ECON 6200 Exam 1
Forecasting: Your company is moving into a new area with 25% lower income on average. You've estimated that your product has an income elasticity of -0.5. By what percentage will your sales increase or decrease?
%Change in sales = (Income Elasticity) * (%Change in Income) = (-0.5) * (-25%) = 12.5% Therefore, sales are expected to increase by 12.5%
Accounting Vs. Economic Profit: A business owner makes 1,000 items a day. Each day she contributes eight hours to produce those items. If hired, elsewhere she could have earned $250 an hour. The item sells for $15 each. Production does not stop during weekends. If the explicit costs total $150,000 for 30 days, the firms' accounting profit for the month equals ___________ and the firms' economic profit for the month equals____________ .
Accounting Profit = TR - Explicit Costs = 450k - 150k = $300k Economic Profit = TR - (Explicit Costs + Implicit Costs) = 450k - (150k + 60k) = $240k TR = PQ TR = $15 ( 30 days * 1000 items) TR = $450,000 Explicit Costs = $150k Implicit Costs = $250(8 hrs)*(30 days) = $60k
Price Gouging: Are you in favor of "price gouging" during natural disasters? Why or why not? Note: I'm asking youto express your opinion, this is intentional. In order to earn the full point, however, I do want you to atleast bring up prices acting as a signal and an incentive in your answer.
Although morally I think price gouging is wrong during a natural disaster, economically, I stand by it in capital America. During a natural disaster prices increase drastically, acting as a signal, representing that resources are extremely scarce and extremely valuable. When prices are incredibly high two major things happen: 1) the product is used more efficiently by the buyer 2) suppliers have an incentive to react as quick as possible to the demand in order to maximize profits. Therefore, price gouging is good in the case of a natural disaster, because it brings the needed resources to the site in the quickest way possible, and it encourages the most efficient use of those products.
Dartboard Startup: e) A year after you open the darts division, a foreign competitor copies your design and starts selling sets of darts similar to yours. This significantly reduces demand for your darts and drives down the price at which you can sell your darts. You are deciding whether you should continue producing the darts. The extra space you bought for $100,000 can be sold for $80,000, but nobody wants the manufacturing equipment you bought for $50,000 to produce the darts. Recall that it costs you $10(in labor and material) to produce a set of darts. If the new estimated demand for your darts is10,000 sets, what is the break-even price for a set of darts? Interpret this number in the context of this question.
Break-even Price = (Avoidable FC / Q) + MC = ($80k / 10,000) + $10 = $18 If you're able to sell your 10,000 sets of darts at $18 or more, then you should produce.
Dartboard Startup: d) Your dartboard venture proves to be a success and so you are considering expanding your business by starting a division that specializes in making darts. You need new manufacturing equipment to make the darts, which you estimate will cost $50,000. You will also need to expand the facility itself to make space for the new division, this will cost you $100,000. On average, it will cost you$10 (in labor and material) to produce a set of darts. If you can sell each set of darts for $20, what is your break-even quantity? Interpret this number in the context of this question.
Break-even QTY = FC/(P - MC) = $150k/ $20 - $10 = 15,000 If you sell more than 15,000 sets of darts at $20, then you'll be profitable
Subway: Subway, the fast-food chain, sells foot-long sandwiches for $6 each on average. However, Subway still sells 6-inch sandwiches for considerably more than $3 each, that is, at a higher price per inch of sub. In many of our price discrimination examples, we think that businesses try to break customers into two groups: more price-sensitive and less price-sensitive. Which of the following groups of Subway customers most likely fall into the more price-sensitive group and which most likely fall into the less price-sensitive group?
Busy Lawyers with 20-minute lunches = less price sensitive College students = more price sensitive Health-conscious soccer moms = less price sensitive Long-haul truck drivers = more price sensitive
Ocean Paradise Grille - Price Discrimination a) If you price discriminate, what is the profit maximizing price for each group? b)Translate this into real world jargon: what "senior citizen discount" would you offer, in percent(round to the nearest percent)? c) How much profit would you make if you price discriminated? d) If it became illegal to discriminate on the basis of age, you would face only one demand curve. Aggregating the two demand curves yields: Qd = 840 - 6P MR = 140 - 1/3Q What are the optimal price and quantity in this unified market (𝑀𝐶 still equals 2𝑄)? e) What is the profit in this discrimination-free market? Keeping in mind that these are average daily demands, and assuming that you're open 365 days a year, how much profit per year do you lose by not discriminating (compare your answer here with the profit calculated in part c)?
Calculations in journal for reference: a)P*1 = $142.50 P*2= $123.75 b) 13% c) profit = $3668.75 d) Q* = $60 P* = $130 e) $3200/day, so it's less than if you discriminated
Time Allocation and Studying: You have exactly 8 hours to study for tests in four different classes (Economics, Mathematics, Spanish, and English). Your objective is to use the information in the following table to determine how to distribute your 8 hours of study time on the four subjects in order to maximize total numerical test scores. Table... reference App 1 Q8 To maximize total numerical scores, you should study how many hours in each subject? (Hint: use marginal analysis) Economics: ______ hours Mathematics: ______ hours Spanish: ______ hours English: ______ hours
Compare additional hour of study to additional score. This is the MB of each extra hour studied. Do this for every class, then compare. Pick the best MB for the first 8 hours: Economics: 4 hours Mathematics: 3 hours Spanish: 1 hours English: 0 hours
Can Manufacturing: A can manufacturing company produces and sells three different types of cans: Versions X, Y, and Z. Corporate overhead (rent, general and administrative expense, etc.) is allocated equally among the three product versions. A high-level, simplified profit/loss statement for the company is provided. Table... reference App 1 Q7 After reviewing the statement, company managers are concerned about the loss on Version Z and are considering ceasing production of that version. Should they immediately discontinue Version Z? Why or why not?
Corporate OH is a fixed cost - therefore you can pay it either way. No, do not discontinue Version Z. If you discontinue Version Z, then you lose $60k If you don't discontinue Version Z, then you only lose $37,500
Yield Management at The Rosebud Motel: Demand is extremely hard to estimate, so suppose that the demand equation estimated by Johnny is only an "expected demand." Actual demand could be higher or lower in any given week. Describe using the context of this question, the costs associated with overpricing if demand turns out to be lower than expected, and the costs associated with underpricing if demand turns out to be more than expected.
Cost of overpricing: If price is higher than demand, then they can miss out on potential revenue. Customers might choose alternatives or not stay due to price. This ultimately leads to lower occupancy and lower revenue. Cost of underpricing: if price is less than actual demand, then occupancy might be high, but the profits will not be maximized. Leads to lower revenue per room.
Hiring Decision: A firm is thinking of hiring an additional worker to their organization who can increase totalproductivity by 110 units a week. The cost of hiring him is $1,400 per week. If the price of each unit is$12, should the firm hire him? Why or why not?
Do not hire him. MB = 110 units * $12 = $1320 MC = $1400 MB < MC
The economist Joseph Schumpeter (1883 - 1950) said that in textbooks, competition is about pushing price down to average cost, "but in capitalist reality as distinguished from its textbook picture, it is not that kind of competition which counts but the competition from the new commodity, the new technology, the new source of supply, the new type of organization...competition which commands a decisive cost or quality advantage and which strikes not at the margins of the profits and the outputs of the existing firms but at their foundations and their very lives...this process of Creative Destruction is the essential fact about capitalism. "Our discussion in this module tells us what we can expect in the long run: zero economic profits across industries. If this were the case, and this fate were unavoidable, going into business would seem to be a fairly dismal choice, given that the end result of zero profits is
Entrepreneurs are the base of all innovation. Shumpeter says that the economy is constantly evolving and entrepreneurs keep it dynamic by challenging the existing structure. Some firms will be very successful by introducing new technology, comodities, structures, etc, whereas other firms won't be successful and will lose a lot of money. Either way, the constant challenge and push for innovation from entrepreneurs keeps the economic engine running. The fate of zero economic profit is unavoidable long term, but you can still make great profits in the short term. Pair the short term profits with the feeling of fulfillment you get when pursuing an entrepreneurial dream, and it's totally worth it. Therefore, it is not a waste of time.
GE Fridges: Some GE refrigerators have ice and water dispensers that won't dispense ice or water unless your filter authenticates as an official component produced by GE. Suppose one popular model costs $800 to produce, and each filter costs just $10 to produce. Suppose further that GE has categorized their consumers into two groups: low-volume users, who buy two filters per year and value the water and ice dispensing fridge at $1000, and high-volume users, who buy six filters per year and value the water and ice dispensing fridge at $1200. GE is considering two pricing strategies: • Pricing strategy 1: $980 for refrigerator & $10 for filters • Pricing strategy 2: $940 for refrigerator & $25 for filters a) Which pricing strategy would GE prefer?
GE would prefer pricing strategy 2 Rev - Cost = Profit Price Strat 1 = (980 + 20) - (820) = 180 = (1060) - (860) = 180 Price Strat 1 = (990) - (820) = 170 = (940 + 150) - (860) = 230
Price Discrimination After Ebay: When will a firm find it easier to use direct price discrimination: before the existence of eBay or afterward? Why?
I would argue that a firm would find price discrimination easier to use after the existence of ebay because the price is always changing. The consumer puts their value on the product through bidding. Whichever consumer values the product more will bid more. As the time to bid decreases and the highest bid increases, consumers can determine whether or not they continue to see value in the product and choose whether or not they want to increase the current bid. Without fail, the highest bidder wins every time.
Dartboard Startup: c) What is your Internal Rate of Return? What does this tell you about the profitability of your investment?
IRR is the discount rate that makes the NPV = 0 Use excel: = IRR(all CF's) be sure to include the initial cash outflow of -30k IRR = 10.56% Tells me this is a profitable investment b/c IRR > 0.09
Yield Management at The Rosebud Motel: Suppose there was a fire that burned down exactly 50 rooms, so that the maximum capacity at the Rosebud is now 100 rooms. Assuming that nothing else changed, what is the profit maximizing price and quantity? Explain why you chose the price and quantity pair you chose.
If MR > MC at capacity, then you want to price to the exact fill capacity. In this case, that is Q* = 100 MR = 150 - Q MR = 150 - 100 = 50 MC = 30 P* = 150 - 1/2Q = 150 - 1/2(100) = $100
Yield Management at The Rosebud Motel: Assuming that Johnny could estimate the relative sizes of the costs of underpricing and overpricing, under what circumstances would you recommend they charge a price higher or lower than the price in part b?
If the cost of overpricing is greater / $90 per room is too high, then lower the price. MR > MC If the cost of underpricing is greater / $90 per room is too low, then raise the price. MR < MC Ultimately, we want MR to equal MC in order to maximize profit.
How much to produce? A company is producing 10,000 units. At this output level, MR is $25 and the MC is $22. The firm sells each unit for $48 and average total cost is $40. Should the company increase production, decrease production, or leave the production amount unchanged? Why?
Increase Production MR = $25 > $22 = MC
Kidney Transplants and the One Lesson of Business: b) Recognizing this inefficiency as a way to make money, you decide to borrow $80 million at 30% annual interest, buy a hospital ship, anchor it in international waters, set up a database to match donors to recipients, broker sales, and fly in experienced transplant teams. In all, this costs you $135,000 per transplant. If you charge $150,000 per transplant, you would need to do a minimum of _________ transplants to cover the interest on your loan. This represents just ______ % of potential demand for kidneys in the United States alone.
Interest on Loan = $80M * 30% = $24M Profit per Transplant = $150k - $135k = $15k Minimum Transplants to Cover Loan = $24M / $15k = 1600 transplants % of potential demand on kidneys = 1600 / 90,000 = 1.78%
Antitrust enforcement: b) Based solely on the information in the question, is it likely that these merged firms sell products that are substitutes or complements? Why?
It's safe to assume that the merged firms sell products that're complements, because you reduce price on complementary products to increase demand. In the past, mergers lowered average price.
Yield Management at The Rosebud Motel: Stevie Budd and Johnny Rose have recently partnered up to run the Rosebud Motel (yes, I'm a fan of Schitt's Creek). Johnny has estimated that demand for motel rooms is given by 𝑄𝑑 = 300 − 2𝑃, which means that marginal revenue is given by MR = 150 − 𝑄𝑑. Suppose that the cost to the motel of each additional stay is $30. a) If the maximum capacity at the motel is 150 rooms, what is the profit maximizing price and quantity pair?
MC = 30 If MR = MC at less than capacity, then capacity won't affect the decision MR = MC MR = 150 - Q Q* = 120, which is less than the capacity of 150 Solve for P: Qd = 300 - 2P P = 150 - 1/2Q P* = 150 - 1/2(120) P* = $90
Demand and Marginal Revenue: Suppose demand for a product is given by 𝑄𝑑 = 90 − 1/3 𝑃. What is the equation for Marginal Revenue?
MR = P Qd = 90 - 1/3P : solve for P to get MR Qd - 90 = -1/3P -Qd + 90 = 1/3P P = -3Qd + 270 Therefore, MR = -3Qd + 270
GE Fridges: b) Based on the information in the question, I want you to come up with a better pricing strategy than what's been proposed. Specifically, what's the optimal price for the refrigerator and the optimal price for filters that will maximize profit (it's not pricing strategy 1 or 2)?
Pr = Price of Refrigerator Pf = Price of filter Low Volume Group: Pr*1 + Pf*2 = $1000 => Pr = 1000 - 2Pf High Volume Group: Pr*1 + Pf*6 = $1200 Plug Pr into HVG equation: = (1000 - 2Pf)*1 + Pf*6 = 1200 = 1000 - 2Pf + 6Pf = 1200 = Pf = 50 Plug Pf into Pr equation: Pr = 1000 - 2Pf = 1000 - 2(50) = Pr = 900
Strategy: Identify an industry that you are interested in and perform a "Porter analysis" on that industry - To the best of your ability, rank each of the five forces as either low, medium, or high and discuss why you chose the ranking you did for each one. Discuss the prospect of entering this industry and the ways in which firms in that industry could use your analysis to improve their competitive advantage.
Roof Top Tent Industry: Porter Analysis: 1) Threat of new entrants - medium specialized market manufacturing / sourcing high quality RTT is difficult consumers have loyalty to other brands 2) Bargaining Power of Suppliers - low basic materials - same material as ground tents all suppliers are capable of making RTT therefore, lots of supplier options 3) Bargaining Power of Buyers - medium there are a lot of end consumers - a lot of people want a RTT good options between brands and RTT functions plethora of price ranges 4) Threat of Substitute Products - low niche product and market no direct competitor Rooftop campers are heavy, bulky, and more than 5x the price ground tents are not elevated and take a lot longer to set up 5) Rivalry among existing competitors - high a lot of different brands large differences in RTT options and pricing some brands are very well established and have a loyal customer base... keep it that way Reference App for the rest of the answer
Mr. D's Barbeque: Mr. D's Barbeque of Pickwick, TN, produces 10,000 dry-rubbed rib slabs per year. Annually Mr. D's fixed costs are $50,000. The average variable cost is a constant $2 per slab. What is the average total cost per slab?
TC = FC + VC Avg TC = TC/Q = FC/Q + VC/Q = Avg FC + Avg VC = 50k/10k + $2 = $7 avg TC per slab
Kidney Transplants and the One Lesson of Business: According to the Organ Procurement and Transplantation Network, there are about 107,000individuals on a waiting list for an organ transplant in the United States. Of those 107,000, about 90,000 are waiting for a kidney. a) It is currently illegal to sell kidneys in the United States, describe why this results in inefficiency. In other words, describe why this might result in certain "assets" staying in relatively low valued uses.
The Kidney Transplant system is a total inefficiency when you look at it from an economic perspective. There is about a 1/10 supply to demand ratio of kidneys to people who need kidneys. Making a healthy kidney the asset in this scenario. The supply is so low because the USA has made it illegal to sell kidneys, making the process both inefficient and keeping the assets in a low valued use.
True or False and Explain: When a monopoly is maximizing its profits, price is greater than marginal cost. Is this statement true or false? Explain.
True, P > MC. As shown in the model above (#12), a monopoly is able to choose the qty based on MR = MC. Then they charge the price that's equal to the highest willingness to pay for the profit maximizing qty, which is given by the demand curve.
Tupelo Honey vs. Grimaldi's: Suppose there are two quite similar restaurants in the same town, Tupelo Honey and Grimaldi's. Both have the same demand for janitorial labor. But all the janitors in town know that it's much more fun to work at Grimaldi's. According to the indifference principle, which restaurant will pay a higher wage for janitors? Why?
Tupelo Honey will pay more, because they have a higher demand for janitorial staff. This is due to the facts that all the janitors would rather work at Grimaldi's. More janitors want to work at Grimaldi's than they can hire. Therefore, Tupelo Honey has to pay a higher wage in order to compete with Grimaldi's.
Own Vs. Rent: You currently pay $10,000 per year in rent for a $100,000 house, which you are considering purchasing. You can qualify for a loan of $80,000 at 9% if you put $20,000 down on the house. To raise money for the down payment, you would have to liquidate stock earning a 15% return. For simplicity, neglect all other concerns, like closing costs, capital gains, and taxes. Considering the information given on the annual cost of renting vs. owning, is it better to rent or own? Why?
Two Alternatives: Cost of Renting vs. Cost of Owning Renting = $10k per year Owning = $80k(9%) + $20k(15%) = $10,200 Therefore, it's cheaper to rent by $200/ month
Uber Surge Pricing: There are certain times when the demand for Uber rides increases (bad weather, rush hour, special events, etc.). Uber uses "surge pricing" as a way of charging more during these periods of high demand. Customers aren't always happy about this (see, for example, surge price and customer complaints), and traditional taxi cab drivers are happy to accuse their rivals of "exploiting customers." Propose at least one way that Uber could market surge pricing that might take into account the psychological biases of it's customers and help limit negative reaction to the practice.
Uber can highlight that the surge pricing incentivizes drivers to get on the road during times of high demand, allowing more people to get rides, faster. During bad weather, rush hour, special events, etc, nobody wants to participate in large wait times just to get a ride. In this situation, the only way to counter the high demand and low supply is by incentivizing more drivers to stop what they're doing and begin driving for Uber. This incentive, surge pricing, is effective.
Dartboard Startup: b) Using your WACC as a measure of your discount rate, what is the Net Present Value of your investment (round to the nearest dollar - I recommend using Excel for this)? What does this tell you about the profitability of your investment?
Use excel for this: = NPV(0.09,Year 1 - 10 Cash Flows) - Initial Outflow = $20,882.89 b/c NPV is greater than 0, that means our investment will be profitable
Dartboard Startup: You are considering opening a new business to sell dartboards. You estimate that in order to start the business, your manufacturing equipment will cost $100,000 and facility updates will cost $200,000.You are able to raise $120,000 from investors with a promise of a 12% return on their investment. Your bank has agreed to loan you the remaining $180,000 at a 7% rate of interest. You estimate that you will bring in $50,000 per year in profit and that your equipment and facility updates will last 10 years. Thus, in the current year (year zero), you incur a $300,000 cost, and in years one through ten of your investment, you make $50,000 in profit each year. a) What is your Weighted Average Cost of Capital (WACC)?
WACC = (120k/300k)*(12%) + (180k/300k)*(7%) = 9%
Post-Investment Hold Up: a) Your firm received an RFP (request for proposal) on a wire harness from GM with avoidable fixed costs of $1 million and MC of $1 with expected sales of 1 million units to GM. What's the minimum price that you would be willing to sell each wire harness to GM (i.e. what's the break-even price)? b) GM agrees to the price in part a), and then hands you with a PO (purchase order) for 0.5 million units. What do you say to them? c) Describe how this situation could result in post-investment hold up and then propose one way to reduce the risk of hold up for your firm?
a) Break-even price = ($1M / 1M) + $1 = $2 b) Break-even price = ($1M / 0.5M) + $1 = $3 Because the fixed costs are still avoidable, I'd tell them we can't support the PO unless they: 1) Increase qty to 1M since that's what our quote is based on 2) Make the $1M investment and we'll honor the previous price for manufacturing the 0.5 million units 3) Sign a long term contract for a 0.5 million unit order with us per year c) If the fixed costs were unavoidable and I had already invested the $1M in infrastructure, then this situation of them wanting to lower the PO to half would cause post-investment hold up. However, because we've already made the investment, we need to do all we can to make it back, so they have negotiation power. In order to reduce the risk I have 2 options: 1) take the PO for 0.5M units and only lose $500k instead of $1M 2) negotiate a long term contract with GM to order 0.5M units per year from me. This will equate to a lot more money over time.
Taxes and Efficiency: A consumer values a boat at $55,000 and it costs a producer $50,000 to make the same boat. a) If there is no sales tax and the transaction is completed at $52,000, the transaction will generate________ worth of buyer surplus and ________ worth of seller surplus. b) If there is a 10% sales tax levied on the seller, then the seller's bottom-line price (minimum willingness to sell) is ________ (round to the nearest dollar). This sales tax deters / does not deter(circle one) the transaction from happening.
a) Buyer surplus = WTP - Price = $55k - $52k = $3k Seller surplus = Price - WTS = $52k - $50k = $2k b) BL tax = Bottom Line with Tax BL tax - BL tax (10%) >= 50k BL tax (1 - .1) >= 50k BL tax (.9) >= 50k = $55,556 Sales tax does deter the sale from happening. The sellers price of $55,556 is greater than the consumers maximum value of $55k
Savor the Sweet Bakery: Savor the Sweet Bakery has been selling 550 boxes of cupcakes per month at a price of $19/box. When they raised their price to $21/box, they sold only 450 boxes. a) What is the price elasticity of demand for Savor the Sweet's cupcakes? b) If the marginal cost is $14 per box of cupcakes, was the price increase a profitable decision? Why or why not? c) Based only on the information in this question, would you recommend they change their price again? If so, why and in what direction? If not, why not? d) Suppose several other bakeries opened up nearby and sold cupcakes similar in quality and taste to those of Savor the Sweet. How would this affect elasticity of demand for Savor the Sweet cup cakes? Describe how this change in elasticity of demand would affect the price mark-up of Savor theSweet's cupcakes (I'm not looking for a specific number here).
a) Ed = (%change in Qd) / (%change in Price) %Change in Qd = [(450 - 550) / 550] = -.1818 = -18.18% %Change in P = [(21-19) / 19] = .1053 = 10.53% Ed = (-18.18% / 10.53%) = -1.73 b) (P - MC) / P = 1 / |Ed| Initial Price ($19) : 0.263 = 0.578 New Price ($21) : 0.333 = 0.578 The price increase was a profitable decision. As shown in the math above, the new price of $21, when plugged into the equation at the top, produces a closer value than the intital price of $19. If the equation represents the optimal markup, then $21 is better than $19. c) The equation in this scenario to represent is (P - MC) / P = 1 / |Ed|. As explained in the previous question, the new price of $21 is closer to the optimal markup, but there is still room to increase: 0.333 = 0.578 Therefore, we need to increase the price. d) Demand would become more elastic due to available substitutes. Savor the Sweet Bakery needs to be more competitive in pricing in order to beat out its new competition.
Hermie's Drive In: The following table represents Frank and Betty's maximum willingness to pay for a burger and fries from Hermie's Drive In. Suppose the marginal cost of making a hamburger is $0.50 and the marginal cost of an order of French fries is $0.25 (assume there are no fixed costs for either) Table for reference - App 3 Q11 a) If Hermie's sets prices individually, what price would maximize profits for hamburgers? FrenchFries? How much profit would they earn from Frank and Betty using this pricing strategy? b) If instead they bundle the hamburger and French fries into a combo meal, what price would maximize profits for the combo? How much profit would they earn from Frank and Betty using this pricing strategy?
a) Individually Burgers = $6 Fries= $3 Profit = $8.25 b) Bundled Price = $6 Profit = $10.50
Jeans: Suppose you produce Jeans and an individual walks into your store. The table below gives this individual's demand for your jeans, as well as your total costs of production. Table for reference - App 3 Q13 a) First, fill in the rest of the table. Suppose you set a single, flat-rate price for your jeans. How much would you charge this individual and how much profit would you make using this pricing strategy? b) Instead of setting a single, flat-rate price for your jeans, describe a way in which you could increase your profit from this individual consumer. How much profit would you make using your new pricing strategy?
a) Price at Flat Rate = $ 14 Profit = $24 b) Volume Discounts: Charge $20 for first pair, then give a $2 discount up to 7 pairs Profit = 98 - 56 = 42 Bundle: sell 7 pairs for 98 Profit = 98 - 56 = 42 Two part pricing: Charge MC for jeans, but require an exclusive club fixed fee ($42) to get into the store Profit = 42
Optimal Book Pricing: Suppose you just wrote your first novel. After doing some research, you decide to self-publish and sell your book on Kindle. Your friend, who is a professional economist, estimates that demand for your book is 𝑄𝑑 = 22 − 𝑃, and 𝑀𝑅 = 22 − 2𝑄𝑑, where 𝑄 is measured in thousands of ebooks and 𝑃 represents price per ebook. a) Suppose your marginal cost is constant at $2 (say, for advertising on social media). You are considering charging a price of $14 per ebook. Is this price too high or too low? Why? b) What price should you charge per ebook in order to maximize profit?
a) Qd = 22 - 14 => 8 MR = 22 - 2(8) => 6 MR=6 > MC=2 MR>MC, therefore the price is too high. To optimize profits, MR = MC. b) MR = MC 22 - 2Qd = 2 2Qd = 20 Qd = 10 Qd = 22 - P 10 = 22 - P P = 12 Therefore, you optimal price to charge is $12 per ebook.
Marijuana: The following are demand and supply equations for marijuana in Nevada (where it is legal): 𝑄𝑑 = 100 − 1/2 𝑃 𝑄𝑠 = 3𝑃 − 75 Price is in terms of an eighth of an ounce of marijuana and quantities are in millions of eighths per month. a) What is the equilibrium price of an eighth of an ounce of marijuana in this market? b) What is the equilibrium quantity in this market? c) If the price is currently $60 per eighth of an ounce, competition among buyers / sellers will put downward / upward pressure on price.
a) Qd = Qs 100 - (1/2)P = 3P -75 P = 50 Therefore, the equilibrium price is $50 b) Qd = 100 - (1/2)P = 100 - (1/2)*50 = 75 Therefore, 75 million eighths of an ounce of marijuana per month c) If the price is currently $60 per eighth of an ounce, competition among buyers will put downward pressure on price.
Ralph's Trail Mix: Ralph opened a small shop selling bags of trail mix. The price of the mix is $5, and the market for trail mix is very competitive. Ralph's cost curves are shown in the figure below: Reference Graph - App 2 Q11 a) At what quantity will Ralph produce? Why? b) When the price is $5, shade the area of profit or loss in the graph provided and calculate Ralph's profit or loss (round up). c) If all other sellers of trail mix have the same marginal and average costs as Ralph, should he expect more or fewer competitors in the future? Why? d) In the long run, will the price of trail mix rise or fall? What will the price of trail mix be in the long run?
a) Ralph will produce 15 bags of trail mix. To find the qty produced, we must set MR = MC. MR = P and P=5, therefore P = MC at Q=15 b) Profit = TR - TC TR = $5 * 15 = $75 TC = $4 * 15 = $60 Therefore, Profit = $15, when priced at $5 c) He should expect more competitors because right now P > AC, meaning the trail mix industry is profitable. Competition will remain the same if P = AC and will decrease if P < AC d) In the long run, the price of trail mix will fall down to $4. This is because firms will join this industry until P = AC. Which pushes price down over time.
Survivor: a) Every year, American television introduces many new shows, but only about one-third of which survive past their first season. Why do you think studios bother to make new shows if most of them will fail? b) In 2000, CBS premiered Survivor, an immensely popular reality show about everyday people living on an island. How did CBS and other networks respond to this surprise hit? c) What happened over the next several years to profits from Survivor? You don't need to check CBS's financial statements to get the answer, though it would be cool if you did. d) What is one strategy that CBS could have implemented to maintain a competitive advantage over the other networks?
a) Studios keep producing new shows because there's always a chance of the new show being the next big hit! Producing a successful show makes up for all the failures. In addition, the market for entertainment trends (what the viewer finds entertaining) is always changing, so this is a good way for studios to test the waters to figure out what the viewer wants to watch. b) CBS and other networks responded by recognizing that this was a new trend and that they needed to capitalize on it. Now there are a ton of different shows that are very similar to theme to Survivor. c) The profits increased! This show, and the revenue streams associated with it, make a lot of money. d) CBS could have implemented some product differentiation. To be specific, CBS could have released different sub-genres of Survivor. Because they already have a large fan base, creating sub-genres would increase their buy-in to Survivor, and ultimately make them more loyal fans.
Stata Software: Stata is an integrated software package used to satisfy data science needs, and is often used by college students and individuals in business. Stata offers a "Stata/IC" version and a "Stata/SE" version of the software. The main difference is that Stata/SE allows for about 16 times more variables in general and about 14 times more explanatory variables in a model. The software has already been developed, so the marginal cost of another software license sold is zero. Suppose the average maximum willingness to pay for the two versions is summarized in the following table for the two groups: a) Suppose that based on this information, Stata decides to charge $1,000 for Stata/SE and $100 for Stata/IC. Why might this be a bad idea? b) What price should Stata charge for each version in order to maximize profits?
a) This pricing might be a bad idea because $1000 for Stata/SE is very expensive compared to $100 for Stata/IC. Stata/SE is way to expensive for Students to be interested, and maybe too expensive for a number of Business users since it's at their maximum willingness to pay. In addition, students who get comfortable working and learning on Stata/IC may opt out of upgrading to Stata/SE upon graduation. This might not be the case if Stata/SE was less expensive. b) To maximize profits, Stata should price Stata/IC at $100 (maximum willingness of Students) and Stata/SE at $900. Although Business Users willingness is at $1000, that rate may turn some business users away. Instead, offering it at $900 offers a $100 consumers surplus, and ultimately avoids cannibalism between IC and SE software.
Lampard City Housing: a) Say the average price of a new home in Lampard City is $160,000. The local government has just passed new licensing requirements for housing contractors. Based on possible shifts in demand or supply and assuming that the licensing changes don't affect the quality of new houses, which of the following is a reasonable prediction for the average price of a new home in the future? a. $140,000 b. $150,000 c. $160,000 d. $170,000 b) Suppose a new employer is also relocating to Lampard City and will be attracting many new people who will want to buy new houses. Assume that the change in licensing requirements mentioned in part a) occurs at the same time. What do you think will happen to the equilibrium quantity of new homes bought and sold in Lampard City? a. It will decrease substantially. b. It will decrease but not by much. c. It will increase. d. Not enough information.
a) d. $170,000 b) d. Not enough information.
Advertising: A firm started advertising its product and this changed the product's elasticity from -2 to -1.5. If, prior to advertising, the firm was maximizing profit by charging $10, the firm should a. raise price from $10 to $15 b. reduce price from $10 to $6.67 c. raise price from $10 to $13.33 d. reduce price from $10 to $7.50
a. raise price from $10 to $15 Less elastic = optimal markup increase P-MC / P = 1 / |e| 10 - MC / 10 = 1 / |-2| = 10 - MC = 5, therefore MC = 5 P - 5 / P = 1 / |-1.5| = P - 5 = 2/3P = 1/3P = 5 = P = $15
Merit Scholarships: Merit scholarships not only allow universities to attract the most talented students but to also practice price discrimination, since meritorious students: a. can easily arbitrage their education. b. have many substitutes for attendance at any particular college. c. do not have to submit their parents' tax returns to the financial aid office. d. have highly inelastic demand for going to college
b. have many substitutes for attendance at any particular college.
Post-Graduation Tradeoffs: After graduating from college, Jim had three choices, listed in order of preference: (1) move to Florida from Philadelphia, (2) work in a car dealership in Philadelphia, or (3) play soccer for a minor league in Philadelphia. Assuming he can't do any of the three choices simultaneously, his opportunity cost of moving to Florida includes a. the benefits he could have received from playing soccer b. the income he could have earned at the car dealership c. both a and b d. cannot be determined from the given information
b. the income he could have earned at the car dealership
Hardware Story Promotion: After running a promotional campaign, the owners of a local hardware store decided to decrease the prices for the advertised products sold in their store. One can infer that a. the promotional expenditures made the demand for the advertised products less elastic. b. the promotional expenditures made the demand for the advertised products more elastic. c. the promotional expenditures had no effect on the demand elasticity. d. the owners got it wrong. To cover the promotional expenses, they should have raised the prices
b. the promotional expenditures made the demand for the advertised products more elastic.
Beef: Which of the following would increase the demand for beef? a. lower pork prices (assuming pork is a substitute for beef). b. an increase in the price of beef. c. higher consumer income (assuming beef is a normal good). d. higher prices of feed grains used to feed beef cattle.
c. higher consumer income (assuming beef is a normal good).
Double Take Beauty: Double Take Beauty is a spa in Provo, UT that offers single needle tattoos done by its founder, Sadie Flores. Suppose Sadie charges about $400 per tattoo on average. The marginal cost of each tattoo is about $100. She is getting better at tattooing and the tattoos are becoming more popular with customers, so she is considering raising the price to $500 per tattoo. What percentage of customers must be retained to ensure that the price increase is profitable? Note: It's conventional when not calculating elasticities to measure percentage changes relative to their initial value ((%𝛥𝑋 = 𝑛𝑒𝑤 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑋 − 𝑜𝑙𝑑 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑋) / 𝑜𝑙𝑑 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑋 ). a. 18% b. 25% c. 66.67% d. 75% e. 84%
d. 75% Markup = (P-MC) / P Markup = (400 - 100) / 400 = .75
Long Run Accounting and Economic Profits: In the long run, which of the following outcomes is most likely for a firm? a. Zero accounting profits but positive economic profits. b. Zero accounting profits. c. Positive account profits and positive economic profits. d. Zero economic profits but positive accounting profits.
d. Zero economic profits but positive accounting profits.
Teachers Per Student: The fact that more teachers per student are employed now than 20 years ago, accompanied by the fact that inflation-adjusted teacher salaries have decreased on average over this period, tells us that the a. demand for teachers has decreased. b. demand for teachers has increased. c. supply of teachers has decreased. d. supply of teachers has increased
d. supply of teachers has increased
COO Compensation: This year, the COO of a consulting firm earned a flat salary of $80,000. Next year, her compensation scheme will change to $40,000 + (1/4) × (profits − $100,000). What effect do you think the change in compensation will have on i) the COO's effort and productivity and ii) overall company profits? Justify your answer.
i) This change in COO compensation will increase COO performance, productivity, and desire due to the incentive to make more money by increasing company profits. ii) Overall company profits should increase. For the COO to make the same salary of $80k as before, the company must have a total profit of $260k. Therefore, the COO is going to do all she can to exceed company profits of $260k so that she can make more money per year. $40k + (1/4) * ($260k - $100k) = $80k
Antitrust enforcement: According to the Federal Trade Commission, "Many mergers benefit competition and consumers by allowing firms to operate more efficiently. But some mergers change market dynamics in ways that can lead to higher prices, fewer or lower-quality goods or services, or less innovation." Antitrust laws often allow the former pro-competitive types of mergers, but prohibit the latter anti-competitive types. Suppose that one looks over the historical record of antitrust enforcement and finds that while the authorities have permitted some mergers and blocked others, the industry's average price has tended to fall whenever a merger has been permitted and occurred. a) Based solely on the information provided above, is it correct then to infer that the antitrust authorities should have been more lenient and permitted more mergers? Why or why not?
no, the ones that were accepted were only accepted b/c they would lower prices. Ones rejected and future ones could still be bad / raise prices
Monopoly Profit Maximization: In the following diagram depicting a monopoly market, label the marginal revenue curve, the profit-maximizing price, the profit maximizing quantity, and the profit: Reference Graph - App 2 Q12
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