QUESTIONS FOR CRITICAL THINKING 4
Salvatore Chapter 8:
Discussion Questions: 2 (a) what is the distinction between marginal cost and incremental
cost (b) how are sunk costs treated in managerial decision making why?
Answer:
(a) Marginal cost is the change in total costs per unit change in output. Incremental cost, on
the other hand, refers to the total increase in costs resulting from the implementation of a
particular managerial decision, such as the introduction of a new product, entering a new
market, improving the quality of the firm's product, etc. While the two concepts are
related, the marginal cost refers simply to the increase in total costs from producing 1
additional unit of the commodity, or the reduction in total costs resulting from the
reduction of output by 1 unit. Incremental cost refers instead to the increase in total costs
from implementing an entire managerial decision. It may involve a large increase in
output or no increase at all (if the firm simply wishes to change only the quality of its
product).
(b) Sunk costs are those costs that are incurred regardless of the current managerial decisions
of the firm. Thus, sunk costs are entirely irrelevant in determining the best course of
action by the firm in the present period. For example, it pays for the firm to produce an
output even if it incurs a loss as long as the loss is smaller than the sunk costs. The reason
is that if the firm decided not to produce the output, it would incur the larger loss equal to
its sunk costs.
.
Problems3 (Airway Express)
1. P3 (a): Calculate and compare the profit under each flight.
2. P3 (b) is asking: Should Airway Express continue providing the flight between
Los Angeles and New York? Even if Airway Express decides not to fly, it still has
to pay the fixed costs of $3,000 per day. The evening flight with the return flight
the next afternoon is counted as 1 day, not 2 days.
Answer:
This problem provides the following information to calculate and compare the profit
under each flight as follows: Price of ticket - $200, Operating cost - $11,000, fixed cost -
$3,000, Airport overnight charge - $1,200, #of evening passengers = 80, # of afternoon
passengers = 50, and the # of morning passengers = 70.
First step is to calculate total cost (TC) as per formula 8-11 of Salvatore (2012), which is
TC=TFC+TVC.
TC =3000+1000+12000
= $15,200
Calculate revenue for each the flights, which is quantity (Q) times price(P).
Q= 80, 50, 70, P=$200
Revenue = 80*200 =50*200 =70*200
=$16,000 = $10,000 = $14,000
Calculate profit for the evening Los Angeles to NY flight, the afternoon flight from NY to
Los Angeles, and the morning flight from Los Angeles to NY, the formula is revenue
minus total cost.
Profit = 16000-15200 =10000-15,200 =14000-15,200
= $800 dollars = - 5,200 = -1,200
Should the airline replace its night flight from Los Angeles with a morning flight?
Should the airline remain in business? Based on the above information, and the profit
differences between these two flights of 5200-1200= -$4,000, the airline should replace
the flights to decrease their profit loss so that they may remain in business and be
profitable.
Problem 4
Electric utility companies usually operate their most modern and efficient equipment
continuously (i.e around the clock) and use their older and less efficient equipment only
to meet periods of peak electricity demand. (a) What does this imply for the short-run
marginal cost of these firm (b) why do these firms not replace all their older equipment
with new equipment in the long run
Answer:
(a) In order to expand output in the short run to meet peak electricity demand, electrical
utility companies bring into operation older and less efficient equipment, causing their
short-run marginal cost to rise sharply.
(b) New generating equipment would have to be run around the clock or nearly so for its
average fixed costs to be sufficiently low to make its average total cost lower than for
older equipment. to meet only peak demand, older and fully depreciated equipment is
cheaper
Problem 12(a) and (b), and spreadsheet problem 1 (p. 364)
What respect to the given date problem 11 (a) find the publisher breakeven output
and the output of $60,000 if, as a result of a technological breakthrough in printing
the publisher was able to lower its TFC to $40,000. (b) Find the publisher breakeven
output and output that would lead to a total profit of $60,000 if total fixed cost
remained at $100,000 but average variable cost declined to $10.
q=40,000/10= 4,000
= 4,000*30= $ 120,000
40,000/50=800
100,000/30=3,333.33
Salvatore Chapter 9:
1. Problems: 7, P7: The tariff-inclusive price will be $3(1+.33) = $4. What are the
impacts of tariff on domestic consumption, domestic production, imports, and
government’s tariff revenue? Show the numbers; for example, at figure 9-4, if you
draw a line starting at Px=$4 and parallel to the X axis, it will cross the demand curve,
Dx, at 500X. Therefore, you know that the domestic consumption will decrease from
600X to 500X.
Answer: When tariffs are imposed, it will increase the overall price.
Price without tariff = $3
Price with tariff = $3*(1+0.33)
= $4. Roundup
In this case, there will be increase in the domestic production with decrease in the
consumption.
On the other hand, there will be an upward movement in the foreign supply curve
i.e. from Sf to Sf +t. At the price level the domestic consumption will be P2F for
the goods X and out of which is domestically supplied is P2D. The gap that is
created is the amount of import (DF).
Effect of tariff on the consumption is CG and production is BH. Decrease in the
imports because of tariff equivalent to CG + BH, thus increase in the government
revenue will be (P2 – P1) x DF
From the figure it is clear that there will be decrease in the domestic consumption
to 500X from 600X. But on the other hand domestic production will increase to
300X from 200X and the DF gap is imported and thus total import will decrease
by:
Decrease = 200X (500X – 300X)
Thus, the tariff revenue will increase:
Tariff revenue = ($4 -$3) x 200X = $200
Problem11,
Most book publisher pay authors a percentage of the revenue from book sales. Explain
the conflit that this creates between publisher and authors.
The conflict that occurs between book publishers and author is when they try to
determine an appropriate and agreed upon percentage of revenue from book sales for the
author to receive. This is difficult the author wrote the book, however the publisher
purchased the contents from the author and without publisher book sales would not occur.
Most book publishers pay authors a percentage of the revenue from book sales. Explain
the conflict that this creates between publishers and authors. Through research, the writer
has learned that there are varying views on this topic. In a 2009 article by Bob Miller,
President and Publisher of HarperStudio states he does not believe that authors should be
paid higher royalties in exchange for marketing ideas. Mr. Miller asks, “shouldn’t author
and publisher alike be doing everything possible to make a book succeed, without
needing to count up who has gone beyond the call of duty?” (Miller, 2009, Para. 3) while
being “equal partners, sharing profits fifty-fifty” (Para. 5) Miller goes on to explain that,
basically, the relationship between publishers and authors need to be rethought. In
interpreting this, the writer believes that there is a certain level of conflict that could exist
between a publisher and a writer in terms of profit sharing. Everyone wants to be sure
that they are receiving the highest possible profit for their work and efforts.
From more of an economic perspective, the writer learned about The Plant Horvitz Model
which signifies that there is “no conflict of interest between authors and publishers over
book prices as long as the royalty percentage is negotiable” (Layson, 1982, p. 1). By this
model, P = book price, Q = book production, a = royalty % per book, C (Q) = production
costs, and T = total royalty payments. From this formula, the profits for publishers can be
determined as follows:
PQ – T –C(Q) = (1 – a) PQ – C(Q) (Layson, 1982, p. 1).
Salvatore's chapter 9 spreadsheet problem 1 (pasted from Excel spreadsheet)
(1a) The market demand function is QD=4,750-50P and P is expressed in dollars, use
Excel to calculate what the equilibrium price is by calculating values of QD and QS for P from 25
to 50 in 1’s.(1d) For (a) only, if TC = 0.005Q2 –Q, what is the profit in each case?
P QS QD Profit=TR-TC Note: Calculate the profit at the equilibrium
25 3250 3500 31687.5
26 3250 3450 34937.5
27 3250 3400 38187.5
28 3250 3350 41437.5
29 3250 3300 44687.5
30 3250 3250 47937.5
31 3250 3200 51187.5
32 3250 3150 54437.5
33 3250 3100 57687.5
34 3250 3050 60937.5
35 3250 3000 64187.5
36 3250 2950 67437.5
37 3250 2900 70687.5
38 3250 2850 73937.5
39 3250 2800 77187.5
40 3250 2750 80437.5
41 3250 2700 83687.5
42 3250 2650 86937.5
43 3250 2600 90187.5
44 3250 2550 93437.5
45 3250 2500 96687.5
46 3250 2450 99937.5
47 3250 2400 103187.5
48 3250 2350 106437.5
49 3250 2300 109687.5
50 3250 2250 112937.5
1. (a) P = $30
(d) For (a), profit = $30(3,250) – 0.005(3,250)2 + 3,250 = $47,937.5
Salvatore's chapter 8 spreadsheet problem 1 (p.364) (pasted from Excel spreadsheet)
Calculate AFC, AVC, ATC, and MC.
Froebet al. Chapter 9:
a. Individual problems: 9-2
Snack food vendors and beer distributers earn some monopoly profits I their local
markers but see them slowly erode from various new substitutes. When California voted
on legalizing marijuana, which side would you think that California beer distributors
were on? What about snack food vendors? Why?
Note: P9-2: Think about substitutes and complements. For example, marijuana and snack
foods are strong complements (or so we are told).
Answer:
Legalizing marijuana was most probably agreed by the beer distributors because of an
expectation that marijuana users will also drink more. The snack distributor will probably
agree as most of the people who drink and smoke tend to get more hunger and consumes
more snacks. In this case, marijuana will complement the growth of beer and snack
consumption it creates equal opportunities for these distributors.
Individual problems: 9-4.
Relative to managers in more monopolistic industries are managers in more competitive
industries more likely to spend their time on reducing costs or on pricing strategies?
Answer:
If we look this from a theoretical point of view, in a monopolistic industry a manager will
not focus on decreasing the cost or change the pricing strategy as there is more protection
from competitive forces. But on the other hand, pricing strategy in a competitive market
change in the pricing is not at discretion of the company it is due to the market force and
decision. But monopolies are coming up with their own pricing strategy as they are the
only seller in the market and there is no competitor or substitute.
Froebet al. Chapter 11
11-4
How does a decrease in U.S. interest rates affect the EU/U.S. exchange rate?
Use the carry trade to predict the impact of lower U.S. interest rates on Euro/$
Answer:
When there is decrease in the US interest rate, more amounts will be invested in foreign currency
to earn higher return and this result in depreciation of the US currency. It will pull down the
exchange rate that is EU/US will decrease.
11-5
How will dollar devaluation affect businesses and consumers in the twin cities of El Paso, United
States, and Juarez, Mexico? Make sure you explain the impact on the twin cities no just 1 city.
Answer:
Devaluation of dollar will increase the demand from the importers. In this case, there will be
higher amount of export by the US country and more amount of import by the Mexico. Thus,
Mexico can buy products at cheaper rate and US can sell all their products quickly and earn
higher profits due to higher demand.
References
Froeb, L., McCann, B., Shor, M., & Ward, M. (2014) Managerial economics: a problem solving
approach (4th ed.). Australia: South-Western Cengage Learning.
Layson, S. K. (1982). Is there a conflict between authors and publishers over book prices?
Southern Economic Journal (Pre-1986), 48(4), 1057 Retrieved from
http://search.proquest.com/docview/217153106?accountid=12085
Miller, R. (2009, August 31). Re-thinking the Publisher/Author Partnership Publishing
Perspectives Publishing Perspectives Retrieved July 19, 2014, from
http://publishingperspectives.com/2009/08/re-thinking-the-publisherauthor-partnership/
Salvatore, D. (2012). Managerial economics in a global economy (7th ed) Oxford: Oxford
University Press.
