Managerial Economics

1. (8 points) The total cost function is as follows: TC= 20+ 4Q

Calculate the following costs at quantity is Q=10.

a. Total fixed cost

b. Total variable cost

c. Average total cost

d. Average fixed cost

2. (6 points) George has been selling 5,000 T-shirts per month for $8.50. When he increased the price to $9.50, he sold only 4,000 T-shirts.

a. What is the price elasticity of demand?

b. Was raising the price profitable?

3. (12 points) You are the manager of a gas station in a small town, and your goal is to maximize profits. Based on your experience, the elasticity of demand of B.C. residents for a car wash is -2, while that of non-BC residents is -1.5. Your marginal cost is $6.

a. Are the conditions necessary for price discrimination to be an effective means of enhancing profits being met? Explain.

b. What is the profit-maximizing price to charge a BC resident for a car wash?

c. What is the profit-maximizing price to charge an Albertan for a car wash?

4. (10 points) A risk-neutral manager is considering two projects. The first is to introduce a new product; the second is to revamp the production facilities at the existing plant. There is a 20 percent chance a rival will enter the market and an 80 percent chance it will not. If the rival enters, the firm will earn $80,000 profit if it introduces the new product, whereas revamping the production facilities will earn it $50,000 in profits. If the rival does not enter, the firm will earn $60,000 profit if it introduces the new product, and revamping the production facilities will earn profit of $60,000. What should the manager do? Why?

5. (10 points) Your product fails about 2% of the time on average. Some customers purchase the extended warranty you offer in which you will replace the product if it fails. Would you want to price the extended warranty at 2% of the product price? Discuss both moral hazard and adverse selection issues.

6. (12 points) You are a bidder in an independent private values auction. Each bidder perceives that valuations are evenly distributed between $100 and $1,000. If there is a total of three bidders and your own valuation of the item is $900, what is your optimal bidding strategy in: a. A first-price, sealed-bid auction? b. A Dutch auction? c. A second-price, sealed-bid auction? d. An English auction? 

7. ( 8 points) Sellers of used cars know the cars’ quality, but buyers do not. Imagine that used Toyota Corollas are worth $10,000 if they are of high quality and $5,000 if they are of low quality. Although buyers may not know the quality of a specific car, they do know that 25 percent of the used Corollas will be of high quality. In such a market, what cars will be sold on the used car market and at what price?

8. (12 points) In a one-shot game, if you advertise and your rival advertises, you will each earn $5 million in profits. If neither of you advertise, your rival will make $4 million and you will make $2 million. If you advertise and your rival does not, you will make $10 million and your rival will make $3 million. If your rival advertises and you do not, you will make $1 million and your rival will make $3 million. a. Write the above game in normal form. b. Do you have a dominant strategy? c. Does your rival have a dominant strategy? d. What is the Nash equilibrium for the one-shot game?

9. (10 points) You are the only pharmacist in a small town; the next closest drugstore is 50 miles away. The population in your town consists of young farmers and older retired families. You have noticed that the young farmers are less sensitive to price changes than the retired population. Specifically, you have found that the working population has an own price elasticity of demand of -2 and the retired farmers have an own price elasticity of -4. How can you use this information to your pricing? 

10. (12 points) Suppose the market for computer chips is dominated by two firms: Intel and AMD. Intel has discovered how to make superior chips and is considering whether or not to adopt the new technology. Adoption would entail a fixed setup cost of C but would increase revenues. However, if Intel adopts the new technology, AMD can easily copy it at a lower setup cost of C/2. If Intel adopts and AMD does not, Intel would earn $20 in revenues while AMD would earn $0. If Intel adopts and AMD does likewise, each firm will earn $15 in revenues. If Intel does not adopt the new technology, it will earn $5 and AMD will earn $2.

a. Write this game in extensive form.

b. Under what conditions (i.e., for what values of C) does AMD have an incentive to adopt the new technology if Intel introduces it?

c. If C = 12, should Intel adopt the new technology? Explain.