel. Philip Cleeve had learnt his life's
lesson.

In truth, he had been more lucky than he deserved, and he was to

be more so yet. Apart from his past follies, the one item of
remembrance that made him wince was the thought that his wife
should have sacrificed a great portion of her little fortune to patch
up his. Even this bitterness was to be taken from him.

Just at this time his brother, Sir Gunton Cleeve, was despatched to
England on some mission by the embassy to which he was attached;
and he snatched an opportunity to run down to Homedale for four-
and-twenty hours. To him Philip made a clean breast of the past,
confessing everything: the card-playing, the billiard-playing, the
personal extravagance in the shape of petty ornaments and the like;
and the voracious silver mine that had quite finished him.

"Why, what a silly young fellow you must have been!" exclaimed the
baronet.

"I know it, Gunton, to my cost. I shall know it all my days."

Sir Gunton had sown a few wild oats during his youth, though he
had long ago steadied down, and he was not inclined to be too
severe.

"What I don't like, Philip, is this, that your wife should have had to
pay the premium to Tiplady. It looks mean--for us. What does the
mother say?--and the Vicar?"

"The Vicar has said nothing to me: I don't think he intends to blow
me up; he has been very good, I must confess. All he said to Maria
was, that the money was her own and he could not interfere. As to
the mother, Gunton, she knows nothing of my wicked folly; she
thinks the twelve hundred pounds was all swallowed up by the mine.
Maria went to Tiplady, and paid over the money without saying a
word to anybody."
"Well, look here, Philip. I can't stand this: a Cleeve was never mean
yet--at least in our day. I am not rich, as you know, but I can
manage this much. I will pay the premium to Tiplady; that is, I will
refund the money to Maria: and you had better let it be settled upon
her. But I do it in the belief that you will never play at folly again:
understand that, young fellow."

The tears had rushed to Philip's eyes.

"Oh, Gunton, you may trust me! How generous you are!"

When Philip had done thanking him, they began to talk of Captain
Lennox and the suspicions attaching to him.

"Where is he now?" asked Sir Gunton.

"Nobody knows. He can't be found--by the police, or by anybody

else. By the way, you knew him three or four years ago. Gunton."

"I knew him!" retorted Sir Gunton. "Knew Lennox!"

"Any way, you have seen him. You met him at Cheltenham, at Major
Piper's. Young Conroy, a fellow up at Heron Dyke, told me that
much. The Major had a card-party, and you and Lennox were both
at it, he said; and the next day the Major's jewels were missing. If
you recollect, you spent a few days at Cheltenham about that time."

"Yes, I did; and I recollect the evening. Lennox?--Lennox? Ay, I do

remember him now. A fair, slender man of very gentlemanly
manners: wore a white rose in his button-hole."

"That's he. One can hardly believe him to be an accomplished

swindler."

"If he played these pranks often, helping himself to jewels and

purses, and the like, he must have been uncommonly lucky to go on
so long without detection," observed Sir Gunton.
"The very remark Conroy made to me."

"Pray, who is Conroy?"

"The luckiest man living," replied Philip, with enthusiasm.

"That's saying a good deal," cried the baronet, lifting his eyebrows.

"Well, upon my word, I think he is, Gunton," returned Philip. "He is

nothing but a man connected with newspapers; draws cartoons for
them, or something of that. He and Miss Winter met somewhere and
fell in love with one another, and she means to marry him and make
him the master of Heron Dyke."

"Oh, indeed. What next?"

"I think that's pretty well. You can't say but he is lucky."

"Is the man a sneak?"

"Just the opposite. A highly-educated, open-mannered, masterful

kind of man, who can hold his own with his betters, and apparently,
not recognise them to be so. To see him and hear him you might
think he had been born the master of Heron Dyke at least. Any way,
that's what Ella Winter intends him to become."

"She has the Denison blood in her veins, I suppose, and we know
the old distich," carelessly remarked Sir Gunton:

"'Whate'er a Denzon choose to do

Need ne'er surprise nor me nor you.'"

The small dinner-party at Heron Dyke, of which Miss Winter spoke to

her housekeeper, was held without much delay. Philip, getting strong
then, was able to attend it with his mother and Maria. Lady Maria
Skeffington, who had been taking a good deal of notice of Maria
since her marriage; the Vicar, and Dr. Spreckley completed the party.

Dinner was over, and they were all back in the large drawing-room
when the evening post was brought in. It was some hours late; the
postman said there had been a break-down on the line. Three or
four newspapers came in, and one letter, which was addressed to
Miss Winter. It bore the American post-mark; and Ella's curiosity
arose, not so much because she knew no one in America, as that
she thought the handwriting was Margaret Ducie's.

"Oh, I must open it," she exclaimed, taking it into the next room.

The intervening doors were open, and they watched her read the
letter. She came back with it in her hand, looking a little pale.

"It is from Mrs. Ducie," she said in a low tone to her guests: "it is
dated from Rhode Island, America. I think you ought to hear it.
Perhaps"--turning to Mr. Conroy--"you will read it aloud."

Conroy took the letter from her hand, glanced over it, and began:

"'Mrs. Ducie, late of The Lilacs near Nullington, takes the liberty of
addressing a few lines to Miss Winter of Heron Dyke. She does it
with great reluctance, as Miss Winter will readily understand; but the
charge is laid upon her, and she cannot evade it: the time being now
come when certain facts connected with the past must be made
known.

"'Mrs. Ducie's brother, known to Miss Winter and to others as

Captain Lennox, died two days ago. Enclosed is a declaration which
he dictated, word for word, before his death; with a request that it
might be forwarded to the proper quarter immediately after that
event should have taken place.
"'Mrs. Ducie can make no attempt to palliate anything that happened
in the past. As it was, so it must remain. If all were known, which it
never can be here on earth, it would sometimes be found that the
greatest sinners were first driven into sin by no wish or will of their
own. Many, who were destined to fill an honourable career, have
been forced by circumstances which they could not control on a
contrary path. The dead are sacred; and she, who is obliged to write
these painful lines, can never forget that she has lost a brother, who,
whatever his faults might be, was dearer to her heart than anyone
now left to her.'"

Such was Mrs. Ducie's note. The enclosed paper was also in her
handwriting. Mr. Conroy went on to read it.

"'I, Ferdinand Lennox, or the man commonly known by that name,

being about to quit this petty planet, and set out on my travels to
that unknown country from which there is no return, am desirous,
while there is still sufficient strength and clearness of mind left me,
to state the facts with regard to a certain event as they really
occurred; which facts will probably be found to be somewhat
different from what the world believes them to be. I allude to the
death of Hubert Stone.

"'The fates had been unpropitious for some time; circumstances

were against me; I had lost heavily on the turf and in other
speculations, and was nearly at my wit's end for lack of ready
money. It was at this time that my sister, quite innocently, told me of
the strange discovery of a quantity of old family jewels at Heron
Dyke.

"'And, in justice to her, my good and faithful sister, I may here

remark that since she came to live with me I have been more
cautious, and have striven to keep my little peccadilloes from her
knowledge. She may have thought sometimes that my luck at the
card-table was something out of the common way, but of the darker
passages of my life she knew absolutely nothing.

"'It did not take me long to decide that I must make those jewels
mine if it were by any means possible to do so. My circumstances
just then were desperate, and a coup de main had become
absolutely necessary. Burglary was altogether out of my line, but in
this case the enterprise seemed to me so peculiarly an easy one that
I could not make up my mind to forego it. I knew the position of the
room in which the jewels were lying. I knew that it was only a
question of opening a window and forcing a shutter, after the family
should be safe in bed. There were no dogs to fear, and the servants
slept in another wing of the house. Nothing could possibly be more
easy. I felt that I could never forgive myself if I allowed such an
opportunity to escape me.

"'Up to a certain point, everything happened in accordance with my

expectations. The Hall was in darkness; there was no sign of life
anywhere. I found the window I was in search of, and a few minutes
later I stood inside the room. I opened a slide of my dark lantern
and took a survey. There stood the bureau in the corner where I had
expected to find it. I had brought a small chisel and one or two
other implements with me, and a very little time sufficed to force
open the receptacle in which the jewels were stored. What a fine
glow filled my heart as I feasted my sight for a few moments on
their flashing beauty, and recognised the fact that they were all my
own! For some time to come my finances were assured.

"'I was wearing an old shooting-jacket with many pockets, so that I

had no difficulty in stowing away my booty. I was putting away the
last handful when a noise behind me made me start and look round.
There was just enough starlight to enable me to discern the figure of
a man standing at the open, window and gazing into the room.
Flashing a ray from my lantern across his face, I at once recognised
the man as Hubert Stone. A moment later he had vaulted over the
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