ASSIGNMENT

MANAGERIAL ECONOMICS
Choose a minimum of 4 questions. 2 conceptual and computational questions, and 2
problems and applications for each chapter. English or Bahasa is acceptable.

BRAMANTYO CIPTA ADI

20/468967/NEK/00362

MAGISTER MANAGEMENT
FAKULTAS EKONOMI DAN BISNIS
UNIVERSITAS GADJAH MADA
2020
 CHAPTER 1

Conceptual and Computation Questions

1. Southwest Airlines begins a "Bags Fly Free"campaign, dunging no fees for a first
and second checked bag. Does this situation best represent producer -producer
rivalry, consumer consumer rivalry, or consumer-producer rivalry? Explain.

Answer:
Producer-producer rivalry best illustrates this situation. Here, Southwest is a
producer attempting to steal customers away from other producers in the form of
lower prices. Southwest believes their business direction is not to charge bag fees
will be a competitive advantage over many other airlines who charges bags to fly.
Airlines are competing with each other to win over a limited amount of
customers. We as consumers want the best price and benefits with the least
amount of stress.
This cannot be consumer-consumer rivalry because there are plenty of airlines
available to the consumers. Consumers are not limited to only Southwest Airlines
so there won’t be any competiveness among consumers to flight for a seat to get
to their destination.
This is not consumer– producer rivalry because there is no debate in pricing.
Southwest provides a price for their flight and we as the customer can either buy
or not buy from Southwest. Customer cannot bargain back and forth with
Southwest for a seat to their destination.

2. What is the maximum amount you would pay for an asset that generates an
income of $250,000 at the end of five years if the opportunity cost of using funds
is 8 percent?

Answer:
The maximum I would be willing to pay for this asset is the present value, which is

PV = 250,000 + 250,000 + 250,000 + 250,000 + 250,000

(1 + 0.08) (1 + 0.08)2 (1 + 0.08)3 (1 + 0.08)4 (1 + 0.08)5
= 998,177.51

The maximum I would be willing to pay for this asset is $998,177.51

1
5. What is the value of a preferred stock that pays a perpetual dividend of $125 at
the end of each year when the interest rate is 5 percent?

Answer:
CF $ 125
PVPerpetuity = i = 0.05 = $2500
So, the value of a preferred stock that pays a perpetual dividend of $125 at
the end of each year with 5 percent interest rate is $2500

Problems and Aplications

12. You are in the market for a new refrigerator for your company's lounge, and you
have narrowed the search down to two models. The energy-efficient model sells
for $1700 and will save you $45 at the end of each of the next five years. The
standard model has features similar to the energy-efficient model but provides no
future electricity savings. It is priced at only $1500. Assuming your opportunity
cost of funds is 6 percent, which refrigerator should you purchase?

Answer:
Effectively, this is a question of whether it pays to spend an extra $200 on a
refrigeratortoday to save $45 over the next 5 years. We need to calculate the NPV
of the $45 over 5 years and see if this is less than or greater than $200.

$ 45 $ 45 $ 45 $ 45 $ 45
NPV = 1.06 + 2 + 3 + 4 + 5 - $200
(1.06) (1.06) (1.06) (1.06)
= $189.56 - $200
= -$10.44
Since we are spending an extra $200 in today’s dollars and only saving $189.6 in
today’s dollars, we should not buy the energy efficient refrigerator. So, we should
purchase the standard model refrigerator.

13. You are the human resources manager for a famous retailer, and you are trying to
convince the president of the company to change the structure of employee
compensation. Currently, the company's retail sales staff is paid a flat hourly wage
of $20 per hour for each eight hour shift worked. You propose a new pay structure
whereby each sales person in a store would be compensated $10 per hour, plus 1
percent of that store's daily profits. Assume that, when run efficiently, each store's
maximum daily profits are $25,000. Outline the arguments that support your
proposed plan.

2
 Answer:
Under a flat hourly wage, employees have little incentive to work hard as working
hard will not directly benefit them. This adversely affects the firm, since its profits
will be lower than the $25,000 per store that is obtainable each day when
employees perform at their peak. Under the proposed pay structure, employees
have a strong incentive to increase effort, and this will benefit the firm. In
particular, under the fixed hourly wage, an employee receives $160 per day
whether he or she works hard or not. Under the new pay structure, an
employee receives $330 per day if the store achieves its maximum possible
daily profit and only $80 if the store’s daily profit is zero. This provides
employees an incentive to work hard and to exert peer pressure on
employees who might otherwise goof off. By providing employees an
incentive to earn extra money by working hard, both the firm and the
employees will get the benefit.

14. Jamie Is Considering Leaving Her Current Job, Which Pays $75,000 Per Year, To
Start A New Company That Develops Applications For Smart Phones. Based On
Market Research, She Can Sell About 50,000 Units During The First Year At A
Price Of $4 Per Unit. With an annual overhead costs and operating
expensesamounting to $145000. Jamie expects a profit of 20 percent. This margin
is 5 percent larger than of herlargest competitors, Apps. Inc.
Answer:
a. Accounting Cost = Overhead costs and operating expenses
= $145000
Implicit Cost = Forgone Salary
= $75000
Opportunity Cost = Accounting Cost + Implicit Cost
= 145000+75000
= $220000
b. Accounting Profit = Total Revenue - Accounting Cost.
Given Accounting Cost = $145000
Total Revenue should be greater than $145000 for positive accounting
profits.
Economic Profit = Total Revenue – Opportunity Cost
Given opportunity cost = $220000
Total Revenue should be greater than $220000 for positive economic
profit.

3
 CHAPTER 2

Conceptual and Computation Questions

3. Suppose the supply function for product X is given by Q sx = -30 + 2 P x - 4 P z

a. How much of product X is produced when P x=$600 and P z=$60?
b. How much of product X is produced when P x=$80 and P z=$60?
c. Suppose P z=$60. Determine the supply function and inverse supply function
for good X. Graph the inverse supply function

Answer:
a. Qsx =−30+2 ( 600 )−4 ( 60 )=930 units.
b. Notice that although Qsx =−30+2 ( 80 )−4 ( 60 ) =−110, negative output is
impossible. Thus, quantity supplied is zero.
c. To find the supply function, insert Pz = 60 into the supply equation to obtain
Q sx =−30+2 Px −4 ( 60 ) =−270+2 P x . Thus, the supply equation is Q sx =−270+2 Px . To
obtain the inverse supply equation, simply solve this equation for Px to
obtain P x =135+0.5 Qsx . The inverse supply function is graphed in the figure
below

$450
$400
$350
$300
Price of X

$250
$200
$150
$100
$50
$0
0 100 200 300 400 500
Quantity of X

5. The demand curve for product X is given by Qdx=300 - 2 P x.

a. Find the inverse demand curve
b. How much consumer surplus do consumers receive when P x=$45?
c. How much consumer surplus do consumers receive when P x=$30?
d. In general, what happens to the level of consumer surplus as the price of a
goods falls?

4
 Answer:
a. Solve the demand function for Px to obtain the following inverse demand
1 d
function: P x =15 0− 2 Q x
b. Notice that when Px = $45, Qdx =300−2 ( 45 )=210 units.
Also, from part a, we know the vertical intercept of the inverse demand
equation is 150. Thus, consumer surplus is $11,025
(computed as (0.5)($150-$45)210 = $11,025).
c. When price decreases to $30, quantity demanded increases to 240 units, so
consumer surplus increases to $14,400
(computed as (0.5)($150-$30)240 = $14,400).
d. So long as the law of demand holds, a decrease in price leads to an increase in
consumer surplus, and vice versa. In general, there is an inverse relationship
between the price of a product and consumer surplus.

Problems and Aplications

17. G.R. Dry Foods Distributors specializes in the wholesale distribution of dry
goods, such as rice and beans. The firm's manager is concerned about an article in
this morning's The Wall Street Journal indicating that the incomes of individuals
in the lowest income bracket are expected to increase by 10 percent over the next
year. While the manager is pleased to see this group of individuals doing well, he
is concerned about the impacts this will have on G.R. Dry Foods. What do you
think is likely to happen to the price of the products G.R. Dry Foods sells? Why?

Answer:
Dry beans and rice are probably inferior goods. If so, an increase in income
shifts demand for these goods to the left, resulting in a lower equilibrium
price. Therefore, G.R. Dry Foods will likely have to sell its products at a
lower price.

21. Seventy-two percent of the members of the United Food and Commercial
Workers Local 655 voted to strike against Stop ’n Shop in the St. Louis area.In fear
of similar union responses, two of Stop ’n Shop’s larger rivals in theSt. Louis
market—Dierberg’s and Schnuck’s—decided to lock out theirunion employees.
The actions of these supermarkets, not surprisingly, caused Local 655 union
members to picket and boycott each of the supermarket’s locations. While the
manager of Mid Towne IGA—one of many smaller competing grocers—viewed
the strike as unfortunate for both sides, he wasquick to point out that the strike
provided an opportunity for his store toincrease market share.

5
To take advantage of the strike, the manager of Mid Towne IGA increased
newspaper advertising by pointing out that Mid Towne employed Local 655 union
members and that it operated under a different contract than “other” grocers in
the area. Use a graph to describe theexpected impact of advertising on Mid Towne
IGA (how the equilibrium price and quantity change). Identify the type of
advertising in which Mid Towne IGA engaged. Do you believe the impact of
advertising will be per-manent? Explain.

Answer:
Mid Towne IGA aimed to educate consumers that its contract with Local 655
union members was different than its rivals, so it engaged in informative
advertising. Mid Towne IGA’s informative advertising increases demand (demand
shifts rightward) resulting from:
a. Local 655 union members locked out of rival supermarkets
b. consumers who are sympathetic to the Local 655 union, and
c. consumers who do not like the aggravation of picketing employees and other
disruptions at the supermarket.

This shift is depicted in the figure below, where the equilibrium price and
quantity both increase. It is unlikely that demand will remain high for Mid
Towne IGA. As contracts are renegotiated and Local 655 union members are
back to work, demand will likely settle back around its original level.
Price

S1

P2

P1

D2

D1

Q1 Q2 Quantity

6
 CHAPTER 3

Conceptual and Computation Questions

1. Answer the following questions based on the accompanying diagram

a. How much would the firm’s revenue change if it lowered the price from $12 to
$10? Is demand elastic or inelastic in this range?
b. How much would the firm’s revenue change if it lowered the price from $4 to
$2? Is demand elastic or inelastic in this range?
c. What price maximizes the firm’s total revenues? What is the elasticity of
demand at this point on the demand curve?

Answer:
a. When P = $12, R = ($12)(1) = $12. When P = $10, R = ($10)(2) = $20. Thus, the
price decrease results in an $8 increase in total revenue, so demand is elastic
over this range of prices.
b. When P = $4, R = ($4)(5) = $20. When P = $2, R = ($2)(6) = $12. Thus, the price
decrease results in an $8 decrease total revenue, so demand is inelastic over
this range of prices.
c. Recall that total revenue is maximized at the point where demand is unitary
elastic. We also know that marginal revenue is zero at this point. For a linear
demand curve, revenue lies halfway between the demand curve and the
vertical axis. In this case, revenue is a line starting at a price of $14 and
intersecting the quantity axis at a value of Q = 3.5. Thus, marginal
revenue is 0 at 3.5 units, which corresponds to a price of $7 as shown
below. Price $14

$12

$10

$8

$6

$4

$2
Demand
$0
0 1 2 3 MR 4 5 6 Quantity
7
2. The demand curve for a product is given by Qdx = 1,200 − 3 Px  − 0.1 Pz where Pz =
$300.
a. What is the own price elasticity of demand when Px = $140? Is demand elastic
or inelastic at this price? What would happen to the firm’s revenue if it decided
to charge a price below $140?
b. What is the own price elasticity of demand when Px = $240? Is demand elastic
or inelastic at this price? What would happen to the firm’s revenue if it decided
to charge a price above $240?
c. What is the cross-price elasticity of demand between good X and good Z when
Px = $140? Are goods X and Z substitutes or complements?

Answer:
a. Qdx =1,200−3 ( 140 ) −0.1 (300 )=750. At the given prices, quantity demanded is 750
units. Substituting the relevant information into the elasticity formula gives:
Px 140
EQ x , Px
=−3 =−3 =−0.56 . Since this is less than one in absolute value,
Qx 750
demand is inelastic at this price. If the firm charged a lower price, total
revenue would decrease.
b. Qdx =1,200−3 ( 240 )−0.1 ( 300 )=450. At the given prices, quantity demanded is 450
units. Substituting the relevant information into the elasticity formula gives:
Px 240
EQ , Px =−3 =−3 =−1.6. Since this is greater than one in absolute value,
x
Qx 750
demand is elastic at this price. If the firm increased its price, total revenue
would decrease.
c. At the given prices, quantity demanded is 750 units, as shown in part a.
Substituting the relevant information into the elasticity formula gives:
Pz 300
EQ x , Pz
=−0.1 =−0.1 =−0.04 . Since this number is negative, goods X and Z
Qx 750
are complements.

10. The demand function for good X is ln  Qdx= a + b ln Px + c ln M + e, where Px is the

price of good X and M is income. Least squares regression reveals that â = 7.42,
bˆ = −2.18, and ĉ = 0.34.
a. If M = 55,000 and Px = 4.39, compute the own price elasticity of demand based
on these estimates. Determine whether demand is elastic or inelastic.
b. If M = 55,000 and Px = 4.39, compute the income elasticity of demand based on
these estimates. Determine whether X is a normal or inferior good.

Answer:
a. The own-price elasticity of demand is -2.18, so demand is elastic.
8
 b. The income elasticity of demand is 0.34, so X is a normal good
Problems and Aplications

11. Revenue at a major smartphone manufacturer was $2.3 billion for the nine
months ending March 2, up 85 percent over revenues for the same period last
year. Management attributes the increase in revenues to a 108 percent increase in
shipments, despite a 21 percent drop in the average blended selling price of its
line of phones. Given this information, is it surprising that the company's revenue
increased when it decreased the average selling price of its phones? Explain.

Answer:
The result is not surprising. Given the information, the own price elasticity
108
of demand for a major smartphone manufacturer is EQ ,P = −21 =−5.14 .Since
this number is greater than one in absolute value, demand is elastic. By the
total revenue test, this means that a reduction in price will increase
revenues.

13. If Starbucks’s marketing department estimates the income elasticity of demand

for its coffee to be 2.6, how will the prospect of an economic boom (expected to
increase consumers’ incomes by 6 percent over the next year) impact the quantity
of coffee Starbucks expects to sell?

Answer:
% ΔQ d
Use the income elasticity formula to write =2.6 .Solving, we see that coffee
6
purchases are expected to increase by 15.6 percent.

15. You are a manager in charge of monitoring cash flow at a major publisher. Paper
books comprise 40 percent of your revenues, which grow about 2 percent
annually. You recently received a preliminary report that suggests the growth rate
in ebook reading has leveled off and that the cross-price elasticity of demand
between paper books and ebooks is –0.3. In 2016, your company earned about
$600 million from sales of ebooks and about $400 million from sales of paper
books. If the own price elasticity of demand for paper books is –2, how will a 4
percent decrease in the price of paper books affect your overall revenues from
both paper book and ebook sales?

Answer:
Using the change in revenue formula for two products,

9
 ∆ R=[ $ 400 ( 1−2 ) + $ 600 (−0.3 ) ] × (−0.04 )=$ 23.2 million, so revenues will increase by
$23.2 million.
CHAPTER 4

Conceptual and Computation Questions

5. Provide an intuitive explanation for why a “buy one, get one free” deal is not the
same as a “half-price” sale.
Answer:
A half-price sale cuts the price of each and every unit in half. In contrast, a
buy-one, get-one-free deal does not change the relative price of any units
between 0 and 1 unit. Furthermore, it makes the price of units purchased
between 1 and 2 units purchased zero.

6. In the following figure, a consumer is initially in equilibrium at point C. The

consumer’s income is $400, and the budget line through point C is given by $400 =
$100X + $200Y. When the consumer is given a $100 gift certificate that is good
only at store X, she moves to a new equilibrium at point D.
a. Determine the prices of goods X and Y.
b. How many units of product Y could be purchased at point A?
c. How many units of product X could be purchased at point E?
d. How many units of product X could be purchased at point B?
e. How many units of product X could be purchased at point F?
f. Based on this consumer’s preferences, rank bundles A, B, C, and D in order
from most preferred to least preferred. g.
g. Is product X a normal or an inferior good?

Answer:
a. Px = $100, Py = $200 and M = $400
M 400
b. P = 200 =2 units.
y

10
 M 400
c. P = 100 =4 units.
x

d. 1 unit (since the $100 gift certificate will purchase exactly one unit of
good X).
M + $ 100 500
e. = =5 units.
Px 100
f. The most preferred is D, B, C, and A is the least preferred
g. Product X is normal good since the amount purchased increases from C to
D as the budget constraint shifts from E to the higher income F.

7. A consumer must spend all of her income on two goods (X and Y). In each of the
following scenarios, indicate whether the equilibrium consumption of goods X and
Y will increase or decrease. Assume good X is a normal good, and good Y is a
inferior good.
a. Income doubles.
b. Income quadruples and all prices double.
c. Income and all prices quadruple.
d. Income is halved and all prices double.

Answer:
a. Consumption of good X will increase and consumption of good Y will
decrease.
b. Consumption of good X will increase and consumption of good Y will
decrease.
c. Nothing will happen to the consumption of either good.
d. Consumption of good X will decrease and consumption of good Y will
increase.

Problems and Aplications

11. It is common for supermarkets to carry both generic (store-label) and brand-
name (producer-label) varieties of sugar and other products. Many consumers
view these products as perfect substitutes, meaning that consumers are always
willing to substitute a constant proportion of the store brand for the producer
brand. Consider a consumer who is always willing to substitute 4 pounds of a
generic store brand for 2 pounds of a brand-name sugar. Do these preferences
exhibit a diminishing marginal rate of substitution? Assume that this consumer
has $24 of income to spend on sugar, and the price of store-brand sugar is $1 per
pound and the price of producer-brand sugar is $3 per pound. How much of each
type of sugar will be purchased? How would your answer change if the price of

11
 store-brand sugar was $2 per pound and the price of producer-brand sugar was
$3 per pound?
Answer:
These preferences do not exhibit a diminishing marginal rate of substitution since
consumers are always willing to substitute the same amount of store-brand
sugar for an additional pound of producer-brand sugar. When store-brand
sugar is $1 per pound and producer-brand sugar is $3 per pound, the
consumer will purchase 24 pounds of store-label sugar and no producer-
brand sugar. After the change, the consumer will purchase no store-label
sugar and 8 pounds of producer-brand sugar.

12. An internal study at Mimeo Corporation - a manufacturer of low-end photocopiers

revealed that each of its workers assembles three photocopiers per hour and is
paid $6 for each assembled copier. Although the company does not have the
resources needed to supervise the workers, a full-time inspector verifies the
quality of each unit produced before a worker is paid for his or her output. You
have been asked by your superior to evaluate a new proposal designed to cut
costs. Under the plan, workers would be paid a fixed wage of $16 per hour. Would
you favor the plan? Explain.

Answer:
Under the existing plan, a worker that does not “goof off” produces 3 copiers
per hour and thus is paid $18 each hour. Under the new plan, each worker
would be paid a flat wage of $16 per hour. While it might appear on the
surface that the company would save $2 per hour in labor costs by switching
plans, the flat wage would be a lousy idea. Under the current plan, workers
get paid the $18 only if they work hard during the hour and produce 3
machines that pass inspection. Under the new plan, workers would get paid
$16 an hour regardless of how many units they produce. Since your firm has
no supervisors to monitor the workers, you should not favor the plan.

13. The average 15-year-old purchases 100 song downloads from iTunes and buys 20
cheese pizzas in a typical year. If cheese pizzas are inferior goods, would the
average 15-yearold be indifferent between receiving a $50 gift certificate for
iTunes and $50 in cash? Explain.

Answer:
Yes. Since pizza is an inferior good, if the consumer is given $50 in cash she
will definitely spend it entirely on downloads from iTunes – just as she
would if given a $50 gift certificate for music downloads.
12
 CHAPTER 5

Conceptual and Computation Questions

1. A firm can manufacture a product according to the production function
Q = F(K, L) = K3/4 L1/4
a. Calculate the average product of labor, APL, when the level of capital is fixed at
81 units and the firm uses 16 units of labor. How does the average product of
labor change when the firm uses 256 units of labor?
b. Find an expression for the marginal product of labor, MPL, when the amount of
capital is fixed at 81 units. Then, illustrate that the marginal product of labor
depends on the amount of labor hired by calculating the marginal product of
labor for 16 and 81 units of labor.
c. Suppose capital is fixed at 81 units. If the firm can sell its output at a price of
$200 per unit of output and can hire labor at $50 per unit of labor, how many
units of labor should the firm hire in order to maximize profits?

Answer:
a. When K = 81 and L = 16, Q = (81)0.75(16)0.25 = 54.
Thus, APL = Q/L = 54/16 = 3.375.
When K = 81 and L = 256, Q = (81)0.75(256)0.25 = (27)(4) = 108.
Thus, APL = 108/81 = 0.422.
b. The marginal product of labor is
MPL = (1/4) × (81)0.75(L)-3/4
= (27/4)(L)-3/4.
When L = 16, MPL = (27/4)(16)-3/4 = 0.844.
When L = 81, MPL = (27/4)(81)-3/4 = 0.25.
Thus, as the number of units of labor hired increases, the marginal product of
labor decreases MPL (16) = 0.844 > 0.25 = MP L (81), holding the level of capital
fixed.
c. We must equate the value marginal product of labor to the wage and solve for L.
V MPL = P x MPL
= ($200)(27/4)(L)-3/4
=1350(L)-3/4.
Setting this equal to the wage of $50 gives 1350(L)-3/4 = 50. Solving for L,
the optimal quantity of labor is L = 81.

13
2. A firm’s product sells for $4 per unit in a highly competitive market. The firm
produces output using capital (which it rents at $25 per hour) and labor (which is
paid a wage of $30 per hour under a contract for 20 hours of labor services).
Complete the following table and use that information to answer these questions.
a. Identify the fixed and variable inputs.
b. What are the firm’s fixed costs?
c. What is the variable cost of producing 475 units of output?
d. How many units of the variable input should be used to maximize profits?
e. What are the maximum profits this firm can earn?
f. Over what range of the variable input usage do increasing marginal returns
exist?
g. Over what range of the variable input usage do decreasing marginal returns
exist?
h. Over what range of input usage do negative marginal returns exist?

Answer:
(1) (2) (3) (4) (5) (6) (7)
Marginal Average Value Marginal
Average
Product of Product Product of
Capital Labor Output Product of
Capital of Labor Capital
Capital APK
MPK APL VMPK
0 20 0 - - - -
1 20 50 50 50 2.50 200
2 20 150 100 75 7.50 400
3 20 300 150 100 15 600
4 20 400 100 100 20 400
5 20 450 50 90 22.50 200
6 20 475 25 79.17 23.75 100
7 20 475 0 67.86 23.75 0
8 20 450 -25 56.25 22.50 -100
9 20 400 -50 44.44 20 -200
10 20 300 -100 30 15 -400

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 11 20 150 -150 13.64 7.50 -600

a. Labor is the fixed input while capital is the variable input.

b. Fixed costs are 20($30) = $600.
c. To produce 475 units in the least-cost manner requires 6 units of capital,
which cost $25 each. Thus, variable costs are ($25)(6) = $150.
d. Using the VMPK = r rule, K = 6 maximizes profits.
e. The maximum profits are $4(475) - $30(20) - $25(6) = $1,150.
f. There are increasing marginal returns when K is between 0 and 3.
g. There are decreasing marginal returns when K is between 3 and 11.
h. There are negative marginal returns when K is greater than 7.

3. Explain the difference between the law of diminishing marginal returns and the
law of diminishing marginal rate of technical substitution.

Answer:
The law of diminishing marginal returns is the decline in marginal
productivity experienced when input usage increases, holding all other
inputs constant. In contrast, the law of diminishing marginal rate of technical
substitution is a property of a production function stating that as less of one
input is used, increasing amounts of another input must be employed to
produce the same level of output.

Problems and Aplications

14. Recently, the Boeing Commercial Airline Group (BCAG) recorded orders for more
than 15,000 jetliners and delivered more than 13,000 airplanes. To maintain its
output volume, this Boeing division combines efforts of capital and more than
90,000 workers. Suppose the European company Airbus enjoys a similar
production technology and produces a similar number of aircraft but that labor
costs (including fringe benefits) are higher in Europe than in the United States.
Would you expect workers at Airbus to have the same marginal product as
workers at Boeing? Explain carefully.

Answer:
The higher wage rate in Europe induces Airbus to employ a more capital
intensive input mix than Boeing. Since Airbus optimally uses fewer workers
than Boeing, and profit-maximization entails input usage in the range of
diminishing marginal product, it follows that the lower quantity of labor

15
 used by Airbus translates into a higher marginal product of labor at Airbus
than at Boeing.

15. You are a manager at Glass Inc.—a mirror and window supplier. Recently, you
conducted a study of the production process for your single-side encapsulated
window. The results from the study are summarized in the following table, and are
based on the eight units of capital currently available at your plant. Each unit of
labor costs $60, each unit of capital is $20, and your encapsulated windows sell for
$12 each. Given this information, optimize your human resource and production
decisions. Do you anticipate earning a profit or a loss? Explain carefully.

Answer:
The following table provides some useful information for making decision.
According to the VMPL = w rule, we should hire 6 units of labor and produce 95
units of output to maximize profits. Fixed costs is ($20)(8) = $160, variable costs is
($60)(6) = $360, and revenues is ($12)(95) = $1,140. So, the maximum profits is
$1,140 – $360 – $160 = $620.
(1) (2) (3) (4) (5) (6) (7)
Value
Marginal Average
Average Marginal
Labor Capital Output Product of Product of
Product of Product of
L K Q Labor Labor
Capital APK Labor
MPL APL
VMPL
0 8 0 - - - -
1 8 10 10 10 1.3 120
2 8 30 20 15 3.8 240
3 8 60 30 20 7.5 360
4 8 80 20 20 10 240
5 8 90 10 18 11.3 120
6 8 95 5 15.8 11.9 60
7 8 95 0 13.6 11.9 0

16
 8 8 90 -5 11.3 11.3 -60
9 8 80 -10 8.9 10 -120
10 8 60 -20 6 7.5 -240
11 8 30 -30 2.7 3.8 -360
16. A Nike women’s-only store in California offers women’s running, training, and
sportswear products and also contains an in-store fitness studio for group and
personal fitness training sessions. The store consistently earns profits in excess of
$500,000 per year and is located on prime real estate in the center of town. The
store owner pays $15,000 per month in rent for the building. A real estate agent
approached the owner and informed her that she could add $8,000 per month to
her firm’s profits by renting out the portion of her store that she uses as a fitness
studio. While the prospect of acquiring this rental income was enticing, the owner
believed the use of that space as a fitness studio was an important contributor to
her store’s profits. What is the opportunity cost of continuing to operate the
fitness studio within the store?

Answer:
The $8,000 per month that could be earned by renting out the space used for
the fitness studio is the opportunity cost.

17. A local restaurateur who had been running a profitable business for many years
recently purchased a three-way liquor license. This license gives the owner the
legal right tosell beer, wine, and spirits in her restaurant. The cost of obtaining the
three-way license was about $90,000 since only 300 such licenses are issued by
the state. While the license is transferable, only $75,000 is refundable if the owner
chooses not to use the license. After selling alcoholic beverages for about one year,
the restaurateur came to the realization that she was losing dinner customers and
that her profitable restaurant was turning into a noisy, unprofitable bar.
Subsequently, she spent about $8,000 placing advertisements in various
newspapers and restaurant magazines across the state offering to sell the license
for $80,000. After a long wait, she finally received one offer to purchase her
license for $77,000. What is your opinion of the restaurateur’s decisions? Would
you recommend that she accept the $77,000 offer?

Answer:
If she did not spent the $8,000 on advertising but instead collected the
$75,000 refund, her total loss would have been limited to her sunk costs of
$15,000. Her decision to spend $8,000 on advertising in an attempt to fetch
an extra $5,000 was clearly foolish. However, the $8,000 is a sunk cost and
therefore irrelevant in deciding whether to accept the $77,000 offer. She

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 should accept the $77,000 offer because doing so makes her $2,000 better
off than obtaining the $75,000 refund.

CHAPTER 6

Conceptual and Computation Questions

1. Discuss the optimal method for procuring inputs that have well-defined and
measurable quality specifications and require highly specialized investments.
What are the primary advantages and disadvantages of acquiring inputs through
this means? Give an example not used in the textbook that uses this method of
procurement.

Answer:
When an input has well-defined and measurable quality characteristics and
requires specialized investments, the optimal procurement method is a
contract. A contract reduces the likelihood of opportunistic behavior and
underinvestment by creating a legal obligation between the firms. One
disadvantage of a contract is that it increases a firm’s transaction costs. An
example, Boeing contracting with an aluminum manufacturer.

2. Discuss the optimal method for procuring a modest number of standardized

inputs that are sold by many firms in the marketplace. What are the primary
advantages and disadvantages of using this method to acquire inputs? Give an
example not used in the textbook that uses this method of procurement.

Answer:
When a firm requires a limited number of standardized inputs that are sold by
many firms in the marketplace, the optimal method of procurement is spot
exchange. One advantage of spot exchange is that they permit firms to specialize.
A disadvantage is that the firm may potentially face the hold-up problem. An
example, a painter purchasing paint from a local paint store.

3. Identify whether each of the following transactions involves spot exchange,

contract, or vertical integration.
a. Barnacle, Inc., has a legal obligation to purchase 2 tons of structural steel per
week to manufacture conveyor frames.
b. Exxon-Mobil uses the oil extracted from its wells to produce raw
polypropylene, a type of plastic.
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 c. Boat Lifts R Us purchases generic AC motors from a local distributor.
d. Kaspar Construction—a home-building contractor—purchases 50 pounds of
nails from the local Home Depot

Answer:
a. Contract
b. Vertical integration
c. Spot exchange (or possibly contract if a specific investment in many
motors is required).
d. Spot exchange

Problems and Aplications

11. During the beginning of the 21st century, the growth in computer sales declined
for the first time in almost two decades. As a result, PC makers dramatically
reduced their orders of computer chips from Intel and other vendors. Explain why
computer manufacturers such as Dell are likely to write relatively short contracts
for computer chips.

Answer:
The market for personal computers is extremely competitive and uncertain.
For example, during those years better computer chips were continuously
launched, even operating systems were launched almost every year, e.g. Windows
98 (1998), Windows 2000 (2000), Windows ME (2000), Windows XP (2001).
Since the life span of computer ships was extremely short, then the risk of
signing long-term contracts was extremely high. Once a new chip was
launched, the price of older chips decreased severely, so it was better to sign
short-term contracts. The rate of technical progress among chip, and other
hardware, manufacturers could increases the marginal cost of signing long-
term contracts.

12. DonutVille caters to its retirement population by selling over 10,000 donuts each
week. To produce that many donuts weekly, DonutVille uses 1,000 pounds of
flour, which must be delivered by 5:00 AM every Friday morning. How should the
manager of DonutVille acquire flour? Explain.

Answer:
The manager should use a contract to decreases the problem of opportunism
and still allows the firm to specialize in production.

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 CHAPTER 6

Conceptual and Computation Questions

1. Ten firms compete in a market to sell product X. The total sales of all firms selling
the product are $2 million. Ranking the firms’ sales from highest to lowest, we find
the top four firms’ sales to be $260,000, $220,000, $150,000, and $130,000,
respectively. Calculate the four-firm concentration ratio in the market for product
X.
Answer:
The four-firm concentration ratio is:
$ 260,000+$ 220,000+$ 150,000+ $ 130,000
C 4= =0.38 .
$ 2,000,000

2. An industry consists of three firms with sales of $300,000, $700,000, and

$250,000.
a. Calculate the Herfindahl-Hirschman index (HHI).
b. Calculate the four-firm concentration ratio (C4).
c. Based on the FTC and DOJ Horizontal Merger Guidelines described in the text,
do you think the Department of Justice would attempt to block a horizontal
merger between two firms with sales of $300,000 and $250,000? Explain.

Answer:
a. The HHI is:
$ 300,000 2 $ 700,000 2 2
$ 250,000
H HI=10,000 [( 1,250,000)( +
$ 1,250,000)(+
$ 1,250,000 ) ]=4,112
b. The four-firm concentration ratio is 100 percent.
c. If the firms with sales of $300,000 and $250,000 were allowed to merge, the
resulting HHI would increase by 960 to 5,072. Since the post-merger HHI
exceeds that under the Guidelines (2,500) and the HHI increases by more than
that permitted under the Guidelines (200), the merger is likely to be
challenged.

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Problems and Aplications
12. Forey, Inc., competes against many other firms in a highly competitive industry.
Over the last decade, several firms have entered this industry and, as a
consequence, Forey is earning a return on investment that roughly equals the
interest rate. Furthermore, the four-firm concentration ratio and the Herfindahl-
Hirschman index are both quite small, but the Rothschild index is significantly
greater than zero. Based on this information, which market structure best
characterizes the industry in which Forey competes? Explain.

Answer:
This industry is most likely monopolistically competitive. Monopolistically
competitive industries have concentration measures close to zero, but since
each firm’s product is slightly differentiated, the Rothschild index will be
greater than zero (unlike perfectly competitive markets).

13. Firms like Papa John’s, Domino’s, and Pizza Hut sell pizza and other products that
are differentiated in nature. While numerous pizza chains exist in most locations,
the differentiated nature of these firms’ products permits them to charge prices
above marginal cost. Given these observations, is the pizza industry most likely a
monopoly, perfectly competitive, monopolistically competitive, or an oligopoly
industry? Use the causal view of structure, conduct, and performance to explain
the role of differentiation in the market for pizza. Then apply the feedback critique
to the role of differentiation in the industry.

Answer:
The industry is monopolistically competitive. In a monopolistically competitive
market, there are many firms, but each firm produces a differentiated product.
According to the causal view, the structure of differentiated products causes firms
to capitalize on the absence of close substitutes by charging higher prices and
earning higher profit. Thus, structure causes conduct resulting in performance.
According to the feedback critique, the conduct of firms may determine the market
structure. Firms’ products may be differentiated because of firms’ conduct in the
industry. Examples of such conduct include advertising and other behavioral
tactics that feed, back into demand, causing consumers to view products as
differentiated. Thus, it is not at all clear that differentiated products are a
structural variable. The willingness of consumers to pay for product variety gives
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 firms an incentive to offer different products (thin-and-crispy pizza, pan pizza,
pizza delivery, etc.).

14. In 2006, the five leading suppliers of digital cameras in the United States were
Canon, Sony, Kodak, Olympus, and Samsung. The combined market share of these
five firms was 60.9 percent. The leading firm was Canon, with a market share of
18.7 percent. The own price elasticity for Canon’s cameras was –4.0 and the
market elasticity of demand was –1.6. Suppose that in 2006, the average retail
price of a Canon digital camera was $240 and that Canon’s marginal cost was $180
per camera. Based on this information, discuss industry concentration, demand
and market conditions, and the pricing behavior of Canon in 2006. Do you think
the industry environment is significantly different today? Explain.

Answer:
The market for color film in the U.S. is somewhat concentrated. The five-firm
concentration ratio is 60.9 percent and Canon alone accounts for 18.7 percent of
all rolls sold. Market demand for color film is relatively elastic at -1.6; indicating
that a 10 percent increase in price leads to a 16 percent decline in quantity
demand for digital cameras. The Rothschild index indicates that market demand
−1.6
relative to the demand for Canon digital cameras is R= −4 =0.4, indicating that
Canon’s demand is notably more sensitive to price changes (2.5 times more
sensitive) compared to the entire market demand. The Lerner index for Canon is
$ 240−$ 180
L= =0.25 , indicating that Canon’s markup factor is 1.33. For every $1
$ 240
spent on digital cameras, $0.25 is markup. Taken together, these things suggest
that the digital cameras industry in the U.S. closely resembles an oligopoly. Due to
the introduction of smartphones with built-in cameras, digital cameras face even
greater competition. Overall, the industry has lost market power and industry
rivalry has increased.

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