# ECO 550 (NEW) Week 6 Problems

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Chapter 11 and Chapter 12 Problems

Chapter 11: Problems 2,4,6

1. Ajax Cleaning Products is a medium-sized firm operating in an industry dominated by one large firm Tile King. Ajax produces a multi-headed tunnel wall scrubber that is similar to a model produced by Tile King. Ajax decides to charge the same price as Tile King to avoid the possibility of a price war. The price charged by Tile King is \$20,000.

Ajax has the following short-run cost curve:

,000 – 5,000Q + 100Q2.

1. Computer the marginal cost curve for Ajax.
2. Given Ajax’s pricing strategy, what is the marginal revenue function for Ajax?

4. Unique Creations holds a monopoly position in the production and sale of manometers. The cost function facing Unique is estimated to be

TC = \$100,000 + 20Q

1. What is the marginal cost for Unique?
2. What is the marginal revenue at the price computed in Part (b)?

1.  Wyandotte Chemical Company sells various chemicals to the automobile industry. Wyandotte currently sells 30,000 gallons of polyol per year at an average price of \$15 per gallon. Fixed costs of manufacturing polyol are \$90,000 per year and total variable costs equal \$180,000. The operations research department has estimated that a 15 percent increase in output would not affect fixed costs but would reduce average variable costs by 60 cents per gallon. The marketing department has estimated the arc elasticity of demand for polyol to be –2.0.

1. How much would Wyandotte have to reduce the price of polyol to achieve a 15 percent increase in the quantity sold?
2. Evaluate the impact of such price cut on (i) total revenue, (ii) total costs, and (iii) total profits.

Chapter 12: Problems 1,2,5

1.  Assume that two companies (C and D) are duopolists that produce identical products. Demand for the products is given by the following linear demand function:

– Qc- Qd

Where Qc and Qd are the quantities sold by the respective firms and P is the selling price. Total cost functions for the two companies are

,000 + 100Qc

,000 + 125Qd.

Assume that the firms act independently as in the Cournot model (i.e., each firm assumes that the other firm Â’s output will not change).

1. Determine the long-run equilibrium output and selling price for each firm.
2. Determine the total profits for each firm at the equilibrium output found in Part (a). This is answer for part (a).

1.   Assume that two companies (A and B) are duopolists who produce identical products. Demand for the products is given by the following linear demand function:

Â– Qa – Qb

Where Qa and Qb are the quantities sold by the respective firms and P is the selling price. Total cost functions for the two companies are:

,500 + 55Qa + Q^2a

,200 + 20Qb + 2Q^2b .

1. Assume that the firms act independently as in the Cournot model (i.e., each firm assumes that the other firm Â’s output will not change).
2. Determine Firm A, Firm B, and total industry profits at equilibrium solution found in Part (a).

1.  Alchem (L) is the price leader in the polyglue market. All 10 other manufacturers (follower [F] firms) sell polyglue at the same price as Alchem. Alchem allows the other firms to sell as much as they wish at the established price and supplies the remainder of the demand itself. Total demand for polyglue is given by the following function ( +QF):

,000 – 4 QT

Alchem marginal cost function for the manufacturing and selling polyglue is

,000 + 5QL

The aggregate marginal cost function for the other manufacturers of polyglue is

?,000 + 4QF

1. What is the total market demand for polyglue at the price established by Alchem in Part (a)? How much of total demand do the follower firms supply?

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# ECO 550 (NEW) Week 5 Problems

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Chapter 9 and Chapter 10 Problems

Chapter 9: Problems 3,4,5

1.  A study of the costs of electricity generation for a sample of 56 British firms in 1946-1947 yielded the following long-run cost function:

+ .003Q + .0000029Q^2 – .000046QZ – .026Z + .00018Z^2

where variable cost measured in pence per kilowatt-hour. (A pence was a British monetary unit equal, at that time to 2 cents U.S.)

measured in millions of kWh per year

size, measured in thousands of kilowatts

1. Determine the long-run variable cost function for electricity generation.
2. Determine the long-run marginal cost function for electricity generation.
3. Holding plant size constant at 150,000 kilowatts, determine the short-run average variable cost and marginal cost functions for electricity generation.
4. For a plant size equal to 150,000 kilowatts, determine the output level that minimizes short-run average variable costs.
5. Determine the short-run average variable cost and marginal cost at the output level obtained in Part (D).

1.  Assuming that all other factors remain unchanged, determine how a firm’s breakeven point is affected by each of the following:
2. The firm finds it necessary to reduce the price per unit because of competitive conditions in the market.
3. The firm’s direct labor costs increase as a result of a new labor contract.
4. The Occupational Safety and Health Administration requires the firm to install new ventilating equipment in its plant. (Assume that this action has no effect on worker product

1.  Cool-Aire Corporation manufactures a line of room air conditioner. Its break even sales level is 33,000 units. Sales are approximately normally distributed. Expected sales next year are 40,000 units with a standard deviation of 4,000 units.

1. Determine the probability that Cool-Aire will incur an operating loss.
2. Determine the probability that Cool-Aire will operate above its break-even point.

Chapter 10: Problems 2,6,10

1.  Television channel operating profits vary from high as 45 to 55 percent at MTV and Nickelodon down to 12 to 18 percent to NBC and ABC. Provide a Porter Five Forces  analysis of each type of network. Why is MTV so profitable relative to major networks?

1.  Assume that a firm is a perfectly competitive industry has the following total cost schedule

Outputs (units)

Total Cost (\$)

10

\$110

15

\$150

20

\$180

25

\$225

30

\$300

35

\$385

40

\$480

1. Calculate a marginal cost and an average cost schedule for the firm.
2. If the prevailing marketing price is \$17 per unit, how many units will be produced and sold? What are the profits per unit? What are the total profits?
3. Is the industry in long-run equilibrium at this price?

1.  Which of the following products and services are likely to encounter adverse selection problems: golf shirts at traveling pro tournaments, certified gemstones from Tiffany’s graduation gift travel packages, or mail-order auto parts? Why or why not?

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# ECO 550 (NEW) Week 4 Problems C

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hapter 7 and Chapter 8 Problems

Chapter 7: Problems 1,6,8,9

In the deep creek mining company described in this chapter table 7.1 suppose again that labor is the variable input and capital is the fixed input. Specifically, assume that the firm owns a piece of equipment having a 500-bhp rating.

1. Complete the following table Labor input L(#of workers

Total production TPL (=Q)

Marginal Product (MPL)

Average Product APL

1

2

3

4

5

6

7

8

9

10

1. Plot the (i) total product, (ii) marginal product, (iii) average product functions.
2. Determine the boundaries of these three stages of production.
3.  Consider the following short-Run production function (where input,):
4. Determine the marginal product
5. Determine the average product function
6. Find the value of L that maximizes Q
7. Find the value of L at which the marginal product function takes on its maximum value
8. Find the value of L at which the average product function takes on its maximum value.

1.  Based on the production function parameter estimates reported in Table 7.4:

1. Which industry (or industries) appears to exhibit decreasing returns to scale? (Ignore the issue of statistical significance.
2. Which industry comes closest to exhibiting constant returns to scale?
3. In which will a given percentage increase in capital result in the largest percentage increase in output?
4. In what industry will a given percentage increase in production workers result in the largest percentage increase in output?

1.  Consider the following Cobb- Douglas production function for the bus transportation system in a particular city:

Q= ?L ^?1 F^?2 K^?3

Where L is the labor input in worker hours;

F is the fuel input in gallons;

K is the capital input in number of buses;

Q is the output measured in millions of bus miles

Suppose that the parameters (a,? 1, ?2, ?3) of this model were estimated using annual data for the past 25 years. The following results were obtained:

?= 0.0012;?; ?; ?

1. Determine the (i) labor, (ii) fuel, and (iii) capital input production elasticities.

1. Suppose that labor input (worker hours) is increased by 2 percent next year (other inputs held constant). Determine the approximate percentage change in output.

1. Suppose the capital input (number of buses) is decreased by 3 percent next year (when certain older buses are taken out of service). Assuming that the other inputs are held constant, determine the approximate percentage change in output.

1. What type of return to scale appears to characterize this bus transportation system? (Ignore the issue of statistical significance.)

1. Discuss some of the methodological and measurement problems one might encounter in using time-series data to estimate the parameters of this model.

Chapter 8: Problems 2,4,6

1. Howard Bowen is a large-scale cotton farmer. The land and machinery he owns has a current market value of \$4M. Bowen owes his local bank \$3M. Last year Bowen sold \$5M worth of cotton. His variable operating costs were \$4.5M; accounting depreciation was \$40,000, although the actual decline in value of Bowen’s machinery was \$60,000 last year. Bowen paid himself a salary of \$50,000, which is not considered part of his variable operating costs. Interest on his bank loan was \$400,000. If Bowen worked for another farmer or a local manufacturer, his annual income would be about \$30,000. Bowen can invest any funds that would be derived, if the farm were sold to earn 10% annually.(Ignore taxes)

1. Compare Bowen’s accounting profits.

1.  From your knowledge of the relationships among the various production functions, complete the following table:

Q

TC

FC

VC

ATC

AFC

AVC

MC

0

125

10

5

20

10.50

30

110

40

255

50

3

60

3

70

5

80

295

1. The Blair Company has three assembly plants located in California, Georgia and New Jersey. Currently the company purchases a major subassembly, which becomes part of the final product, from an outside firm. Blair has decided to manufacture the subassemblies within the company and must now consider whether to rent one centrally located facility, where all the subassemblies would be manufactured or to rent three separate facilities, each located near one of the assembly plants, where each facility would manufacture only the subassemblies needed for the nearby assembly plant. A single, centrally located facility, with a production capacity of 18,000 units per year, would have fixed costs of \$900,000 per year, and variable costs of \$250 per unit. Three separate, decentralized facilities, with production capacities of 8,000, 6,000 and 4,000 units per year, would have fixed costs of \$475,000, \$425,000 and \$400,000, respectively. Variable costs per unit produced in any of these three, decentralized facilities equal \$225 (per unit). The current production rates at the three assembly plants are 6,000, 4,500 and 3,000 units per year, respectively.

1. Assuming that the current production rates are maintained at the three assembly plants, which alternative should management select?

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# ECO 550 (NEW) Week 3 Problems

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Chapter 5 and Chapter 6 Problems

Chapter 5: Problems 1,5,6,9

1.  The forecasting staff for the Prizer Corporation has developed a model to predict sales of its air-cushioned-ride snowmobiles. The model specifies that sales S vary jointly with disposable personal income Y and the population between ages 15 and 40, Z, and inversely with the price of the snowmoblies P. Based on past data, the best estimate of this relationship is *YZ/P where k has been estimated (with past data) to equal 100.

1. If Y = \$11,000, Z = \$1,200, and P = \$20,000, what value would you predict for S ?
2. What happens if P is reduced to \$17,500?
3. How would you go about developing a value for k?
4. What are the potential weaknesses of  his model?

1.  A firm experienced the demand shown in the following table.

year —— actual demand—- 5 yr moving avg — 3 yr moving avg– exponential smoothing — exponential smoothing ( ) — ( ) _________________________________________________________________________________________________ 2000 | 800 | xxxx | xxxx | xxxx | xxxxx 2001 | 925 | xxxx | xxxx | _____ | __________ 2002 | 900 | xxxx | xxxx | ______ | __________ 2003 | 1025 | xxxx | _____ | ________ | ___________ 2004 | 1150 | xxxx | ______ | _________ | ____________ 2005 | 1160 | _____ | _______ | __________ | _____________ 2006 | 1200 | _______ | _______ | __________ | ____________ 2007 | 1150 | _______ | ________ | ___________ | ____________ 2008 | 1270 | ________ | ________ | ___________ | ____________ 2009 | 1290 | _________ | ________ | ____________ | ___________ 2010 | * | _________ | _________ | ____________ | ____________ Unknownfuture value to be forecast.

1. Fill in the table by preparing forecasts based on a five- year moving average, a three- year moving average, and exponential smoothing( with a and a ). Note: The exponential smoothing forecasts may be begun by assuming Yt+
2. Using the forecasts from 2005 through 2009, compare the accuracy of each of the forecasting methods based on the RMSE criterion.
3. Which forecast would you have used for 2010? Why?

1.  The economic analysis division of Mapco Enterprises has estimated the demand function for its line of weed trimmers as ,000 + 0.4N – 350Pm + 90Ps where of new homes completed in the primary market area of the Mapco trimmer of its competitor’s Surefire trimmer In 2010, 15,000 new homes are expected to be completed in the primary market area. Mapco plans to charge \$50 for its trimmer. The Surefire trimmer is expected to sell for \$55.

1. What sales are forecast for 2010 under these conditions?

1. If its competitor cuts the price of the Surefire trimmer to \$50, what effect will this have on Mapco’s sales?

1. What effect would a 30 percent reduction in the number of new homes completed have on Mapco’s sales ( ignore the impact of the price cut of the Surefire trimmer)?

1. Savings-Mart (a chain of discount department stores) sells patio and lawn furniture. Sales are seasonal, with higher sales during the spring and summer quarters and lower sales during the fall and winter quarters. The company developed the following quarterly sales forecasting model:

+ 0.125t 2.75D1t + 2.25D2t + 3.50D3t

Where sales (\$ million) in quarter t

sales (\$ million) when

period (quarter) where the fourth quarter of First quarter of , second quarter of ,. . .

for first-quarter observations 0 otherwise

for second quarter observations 0 otherwise

for third-quarter observations 0 otherwise

Forecast Savings-Mart s sales of patio and lawn furniture for each quarter of 2010.

Chapter 6: Problems 2,7,9,10

1. If the U.S. dollar were to appreciate substantially, what steps could a domestic manufacturer such as Cummins Engine Co. of Columbus, Indiana take in advance to reduce the effect of the exchange rate fluctuation on company profitability?

1.  If Boeing aircraft prices in dollars increase 20 percent and the yen/dollar exchange rate declines 15 percent, what effective price increase is facing Japan Airlines for the purchase of a Boeing 747? Would Boeing’s margin likely rise or fall if the yen then depreciated and competitor prices were unchanged? Why?

1.  If unit labor costs in Spain and Portugal rise, but unit labor costs in Germany decline and other producer prices remain unchanged, what effect should these factors by themselves have on export trade and why?

1.  What three factors determine whether two economies with separate fiscal and monetary authorities should form a currency union? Give an illustration of each factor using NAFTA economies.

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# ECO 550 (NEW) Week 2 Quizzes Chapter 1 & 2

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Chapter 1—Introduction and Goals of the Firm

MULTIPLE CHOICE

1. The form of economics most relevant to managerial decision-making within the firm is:

a. macroeconomics

b. welfare economics

c. free-enterprise economics

d. microeconomics

e. none of the above

2. If one defines incremental cost as the change in total cost resulting from a decision, and incremental revenue as the change in total revenue resulting from a decision, any business decision is profitable if:

a. it increases revenue more than costs or reduces costs more than revenue

b. it decreases some costs more than it increases others (assuming revenues remain constant)

c. it increases some revenues more than it decreases others (assuming costs remain constant)

d. all of the above

e. b and c only

3. In the shareholder wealth maximization model, the value of a firm’s stock is equal to the present value of all expected future ____ discounted at the stockholders’ required rate of return.

a. profits (cash flows)

b. revenues

c. outlays

d. costs

e. investments

4. Which of the following statements concerning the shareholder wealth maximization model is (are) true?

a. The timing of future profits is explicitly considered.

b. The model provides a conceptual basis for evaluating differential levels of risk.

c. The model is only valid for dividend-paying firms.

d. a and b

e. a, b, and c

5. According to the profit-maximization goal, the firm should attempt to maximize short-run profits since there is too much uncertainty associated with long-run profits.

a. true

b. false

6. According to the innovation theory of profit, above-normal profits are necessary to compensate the owners of the firm for the risk they assume when making their investments.

a. true

b. false

7. According to the managerial efficiency theory of profit, above-normal profits can arise because of high-quality managerial skills.

a. true

b. false

8. Which of the following (if any) is not a factor affecting the profit performance of firms:

a. differential risk

b. innovation

c. managerial skills

d. existence of monopoly power

e. all of the above are factors

9. Agency problems and costs are incurred whenever the owners of a firm delegate decision-making authority to management.

a. true

b. false

10. Economic profit is defined as the difference between revenue and ____.

a. explicit cost

b. total economic cost

c. implicit cost

d. shareholder wealth

e. none of the above

11. Income tax payments are an example of ____.

a. implicit costs

b. explicit costs

c. normal return on investment

d. shareholder wealth

e. none of the above

12. Various executive compensation plans have been employed to motivate managers to make decisions that maximize shareholder wealth. These include:

a. cash bonuses based on length of service with the firm

b. bonuses for resisting hostile takeovers

c. requiring officers to own stock in the company

d. large corporate staffs

e. a, b, and c only

13. The common factors that give rise to all principal-agent problems include the

a. unobservability of some manager-agent action

b. presence of random disturbances in team production

c. the greater number of agents relative to the number of principals

d. a and b only

e. none of the above

14. The Saturn Corporation (once a division of GM) was permanently closed in 2009.  What went wrong with Saturn?

a. Saturn’s cars sold at prices higher than rivals Honda or Toyota, so they could not sell many cars.

b. Saturn sold cars below the prices of Honda or Toyota, earning a low 3% rate of return.

c. Saturn found that young buyers of Saturn automobiles were very loyal to Saturn and GM.

d. Saturn implemented a change management view that helped make first time Saturn purchasers trade up to Buick or Cadillac.

e. all of the above

15.  A Real Option Value is:

a. An option that been deflated by the cost of living index makes it a “real” option.

b. An opportunity cost of capital.

c. An opportunity to implement a new cost savings or revenue expansion activity that arises from business plans that the managers adopt.

d. An objective function and a decision rule that comes from it.

e. Both a and b.

16. Which of the following will increase (V0), the shareholder wealth maximization model of the firm:

V0∙(shares outstanding) = S¥t=1 (p t ) / (1+ke)t   + Real Option Value.

a. Decrease the required rate of return (ke).

b. Decrease the stream of profits (pt).

c. Decrease the number of periods from ¥ to 10 periods.

d. Decrease the real option value.

e. All of the above.

17. The primary objective of a for-profit firm is to ___________.

a. maximize agency costs

b. minimize average cost

c. maximize total revenue

d. set output where total revenue equals total cost

e maximize shareholder value

18. Possible goals of Not-For-Profit (NFP) enterprises include all of the following EXCEPT:

a. maximize total costs

b. maximize output, subject to a breakeven constraint

c. maximize the happiness of the administrators of the NFP enterprise

d. maximize the utility of the contributors

e. a. and c.

19. The flat-screen plasma TVs are selling extremely well.  The originators of this technology are earning higher profits.  What theory of profit best reflects the performance of the plasma screen makers?

a. risk-bearing theory of profit

b. dynamic equilibrium theory of profit

c. innovation theory of profit

d. managerial efficiency theory of profit

e. stochastic optimization theory of profit

20.  To reduce Agency Problems, executive compensation should be designed to:

a. create incentives so that managers act like owners of the firm.

b. avoid making the executives own shares in the company.

c. be an increasing function of the firm’s expenses.

d. be an increasing function of the sales revenue received by the firm.

e. all of the above

21. Recently, the American Medical Association changed its recommendations on the frequency of pap-smear exams for women.  The new frequency recommendation was designed to address the family histories of the patients.  The optimal frequency should be where the marginal benefit of an additional pap-test:

a. equals zero.

b. is greater than the marginal cost of the test

c. is lower than the marginal cost of an additional test

d. equals the marginal cost of the test

e. both a and b.

Chapter 2—Fundamental Economic Concepts

MULTIPLE CHOICE

1. A change in the level of an economic activity is desirable and should be undertaken as long as the marginal benefits exceed the ____.

a. marginal returns

b. total costs

c. marginal costs

d. average costs

e. average benefits

2. The level of an economic activity should be increased to the point where the ____ is zero.

a. marginal cost

b. average cost

c. net marginal cost

d. net marginal benefit

e. none of the above

3. The net present value of an investment represents

a. an index of the desirability of the investment

b. the expected contribution of that investment to the goal of shareholder wealth maximization

c. the rate of return expected from the investment

d. a and b only

e. a and c only

4. Generally, investors expect that projects with high expected net present values also will be projects with

a. low risk

b. high risk

c. certain cash flows

d. short lives

e. none of the above

5. An closest example of a risk-free security is

a. General Motors bonds

b. AT&T commercial paper

c. U.S. Government Treasury bills

d. San Francisco municipal bonds

e. an I.O.U. that your cousin promises to pay you \$100 in 3 months

6. The standard deviation is appropriate to compare the risk between two investments only if

a. the expected returns from the investments are approximately equal

b. the investments have similar life spans

c. objective estimates of each possible outcome is available

d. the coefficient of variation is equal to 1.0

e. none of the above

7. The approximate probability of a value occurring that is greater than one standard deviation from the mean is approximately (assuming a normal distribution)

a. 68.26%

b. 2.28%

c. 34%

d. 15.87%

e. none of the above

8. Based on risk-return tradeoffs observable in the financial marketplace, which of the following securities would you expect to offer higher expected returns than corporate bonds?

a. U.S. Government bonds

b. municipal bonds

c. common stock

d. commercial paper

e. none of the above

9. The primary difference(s) between the standard deviation and the coefficient of variation as measures of risk are:

a. the coefficient of variation is easier to compute

b. the standard deviation is a measure of relative risk whereas the coefficient of variation is a measure of absolute risk

c. the coefficient of variation is a measure of relative risk whereas the standard deviation is a measure of absolute risk

d. the standard deviation is rarely used in practice whereas the coefficient of variation is widely used

e. c and d

10. The ____ is the ratio of ____ to the ____.

a. standard deviation; covariance; expected value

b. coefficient of variation; expected value; standard deviation

c. correlation coefficient; standard deviation; expected value

d. coefficient of variation; standard deviation; expected value

e. none of the above

11. Sources of positive net present value projects include

a. buyer preferences for established brand names

b. economies of large-scale production and distribution

c. patent control of superior product designs or production techniques

d. a and b only

e. a, b, and c

12. Receiving \$100 at the end of the next three years is worth more to me than receiving \$260 right now, when my required interest rate is 10%.

a. True

b. False

13.  The number of standard deviations z that a particular value of r is from the mean ȓ can be computed as z = (r – ȓ)/ s.  Suppose that you work as a commission-only insurance agent earning \$1,000 per week on average.  Suppose that your standard deviation of weekly earnings is \$500.  What is the probability that you zero in a week?  Use the following brief z-table to help with this problem.

Z value Probability

-3 .0013

-2 .0228

-1 .1587

0 .5000

a. 1.3% chance of earning nothing in a week

b. 2.28% chance of earning nothing in a week

c. 15.87% chance of earning nothing in a week

d. 50% chance of earning nothing in a week

e. none of the above

14. Consider an investment with the following payoffs and probabilities:

State of the Economy Probability Return

Stability .50 1,000

Good Growth .50 2,000

Determine the expected return for this investment.

a. 1,300

b. 1,500

c. 1,700

d. 2,000

e. 3,000

15. Consider an investment with the following payoffs and probabilities:

State of the Economy Probability Return

GDP grows slowly .70 1,000

GDP grow fast .30 2,000

Let the expected value in this example be 1,300.  How do we find the standard deviation of the investment?

a. s = Ö { (1000-1300)2 + (2000-1300)2 }

b. s = Ö { (1000-1300) + (2000-1300) }

c. s= Ö { (.5)(1000-1300)2 + (.5)(2000-1300)2 }

d. s= Ö { (.7)(1000-1300) + (.3)(2000-1300) }

e. s= Ö { (.7)(1000-1300)2 + (.3)(2000-1300)2 }

16. An investment advisor plans a portfolio your 85 year old risk-averse grandmother.  Her portfolio currently consists of 60% bonds and 40% blue chip stocks.  This portfolio is estimated to have an expected return of 6% and with a standard deviation 12%.  What is the probability that she makes less than 0% in a year? [A portion of Appendix B1 is given below, where z = (x – m)/s,with mas the mean and sas the standard deviation.]

a. 2.28%

b. 6.68%

c. 15.87%

d. 30.85%

e. 50%

Table B1 for Z

Z       Prob.

-3 .0013

-2.5 .0062

-2. .0228

-1.5 .0668

-1 .1587

-.5 ..3085

0 .5000

17. Two investments have the following expected returns (net present values) and standard deviations:

PROJECT Expected Value Standard Deviation

Q \$100,000 \$20,000

X   \$50,000 \$16,000

Based on the Coefficient of Variation, where the C.V. is the standard deviation dividend by the expected value.

a. All coefficients of variation are always the same.

b. Project Q is riskier than Project X

c. Project X is riskier than Project Q

d. Both projects have the same relative risk profile

e. There is not enough information to find the coefficient of variation.

PROBLEMS

1. Suppose that the firm’s cost function is given in the following schedule (where Q is the level of output):

Output Total

Q (units) Cost

0   7

1 25

2 37

3 45

4 50

5 53

6 58

7 66

8 78

9 96

10   124

Determine the (a) marginal cost and (b) average total cost schedules

2. Complete the following table.

Total Marginal Average

Output Profit Profit Profit

0 -48             0 ______

1 -26   ______ ______

2 -8 ______ ______

3   6 ______ ______

4 16 ______ ______

5 22 ______ ______

6 24 ______ ______

7 22 ______ ______

8 16 ______ ______

9   6 ______ ______

10   -8 ______ ______

3. A firm has decided to invest in a piece of land. Management has estimated that the land can be sold in 5 years for the following possible prices:

Price Probability

10,000 .20

15,000 .30

20,000 .40

25,000 .10

(a) Determine the expected selling price for the land.

(b) Determine the standard deviation of the possible sales prices.

(c) Determine the coefficient of variation.

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# ECO 550 (NEW) Week 2 Problems

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Chapter 3 and Chapter 4 Problems

Chapter 3: Problems 3, 4, and 7

1. The Olde Yogurt Factory has reduced the price of its popular Mmmm Sundae from \$2.25 to \$1.75. As a result, the firm’s daily sales of these sundaes have increased from 1,500/day to 1,800/day. Compute the arc price elasticity of demand over this price and consumption quantity range.

1. The subway fare in your town has just been increased from a current level of 50 cents to \$1.00 per ride. As a result, the transit authority notes a decline in rider-ship of 30 percent.
2. Compute the price elasticity of demand for subway rides.
3. If the transit authority reduces the fare back to 50 cents, what impact would you expect on the ridership? Why?

1. In an attempt to increase revenues and profits, a firm is considering a 4 percent increase in price and an 11 percent increase in advertising. If the price elasticity of demand is −1.5 and the advertising elasticity of demand is +0.6, would you expect an increase or decrease in total revenues?

Chapter 4: Problems 5, 6, and 7

1. General Cereals is using a regression model to estimate the demand for Tweetie Sweeties, a whistle-shaped, sugar-coated breakfast cereal for children. The following (multiplicative exponential) demand function is being used:

1. The demand for haddock has been estimated as log + b log P + c log I + d log Pm

measure of personal income in the New England region

index of the price of meat and poultry

1. Determine the price elasticity of demand.
2. Determine the income elasticity of demand.
3. Determine the cross price elasticity of demand.
4. How would you characterize the demand for haddock? Apparently the Haddock is plentiful since it a white fish. New England has lots of ocean access to fish.
5. Suppose disposable income is expected to increase by 5 percent next year.

1. An estimate of the demand function for household furniture produced the following results:

1.08  .16  -.48

Y  R  P

where expenditures per household

personal income per household

of private residential construction per household

of the furniture price index to the consumer price index

1. Determine the point price and income elasticities for household furniture.
2. What interpretation would you give to the exponent for R? Why do you suppose R was included in the equation as a variable?
3. If you were a supplier to the furniture manufacturer, would you have preferred to see the analysis performed in physical sales units rather than dollars of revenue? How would this change alter the interpretation of the price coefficient, presently estimated as −0.48?

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# ECO 550 (NEW) Week 1 Problems

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Chapter 1 and Chapter 2 Problems

Chapter 1: Exercises 2, 3, and 6

1. Explain several dimensions of the shareholder-principal conflict with manager-agents known as the principal-agent problem. To mitigate agency problems between senior executives and shareholders, should the compensation committee of the board devote more to executive salary and bonus (cash compensation) or more to long-term incentives? Why? What role does each type of pay play in motivating managers?

1. Corporate profitability declined by 20 percent from 2008 to 2009. What performance percentage would you use to trigger executive bonuses for that year? Why? What issues would arise with hiring and retaining the best managers?

1. In the context of the shareholder wealth-maximization model of a firm, what is the expected impact of each of the following events on the value of the firm? Explain why.

Chapter 2: Exercises 1, 5, and 6

1.  For each of the determinants of demand in Equation 2.1, identify an example illustrating the effect on the demand for hybrid gasoline-electric vehicles such as the Toyota Prius. Then do the same for each of the determinants of supply in Equation 2.2. In each instance, would equilibrium market price increase or decrease? Consider substitutes such as plug-in hybrids, the Nissan Leaf and Chevy Volt, and complements such as gasoline and lithium ion laptop computer batteries.

1. Two investments have the following expected returns (net present values) and standard deviation of returns:

PROJECT  EXPECTED RETURNS   STANDARD DEVIATION

A  \$ 50,000  \$ 40,000

B  \$250,000   \$125,000

1. The manager of the aerospace division of General Aeronautics has estimated the price it can charge for providing satellite launch services to commercial firms. Her most optimistic estimate (a price not expected to be exceeded more than 10 percent of the time) is \$2 million. Her most pessimistic estimate (a lower price than this one is not expected more than 10 percent of the time) is \$1 million. The expected value estimate is \$1.5 million. The price distribution is believed to be approximately normal.

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# ECO 550 Final Exam (CHAPTER 9 To CHAPTER 17)

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MULTIPLE CHOICE

1. Evidence from empirical studies of short-run cost-output relationships lends support to the:

a. existence of a non-linear cubic total cost function

b. hypothesis that marginal costs first decrease, then gradually increase over the normal operating range of the firm

c. hypothesis that total costs increase quadratically over the ranges of output examined

d. hypothesis that total costs increase linearly over the range of output examined

e. none of the above

2. The short-run cost function is:

a. where all inputs to the production process are variable

b. relevant to decisions in which one or more inputs to the production process are fixed

c. not relevant to optimal pricing and production output decisions

d. crucial in making optimal investment decisions in new production facilities

e. none of the above

3. Theoretically, in a long-run cost function:

a. all inputs are fixed

b. all inputs are considered variable

c. some inputs are always fixed

d. capital and labor are always combined in fixed proportions

e. b and d

4. Break-even analysis usually assumes all of the following except:

a. in the short run, there is no distinction between variable and fixed costs.

b. revenue and cost curves are straight-lines throughout the analysis.

c. there appears to be perfect competition since the price is considered to remain the same regardless of quantity.

d. the straight-line cost curve implies that marginal cost is constant.

e. both c and d

5.  What is another term meaning the degree of operating leverage?

a. The measure of the importance of fixed cost.

b. The operating profit elasticity.

c. The measure of business risk.

d. D.O.L.

e. All of the above.

6. In a study of banking by asset size over time, we can find which asset sizes are tending to become more prominent.  The size that is becoming more predominant is presumed to be least cost. This is called:

a. regression to the mean analysis.

b. breakeven analysis.

c. survivorship analysis.

d. engineering cost analysis.

e. a Willie Sutton analysis.

7. George Webb Restaurant collects on the average \$5 per customer at its breakfast & lunch diner. Its variable cost per customer averages \$3, and its annual fixed cost is \$40,000.  If George Webb wants to make a profit of \$20,000 per year at the diner, it will have to serve__________ customers per year.

a. 10,000 customers

b. 20,000 customers

c. 30,000 customers

d. 40,000 customers

e. 50,000 customers

8. In determining the shape of the cost-output relationship only ____ depreciation is relevant.

a. direct

b. indirect

c. usage

d. time

e. scheduled

9. Which of the following is not a limitation of the survivor technique for measuring the optimum size of firms within an industry?

a. since the technique does not employ actual cost data in the analysis, there is no way to assess the magnitude of the cost differentials between firms of varying size and efficiency.

b. the managerial and entrepreneurial aspects of the production process are not included in the analysis

c. because of legal factors, the long-run cost curve derived by this technique may be distorted and may not measure the cost curve postulated in economic theory

d. a and b

e. b and c

10. The primary disadvantage of engineering methods for measuring cost functions is that they deal with the managerial and entrepreneurial aspects of the production process or plant.

a. true

b. false

11. A linear total cost function implies that:

a. marginal costs are constant as output increases

b. average total costs are continually decreasing as output increases

c. a and b

d. none of the above

12. A ____ total cost function implies that marginal costs ____ as output is increased.

a. linear; increase linearly

c. cubic; increase linearly

d. a and b

e. none of the above

13. A ____ total cost function implies that marginal costs ____ as output is increased.

a. linear; increase linearly

c. cubic; increase linearly

d. linear; are constant

e. none of the above

14. A ____ total cost function yields a U-shaped average total cost function.

a. cubic

c. linear

d. a and b only

e. a, b, and c

15. In the linear breakeven model, the difference between selling price per unit and variable cost per unit is referred to as:

a. variable margin per unit

b. variable cost ratio

c. contribution margin per unit

d. target margin per unit

e. none of the above

16. Which of the following is not an assumption of the linear breakeven model:

a. constant selling price per unit

b. decreasing variable cost per unit

c. fixed costs are independent of the output level

d. a single product (or a constant mix of products) is being produced and sold

e. all costs can be classified as fixed or variable

17. In the linear breakeven model, the breakeven sales volume (in dollars) is equal to fixed costs divided by:

a. unit selling price less unit variable cost

b. contribution margin per unit

c. one minus the variable cost ratio

d. a and b only

e. a, b, and c

18. The degree of operating leverage is equal to the ____ change in ____ divided by the ____ change in ____.

a. percentage; sales; percentage; EBIT

b. unit; sales; unit; EBIT

c. percentage; EBIT; percentage; sales

d. unit; EBIT; unit; sales

e. none of the above

19. The linear breakeven model excludes ____ from the analysis.

a. financing costs

b. taxes

c. contribution margin

d. a and b only

e. a, b, and c

20. In the linear breakeven model, the relevant range of output is that range where the linearity assumptions of the model are assumed to hold.

a. true

b. false

21. In the linear breakeven model, the breakeven sales volume (in dollars) can be found by multiplying the breakeven sales volume (in units) by:

a. one minus the variable cost ratio

b. contribution margin per unit

c. selling price per unit

d. standard deviation of unit sales

e. none of the above

22. In the linear breakeven model, a firm incurs operating losses whenever output is less than the breakeven level.

a. true

b. false

PROBLEMS

1. For each of the following cost-output relationships, describe the shape (U-shape, decreasing, increasing, constant) of the average total cost and marginal cost functions (C = total cost, Q = output):

(a) C = 42,500,000 + 2550Q

(b) C = 8.48 + 0.65Q + .00220Q2

2. Offshore Petroleum’s fixed costs are \$2,500,000 and its debt repayment requirements are \$1,000,000. Selling price per barrel of oil is \$18 and variable costs per barrel are \$10.

(a) Determine the breakeven output (in dollars).

(b) Determine the number of barrels of oil that offshore must produce and sell in order to earn a target (operating) profit of \$1,500,000.

(c) Determine the degree of operating leverage at an output of 400,000 barrels.

(d) Assuming that sales of oil are normally distributed with a mean of 362,500 barrels and a standard deviation of 100,000 barrels, determine the probability that Offshore will incur an operating loss.

Chapter 10—Prices, Output, and Strategy: Pure and Monopolistic Competition

MULTIPLE CHOICE

1. The main difference between perfect competition and monopolistic competition is:

a. The number of sellers in the market

b. The ease of entry and exit in the industry

c. The degree of information about market price

d. The degree of product differentiation

e. Whether it is the short run or the long run

2. Long distance telephone service has become a competitive market. The average cost per call is \$0.05 a minute, and it’s declining.  The likely reason for the declining price for long distance service is:

a. Governmental pressure to lower the price

b. Reduced demand for long distance service

c. Entry into this industry pushes prices down

d. Lower price for a barrel of crude oil

e. Increased cost of providing long distance service

3. What is the profit maximization point for a firm in a purely competitive environment?

a. The output where P = MC

b. The output where P < MC

c. The output where P > MC

d. The output where MR = MC

e. The output where AVC < P

4. All of the following are true for both competition and monopolistic competition in the long run, except one of them.  Which is it?

a. P = MC

b. P = AC

c. Economic profits become zero in the long-run

d. The barriers to entry and exit are relatively easy

e. None of the above is an exception

5. Which of the following statements is (are) true concerning a pure competition situation?

a. Its demand curve is represented by a vertical line.

b. Firms must sell at or below market price.

c. Marginal revenue is equal to price.

d. both b and c

e. both a and b

6. In pure competition:

a. the optimal price-output solution occurs at the point where marginal revenue is equal to price

b. a firm’s demand curve is represented by a horizontal line

c. a firm is a price-taker since the products of every producer are perfect substitutes for the products of every other producer

d. a and b only

e. a, b, and c

7. In the short-run for a purely competitive market, a manufacturer will stop production when:

a. the total revenue is less than total costs

b. the contribution to fixed costs is zero or less

c. the price is greater than AVC

d. operating at a loss

e. a and b

8. In the purely competitive case, marginal revenue (MR) is equal to:

a. cost

b. profit

c. price

d. total revenue

e. none of the above

9. In long-run equilibrium, all firms in a pure competition market situation operating under a condition of certainty will have identical costs even though they may use different production and operation techniques.

a. true

b. false

10. If price exceeds average costs under pure competition, ____ firms will enter the industry, supply will ____, and price will be driven ____.

a. more; decrease; down

b. more; decrease; up

c. more; increase; down

d. more; increase; up

e. none of the above

11. A firm in pure competition would shut down when:

a. price is less than average total cost

b. price is less than average fixed cost

c. price is less than marginal cost

d. price is less than average variable cost

12. In the long-run, firms in a monopolistically competitive industry will

a. earn substantial economic profits

b. tend to just cover costs, including normal profits

c. seek to increase the scale of operations

d. seek to reduce the scale of operations

13. Uncertainty includes all of the following except ____.

a. unknown effects of deliberate actions

b. incomplete information as to the type of competitor

c. random disturbances

d. unverifiable claims

e. accidents due to weather hazards

14. Experience goods are products or services

a. that the customer already knows

b. whose performance is highly unusual

c. whose quality is undetectable when purchased

d. not likely to cause repeat purchases

e. all of the above

15. Buyers anticipate that the temporary warehouse seller of unbranded computer equipment will

a. deliver high quality products consistent with expectations

b. not attempt to establish any warranty enforcement mechanisms

c. offer several prices and qualities

d. produce only one quality

e. none of the above

16. All of the following are mechanisms which reduce the adverse selection problem except ____.

a. warranties from established enterprises with non-redeployable assets

b. high interest rates

c. large collateral requirements

d. brand names and product-specific promotions and retail displays

e. higher prices in repeat customer transactions

17. Asset specificity is largest when

a. value in first best use is large

b. value in second best use is large

c. customers choose their supplier at random

d. very valuable assets are non-redeployable

e. customers are loyal to a particular seller

18. Under asymmetric information,

a. you never get what you pay for

b. you sometimes get cheated

c. you always get cheated

d. at best you get what you pay for

e. sellers make profits in excess of competitive returns

19. To escape adverse selection and elicit high quality experience goods buyers can

a. offer price premiums to new firms in the market

b. seek out unbranded goods

c. buy from generic storefronts that have leased temporary space

d. secure warranties from warehouse retailers

e. none of the above

20. The problems of asymmetric information exchange arise ultimately because

a. one party to the exchange possesses different information than another

c. one party knows nothing

d. one party cannot independently verify the information of another

e. information is scarce

21. The market for “lemons” is one in which

b. the seller’s product claims are unverifiable at the point of purchase

c. “the bad apples drive out the good”

d. the problem of adverse selection is rampant

e. all of the above

22. The fraudulent delivery of low quality experience goods at high prices is more likely if

a. interest rates decline

b. information about notorious firms is speedily disseminated

c. price premiums for allegedly high quality increase

d. sellers invest in non-transferable reputation

e. none of the above

23. An “experience good” is one that:

a. Only an expert can use

b. Has undetectable quality when purchased

c. Can be readily experienced simply by touching or tasting

d. Improves with age, like a fine wine

e. All of the above

24. A “search good” is:

a. One that depends on how the product behaves over time

b. A product whose quality is only found out over time by finding how durable it is

c. Like a peach that can be examined for flaws

d. Like a used car, since it is easy to determine its inherent quality

e. None of the above

25. The price for used cars is well below the price of new cars of the same general quality.  This is an example of:

a. The Degree of Operating Leverage

b. A Lemon’s Market

c. Redeployment Assets

d. Cyclical Competition

e. The Unemployment Rate

PROBLEMS

1. Sunrise Juice Company sells its output in a perfectly competitive market. The firm’s total cost function is given in the following schedule:

Output Total Cost

(Units) (\$)

0   50

10 120

20 170

30 210

40 260

50 330

60 430

Total costs include a “normal” return on the time (labor services) and capital that the owner has invested in the firm. The prevailing market price is \$7 per unit.

(a) Prepare (i) marginal cost and (ii) average total cost schedules for the firm.

(b) What is the firm’s profit maximizing output level?

2. Superior Metals Company has seen its sales volume decline over the last few years as the result of rising foreign imports. In order to increase sales (and hopefully, profits), the firm is considering a price reduction on luranium–a metal that it produces and sells. The firm currently sells 60,000 pounds of luranium a year at an average price of \$10 per pound. Fixed costs of producing luranium are \$250,000. Current variable costs per pound are \$5. The firm has determined that the variable cost per pound could be reduced by \$.50 if production volume could be increased by 10 percent (fixed costs would remain constant). The firm’s marketing department has estimated the arc elasticity of demand for luranium to be 1.5.

(a) How much would Superior Metals have to reduce the price of luranium in order to achieve a 10 percent increase in the quantity sold?

(b) What would the firm’s (i) total revenue, (ii) total cost, and (iii) total profit be before and after the price cut?

Chapter 11—Price and Output Determination: Monopoly and Dominant Firms

MULTIPLE CHOICE

1. Unique Creations has a monopoly position in magnometers.  If the marginal cost for a magnometer is \$50 and the price elasticity for magnometers is -4, what is the optimal monopoly price?

Hint:  P (1 +1/E) = MC.

a. \$37.50

b. \$41.25

c. \$66.67

d. \$75.00

e. \$82.50

2. Land’s End estimates a demand curve for turtleneck sweaters to be:

Log Q = .41 + 2.3 Log Y – 3 Log P

where Q is quantity, P is price, and Y is a measure on national income.  If the marginal cost of imported turtleneck sweaters is \$9.00.  (HINT:  P (1 +1/E) = MC).  The optimal monopoly price would be:

a. P = \$13.50

b. P = \$26.50

c. P = \$27.50

d. P = \$34.50

e. P = \$56.22

3. Declining cost industries

a. have upward rising AC curves.

b. have upward rising demand curves.

c. have Ç-shaped total costs.

d. have diseconomies of scale.

e. have marginal cost curves below their average cost curve.

4. A monopolist seller of Irish ceramics faces the following demand function for its product: P = 62 – 3Q.  The fixed cost is \$10 and the variable cost per unit is \$2.  What is the maximizing QUANTITY for this monopoly?  Hint:  MR is twice as steep as the inverse demand curve:  MR = 62 – 6 Q. (Pick closest answer)

a. Q = 10

b. Q = 15

c. Q = 22

d. Q = 37

e. Q = 41

5. Globo Public Supply has \$1,000,000 in assets.  Its demand curve is: P = 206 – .20•Q and its total cost function is: TC = 20,000 + 6•Q where TC excludes the cost of capital.  If Globo Public Supply is UNREGULATED, find Globo’s optimal price.

a. \$206

b. \$106

c. \$56

d. \$6

e. \$3

6. A monopolist faces the following demand curve: P = 12 – .3Q with marginal costs of \$3.  What is the monopolistic PRICE?

a. P = \$5.50

b. P = \$6.50

c. P = \$7.50

d. P = \$8.50

e. P = \$9.50

7.

8.

9.

10.

11.

12.

7. In natural monopoly, AC continuously declines due to economies in distribution or in production, which tends to found in industries which face increasing returns to scale.  If price were set equal to marginal cost, then:

a. price would equal average cost.

b. price would exceed average cost.

c. price would be below average cost.

d. price would be at the profit maximizing level for natural monopoly

e. all of the above

8. The profit maximizing monopolist, faced with a negative-sloping demand curve, will always produce:

a. at an output greater than the output where average costs are minimized

b. at an output short of that output where average costs are minimized

c. at an output equal to industry output under pure competition

d. a and c

e. none of the above

9. In the case of pure monopoly:

a. one firm is the sole producer of a good or service which has no close substitutes

b. the firm’s profit is maximized at the price and output combination where marginal cost equals marginal revenue

c. the demand curve is always elastic

d. a and b only

e. a, b, and c

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# ECO 550 (NEW) Week 8 Problems

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Chapter 15 Problems

Chapter 15: Problems 2, 5, and 6

1. If contract promises were not excused because of acts of war, would the clearing and settlements clients of Bank of New York change their behaviour? If so, how? What reliance behaviour would be considered efficient? What reliance behaviour would be considered excessive?

1. Would warehouse operators insist on owning their own trucking companies?

Why or why not? What coordination and control problems and contractual hazards would these companies encounter?

1. What organizational form would warehouse operators and truck hauling companies adopt?

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# ECO 550 (NEW) Week 9 Problems

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Chapter 16 Problems

Chapter 16: Problems 4, 6(a, c), 9

1.  What are the incentives to innovate for a monopoly firm’s as compared with a firm in a competitive market if patent protection is not available.

1. The industry demand function for bulk plastics is represented by the following equation:

Where Q represents millions of pounds of plastics

The total cost function for the industry, exclusive of a required return on invested capital, is

+ 500Q +10Q2

Where Q represents millions of pounds of plastic

(a)  If this industry acts like a monopolist in the determination of price and output, compute the profit maximizing level of price and output

(b)  What are total profits at this price and output level?

© Assume that this industry is composed of many (500) small firms, such that the demand function facing any individual firm is

P=\$620

Compute the profit-maximizing level of price and output under these conditions (the industry’s total cost function remain unchanged)

1. Branding Iron Products, a specialty steel fabricator, operates a plant in the town of West Star, Texas. The town has grown rapidly because of recent discoveries of oil and gas in the area. Many of the new residents have expressed concern at the amount of pollution (primary particulate matter in the air and waste water in the town’s river) emitted by Brandon Iron. Three proposals have been made to remedy the problem:

(a) Impose a tax on the amount of particulate matter and the amount of waste water emitted by the firm.

(b) Prohibit pollution by the firm

(c) Offer tax incentives to the firm to clean up its production processes.

Evaluate each of these alternatives from the perspectives of economic efficiency, equity, and the likely long-term impact on the firm.

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