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Gsjfna nadj.jsnds ca

- 1. 1 Managerial Economics Chapter 1 1. Managerial economics:-studies how to direct scarce resources in the way that most efficiently achieves a managerial goal 2. Levi Strauss & Co. paid $46,532 for a 110-year-old pair of Levi’s jeans—the oldest known pair of blue jeans—by outbidding several other bidders in an eBay Internet auction. Does this situation best represent producer–producer rivalry, consumer–consumer rivalry, or producer– consumer rivalry? Explain. Answer:-Consumer–consumer rivalry best illustrates this situation. Here, Levi Strauss& Co. is a buyer competing against other bidders for the right to obtain the antique blue jeans. 3. What is the maximum amount you would pay for an asset that generates an income of $150,000 at the end of each of five years if the opportunity cost of using funds is 9 percent? Answer Solution: PV = 150,000 + 150,000 + 150,000 + 150,000 + 150,000 (1+0.09)1 (1+0.09)2 (1+0.09)3 (1+0.09)4 (1+0.09)5 PV = 150,000 + 150,000 + 150,000 + 150,000 + 150,000 1.09 1.1881 1.2950 1.4115 1.5386 PV = 137,614.67 + 126,251.99 + 115,830.11 + 106,269.92 + 97,491.22 PV = $ 583,457.91 What is the maximum value that a manager should pay for an oil rig that generates an income of $155,000 at the end of each of 5 years, if the opportunity cost of using funds is 8 percent? $618,870.06 4. Suppose that the total benefit and total cost from an activity are, respectively, given by the following equations: B(Q) = 150 + 28Q - 5Q2 and C(Q)= 100 + 8Q. (Note: MB(Q) = 28-10Q and MC(Q) = 8.) a) Write out the equation for the net benefits. b) What are the net benefits when Q 1? Q 5? c) Write out the equation for the marginal net benefits. d) What are the marginal net benefits when Q 1? Q 5? e) What level of Q maximizes net benefits? f) At the value of Q that maximizes net benefits, what is the value of marginal net benefits? Answer: a) Net Benefit = Total benefit - Total cost =150 + 28Q – 5Q^2 - 100 - 8Q = 50 + 20Q - 5Q^2 b) AtQ = 1 . Net benefit = 50 + 20 - 5 = 65 At Q = 5 ,Net benefit = 50 + 100 - 125 = 25 c) Marginal Net benefit =MB(Q) -MC(Q) =28 – 10Q - 8 = 20 - 10Q d) At Q = 1 ,Marginal Net benefit = 20 – 10Q = 10, at Q=5 Marginal Net benefit =-30
- 2. 2 ((d) What are the marginal net benefits when Q =1? Q = 5? Marginal net benefits when Q = 1 are MNB(1) = 20 0 = 0 and when Q = 5 they are MNB(5) = = 30. (e) What level of Q maximizes net benefits? Setting MNB(Q) = 20 0Q = 0 and solving for Q, we see that net benefits are maximized when Q = 2. (f) At the value of Q that maximizes net benefits, what is the value of marginal net benefits? When net benefits are maximized at Q = 2, marginal net benefits are zero. That is, MNB(2) = = 0. 5. A firm’s current profits are $550,000. These profits are expected to grow indefinitely at a constant annual rate of 5 percent. If the firm’s opportunity cost of funds is 8 percent, determine the value of the firm: a) The instant before it pays out current profits as dividends. b) The instant after it pays out current profits as dividends. Solution a) PV firm=550,000(1+0.08/0.08-0.05)=$19.8 million b. $19,250,000 6. What is the value of a preferred stock that pays a perpetual dividend of $75 at the end of each year when the interest rate is 4 percent? What is the value of a share of Coca Cola preferred stock that pays a perpetual dividend of $80 at the end of each year when the interest rate is 4 percent? d. $2,000 Maria spends $20,000 per year on painting supplies and storage space. She recently received two job offers from a famous marketing firm. Offer A was for $100,000 per year, and offer B was for $90,000 per year. However, she turned both job offers down to continue a painting career. If Maria sell 20 paintings per year at a price of $10,000 each, then a. her economic profit is $90,000 per year. b. her economic profit is $100,000 per year. c. her economic profit is $180,000 per year. d. her accounting profit is $80,000 per year. e. her accounting profit is $180,000 per year.
- 3. 3 7. It is estimated that over 90,000 students will apply to the top 30 M.B.A. programs in the United States this year. a) Using the concept of net present value and opportunity cost, explain when it is rational for an individual to pursue an M.B.A. degree. b) What would you expect to happen to the number of applicants if the starting salaries of managers with M.B.A. degrees remained constant but salaries of managers without such degrees increased by 15 percent? Why? Solution
- 4. 4 a) The net present value of student’s application of top 30 M.B.A programs in USA is the value of benefits which these students are received from attending school minus the opportunity cost of attending school instead of doing something else. The rational for an individual to pursue an M.B.A degree when student’s net present value is higher than the opportunity cost or their net present value is higher than "zero. b) If the salaries of managers with M.B.A degrees remained constant in while none degrees managers decreased by 20% percent& it will be increased the present value of student’s application and decreased the opportunity! cost of getting M.B.A. Therefore& the number of applicants would expect more students to apply. 8. Jaynet spends $20,000 per year on painting supplies and storage space. She recently received two job offers from a famous marketing firm—one offer was for $100,000 per year, and the other was for $90,000. However, she turned both jobs down to continue a painting career. If Jaynet sells 20 paintings per year at a price of $10,000 each: a. What are her accounting profits? b. What are her economic profits? Solution a. Accounting profits only look at the actual revenue (in dollars) received and the actual costs (in dollars) spent. In this scenario her revenue is 20 x $10,000 = $200,000 and her costs are $20,000 (for the supplies). Thus, accounting profit is $180.000. b. Economic profits include the monetary revenue and costs but also include opportunity costs. An opportunity cost is the value of the next best alternative. In this example she can only take one other job. The best other job would be the higher paying one of $100,000. Thus, this is her opportunity costs. Hence, total economic costs are $100,000 + $20,000 = $120,000 so that her economic profit is $200,000 - $120,000 = $80,000. 9. Suppose the total benefit derived from a given decision, Q, is B(Q) =25Q -Q2 and the corresponding total cost is C(Q) =5 + Q2, so thatMB(Q) =25 _ 2Qand MC(Q) =2Q. a. What is total benefit when Q = 2? Q =10? b. What is marginal benefit when Q = 2? Q =10? c. What level of Q maximizes total benefit? d. What is total cost when Q =2? Q =10? e. What is marginal cost when Q =2? Q =10? f. What level of Q minimizes total cost? g. What level of Q maximizes net benefits?
- 5. 5 Total Cost Function: C(Q)=5+Q2 Total Cost when Q = 2: C(2)=5+(2)2C(2)=5+4C(2)=9 Total Cost when Q = 10: C(10)=5+(10)2C(10)=5+100C(10)=105 Ans. b. Marginal Cost Function: MC(Q)=2Q Marginal Cost when Q = 2: MC(2)=2(2)MC(2)=4 Marginal Cost when Q = 10: MC(10)=2(10)MC(10)=20 Ans. c. The total cost is minimized at a level where the first derivative of the total cost function with respect to quantity becomes equal to zero. ⇒ddQ(C(Q))⇒ddQ(5+Q2)⇒2Q Equating the first-order derivative with zero: 2Q=0Q=0 The total cost of production is minimized when the total quantity produced is zero. Ans. d. Net Benefit Function: NB=25Q−Q2−5−Q2NB=−2Q2+25Q−5 Net benefits will be maximized at the point where the first-order derivative of the net benefit function becomes zero: ⇒ddQ(NB)⇒ddQ(−2Q2+25Q−5)⇒−4Q+25 Equating the first-order derivative with zero: −4Q+25=04Q=25Q=6.25 Net benefits are maximized when the quantity is equal to 6.25 units.
- 6. 6 10. An owner can lease her building for $100,000 per year for three years. The explicit cost of maintaining the building is $35,000, and the implicit cost is $50,000. All revenues are received, and costs are borne, at the end of each year. If the interest rate is 4 percent, determine the present value of the stream of: a. Accounting profits. b. Economic profits. I'm giving you answer of a very similar question. Solve this question same way. It will be helpful for you. Question- An owner can lease her building for $120,000 per year for three years. The explicit cost of maintaining the building is $40,000, and the implicit cost is $55,000. All revenues are received, and costs borne, at the end of each year. If the interest rate is 5 percent, determine the present value of the stream of: Answer- Accounting Profit: First you need to start with the Account Profit formula: Accounting Profit = Total Revenue - Explicit Cost Accounting Profit = 120,000-40,000 Accounting Profit = 80,000 After you find your Accounting Profit you need to use the Present Value of a Stream Formula which is: PV = FV1/(1+i)^1 + FV2/(1+i)^2 + FV3/(1+i)^3 After plug in what you know.. PV = 80,000/(1+5%)^1 + 80,000/(1+5%)^2 + 80,000/(1+5%)^3 PV = 217,859.84. 11. You are in the market for a new refrigerator for your company’s lounge, and you have narrowed the search down to two models. The energy efficient model sells for $500 and will save you $25 at the end of each of the next five years in electricity costs. The standard model has features similar to the energy efficient model but provides no future saving in electricity costs. It is priced at only $400. Assuming your opportunity cost of funds is 5 percent, which refrigerator should you purchase? (15) pts) You are in the market for a new refrigerator for your company’s lounge. You have narrowed the search down to 2 models. The energy efficient model sells for $700 and will save you $45 at the end of each of the next 5 years in electricity costs. The standard model has the same features as the energy efficient model, but no savings in electricity costs. It is priced only at $500. a. Assuming that the discount rate is 6% and each refrigerator will last 5 years (and have the same scrap value), which refrigerator should you purchase? b. If the savings from the energy efficient model go up to $75 a year because of higher electricity costs, will your decision change? Why? ANSWER TO #1 a. Effectively, this is a question of whether it pays to spend an extra $200 on a refrigerator today to save $45 over the next 5 years. You need to calculate the PV of the $45 over 5 years and see if this is less than or greater $200. PV = 45/(1+.06) + 45/(1+.06) 2 + 45/(1+.06) 3 + 45/(1+.06) 4 + 45/(1+.06) 5 = $189.6 Since you are spending an extra $200 in today’s dollars and only saving $189.6 in today’s dollars, you should not buy the energy efficient refrigerator. Alternatively, you could have said that the energy efficient model net cost in today’s dollars is - $510.5 (-$700 + 189.6) versus the standard model cost in today’s dollars of -$500. Since the cost of the energy efficient refrigerator is greater than the cost of the standard model in today’s dollars, you should not buy the energy efficient refrigerator
- 7. 7 b. With a saving of $75 each year for 5 years, the present value of those savings today is: PV = 75/(1+.06) + 75/(1+.06) 2 + 75/(1+.06) 3 + 75/(1+.06) 4 + 75/(1+.06) 5 = $315.9 Since the savings of $75 for five years is worth $315.90 today, the net cost of the energy efficient refrigerator today is $385.10 (or $700 - $315.90) which is less than $500 for the standard refrigerator. You should buy the energy efficient refrigerator. 12. You are the human resources manager for a famous retailer, and you are trying to convince the president of the company to change the structure of employee compensation. Currently, the company’s retail sales staff is paid a flat hourly wage of $18 per hour for each eight-hour shift worked. You propose a new pay structure whereby each salesperson in a store would be compensated $8 per hour, plus five-tenths of 1 percent of that store’s daily profits. Assume that, when run efficiently, each store’s maximum daily profits are $40,000. Outline the arguments that support your proposed plan. The employee’s pay depends on store profit so they will work hard to achieve higher profit. 13. Tara is considering leaving her current job, which pays $56,000 per year, to start a new company that manufactures a line of special pens for personal digital assistants. Based on market research, she can sell about 160,000 units during the first year at a price of $20 per unit. With annual overhead costs and operating expenses amounting to $3,160,000, Tara expects a profit margin of 25 percent. This margin is 6 percent larger than that of her largest competitor, Pens, Inc. a. If Tara decides to embark on her new venture, what will her accounting costs be during the first year of operation? Her implicit costs? Her opportunity costs? b. Suppose that Tara’s estimated selling price is lower than originally projected during the first year. How much revenue would she need in order to earn positive accounting profits? Positive economic profits? Solution a) accounting cost(explicit cost)=$3,160,000 overhead and operating cost, implicit cost=56,000 salary,opportunity cost=implicit cost + explicit cost=3,160,000+56,000=3,216,000 b) to earn positive accounting profit the revenue per year should be greater than 3,160,000 and to earn positive economic profit the revenue per year should be greater than 3,216,000 14. You are the manager of Local Electronics Shop (LES), a small brick-and-mortar retail camera and electronics store. One of your employees proposed a new online strategy whereby LES lists its products at Pricesearch.com—a price comparison Web site that allows consumers to view the prices of dozens of retailers selling the same items. Would you expect this strategy to enable LES to achieve sustainable economic profits? Explain. Answer: The correct answer is No, because due to intense producer-producer rivalry. Explanation: In economics, competition means rivalry of competition between companies that participate in a market that apply better strategies so that they can minimize their
- 8. 8 costs, maximize their profits and thus remain active and innovative vis-à-vis other companies. With this, it seeks that the economic agents strive to improve the use of resources to produce goods and services, and to improve and innovate in the quality and variety of these, with the purpose that results in improvements in competitiveness and more benefit for the consumer , all this to achieve greater economic growth and social welfare. 15. Two months ago, the owner of a car dealership (and a current football star) significantly changed his sales manager’s compensation plan. Under the old plan, the manager was paid a salary of $6,000 per month; under the new plan, she receives 2 percent of the sales price of each car sold. During the past two months, the number of cars sold increased by 40 percent, but the dealership’s margins (and profits) significantly declined. According to the sales manager, “Consumers are driving harder bargains and I have had to authorize significantly lower prices to remain competitive.” What advice would you give the owner of the dealership? Increase the percentage of the sales price the manager receives. Offer the manager a percentage of profits rather than sales. Pay the manager a fixed salary only. CHAPTER-2 DEMAND AND SUPPLY Q#1.The X-Corporation produces a good (called X) that is a normal good. Its competitor, Y- Corp., makes a substitute good that it markets under the name “Y.” Good Y is an inferior good. a. How will the demand for good X change if consumer incomes increase? b. How will the demand for good Y change if consumer incomes decrease? c. How will the demand for good X change if the price of good Y decreases? d. Is good Y a lower-quality product than good X? Explain. Solution a. How will the demand for good X change if consumer incomes increases? Since X is a normal good then its demand will shift out when income levels increase. b. How will the demand for good Y if consumer incomes decreases? Since Y is an inferior good its demand will shift in if income increases. c. How will the demand for good X change if the price of good Y decreases? Since the two are substitute goods a decrease in the price of Y draws away consumers from X. Thus, the demand for X shifts in. d. Is good Y a lower-quality product than good X? Explain. Probably not, but this is a weird question. All we know is that it is an normal good so that people with higher incomes consume it and it has a substitute which is an inferior good. So it seems
- 9. 9 likely that it is of higher quality. What is an easier argument to make is that a lower-quality good tends to be an inferior good and a higher-quality good tends to be a normal good. Q#2.Good X is produced in a competitive market using input A. Explain what would happen to the supply of good X in each of the following situations: c. The price of input A increases. d. An excise tax of $1 is imposed on good X. e. An ad valorem tax of 5 percent is imposed on good X. f. Atechnological change reduces the cost of producing additional units of good X. Solution a. The price of input A increases. Supply would shift in. b. An excise tax of $1 is imposed on good X. Supply would shift in. c. An ad valorem tax of 5 percent os imposed on good X. Supply would shift in. d. A technological change reduces the cost of producing additional units of good X. Supply would shift out. Q#3.Suppose the supply function for product X is given by Qx s =- 50 + 0.5Px- 5Pz. g. How much of product X is produced when Px =$500 and Pz =$30? h. How much of product X is produced when Px= $50 and Pz =$30? i. Suppose Pz =$30. Determine the supply function and inverse supply function for good X. Graph the inverse supply function. Solution a. How much of product X is produced when P of x = $500 and P of z = $30? 50 b. How much of product X is produced when P(Price) of x = $50 and P(Price) of z = $30? I think there may be either a typo in this question or it is a trick question. Plug in the prices Q = - 175, which cannot happen. At these low prices no firm would supply the good. I would say the answer is zero. c. Suppose P(price) of z = $30. Determine the supply function and inverse supply function for good X. Graph the inverse supply function. The supply function is Qs = 0.5Px - 200. The inverse supply function is Px = 2Q + 400. The line you graph should be a straight line with a positive slope. It should hit the y-axis at a price of 400.
- 10. 10 Q#4. The demand for good X is given by Qxd =1,200-1/2 Px +1/4 Py -8Pz+1/10M Research shows that the prices of related goods are given by Py =$5,900 and Pz=$90, while the average income of individuals consuming this product is M=$55,000. a. Indicate whether goods Y and Z are substitutes or complements for good X. b. Is X an inferior or a normal good? c. How many units of good X will be purchased when Px =$4,910? d. Determine the demand function and inverse demand function for good X. Graph the demand curve for good X. Solution a. Indicate whether goods Y and Z are substitutes of complements for good X. The sign of the coefficient in front of the price of good Y is positive, +(1/4). This means that an increase in the price of good Y increases the quantity demanded of good X (even when the price of X stays the same). This happens when consumers of good Y shift their demand to X when Y becomes more expensive. Thus, they are substitutes. The sign of the coefficient in front of the price of good Z is negative, -8. This means that an increase in the price of good Z decreases the quantity demanded of good X (even when the price of X stays the same). This happens when consumers of good Z (who consume a smaller quantity of good Z) also decrease their demand for Z. Thus, they are complements. b. Is X an inferior or a normal good? The sign of the coefficient in front of the income variable is positive, +(1/10). Thus, an increase in income, M, increases the quantity demanded. Thus, X is a normal good. c. How many units of good X will be purchased when P(Price) of x = $4,910? Using the earlier numbers Q = 1200 - .5(4910) +.25(5900) - 8(90) + .1(55000) = 1200 - 2455 + 1475 - 720 +5500 = 5000. Thus, 5000 units will be demanded. d. Determine the demand function and inverse demand function for good X. Graph the demand curve for good X. The demand curve is given in the problem Q = 1200 - .5Px +.25Py - 8Pz +.1M. The inverse demand curve simply solves this for Px, or rather, Px = 2400 - 2Q + .5Py - 16Pz + .2M. I cannot graph this for you here. But I can describe it. Px should be on the vertical axis and Q on the horizontal. The demand curve should be a straight, downward- sloping line (the slope is -2). It should intercept the y-axis at 2400 + .5py - 16Pz + .2M.
- 11. 11 5. The demand curve for product X is given by Qxd= 460 - 4Px. a. Find the inverse demand curve. b. How much consumer surplus do consumers receive when Px =$35? c. How much consumer surplus do consumers receive when Px =$25? d. In general, what happens to the level of consumer surplus as the price of a good falls? Solution a. Find the inverse demand curve. PX = - QXd Instructions: Round your answer to the nearest penny (2 decimal places). b. How much consumer surplus do consumers receive when Px = $35?$ c. How much consumer surplus do consumers receive when Px = $25?$ d. In general, what happens to the level of consumer surplus as the price of a good falls? The level of consumer surplus (Click to select)doesn't change increases decreases as the price of a good falls. 6. Suppose demand and supply are given by Qd =50- P and Qs =1/2P -10. a) What are the equilibrium quantity and price in this market? b) Determine the quantity demanded, the quantity supplied, and the magnitude of the surplus if a price floor of $42 is imposed in this market. c) Determine the quantity demanded, the quantity supplied, and the magnitude of the shortage if a price ceiling of $30 is imposed in this market. Also, determine the full economic price paid by consumers. Solution a. What are the equilibrium quantity and price in this market? You need to find the price where the quantity demanded equals the quantity supplied, or rather, the P* where 50 - P* = (1/2)P* - 10. Simplifying, 60 = (3/2)P*, or rather, P* = 120/3 = 40. Thus, the equilibrium price is 40. You can plug it into either the demand or supply curve to find the quantity (both allows you to double check). The equilibrium quantity is 10. b. Determine the quantity demanded, the quantity supplied, and the magnitude of the surplus is a price floor of $42 is imposed in this market. A price floor is a minimum allowable price. Since equilibrium is at $40 the floor matters. At a price of 42 the quantity demanded is Qd = 50 - 42 = 8. At a price of 42 the quantity supplied is Qs = (1/2)(42) - 10 = 21 - 10 = 11.
- 12. 12 c. Determine the quantity demanded, the quantity supplied, and the magnitude of the shortage if a price ceiling of $30 is imposed in this market. Also, determine the full price paid by consumers. A price ceiling is a maximum allowable price. At a price of 30 the quantity demanded is Qd = 50 - 30 = 20. The quantity supplied is Qs = (1/2)(20) - 10 = 0. The shortage is the gap between the quantity demanded and the quantity supplied, or rather, 20 - 0 = 20. I have never heard of the term "full price", but I expect it means the price charged for the goods, which is $30. 7. Suppose demand and supply are given byQx s =7-1/2px and Qx s =1/4px-1/2 a. Determine the equilibrium price and quantity. Show the equilibrium graphically. b. Suppose a $6 excise tax is imposed on the good. Determine the new equilibrium price and quantity. c. How much tax revenue does the government earn with the $6 tax? Solution a. Determine the equilibrium price and quantity. SHow the equilibrium graphically. You need to find the price where the quantity demanded equals the quantity supplied, or rather, the P* where 7 - (1/2)P* = (1/4)P* - 1/2. Simplifying, 15/2 = (3/4)P*, or rather, P* = 30/3 = 10. Thus, the equilibrium price is 10. You can plug it into either the demand or supply curve to find the quantity (both allows you to double check). The equilibrium quantity is 2. Again, I can only explain what the graph should look like. The demand curve should be a straight, downward-sloping line. It intersects the y-axis at a price of 14 and intersects the x-axis at a quantity of 7. The supply curve is a straight, upward-sloping line. It hits the y-axis at a price of 2. b. Suppose a $6 excise tax is imposed on the good. Determine the new equilibrium price and quantity. To model an excise tax the supply curve needs to shift up by $6. The old supply curve can be rewritten as P = 4Q + 2. Add 6 to the intercept term to shift it up for the new tax to P = 4Q + 8, which can be rewritten in the typical form Q = (1/4)P - 2. Setting this equal to the demand curve you get (1/4)P - 2 = 7- (1/2)P, which simplifies to (3/4)P = 9, or rather, P = 36/3 = 12. The new equilibrium price is 12. To find the quantity plug this into the demand curve, Q = 7 - (1/2)(12) = 7 - 6 = 1. The new equilibrium quantity is 1. c. How much tax revenue does the government earn with the $6 tax? One unit is sold at a $6 is charged. Thus, total tax revenue is $6. 8. The supply curve for product X is given by Qs x = -340 +10P x . a. Find the inverse supply curve. b. How much surplus do producers receive when Qx =350? When Qx =1,000? a)Inverse supply curve P=34+Q/10
- 13. 13 b) QX=350, PX=34+1/10(350)=34+35=69 QX=1000,px=34+1/10(1000)=134 11.You are the manager of a midsized company that assembles personal computers. You purchase most components such as random access memory (RAM) in a competitive market. Based on your marketing research, consumers earning over $75,000 purchase 1.3 times more RAM than consumers with lower incomes. One morning, you pick up a copy of The Wall Street Journal and read an article indicating that a new technological breakthrough will permit manufacturers to produce RAM at a lower unit cost. Based on this information, what can you expect to happen to the price you pay for random access memory? Would your answer change if, in addition to this technological breakthrough, the article indicated that consumer incomes are expected to grow over the next two years as the economy pulls out of recession? Explain. In this case, the price of the RAM can rise because cost increase, assume the news of the Wall Street Journal, people with earning lower $80,000 they won't buy RAM because is too expensive, and people with over these earnings will buy less RAM, in addition, the incomes will fall, and the demand of RAM will fall too, but for the same reason the price could fall for the poor demand. 12. You are the manager of a firm that produces and markets a generic type of soft drink in a competitive market. In addition to the large number of generic products in your market, you also compete against major brands such as Coca-Cola and Pepsi. Suppose that, due to the successful lobbying efforts of sugar producers in the United States, Congress is going to levy a $0.50 per pound tariff on all imported raw sugar—the primary input for your product. In addition, Coke and Pepsi plan to launch an aggressive advertising campaign designed to persuade consumers that their branded products are superior to generic soft drinks. How will these events impact the equilibrium price and quantity of generic soft drinks? The tariff leads to decrease in supply of sugar and hence the prices of sugar shall rise which form input products to soft drinks. Thus increasing soft drink prices will now lead to decrease in supply of generic soft drinks. Now due to aggressive marketing by Coke and Pepsi the demand fir generic soft drinks shall reduce and hence the equilibrium quantity will reduce and so will the equilibrium prices. 13. Some have argued that higher cigarette prices do not deter smoking. While there are many arguments both for and against this view, some find the following argument to be the most persuasive of all: “The laws of supply and demand indicate that higher prices are ineffective in reducing smoking. In particular, higher cigarette prices will reduce the demand for cigarettes. This reduction in demand will push the equilibrium price back down to its original level. Since the equilibrium price will remain unchanged, smokers will consume the same number of cigarettes.” Do you agree or disagree with this view? Explain. 15. As a result of increased tensions in the Middle East, oil production is down by 1.21 million barrels per day a 5 percent reduction in the world’s supply of crude oil. Explain the likely impact of this event on the market for gasoline and the market for small cars.
- 14. 14 16. You are an assistant to a senator who chairs an ad hoc committee on reforming taxes on telecommunication services. Based on your research, AT&T has spent over $15 million on related paperwork and compliance costs. Moreover, depending on the locale, telecom taxes can amount to as much as 25 percent of a consumer’s phone bill. These high tax rates on telecom services have become quite controversial, due to the fact that the deregulation of the telecom industry has led to a highly competitive market. Your best estimates indicate that, based on current tax rates, the monthly market demand for telecommunication services is given by Qd =250-5P and the market supply (including taxes) is Qs =4P-110 (both in millions), where P is the monthly price of telecommunication services. The senator is considering tax reform that would dramatically cut tax rates, leading to a supply function under the new tax policy of Qs =4.171P - 110. How much money would a typical consumer save each month as a result of the proposed legislation?
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- 19. 19 CHAPTER 2 DEMAND ELASTICITY 1. Answer the following questions based on the accompanying diagram. a. How much would the firm’s revenue change if it lowered price from $12 to$10? Is demand elastic or inelastic in this range? b. How much would the firm’s revenue change if it lowered price from $4 to$2? Is demand elastic or inelastic in this range? c. What price maximizes the firm’s total revenues? What is the elasticity ofdemand at this point on the demand curve? Answer a) When price is $12,Revenue = Demand X Price= 1 X $12= $12 When price is $10,Revenue = Demand X Price= 2 X $10= $20 The change in revenue is $8. Price elasticity of demand= % change in quantity /% change in price = 50% / -17%= - 2.94The value of -2.94 means that when price decrease, demand will increase and vice versa.This shows that demand of the product is inelastic 2.The demand curve for a product is given byQxd =1,000-2Px+0.02Pz,where Pz=$400. a) What is the own price elasticity of demand when Px=$154? Is demand elastic or inelastic at this price? What would happen to the firm’s revenue if it decided to charge a price below $154? b) What is the own price elasticity of demand when Px=$354? Is demand elastic or inelastic at this price? What would happen to the firm’s revenue if it decided to charge a price above $354? c) What is the cross-price elasticity of demand between good X and good Z when Px=$154? Are goods X and Z substitutes or complements? Solution Preview 1. The demand curve for a product is given by Qdx =1,000 - 2Px +.02Pz where Pz = $400. a. What is the own price elasticity of demand Px = $154? Is demanded elastic or inelastic at this price? What would happen to the firm's revenue if it decided to charge a price below $154? Qdx =1,000 - 2Px +.02Pz On, differentiating with respect to Px, we get d(Qdx)/dPx=-2 Value of Qdx at Px=$154 and Pz=$400 Qdx=1000-2*154+0.02*400=700
- 20. 20 Own price elasticity of demand= [d(Qdx)/dPx]*[Px/Qdx] =-2*(154/700)=-0.44 Absolute value of own price elasticity of demand is less than 1, we can say that demand is inelastic at Px=$154. In case of inelastic demand, total revenue will decrease if price decreases. We can say that total revenue will fall if firm changes a price below $154. b. What is the own price elasticity of demand Px = $354? Is demanded elastic or inelastic at this price? What would happen to the firm's revenue if it decided to charge a price below $354? Qdx =1,000 - 2Px +.02Pz On, differentiating with respect to Px, we get d(Qdx)/dPx=-2 Value of Qdx at Px=$354 and Pz=$400 Qdx=1000-2*354+0.02*400=300 3. Suppose the demand function for a firm’s product is given by lnQd x=3-0.5lnPx-2.5Py+lnM+2lnA WherePx=10, Py=4, M=20,000 ,A=250 a. Determine the own price elasticity of demand, and state whether demand iselastic, inelastic, or unitary elastic. b. Determine the cross-price elasticity of demand between good X and goodY, and state whether these two goods are substitutes or complements. c. Determine the income elasticity of demand, and state whether good X is anormal or inferior good. d. Determine the own advertising elasticity of demand. Answer a. Own price elasticity of demand = lnQx/ lnPx. E = -1.5 Demand is elastic because the absolute value of the elasticity is greater than one. b. Cross price elasticity Ec = Ln Qx/ Ln Py. Ec = 2. the two goods in question are substitutes. This is because a positive relation between the price of one and demand of the other proves the same. As the price of one
- 21. 21 increases, the other automatically becomes cheaper to buy and hence the demand increases. c. Income elasticity Em = Ln Qx/ Ln M. Em = -0.5. Negative sign shows that the good X is an inferior good. d. Advertising elasticity Ea = Ln Qx/ Ln A. Ea = 1. 4. Suppose the own price elasticity of demand for good X is -2, its income elasticityis 3, its advertising elasticity is 4, and the cross-price elasticity ofdemand between it and good Y is -6. Determine how much the consumptionof this good will change if: a. The price of good X increases by 5 percent. b. The price of good Y increases by 10 percent. c. Advertising decreases by 2 percent. d. Income falls by 3 percent. 5. Suppose the cross-price elasticity of demand between goods X and Y is -5.How much would the price of good Y have to change in order to increase theconsumption of good X by 50 percent? The formula for cross-price elasticity of demand (CPE) is the following: Next, we plug in the given values of CPE and percentage change of... See full answer below. 6. You are the manager of a firm that receives revenues of $30,000 per year fromproductXand $70,000 per year from product Y. The own price elasticity ofdemand for product X is -2.5, and the cross-price elasticity of demand betweenproductYandX is 1.1. How much will your firm’s total revenues (revenuesfrom both products) change if you increase the price of good X by 1 percent? Answer It is given that the own price elasticity if -2.5, it implies that a 1% change rise in the price level will decrease the demand for product X by 2.5% Therefore, revenue loss on product X would be:
- 22. 22 30,000*(-2.5)/100=-750 similarily Cross price elasticity of demand is given as 1.1, it implies that 1% increase in the price of good x will lead to an increase in the demand for product y would be 1.1 Therefore, the revenue gain on product would be: 70,000*1.1/100=770 Using the change in revenue of both product, firms total revenue would be :- -750+770=20 hence 1% change in the price of product x leads to increase in the total revenue of the firm by 20. 7. Revenue at a major cellular telephone manufacturer was $1.4 billion for the ninemonths ending March 2, up 97 percent over revenues for the same period lastyear. Management attributes the increase in revenues to a 137 percent increase inshipments, despite a 17 percent drop in the average blended selling price of itsline of phones. Given this information, is it surprising that the company’s revenueincreased when it decreased the average selling price of its phones? Explain. 8. You are the manager of a firm that sells a leading brand of alkaline batteries.A file named Q12.xls with data on the demand for your product is availableonline at www.mhhe.com/baye7e. Specifically, the file contains data on thenatural logarithm of your quantity sold, price, and the average income of consumersin various regions around the world. Use this information to perform alog-linear regression, and then determine the likely impact of a 3 percentdecline in global income on the overall demand for your product. 9. For the first time in two years, Big G (the cereal division of General Mills)raised cereal prices by 2 percent. If, as a result of this price increase, the volumeof all cereal sold by Big G dropped by 3 percent, what can you infer aboutthe own price elasticity of demand for Big G cereal? Can you predict whetherrevenues on sales of its Lucky Charms brand increased or decreased? Explain. 10. If Starbucks’s marketing department estimates the income elasticity of demandfor its coffee to be 1.75, how will looming fears of a recession (expected todecrease consumers’ incomes by 4 percent over the next year) impact the quantityof coffee Starbucks expects to sell? 11. You are a division manager at Toyota. If your marketing department estimates thatthe semiannual demand for the Highlander is Q = 100,000 -1.25P, what price should you charge in order to maximize revenues from sales of the Highlander? Given the semi-annual demand for the Highlander is Q = 100,000 – 1.25P Or P = (100,000 / 1.25) – (1// 1.25)*Q P = 80,000 - 0.8Q Total revenue (TR) = P*Q = 80,000Q - 0.8Q^2 MR = 80,000 - 1.6Q (differentiating TR w.r.t. Q) Total revenue is maximum when marginal revenue is zero, . The profit maximizing quantity and price can be determined by setting marginal revenue equal to zero, which occurs...
- 23. 23 12. You are a manager in charge of monitoring cash flow at a company that makesphotography equipment. Traditional photography equipment comprises 80 percentof your revenues, which grow about 2 percent annually. You recentlyreceived a preliminary report that suggests consumers take three times more digitalphotographs than photos with traditional film, and that the cross-price elasticityof demand between digital and disposable cameras is -0.2. In 2009, yourcompany earned about $400 million from sales of digital cameras and about$600 million from sales of disposable cameras. If the own price elasticity ofdemand for disposable cameras is -2.5, how will a 1 percent decrease in theprice of disposable cameras affect your overall revenues from both disposableand digital camera sales? (a) Own-price elasticity for disposable camera = % Change in quantity of disposable camera / % Change in its own price -2.5 = % Change in quantity of disposable camera / (-1%) % Change in quantity of disposable camera = (-2.5) x (-1)=2.5 13. The owner of a small chain of gasoline stations in a large Midwestern town read an article in a trade publication stating that the own-price elasticity of demand for gasoline in the United States is -0.2. Because of this highly inelastic demand in the United States, he is thinking about raising prices to increase revenues and profits. Do you recommend this strategy based on the information he has obtained? Explain? B. Yes - since his elasticity is -0.2, a price increase will raise revenues. CHAPTER 3 Production and Costs A firm can manufacture a product according to the production function Q=F(K, L)K3/4L1/4 a. Calculate the average product of labor, APL, when the level of capital is fixed at 16 units and the firm uses 16 units of labor. How does the average product of labor change when the firm uses 81 units of labor? b. Find an expression for the marginal product of labor, MPL, when the amount of capital is fixed at 16 units. Then, illustrate that the marginal product of labor depends on the amount of labor hired by calculating the marginal product of labor for 16 and 81 units of labor. c. Suppose capital is fixed at 16 units. If the firm can sell its output at a price of $100 per unit and can hire labor at $25 per unit, how many units of labor should the firm hire in order to maximize profits? Solution 1a. k=81,L=16 Q=(81)3/4 (16)1/4 =54 APL=Q/L=54/16=3.38
- 24. 24 1b. K=81 Q=(81)3/4 L1/4=27*L1/4 MPL=dQ/dL=27*1/4/L3/4 When L=16,MPL=6.75*/(16)3/4=0.84 When L=81,MPL=6.75*/(81)3/4=0.25 1c. L =16. 2. Afirm’s product sells for $2 per unit in a highly competitive market. The firm produces output using capital (which it rents at $75 per hour) and labor (which is paid Q F(K, L) K3/4L1/4 a wage of $15 per hour under a contract for 20 hours of labor services). Complete the following table and use that information to answer the questions that follow. a. Identify the fixed and variable inputs. b. What are the firm’s fixed costs? c. What is the variable cost of producing 475 units of output? d. How many units of the variable input should be used to maximize profits? e. What are the maximum profits this firm can earn? f. Over what range of the variable input usage do increasing marginal returns exist? g. Over what range of the variable input usage do decreasing marginal returns exist? h. Over what range of input usage do negative marginal returns exist? Solution 2a. Labor is the fixed input while capital is the variable input 2B. FIXED COST=20*15=300 2C) 475 UNITS CAN BE PRODUCED BY either 6 and 7 units of capital so the variable cost of producing 475 units is 450 or 525 2d) firms must hire capital upto the point where the difference b/n the vmpk and its rental price is minimum. This occurs at K=6 2e) total cost=300+6*75=750 Total revenue =2*475=950 Profit=TR-TC=200 2f) Till K=3, there is increasing marginal returns
- 25. 25 2g) Till k=4 till k=7 there are diminishing marginal returns 2h) k=8 there is negative marginal returns 3. Explain the difference between the law of diminishing marginal returns and the law of diminishing marginal rate of technical substitution. 4. An economist estimated that the cost function of a single-product firm is C(Q)=50+25Q+30Q2 +5Q3 Based on this information, determine: a. The fixed cost of producing 10 units of output. b. The variable cost of producing 10 units of output. c. The total cost of producing 10 units of output. d. The average fixed cost of producing 10 units of output. e. The average variable cost of producing 10 units of output. f. The average total cost of producing 10 units of output. g. The marginal cost when Q 10. Solution 4. a. FC = $50. 5. A manager hires labor and rents capital equipment in a very competitive market. Currently the wage rate is $6 per hour and capital is rented at $12 per hour. If the marginal product of labor is 50 units of output per hour and the marginal product of capital is 75 units of output per hour, is the firm using the cost-minimizing combination of labor and capital? If not, should the firm increase or decrease the amount of capital used in its production process? C(Q) 50 25Q 30Q2 5Q3 6. A firm’s fixed costs for 0 units of output and its average total cost of producing different output levels are summarized in the table below. Complete the table to find the fixed cost, variable cost, total cost, average fixed cost, average variable cost, and marginal cost at all relevant levels of output. 7. A multiproduct firm’s cost function was recently estimated as C(Q1, Q2)=75-0.25Q1Q2+0.1Q1 2 +0.2Q2 2 a. Are there economies of scope in producing 10 units of product 1 and 10 units of product 2? b. Are there cost complementarities in producing products 1 and 2?
- 26. 26 c. Suppose the division selling product 2 is floundering and another company has made an offer to buy the exclusive rights to produce product 2. How would the sale of the rights to produce product 2 change the firm’s marginal cost of producing product 1? Solution 7. b. Cost complementarities exist since a =0.25 < 0 8. Explain the difference between fixed costs, sunk costs, and variable costs. Provide an example that illustrates that these costs are, in general, different. 9. A firm produces output according to a production function Q =F(K,L) =min {2K,4L}. a. How much output is produced when K =2 and L =3? b. If the wage rate is $30 per hour and the rental rate on capital is $10 per hour, what is the cost- minimizing input mix for producing 4 units of output? c. How does your answer to part b change if the wage rate decreases to $10 per hour but the rental rate on capital remains at $10 per hour? 10. A firm produces output according to the production function Q = F(K,L) =2K+4L. a. How much output is produced when K =2 and L= 3? b. If the wage rate is $30 per hour and the rental rate on capital is $10 per hour, what is the cost- minimizing input mix for producing 16 units of output? c. How does your answer to part b change if the wage rate decreases to $10 per hour but the rental rate on capital remains at $10 per hour? C(Q1, Q2) 75 Chapter-4 Market structure 1. Ten firms compete in a market to sell product X. The total sales of all firms selling the product are $1 million. Ranking the firms’sales from highest to lowest, we find the top four firms’sales to be $175,000, $150,000, $125,000, and $100,000, respectively. Calculate the four-firm concentration ratio in the market for product X. Solution 175,000+150,000+125,000+100,000/1000000=0.55 2. Evaluate the following statement: “Managers should specialize by acquiring only the tools needed to operate in a particular market structure. That is, managers should specialize in managing either a perfectly competitive, monopoly, monopolistically competitive, or oligopoly firm.”
- 27. 27 Managers should not specialize in learning to manage a particular type of marketstructure. Market structure generally evolves over time, and managers must adapt tothese changes. 3. Consider a firm that operates in a market that competes aggressively in prices. Due to the high fixed cost of obtaining the technology associated with entering this market, only a limited number of other firms exist. Furthermore, over 70 percent of the products sold in this market are protected by patents for the next eight years. Does this industry conform to an economist’s definition of a perfectly competitive market? No. The conditions for perfect competition include: a. There are many buyers and sellers of products. b. The products are homogenous. c. Consumers and producers have perfect information. d. There is free entry and exit 4. Firms like Papa John’s, Domino’s, and Pizza Hut sell pizza and other products that are differentiated in nature. While numerous pizza chains exist in most locations, the differentiated nature of these firms’products permits them to charge prices above marginal cost. Given these observations, is the pizza industry most likely a monopoly, perfectly competitive, monopolistically competitive, or an oligopoly industry? Use the causal view of structure, conduct, and performance to explain the role of differentiation in the market for pizza. Then apply the feedback critique to the role of differentiation in the industry. The pizza market belongs to the monopolistic compitetive market with a few large firms but tens of thousands of small independent family owned outlets. 5. Del Monte has a long and rich tradition in the American food processing industry. It is perhaps best known for packaging canned fruits and vegetables. Part of its success has involved acquiring other brands of canned fruits and vegetables. Suppose that Del Monte is continuing its business plan of expansion by acquisition and that the following table summarizes potential acquisition targets. As the CEO’s horizontal merger and acquisition advisor, it is your task to guide the decision-making process. Based only on the information contained in the table, is a horizontal merger with one of these companies likely to pass the U.S. government’s scrutiny and enhance Del Monte’s performance? Justify your conclusion. Answer Based on the information united states government scrutiny will not allow Del monte to acquire an other company. 6. In January 2007, XM enjoyed about 58 percent of satellite radio subscribers, and Sirius had the remaining 42 percent. Both firms were suffering losses, despite their dominance in the satellite radio market. In 2008, the DOJ decided not to challenge a merger, and these two firms united to become Sirius XM. If you were an economic consultant for Sirius, what economic arguments would you have presented to the DOJ to persuade it not to challenge the merger? Explain. I woudld persuade the DOJ not to challenge the merger on the bases that the market for satellite radio is unit elastic. A consumer have a choice.