Arcadia University BA 620 Managerial Economics

Class code: SN5

Leo TAN Jian Liang, P000096369

Dr TAN Boon Seng

Problem Set #1

Question 1:

Control Variable

(Q)

Total Benefit

B(Q)Total

Cost C(Q)

Net Benefit

N(Q)

Marginal Benefit MB(Q)

Marginal Cost

MC(Q)

Marginal Net Benefit

MNB(Q)100 1200 1000 200 210 90 120101 1400 1100 300 200 100 100102 1590 1210 380 190 110 80103 1770 1330 440 180 120 60104 1940 1460 480 170 130 40105 2100 1600 500 160 140 20106 2250 1750 500 150 150 0107 2390 1910 480 140 160 -20108 2520 2080 440 130 170 -40109 2640 2260 380 120 180 -60110 2750 2450 300 110 190 -80

a. At level 106 where the Net Benefit is 500

b. The relation between Marginal Benefit and Marginal Cost at this level are

the same.

Question 2:

a. To obtain the level of Q that maximize the total benefit, MB should be

equals to 0, it would yield Q=25

b. The level if Q that minimizes the total costs would be Q=0

c. To obtain the level of Q that maximizes the net benefit, equate MB = MC, it

would yield Q=24.5

d. The optimal level of recycling would Q=24.5 which the net benefit and

maximized

Question 3:

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The NPV of the investment is

NPV= $15,000

(1+0.20 )1−$10,000=$ 2,500

The investment should be undertaken, firstly the investment has a positive

NPV, secondly the since the NPV is positive, in one year’s time, the $15,000

generated from the investment will be able to pay off the loan plus interest

and the firm will gain $2,500 from this investment.

Question 4:

a. Option A had the highest first year profits comparing to the other two

options, however it has the lowest second and third year. Option B has the

moderate profit for first year, and subsequent years. Option C has the lowest

first year profit but the highest profit for second and third year. A possible real

world option is investing in advertising, the investment for the first year, will

erode the profit, but bring about greater profit in the subsequent years.

Question 5:

Question 6:

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a. The inverse demand curve would be

Q=100-20P

Q-100=-20P

P=5-(Q/20)

b. The consumer surplus will be $9,000

c. The consumer surplus will be $16,000

d. Generally the consumer surplus will increase when the price falls

Question 7:

The proposed bill is a price ceiling of $.50. This would create a shortage of

ATMs. The amount of the shortage will equal the difference between the

quantity demanded and the quantity supplied at the price ceiling, Longer lines

are likely to develop at ATM machines. Including the value of lost time; the full

economic price paid for ATM usage will exceed the current price of $1.35 per

transaction. Note that the actual magnitude of the shortage and full economic

price will depend on the relative slopes of the demand and supply curves.

Since ATMs are durable equipment, the short-run quantity supply response

may be small.

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Question 8:

Pre-advertising Post-advertisingIncremental

Revenue and CostsTotal Revenue 22,540,100 32,347,800 9,807,700

Variable CostTV airtime 6,100,000 9,045,700 2,945,700Ad development labor 2,357,100 3,536,200 1,179,100Total variable costs 8,457,100 12,581,900 4,124,800

Direct Fixed CostDepreciation-computer equipment 1,500,000 1,500,000Total direct fixed cost 1,500,000 1,500,000 0

Indirect Fixed CostManagerial salaries 8,458,100 8,458,100Office supplies 2,003,500 2,003,500Total indirect fixed cost 10,461,600 10,461,600 0

Profit 2,121,400 7,804,300 5,682,900

Conclusion: We should launch the campaign because the incremental

revenue of $9,807,700 exceeds the incremental costs of $4,124,800. Doing

so will add $5,682,900 to the bottom-line.

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Problem Set #2

Question 1:

a. At the given prices, quantity demanded is 1500 units: Substituting the

relevant information into the elasticity formula:EQ ,P=−5PXQX

gives -0.40. Since

this is less than one in absolute value, demand is inelastic at this price. If the

firm charged a lower price, total revenue would decrease.

b. At the given prices, quantity demanded is 850 units: Substituting the

relevant information into the elasticity formula:EQ ,P=−5PXQX

gives -1.56. Since

this is more than one in absolute value, demand is elastic at this price. If the

firm charged a higher price, total revenue would decrease.

Question 2:

a. Q = (0.1)(500) = 5. Demand for hotel will increase by 5 units.

b. Q= (0.8)(-10) = -8. Demand for hotel will decrease by 8 units.

c. Q= (-2.25)(7) = - 15.75. Demand for hotel will decrease by 16 units

d. Q= -1.5(5) + 0.1(8) = -7.42. Demand for hotel will decrease by 7 units

Question 3:

Using the formula for income elasticity, the demand for lawn furniture will drop

by 4.25 percent for this year. The approach would be to order 4.25 percent

less PVC pipe.

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Question 5:

a. Sue’s preference is not consistent with the assumption of consumer

behavior. The rule of transitivity is not fulfilled. Given that she prefers Mr. Lee

to Ms. Doe, Ms. Doe to Mr. James, then she must prefer Mr. Lee to Mr.

James but no the reverse.

b. If they were voted on in pairs, it would depend on which pair was voted on

first. For example, if Lee and Doe were paired first, Lee would win the first

vote, and James the second.

Question 6:

The statement is false. The frequent flyer programs are, in effect, a "buy 5

tickets, get one free" deal. The price of the first 5 tickets remains unchanged

under the deal (5 tickets cost $300 each, or $1500), while the price of the 6th

ticket is zero. That can result in higher quantity demand for tickets than if the

price were lowered to $250 (6 tickets cost $1500). It is like “buy 1 pizza, get 1

free” resulting in higher quantity demand than if, instead, price was lowered

50%.

Question 7A:

a. The price of X is and Y is $50 and $100 respectively

b. 0 units of product X could be purchased at point A

c. 6 units of product X could be purchased at point E

d. 1 units of product X could be purchased at point B

e. 7 units of product X could be purchased at point F

f The most preferred would in the order of D, B, C, A

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Question 8:

Psat = 60

Qsat = 168 – 0.9 (60) + 1.05 (25) + 1.10 (30) = 173.25 (in thousands)

R = 173.25 * 60 = 10395 (in thousands) = 10.395 million

(this is not enough to cover the monthly cost)

Qsat = 227.25 – 0.9Psat

R = 227.25 – 0,9P2

MR = 227.25 – 1.8P = 0

P = $126.25

Q = 227.25 – 0.9 (126.25) = 113.625

The monthly subscription of $60 is not enough to cover the cost. It is possible

for News Corp to cover its cost if it charges $126.25.

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Problem Set #3

Question 1:

L K Q MP(L) AP(L) AP(K) VMP(L)0 5 0 - - - -1 5 10 10 10 2 502 5 30 20 15 6 1003 5 60 30 20 12 1504 5 80 20 20 16 1005 5 90 10 18 18 506 5 95 5 16 19 257 5 95 0 14 19 08 5 90 -5 11 18 -259 5 80 -10 9 16 -50

10 5 60 -20 6 12 -10011 5 30 -30 3 6 -150

a. Capital is the fixed input and Labor is the variable input

b. Fixed costs: (5)($20) = $100.

c. Assume that labor is indivisible, (must be rented in an integer number of

units). Then the required variable cost is (2)($5), which equals $10.

d. Using the VMPK = r, 6 units of capital should be used to maximize profits.

e. The maximum profits are ($5)(95) - ($5)(6) - ($20)(5) = $345.

f. There are increasing marginal returns when K is less than or equal to 3.

g. There are decreasing marginal returns when K is greater than 3.

h. There are negative marginal returns when K is greater than 7.

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Question 2:

a. 2,000 ($40) = $80,000

b. It is dependent on how much the competitors are offering at the moment.

Question 3:

Question 4:

With a flat long-run average cost curve, there are neither economies nor

diseconomies of scale in banking services. Consolidation would mean that

2,500 banks would each have to double their output in order to service the

consumers initially served by 5,000 banks. But the corresponding average

cost per firm, as well as total costs for the industry, would be unchanged.

Question 5:

a. Spot Exchange

b. Vertical Integration

c. Contract

d. Spot Exchange

e. The contract should be reduced or changed to a spot exchange.

Question 6:

The principal agent problem is found in most employer/employee

relationships. In this case, since the police officers are not carrying out their

supposed duties. The mayor is facing the hold up problem, as the police

officers is trying to take advantage of the city’s investment in the RNC.

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Q FC VC TC AFC AVC ATC MC0 $20,000 - $20,000 - - - -

100 $20,000 $580,000 $600,000 $200 $5,800 $6,000 $5,800200 $20,000 $730,000 $750,000 $100 $3,650 $3,750 $1,500300 $20,000 $1,180,000 $1,200,000 $67 $3,933 $4,000 $4,500400 $20,000 $2,180,000 $2,200,000 $50 $5,450 $5,500 $10,000500 $20,000 $2,980,000 $3,000,000 $40 $5,960 $6,000 $8,000600 $20,000 $4,480,000 $4,500,000 $33 $7,467 $7,500 $15,000

Question 7:

a. Insurance agents: Commission based which is correlated to the amount of

insurance contracts sold by that agent. The commission incentivizes the

agents to find new clients and sell insurance contracts, thereby increasing the

firm’s revenue.

b. Football players: Fixed salary. Performance is usually easy to measure for

football players so their fixed salary will be tied to how well they performed.

c. Authors: Measure of performance based on book sales. Authors usually

receive a percentage of the revenues generated by their books. This

incentivizes the authors to write good books.

d. CEOs of major corporations: It is not always easy to measure a CEOs

performance. Usually the variable component is much higher than the fixed

component of CEO’s compensation due to the fact that performance is not

easy to measure and to incentivize the CEO to perform to his/her best ability.

e. Food servers: Normally the compensations are fixed with a variable

component. Depending on the culture of the country the variable may be a lot

higher to the fixed in order to incentivize the servers to perform.

Question 8:

To maximize profits, the firm should continue adding workers so long as the

value marginal product exceeds the wage. The value marginal product is

defined as the marginal product times the price of output. Here, output sells

for $100 per unit, so the value marginal product of the third worker is $100(29)

= $2,900. The table above summarizes the VMPL for each possibility. Since

the wage is $2,800, the profit maximizing number of workers is 3.

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Problem Set #4

Question 1:

a. HHI = 10,000[(.35)2 + (.25)2 + (.1)2 + (.1)2 + (.1)2 + (.1)2] = 2,250.

b. C = 35 + 25 + 10 + 10 = 80

c. After the merger the HHI increases to 10,000[(.35)2 +(.25)2 +(.10)2 +(.10)2

+(.20)2 ] = 2,450. The merger is likely to be challenged because (a) the

original HHI, 2,250, is greater than that in the Guidelines (1,800) and (b) the

new HHI increases by 200, which is greater than that in the Guidelines (100).

Question 2:

Munopliee Air is monopolizing the route from Erewhon and El Dorado. A

monopolist firm will always maximize their profit by providing less than market

demand and charging a higher price. Therefore, load factor fo85% for

Munopilee Air could be due to the high price they charge that only certain

group of travelers can afford to pay. Upstart Airways will introduce competition

to this monopolistic environment. In the long run, thi s will drive the market

towards a lower cost to consumers travelling from Erewhon and El Dorado.

With a lower price, consumer will be able to afford flying which means the

current load factor of 85% will not be valid as the occupation rate will go

beyond 85%.

Question 3:

Monopolistically competitive. In a monopolistically competitive market, there

are many firms, but each firm produces a differentiated product. Competition

is in the form of free-entry until the profits from each firm's price-cost margins

just covers their fixed costs.

According to the causal view, the structure of differentiated products causes

firms to capitalize on the absence of close substitutes by charging higher

prices.

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According to the feedback critique, the conduct of firms may determine the

market structure. The products of firms may be differentiated because of the

conduct of firms in the industry. Examples of such conduct include advertising

and other behavioral tactics that feedback into demand, causing consumers to

view products as differentiated. Thus, it is not at all clear that differentiated

products are a structural variable.

Question 4:

Wal-Mart operates in a more competitive environment then Intel in 1994. Intel

was reluctant to take actions because the cost of not taking action was lower

than in the case of Wal-Mart.

Question 5:

a.

b. Genside Bolt should produce 40 units per hour to maximize its profit.

c. Short Run: > $0.5, Long Run: < $8

Question 6:

a. MR = MC,

480 – 16Q = 8Q

Q = 20

P = 480 – 8Q

P =320.

Hence when Q is 20, Price is $320 per unit, profit is maximized.

Hourly Cost Data, Glenside Bolt companyOutput Variable Cost Marginal Cost Average Variable Cost

0 0 NA NA10 5 0.5 0.520 10 0.5 0.530 15 0.5 0.540 20 0.5 0.5

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b. Revenue = 320 x 20 = $6,400,

Cost = 500 + 4Q2

Cost = 500 + 4(20)2 = $2,100

$6,400 - $2,100 = $4,300

Maximum profit should be $4,300

c. Demand is elastic

d. To maximize revenue, MR = 0

480 – 16Q = 0

Q= 30

P=480 – 8Q

P=480 – 8(30)

P=240

Price is at $240

e. Maximum revenue = 240 x 30 = $7,200

f. Demand is unit elastic when a firm maximized its revenue.

Question 7:

The only costs relevant for making this decision are your variable costs of

producing 100,000 units. These relevant costs include materials ($250,000)

and labor ($10,000). The depreciation reflects a charge for expenditures

already made, and thus this amount will be lost regardless of your decision.

By signing the contract, your revenues increase by $30,000,000 and your

variable costs increase by only $260,000. You should sign the contract

because doing so adds $29,740,000 to your bottom line that you will not get if

you shut down your operation.

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Question 8:

In the short run, eliminating the patent might allow other firms to enter and

lower the price to cardiac patients. In the long run, however, it is not at all

clear that cardiac patients would benefit. Absent patent protection, firms like

Genentech would be unwilling to invest the substantial sums in R&D that are

required to develop products like TPA. The monopoly profits earned by

Genentech are its reward for developing the new product, and taking away

that reward would likely harm cardiac patients in the long run.

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Problem Set #5

Question 1:

a.

Rival

Advertise No Advertise

USAdvertise 5, 5 10,3

No Advertise 1,3 2,4

b. Yes, I will advertise to maximize profit

c. No, my rival does not have the dominant strategy and will follow whatever

strategy we are going with.

d. Both my rival and myself will advertise (5,5)

e. If I were to advertise, my rival will make 5 million or 3 million, depending on

his actions, a difference of 2 million. I am willing to bribe my rival between 2 to

5 million

Question 2:

a. I will charge $250 since I have a much bigger market share, irregardless of

how much Toshiba price its DVD machine.

b. 60% of the market share, Toshiba will price its DVD machines at $250

because it gives them the largest available market share of 40%, instead of

10% when P= $500 and 30% when P=$1,000.

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Question 3:

a.

c. If Intel does not adopt the new technology at C=12. They would make $5

instead of $3. They should not adopt the technology at C=12 as it is

detrimental on their revenues and beneficial to AMD’s revenue.

b. AMD will adopt the new technology if C < 30 (15 – C/2=0, C=3)

Question 4 :

Suppose the marginal cost to the gold course of each visit is 0. The most a

customer is willing to pay is his/her total valuation of the quantity of goods

consumed. The total valuation is measured by the area under the inverse

demand curve and t he horizontal axis for that range of quantity. Hence, the

most a property owner is willing to pay is .5($100)(200) = $10,000 per month.

The most a tourist is willing to pay is .5($40)(400) = $8,000 per week. Hence,

your optimal pricing policy is: charge property owners a membership fee of

$10,000 per month per person; charge tourists a membership fee of $8,000

per week per person. And then let each golfer play golf for free.

Question 5:

a. MR = MC

Q = 200 – 2P, P = 100 – 0.5Q

MR = 100 – Q

MR=MC

80 = 100 – Q, Q = 20

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Optimal number of units should be 20.

b. P = 100 – 0.5Q, P = 100 – 10 = 90

The monopoly should charge the package at $90.

Question 6:

MR = MC to maximize profit

16 – 0.012Q = 4

Q = 1,000

P=16 – 0.006Q = 16 – 0.006 (1000) = $10

24-0.012Q = 4

Q = 1,667

P=24 – 0.006Q = 24 – 0.006(1667) = $14

The movie theater should charge $10 for weekday tickets and weekend ticket

at $14 each.

Question 7:

If managers of each division were to maximize each division’s profit

separately, double marginalization will occur and the overall profit for Blue

skies aviation will not be maximized.

Cost of Engines = 4,000Qe2, MCe = 4000(2) Q = 8,000Q

Cost of Airplanes = 10,000Q, MCa = 10,000

Total Revenue = Price x QuantityTR = (610000 – 2000Q) x Q

TR = 610000Q – 2000Q2

MR = 610000 – 2000(2)Q = 610000 – 4000Q

(MR = TMC) = Profit maximization.TMC = MCe + MCa = 8000Q + 10000MR = TMC

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610000 – 4000Q = 8000Q + 10000Q = 50

MCe = 8000Q, thereforeMCe = 8000(50)MCe = 400000

Engines should be priced at $400,000 to prevent double marginalization and also to maximize Blue Skies Aviation’s overall profit.

Question 8:

a. The manager is considering Predatory Pricing Strategy – Aggressive

pricing (“undercutting”) intended to drive its competitor from the market.

b. Net Present Value

20 million/0.05 = 400 Million

The pricing strategy will be profitable.

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