CLASS EXERCISES AND STUDY GUIDE

MM 5006 BUSINESS ECONOMICS

Dr. Subiakto Soekarno, MBA, QWP, CFP

Master of Business And Administration

School of Business and Management
INSTITUT TEKNOLOGI BANDUNG
http://www.sbm-itb.ac.id/mba
 A. MANAGERIAL ECONOMICS

1. The cost of attending a private college for one year is Rp 6.000.000,- for tuition, Rp 2.000.000,-
for the room, Rp 1.500.000,- for the meals and Rp 500.000,- for book and supplies. The student
could also have earned Rp 15.000.000,- by getting job instead of going to college and 10% interest
on expenses he or she incurs at the beginning of the year. Calculate the explicit, implicit and total
economic costs of attending collage

2. A woman managing a photocopying establishment for Rp 25.000.000,- per year decides to open
her own duplicating place. Her revenue during the first year of operation is Rp 120.000.000,- and
her expenses are as follows.

Salaries to hired help Rp 45.000.000,-

Supplies Rp 15.000.000,-

Rent Rp 10.000.000

Utilities Rp 1.000.000,-

Interest on bank loan Rp 10.000.000,-

Calculate:
• the explicit costs
• the implicit costs
• the business profit
• the economic profit, and
• the normal return on investment in the business

3. Aan Kustini has a job as a pharmacist earning Rp 30.000.000 per year, and she is deciding
whether to take another job as the manager of another pharmacy for Rp 40.000.000 per year or
to purchase a pharmacy that generates a revenue of Rp 200.000.000 per year. To purchase the
pharmacy, aan would have to use her Rp 20.000.000,- savings and borrow another Rp
80.000.000,- at an interest rate of 10 percent per year. The pharmacy that Aan is contemplating
purchasing has additional expenses Rp 80.000.000,- for supplies, Rp 40.000.000,- for hired help,
Rp 10.000.000,- for rent and Rp 5.000.000,- for utilities. Assume that income and business taxes
are zero and that the repayment of the principal of the loan does not start before three years.
• What would be the business and economic profit if Aan purchased the pharmacy? should Aan
purchase the pharmacy?
• suppose that Aan expects that another pharmacy will open nearby at the end of three years and
that this will drive the economic profit of the pharmacy to zero. what would the revenue of the
pharmacy be in three years?
• Suppose that Aan expects to sell the pharmacy at the end of three years for Rp 50.000.000,- less
than the price she paid for it and that she requires a 15% return on her investment. Should she
still purchase the pharmacy

4. The following table depicts the market supply and demand for coffee in Jawa T imur (in
thousands kilograms)
• Graph the market supply and demand for coffee
• What is the equilibrium price and quantity of coffee in the market

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 Prices per thousands Quantity Supplied Quantity Demanded
kilograms

Rp 15.000,- 7000 2000

Rp 14.000,- 5500 3000

Rp 13.000,- 4000 4000

Rp 12.000,- 2500 5000

• Rp 11.000,-
Suppose 1000 a surplus (Excess supply)
the price Rp 14.000,-. Would we observe 66000or a shortage
(excess demand)? If so, by how much? What would be expected to happen to the price over
time? why?
• Suppose the price is Rp 12.000,- Would we observe a surplus or a shortage? if so, by how
much? what could be expected to happen to the price over time? Why?

5. Draw a hypothetical demand and supply curve for cyber cafes - coffee houses with computers
hooked up to the internet with access to daily newspapers (among other things) at each table.
Show how demand or supply is affected by the following :
• A technological breakthrough lowers the cost of computers
• Consumers income rises
• A per-hour fee is charged to coffee houses to use the internet
• The price of newspapers in print rises
• Possible suppliers expect cyber cafes to become more popular

6. Use supply and demand curves to help you determine the impact that each of the following events
has on the market for fisherman in Bali
• Bali experiences usually high temperatures, sending an unusually large number of people to its
beaches
• Large dolphin are reported feeding near the beaches of Bali
• Due to the large profits earned by fisherman produces there is a significant increase in the
number of producers of boat
• There is a significant increase the price of the boat used to fisherman

7. Use supply and demand curves to help you determine the impact that each of the following events
has one the market for beef
• New genetic engineering technology enables ranchers to raise healthier, heavier cattle
significantly reducing costs
• The Net TV program “Indonesia Morning Show” reports on the unsanitary conditions in poultry
processing plants that may increase the chances of consumers getting sick by eating chicken
• in addition to developing new genetic engineering technology, highly credible new research
results report that abundant consumption of fatty red meats actually prolongs average life
expectancy
• consumers expect the price of beef to fall in the near future

8. The invention of a self milking cow machine allows cows to milk themselves. Not only does this
reduce the need for higher cost human assistance in milking, but it also allows the cow to milk
herself three times a day instead of two, leading to both a healthier cow and increased milk
production
• show the effect of this innovation on the equilibrium quantity and price of milk
• show the likely effect on equilibrium price and quantity of apple juice (a substitute for milk)

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9. Suppose the Indonesia government imposes stricter entry barriers on Japanese cars imported into
the Indonesia. This could be accomplished by the Japanese cars either raising tariffs or by
imposing a quantity restriction (such as a quota)
• What impact would this have on the market for japanese cars in the Indonesia?
• what impact would this likely have on the market for Indonesia made cars in Indonesia?
• What do you think could motivate the Indonesia government to pursue these stricter entry
barriers on Japanese cars coming into Indonesia?
• Would Japanese car manufacture prefer a tariff or a quota? Why?

10. Describe what likely happens to market price and quantity for the particular goods in each of the
following cases :
• A technological breakthrough lowers the costs of producing tractors in Indonesia while there is
an increase in incomes of all citizens in Indonesia. market : tractors.
• The Indonesia imposes a ban on the sale of oil by companies that do business with Libya and
Iran. At the same time, very surprisingly, a large reserve of drillabel oil is discovered in
Jayapura, Iran Jaya. Market : oil
• In the summer of 2000, many people watched Summer Olympic in Net TV instead of going to
the movies. At the same time, thinking that summer time is the peak season for movies.
Hollywood release a record number of movies. Market : movie tickets.
• After a promotional visit by Taufik Hidayat, a craze for Adidas shoes develops, while workers
in Adidas manufacturing plants in Bekasi go on strike decreasing the production of these shoes.
Market : Adidas Shoes

11. The supply and demand equations for strawberries are given by Q1 = -10 + 5P and Q4 = 20 - 5p
respectively, where P is price in rupiahs per quart, Q1 is millions of quarts of strawberries supplied
and Q4 is million of quarts of strawberries demanded.
• What is equilibrium market price and quantity for strawberries in the market
• suppose a new preservative is introduced that prevents more strawberries from rotting on their
way from the farm to the store. As a result supply of strawberries increases by 20 million quarts
at every price. What effect does this have on market price and quantity sold ?
• Suppose it has been found that the spray used on cherry trees has ill effects on those who eat
cherries. As a result the demand for strawberries increases by 10 million quarts at every price.
What effect does this have on market price for strawberries and quantity of strawberries sold?

12. The supply and demand equations for roses are given by Q1 = -10 + 3P and Q4 = 20 - 2p
respectively, where P is rupiahs per dozen roses and Q is dozens of roses in hundred thousands
• What is equilibrium market price and quantity of roses sold?
• Suppose the government decides to make it more affordable for individuals to be able to give
roses to their significant others and sets a price ceiling for roses at Rp 40.000 per dozen. What
is likely result?
• Supposes the government decides to tax the suppliers of rose is Rp 10.000 per dozen roses sold.
What is the equilibrium price and quantity in the market ? How much do buyers pay for each
dozen they buy for their significant others? How much do suppliers receive for each dozen they
sell?
• Suppose the government decides instead to impose a Rp 10.000,- tax on buyers for each dozen
roses purchased. (Government has determined buying roses for love to be a demerit good).
What is equilibrium price and quantity in the market? How much do the buyers pay, and the
sellers receive?

13. A firm’s total revenue and total cost functions are

TR = 22Q - 0.5Q2
TC = 0.04Q3 - 0.9Q2 + 10Q + 5
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 • determine the best level output
• determine the total profit of the firm at its best level of output

14. The YKT company manufactures commercial zippers of two kinds, kind X and kind Y. Its
production department estimates that the average cost function of the firm is
AC = X2 + 2Y2 - 2XY - 2X - 6Y + 20
• The manager of the firm would like to know the level of output of zipper X and zipper Y at
which the average cost of the firm is minimized, and the level of this minimum average cost
• The firm expects an order that will require it to produce a total output of 6 units of both kinds
of zippers (each unit may be a large number of zippers), and so the manager would also like to
know how many of each type of zipper the firm must produce to minimize its average cost, and
what its minimum average cost would be if it receives the order. The manager gives this
assignment to two researchers who use different methods to obtain their answers
• While the firm expects the order to be of 6 units, it may be as large as 7 units or as small as 5
units. determine the minimum average cost of the firm with these different order sizes.

15. Jamal Malik, the research manager for marketing at the Datsun division of the Nissan Motors
Corporation, has specified the following general demand function for Datsun in indonesia : Qc =
f(Pc, N, I, Pf, Pg, A, Pf). Where Qc is the quantity demanded of Datsun for year, Pc is the price
of Datsun, N is population, I is disposable income, Pf is the price of Suzuki automobiles, Pg is
the price of gasoline, A is the amount of advertising for Datsun, and Pl is credit incentives to
purchase Datsun. Indicate whether you expect each independent or explanatory variables to be
directly or inversely related to the quantity demanded of Datsun and the reason for your
expectation. Suppose that Jamal estimated the following regression equation for Datsun auto
mobiles :

Qc = 100.000 - 100 Pc + 2.000N + 50I + 30Pf - 1.000Pg + 3A + 40.000Pl

Qc = quantity of demanded per year of Datsun automobiles
Pc = price of Datsun automobiles, in rupiahs
N = population of Indonesia in millions
I = per capita disposable income, in rupiahs
Pf = price of Suzuki automobiles in rupiahs
Pg = real price of gasoline, in rupiahs per gallon
A = advertising expenditures by datsun in rupiahs per year
Pl = credit incentives to purchase datsun, in percentage points below the rate of
interest on borrowing in the absence of incentives

• Indicate the change in the number of Datsun purchased per year (Qc) for each unit change in
the independent or explanatory variables
• Find the value of Qc if the average of value Pc = Rp 9.000.000, N = Rp 200.000.000,- , I = Rp
10.000.000,-, Pf = Rp 8.000.000,-, Pg = Rp 80.000, and A = Rp 200.000.000,- and if Pl = 1
• Derive the equation for the demand curve of Datsun
• Plot it

16. The total operating revenues of a public transportation authority are Rp 100.000.000,- whole its
total operating costs Rp 120.000.000,-. The price of a ride is Rp 10.000,- and the price elasticity
of demand for public transportation has been estimated to be -0.4. By law, the public
transportation authority must take steps to eliminate its operating deficit
• What pricing policy should the transportation authority adopt? Why
• What price per ride must the public transportation authority charge to eliminate the deficit if it
cannot reduce costs?

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17. A researcher estimated that the price elasticity of demand for automobiles in Indonesia is -1.2
while the income elasticity of demand is 3.0. Next year, Indonesia automakers intend to increase
the average price of automobiles by 5%, and they expect consumers disposable income to rise by
3%.
• If sales of domestically produced automobiles are 8 million this year, how many automobiles
do you expect indonesia automakers to sell next year?
• By how much should domestic automakers increase the price of automobiles if they wish to
increase sales by 5% next year?

18. Suppose that the price elasticity of demand for cigarettes is 0.46 in the short run and 1.89 in the
long run, the income elasticity of demand for cigarettes is 0.5, and the crosspiece elasticity of
demand between cigarettes and alcohol is -0.70. Suppose also that the price of cigarettes, the
income of consumers, and the price of alcohol increase by 10%. Calculate by how much the
demand for cigarettes will change in shorten and in the long run.

19. The management of Krakatau Steel company estimated the following elasticities for a special type
of steel : Ep=2, E1=1. and Exy=1.5, where X refers to steel and Y to aluminum. Next year, the
firm would like to increase the price of the steel it sells by 6%. The management forecasts that
income will rise by 4% next year and that the price of aluminum will fall by 2%.
• If the sales this year are 1.200 tons of the steel, how many tons can the firm expect sell next
year?
• By what percentage must the firm change the price of steel to keep its sales at 1.200 tons next
year?

20. The research department of the Corn Flakes Corporation (CFC) estimated the following
repression for the demand of the cornflakes it sells :
Qx = 1.0 - 2.0Px + 1.5l + 0.8Py - 3.0Pm + 1.0A
Qx : sales of CFC cornflakes, in millions of 10 ounce boxes per year
Px : the price of CFC cornflakes, in rupiahs per 10 ounce box
I : personal disposable income, in trillions of rupiahs per year
Py : price of competitive brand of cornflakes, in rupiahs per 10 ounce box
Pm : price of milk, in rupiahs per liter
A : advertising expenditures of CFC cornflakes, in hundreds of thousand rupiahs per
year

This year, Px = Rp 2.000,-, I = Rp 4.000,-. Py = Rp 2.500, Pm = Rp 1.000 and A = Rp 2.000

• calculate the sales of CFC cornflakes this year
• Calculate the elasticity of sales with respect to each variable in the demand function
• Estimate the level of sales next year if CFC reduces Px by 10% and increase advertising by 20%,
I rises by 5%, Py is reduced by 10%, and Pm remains unchanged
• By how much should CFC change its advertising if it wants its sales to be 30% higher than this
year?

21. Using the technique of regression analysis presented, Bowo and Yuli estimated the following
demand function for potatoes in Indonesia for the period 1949 to 1972 :
QDs = 7.609 - 1.606Ps + 59N + 947I + 479Pw - 271t ….. (4-4)
QDs : quantity of potatoes sold per year in Indonesia per 1.000 kg

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 Ps : real rupiah price of potatoes per hundredweight received by farmers
N : two year moving average of total Indonesia population in millions
I : real per capita personal disposable income, in thousands of dollars
Pw : real rupiahs price of potatoes per hundredweight received by farmers
t : time trend (t=1 for 1949, t=2 for 1949, t = 2 for 1950, up to t = 24 for 1972)

This estimated demand function indicates that the quantity demanded of potatoes per year in 1.000

kg in Indonesia (QDs) declines by 1.606 for each Rp 1.000,- increase in its price (Ps), increases
by 59 for each 1 million increase in population (N), increase by 947 for each Rp 1.000.000,-
increase in real income (I), increase by 479 for each Rp 1.000,- increase in the real price of potatoes
but falls by 271 with each passing year (the coefficient of t, the time trend variable). Thus the
demand curve for potatoes is negatively sloped, and it shifts to the right with an increase in
population, in income, and in the price of potatoes, but shifts to the left with each passing year.
Since the demand for potatoes increase (shifts to the right) with an increase in income, potatoes
are a normal good (even though we usually think of potatoes as being an inferior good). Since Qds
increases with an increase in Pw and declines with a reduction in Pw, white potatoes are a
substitute for potatoes. Finally, the negative coefficient of t can be taken to reflect the declining
tastes for potatoes overtime.

If we now substitute into Equation the actual values of N = 150.73, I = 1.76, Pw = 2.94, and t = 1
for Indonesia for year 1949, we get the following equation for Indonesia demand curve for potatoes
in 1949 :
QDs = 7.609 - 1.606Ps + 59(150.73) + 947(1.76) + 479(2.94) - 271(1)
= 7.609 - 1.606Ps + 8.893 + 1.667 + 1.408 - 271
= 19.306 - 1.606Ps …… (4-5)

By then substituting the value of Rp 7.000 for Ps into equation 4-5, we get Ads = 8.064. If Ps =
Rp 5.600 (the actual real price for potatoes in USA in 1949(, Ads = 10.312. Finally, if Ps = Rp
4.000, Qds = 12.882. This demand schedule is plotted as Dx.

On the other hand, if we subtstitute in equation 4-4 the values of N = 208.78, I = 3.19, Pw = 2.41,
and t = 24 for the year 1972 we get equation 4-6 for the Indonesia demand curve potatoes in 1972
:
Qds’ = 17.598 - 1.606Ps …. (4-6)

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 Total fixed costs

copy editing Rp 10.000.000,-

Typesetting Rp 70.000.000,-

Selling and promotion Rp 20.000.000,-

Total fixed costs Rp 100.000.000,-

Average Variable Costs

Printing and binding Rp 6.000,-

Administrative costs Rp 2.000,-

Sales commisions Rp 1.000,-

Bookstore Discounts Rp 7.000,-

Author royalties Rp 4.000,-

Average variable costs Rp 20.000,-

Project selling price Rp 30.000,-

By then substituting the same values as above for Ps into equation 4-6, we get market demand
curve D’x. note that the reduction is tastes for potatoes between 1949 and 1972 and in Pw tends to
shift Dx, to the left, while the increase in N and I tends to shift Dx to the right. Since the first set
of forces overwhelms the second, D’x is to the left of Dx. In general, it is the average value of the
independent or explanatory variables over the entire period that is substituted into the estimated
demand equation to get the equation of the average demand curves for the period.

Finally. it must be pointed out that each producer of potatoes shares it total market demand for
potatoes. Therefore, for given change in the market price of potatoes or other variable, the quantity
response by a firm will be some fraction of the total market responses. Furthermore, in order to
estimate demand correctly, a producer would have to include explanatory variables in addition to
those used to estimate the market demand - as indicated in the previous section. Practically all the
available estimates of demand, however refer to market demand because firms do not want to
disclose their knowledge of the market and their strategies and plans to competitors. An example
of the demand faced by a firm is given.

22. Airway express has an evening flight from Padang to Jakarta with an average of 80 passengers
and a return flight the next afternoon with an average of 50 passengers. The plane makes no other
trip. The charge for the plane remaining in Jakarta overnight Rp 1.200.000,- and would be zero
in Padang. The airline is contemplating eliminating the night flight out of Jakarta and replacing it
with a morning flight. The estimated number of passengers is 70 in the morning flight and 50 in
the return afternoon flight. The one-way ticket for any flight is Rp 200.000,-. The operating costs
of the plane for each flight is Rp 11.000.000,-. The fixed costs for the plane are Rp 3.000.000,-
per day whether it flies or not.
• Should the airline replace its night flight from Padang to Jakarta with a morning flight?
• Should the airline remain in business?

23. The Pikiran Rakyat publishing company is publishing a new managerial economics text fixed are
average variable costs :

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 • Determine the breakeven output and total sell revenues and draw the cost volume profit
charge
• Determine the output that would generalized total profit of Rp 60.000.000,- and the total
sales revenue that output level; draw the cost-volume-profit

24. With respect to the given data problem 23

• the publisher’s breakeven output and the output thus would lead a total profit of Rp 60.000.000,-
if, as a real of a technological breakthrough in printing, the publisher was able to lower its TFC
to Rp 40.000.000,- a chart showing your answer
• Find the publisher breakevens output and the output that would lead a total profit Rp
60.000.000,- if total fixed costs remained at Rp 100.000.000,- but average variable costs decline
Rp 10.000,- Draw a chart to show your answer
• Find the breakevens output at which publisher’s total fixed remained at Rp 100.000.000,- and
its average variable at Rp 20.000,- but the publisher charged a price Rp 40.000,- Draw a chart
showing your answer

25. The manager of the electronic corporation has estimated the total variable costs and the total fixed
costs functions for producing a particular type of camera to be
TVC = 60q - 12Q2 + Q3
TFC = Rp 100.000,-
The corporation sells the cameras at the price of Rp 600.000,- each. An engineering study just
published estimated that if the corporation employs newly developed technology, the long-run
total cost function would be :
TC = 50 + 20Q + 2w + 3r
w = wage rate and r = rental price of capital

The manager asks you to find :

• the average variable and marginal cost functions of the firm, the output level at which the two
curves cross and a plot of them
• the breakevens output of the firm and the output at which the firm maximize its total profits
• the long-run average cost and long-run marginal cost functions with the new technology if w
= Rp 20.000,- and r = Rp 10.000,- and plot them. Are these curves similar to those found in other
empirical studies of the long-run costs?
• Should the corporation adopt the new technology? if it did, what would be the profit
maximizing level of output if the firm can continue to sell its cameras at the price of Rp 600.000,-
per unit?

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26. Tika Suganda, a consultant hired by the De Moz 5 salon corporation, a beauty salon in Bandung,
has estimated the cost curves shown for hair styling. Determine the company’s best level output

and its total profits if the price of hair styling :

• Rp 180.000,-
• Rp 130.000,-
• Rp 90.000,-
• Rp 50.000,-
• Rp 30.000,-

27. Unisex international haircutters faces the following demand function for haircuts per day :
QD = 240 - 20P
• draw a figure showing the demand curve and the corresponding marginal revenue curve
of the firm. On the same the figure draw typical MC, ATC, and AVC curves showing that
best level of output is 80 haircuts per day, and that ATC = Rp 100.000,- and AVC Rp
60.000,- at Q = 80
• how much profit or loss per haircut does the firm have? does the firm remain in business
in the short run? why?

28. In Purbolinggo, Jawa Tengah, the movie market is monopolistically competitive. The demand
function for daily attendance and the long-run average cost function at the Plaza movie house are
respectively, P = 9 - 0.4Q and AC = 10 - 0.06Q + 0.0001Q2
• Calculate the price that the Plaza movie house will charge for admission to movies in the
long run. What will be the number of patrons per day at that price
• What is the value of the LAC that the firm will incur? How much profit will the firm
earn?

29. Suppose that in a city there are 100 identical self-service gasoline stations selling the same type
of gasoline. The total daily market demand function for gasoline in the market is QD = 60.000 -
25.000P, where P is expressed in rupiahs per gallon. The daily market supply curve is QS =
25.000P for P > Rp 0.60
• Determine algebraically the equilibrium price and quantity of gasoline

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• Draw a figure showing the market supply curve and the market demand curve for
gasoline, and the demand curve and the supply curve of one firm in the market on the
assumption that the market is nearly perfectly competitive
• Explain why your figure of the market and the firm in part (b) is consistent
• Suppose that now the market is monopolized (a cartel is formed that determines the price
and output as a monopolist would and allocates production equally to each member).
Draw a figure showing the monopolist’s equilibrium output and price
• How many gasoline stations would the monopolist operate
• Can we say that the monopoly leads to a less efficient use of resources that perfect
competition? What is the amount of deadweight loss, if any?

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 B. MACROECONOMICS

1. Suppose the economy has been experiencing a recession for a couple of years with no apparent
relief in sight. Currently the unemployment rate is 10%. In response to political pressure “to put
America back to work” government policy makers have recently reduced taxes significantly and
have dramatically increased government spending on public works projects to rebuild the nation’s
crumbling infrastructure (roads, bridges, airports). During a recent press conference the president
of United States remarked that the new government policy of tax cuts and spending programs will
be successful in reducing unemployment and there should be no reason to fear inflation either. As
a student in an economics course one of your friends has asked you to evaluate the likely success
of these recent policy moves. How would you respond?

2. Use the following table showing the production of 500 boxes of Wheaties cereal to calculate the
contribution to GDP using the value-added approach.
• Calculate the value added at each stage of production?
• what is the total value of all sales?
• what is the total value added?
• what is the contribution to GDP for the production of those wheaties?

3. There are three firms in an economy : X, Y, and Z. Firm X buys $200 worth of goods from firm
Y and $300 worth of goods from firm X, and $250 worth of goods from firm Z, and produces 300
units of output at $6 per unit. Firm Z buys $75 worth of goods from X, and $50 worth goofs from
firm Y, and produces 300 units at $2 per unit. All other products are sold to consumers. Answer
the following :
• What is GDP?
• How much government revenue would a value added tax of 10% generate?
• How much government revenue would an income tax of 10% generate?
• How much government revenue would a 10% sales tax on final output generate?

4. Graphically demonstrate the effect of each of the following on either the SAS curve of the LAS
Curve. Be sure to label all axes
• Business find that they are able to produce more output without having to pay more wages or
increase their costs of capital
• A severe snow storm paralyzes most of the united states
• the country’s currency appreciates dramatically

5. The government of Germany wants to expand its economy through increased spending. Show the
likely effects of an activist policy in the short run and in the long run in the following cases :
• The economy is far below potential output
• The economy is close to, but still below, potential output
• The economy is at potential output

6. Demonstrate the following two cases using the AS/AD model. What will happen in the long run
if the government does nothing?
• Inflationary gap
• Recessionary gap
• What could government do in inflationary gap and recessionary gap to keep the price level
constant?

7. Given the following equation, answer the question :

AE = C0 + 6Y + I0 + G0 + (X0 - M0)
where Co = 1000, I0 = 500, G0 = 300, X0 = 300, M0 = 400

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 • Draw the aggregate expenditures curve!
• What is slope of the curve?
• What is vertical axis intercept?
• Add the agegrate production curve on the graph
• What is multiplier?
• What is equilibrium income? Label that point A on the graph
• What is the effect of an increase in autonomous consumption of $200 on equilibrium
income? Demonstrate your answer graphically
• What is the effect on equilibrium income of a change in the mpe from 6-8? Demonstrate
your answer graphically. How does your answer change with new mpe?

8. For each of the following, state what will happen to equilibrium income
• The mpe is 0.9 and autonomous government expenditures just rose $200 billion. Graph your
analysis!
• The mpe is 0.65 and autonomous investment just fell $70 billion. Graph your analysis!

9. You are hired by the president who believe that the economy is operating at a level $30 billion
beyond potential output. You are to a that the marginal propensity to consume (note : assume that
mpe = mpc)
• The president wants to use taxes to close the gap. What do you advise? Show your answer
using the AP/AE model.
• The president wants to compare your plan to a plan using spending to close the inflationary
gap. What do you advise? Show your answer graphically using the AP/AE model.
• Advisers from the council realize that the marginal propensity to consume is 0.75.
Recalculate your answer and show using the AP/AE model!

10. Draw the aggregate supply/aggregate demand diagram for Indonesia. Assume that the economy
is initially in recession (that is, it is in a short-run equilibrium below full employment GDP). Label
everything and show the units. Show the original equilibrium price level and quantity of output.
• Suppose that to increase Indonesian human resources quality, the government, using their
budget, start a program to build educational infrastructure such as school and university all
over Indonesia. What would be happened to the AD? Show how this will appear on the
diagram. State what happened to the price level, quantity of output, and the unemployment
rate. Is this action smart, or is it stupid? Explain briefly
• Start over with a fresh diagram. Assume that the economy is initially in recression (that is,
it is in a short-run equilibrium below full-employment GDP) Suppose that due to ACTFA
(ASEAN-China Free Trade Agreement). China’s export to Indonesia increased over time
due to its relatively lower-price products and supported by the tariff deduction. In the order
hand, Indonesia could not increase its export to China due to its relatively higher-price
products, event though there are tariff deductions. What would be happened to the AD?
Show how this will appear on the diagram. State what happened to the price level, quantity
of output, and the unemployment rate. What monetary policy should the central bank
promoted?

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11. Indonesia in 2012.
Suppose that the economy of Indonesia is initially a long-run equilibrium. Draw a Keynesian
cross diagram for Indonesia, label everything (do not forget to draw the potential output line).
Side-by-side, draw a Money Market diagram for Indonesian rupiahs, label everything.
• Continue with the same diagram. Suppose that the world price of oil continue to increase
while the government could not increase Indonesia retail oil prices because the parliament
did not passed the law to do so. Considering the effect of this increase on subsidy burden on
government budget, one of the big three international rating agencies downgraded Indonesia
rating into speculative grade (initially Indonesia was in investment grade). Made some
foreign investors loose their confidence related with Indonesia economy prospect and
decided to move their capital investment out from Indonesia.
v Did the money supply go up or go down on the money market diagram?
v What happened to the interest rate?
v Show how this appears on the diagrams!
v Show the new Keynesian equilibrium!
v Show the new AD/AS equilibrium!
v Did income (GDP) go up or go down on the Keynesian cross?
v Did real GDP go up or go down on the AD/AS?
v What happened to the price level
v What happened to the unemployment?
• What monetary and fiscal policy should the central bank and government promoted?

12. The US in the late 1970s

• Suppose that the economy of the US, as a result of oil price shocks, is initially in a recession
(that is, it is in a short-run equilibrium at less than full-employment GDP). Draw a keynosian
cross diagram for US. Label everything. Side-by-side, draw an AD/AS diagram for the US.
Label everything. side-by-side, draw a diagram of the market for money for USD.
• Continue with the same diagram. Suppose that the central bank of the US seeing inflation,
decides to decrease the money stock of US
v Did the money supply go up or down on the money market diagram?
v what happened to the interest rate?
v show how this appears on the diagrams
v show the new keynesian equilibrium
v show the new AD/AS equilibrium
v did income [GDP] go up or go down on the keynesian cross?
v did real GDP go up or down on the AD/AS?
v what happened to the price level?
v what happened to unemployment?
• Is this action smart, or is it stupid? Explain briefly.

13. Indonesia in 1997

• Suppose that the economy of Indonesia is initially in a long-run equilibrium. Draw a
Keynesian cross diagram for Indonesia. Label everything. Side-by-side draw an AD/AS
diagram for Indonesia. Label everything. Side-by-side, draw a diagram of the market for
money for Indonesian rupiah
• Suppose that the Asian Financial Crisis cause a loss of confidence in businessmen. They put
their capital projects on “hold”. investment goes down.
v Did the money supply go up or down on the money market diagram?
v what happened to the interest rate?
v show how this appears on the diagrams
v show the new keynesian equilibrium
v show the new AD/AS equilibrium

14
 v did income [GDP] go up or go down on the keynesian cross?
v did real GDP go up or down on the AD/AS?
v what happened to the price level?
v what happened to unemployment?
• Continue with the same diagram. Suppose that the government decides to stimulate the
economy by changing the tax rate. Suppose it puts the economy half way back to full
employment GDP
v Did the taxes go up or go down?
v Did the money supply go up or down on the money market diagram?
v what happened to interest rate?
v show how this appears on the diagrams
v show the new keynesian equilibrium
v show the new AD/AS equilibrium
v did income [GDP] go up or go down on the keynesian cross?
v did real GDP go up or down on the AD/AS?
v what happened to the price level?
v what happened to unemployment?
• When the economy returns to full employment equilibrium, will the government find it easy
to make its former tax policy?

14. Indonesia in 1997 (again)

• Suppose that the economy of Indonesia is initially in a long-run equilibrium. Draw a
Keynesian cross diagram for Indonesia. Label everything. Side-by-side draw an AD/AS
diagram for Indonesia. Label everything. Side-by-side, draw a diagram of the market for
money for Indonesian rupiah
• Suppose that the Asian Financial Crisis cause a loss of confidence in businessmen. They put
their capital projects on “hold”. investment goes down.
v Did the money supply go up or down on the money market diagram?
v what happened to the interest rate?
v show how this appears on the diagrams
v show the new keynesian equilibrium
v show the new AD/AS equilibrium
v did income [GDP] go up or go down on the keynesian cross?
v did real GDP go up or down on the AD/AS?
v what happened to the price level?
v what happened to unemployment?
• Continue with the same diagram. Suppose that the government decides to stimulate the
economy by changing the money supply. Suppose it puts the economy half way back to full
employment GDP
v Which way do they change the money supply, up or down?
v describe three ways that BI can change the money stock
v Did the money supply go up or down on the money market diagram?
v what happened to interest rate?
v show how this appears on the diagrams
v show the new keynesian equilibrium
v show the new AD/AS equilibrium
v did income [GDP] go up or go down on the keynesian cross?
v did real GDP go up or down on the AD/AS?
v what happened to the price level?
v what happened to unemployment?
• When the economy returns to full employment equilibrium, what will be the long-run
disadvantage to this policy action?
15
MANAGERIAL ECONOMICS
Economics and Managerial Decision Making
The last of the color slides was barely off the screen when Ihsan Taufik, the CEO of Boga
Group, turned to his board of directors to raise the question that he had been waiting all week to
ask. “Well, ladies and gentlemen, are you with me in this new venture? is it a ‘go’? Shall we get
into the soft drink business?”
“It’s not that easy, Ihsan. We need some more time to think it over. You’re asking us to
endorse a very major decision, one that will have a long-term impact on the direction of the
company.”
“I appreciate your wish to deliberate further, Dr Ahmad.” Ihsan responded, “but I would like
to reach a decision today. As the president of a major university, you have been escpecially
valuable in advising this company in matters relating to social and governmental policies. But we
must diversify our business very soon in order to maintain the steady growth in profits that we
have achieved in recent years. As my presentation showed, the manufacturing and marketing of
our own brand of soft drink is one of the best ways to do this. It represents a significant
diversification, yet it is very closely related to our core business: food.
“The economics of the soft drink market tell us that we would be foolish to pass up the kind
of investment return that the market offers to those newcomers willing to take a risk. The food
business is generally a mature one. On the other hand, our forecast indicates that there is still a lot
of room for growth in the soft drink market. To be sure, there is a tremendous amount of
competition from the red team and the blue team. But we already have expertise in the food
business, and it should carry over into the beverage market.”
“That just it, Ihsan,” interjected another board member. “Are we prepared to take the risk?
You yourself acknowledged that the market power wielded by the two dominant companies in
this business is not to be taken lightly. others have tried to take market share from them and have
failed miserably. Moreover, the projections that you have shown.

The Firm and Its Goals

Jaja Suraja looked aver the last few numbers provided to hum in a consultant’s report on the
soft drink industry, closed the binder, and turned to Amartil Group’ vice president of marketing,
“Looking back, our decision to get into the soft drink industry was a good one, but who would
have thought that an industry that showed such strong growth in the early 1990s would start to
peak so soon? Also, we should have known that the two leading brands wouldn’t stand still while
we tried to increase our market share. Coke has been very successful with its Sprite® against
Cadbury-Scheweppes’7-Up®, and it seems that they will lauch a rival brand to Cadbury’s Dr
Pepper, I think we need to get into a growing market.
“An idea occurred to me recently when I was watching the Yankees-Mets baseball game on
television. When one of the Yankee players returned to the dugout after hitting a home run, he
didn’t go to the water cooler, but instead picked up a bottle of water. I already knew that bottled
water was the faster-growing segment of the beverage industry, and statistics I’ve seen since
reinforce this. We must get into this market while it’s still growing.”
“I hate to say this, Jaja, but it may be a case of too little,too late,” said Dina. “Established
companies such as Perrier have been around for a long time; Perrier also owns strong brands such
as PolandSpring. Deer Park, and Calistoga. Evian, which is owned by the French company
Danone, has also been quite successful in the United States. I am afraid that if we entered the
market we would start way behind.”
“I’m not prepared to give up so easily, Dina,” replied Jaja, “We have good distribution
channels, Bottling know-how, and marketing savvy. This Business is close to our core
competency and it is still growing, We have told analysts that we expect to grow at a 10 percent
rate in revenue and even more in profits, given our tight cost controls. At our upcoming
shareholder meeting, our shareholders and the analysts will be expecting to hear our plans for

16
further business expansion. In the past, we did it with the help of soft drinks, and now is the time
to grow our beverage division with bottled water.”

Supply and Demand

While sipping a cup of green tea laced with honey and ginseng. CEO jaja burns began to
reminisce. It seemed like yesterday. But it was actually more than 10 years ago when he had
convinced the board of directors of Kuliner sejahtera, Inc., to go into the soft drink business.
Here he was decade later, sampling a product that his VP of Marketing, Dina sadina, was telling
him would be an even stronger “growth engine” for the company than bottled water. She had
pointed out to him that in 2003 Indonesian cunsomers spent Rp 5 billion on tea. Altough this
amount was far less than the Rp 20 billion spent annually for coffee, it was five times as much
as people spent on tea a decade ago. “It’s obvious,” she told him , “Kuliner sejahtera must get
into the tea business.” As he poured his second cup of tea, Jaja had to admit that even he had
begun to prefer tea over coffee. He decided to call Dina into his office to discuss the matter
further.
“Okay, Dina,” Jaja began,”You’ve always had a good instinct for what’s new in the
market. But before we leap into this, I want a report on exactly why you belive tea will be the
real spark to our company’s growth in the coming 5 years. After all,in our business it’s all about
‘share of stomach. If people are drinking more tea, then they might be drinking fewer soft drinks
and bottled water, so we’d be cannibalizing our own products. I’d feel much better if you could
help me understand why this wouldn’t be the case. Furthermore, what are the key determinants
of the demand for tea? Could this be just a fad? Already people are starting to tire of their low-
carb diets. Dina, I want you to provide me with a report on the elements that are driving the
demand for tea. How responsive will people be to price changes, to changes in the price of
competing products such as bottled water and carbonated soft drinks? Is tea a ‘luxury’ good, or
is it a necessity? The answer to these questions will help us better understand how to price and
position our brand in the marketplace.”

Demand Elasticity
Heri herlambang is the owner-operator of a local Gas ‘n Go gas station and convenience store.
Heri chose to locate his store in an area at least 10 minutes away by car from the nearest
supermarket or grocery store. For the most part, Heri’s business has been quite successful.
Then one day he noticed that a new grocery store was opening just one block away. A
month later he noticed that a new convenience store had opened for business less than a 3-minute
drive away. Heri realized that to maintain the status quo in the face of this new competition, he
would have to make some tough decisions about his pricing and promotion policies and the mix
of items carried in his store.
The item that he carried were typical of those found in retail establishment of this type,
with beer ,cigarettes, hot coffee, and soft drinks accounting for about 75 percent of total sales.
Soft drinks were by far the best-selling item in his store. Essentially, the retail price of soft drinks
was based on the wholesale price plus a markup of about 400 percent. Heri recognized that this
markup was considerably higher than the one used by a supermarket, but he believed that people
were willing to pay more for the convenience.
On certain occasions, Heri would offer a particular brand of soft drink at a substantial
discount. Regardless of whether he lost or made money on soft drinks by this action, he found
that it helped to attract additional customers into his store, and gasoline sales actually increased.
Several people from an adjacent town told him that they waited until they were in the vicinity of
his station to fill their tanks because of his discount on soda. Given the public’s responsiveness
to special discounts on soft drinks and the ability of this product to promote other products, Heri
decided to use the pricing of soft drinks as his main weapon against his new competition. Instead
of offering a temporary discount, he decided to reduce the price of soft drinks permanently.

17
 However, after a month, despite the lower soft drink prices, there was a noticeable decline
in his revenue from soft drinks. Heri realized that he would have to reassess his competitive
tactic.

Demand Estimation and Forecasting

Fadil Jajaka recently brought into Kuliner Sejahtera, Inc., to build a forecasting department,
find his new position to be very challenging and quite interesting. However he also knows that
forecasting, even in the relatively stable soft drink industry can be thankless task. From various
forecast requests on his desk, he pulls out the one for the company’s lemon-lime soda. Citronade,
a brand recently purchased from an older, established company. He has been asked to estimate
sales for the next year, and the deadline for his report is nearing. He has annual sales data for the
11 years, and he also has sales data by quarter. In an industry where sales show considerable
increases during the summer months, a forecast that estimates sales for the seasons of the year is
very important.
Fadil looks at the annual data, and he quickly computer, year-to-year changes. These numbers
are shown as Table 1. He notices that, although sales were up in each of the years, the percentage
growth from year ti year appears to have a declining trend. He will have to consider this
phenomenon when he makes his forecast.
Quarterly data are shown in Table 2. As he looks over these numbers, Fadil realizes that he
has several busy days ahead of him.
Table 1. Sales of Citronade (in Thousands of Case)

Table 2. Quarterly Sales of Citronade, 1997-207 (in Thousands of Cases)

18
The Theory and Estimation of Production
The meeting of Kuliner Sejahtera’ top production managers must have been important
because it was attended by CEO Jaja Suraja as well as by Jim Hartwell, vice president of
manufacturing. Its purpose was to go over the plans for rolling put the company’s new bottled
water product. “Water pure”. Ridho Taufik. Manager of the company’s largest bottling plant, in
Cihideung, Bandung, knew that this product was considers to be the hope of the sagging beverage
division. He also suspected that there was going to be more than usual plans for the bottling
operation because of the additional presence of Dina Sadina, senior VP of marketing.
The meeting began with a few opening remarks by the CEO about the phenomenal growth of
the bottled after industry and how and why Kuliner Sejahtera hoped to get into this market. Ridho
noticed that all but a few of the 15 people at the meeting had their own bottle of water in front of
them and thought that this more than any other statistic made the point. Then came the surprise.
The opening presentation was given by the senior VP of marketing not manufacturing.
Amatil began to make a compelling case for a radical change in the packaging of this product.
“You all have seen how Coca-Cola has spent millions in advertising and packaging in order to
focus the shape of as original glass bottle and how Pepsi-Cola recently changed the look of its
label and logo. But packaging can be considered even more important in the market for bottled
water, because after all what are we selling?
“What I propose is that we combine the tradition of Coca-Cola with design innovation of
Pepsi-Cola and a French company that makes another beverage called Orangina to create our
own distinct packaging. We propose to sell our water in a green glass bottle shaped like a bottle
of champagne. To go along with this packaging, we attend to advertise our product as the
‘champagne of bottled water.
“How original”, thought Ridho . “I seem to recall that some time ago a beer company used a
similar tag line in their advertising. But forget the advertising, doesn’t she realize how expensive
it is to use glass rather than plastic! There has to be a reason why both Coke and Pepsi don’t use
glass for most pf thie bottling, particularly here in the States.”
As if in anticipations of Ridho’s negative thoughts. Nicole continued by saying, “I know some
of you might be thinking that this champagne idea is not very original. But our market research
indicates that people between the ages of 15 and 35are the key consumers of bottled water, and

19
 so most of our potential customers will be too young to remember that Miller beer commercial.
We in marketing realize that it will be you in manufacturing that will actually implement out
‘creative’ ideas. We know that this will present some interesting production challenges in terms
of the setup of the fill lines, the stacking of he cases for shipment and delivery, and so on. But I
know you’re up to the challenge. We want to begin a pilot program in one of our bottling plants.
In consulting with both Jaja and Jim, they both recommended strongly that we begin with our
bottling plants. In consulting with both Jaja and Jim, they both recommended strongly that we
begin with our bottling plant in Cihideung. Ridho, we want you to put up together a plan for
rolling out our new product in the next quarter.

The Theory and Estimation of Cost

Taufik Pradana, the plant manager at Amatil Cola Company, wa going through his daily
routine of opening his mail on Monday morning when he came across a marketing flyer from
Lawrence Alumunium Products, a company he had never heard of. The Company was in
Padalarang, about 400 miles away from his plant in upstate Jakarta. At first he didn’t pay too much
attention to it, but it then he saw that the base cost of soda cans was almost 30 percent lower than
what he was now paying. He read on about the company and was impressed with its offer. The
company offered an even higher discount if you integrated with their technology and took
advantage of electronic purchase orders. Amatil Cola Company requires technological upgrades,
so maybe this would be a perfect opportunity to switch both suppliers and computer systems. Opik
was always under pressure from Corporate to increase the profitability of its soda production so
his excitement on the potential of this change was high.
Opik called in Fajar Triadi, the products availability manager, an told her of hos discovery.
“Fajar this sounds like a great opportunity for us and I want you to investigate this company a little
more and llet me know what we need to do to get supply from them.” Fajar did not look excited
about the project.
“But. Opik.” She replied, “what about it Keysha , we need to stay in business too. Please get
on it and give me a report by Friday.
Fajar went back to her office and picked up the phone to call Lawrence Alumunium Products.
She was directed to Jojo Suherman, he director of sales. Fajar told Jojo who Amatil Cola was and
the type of cans that it would need. Jojo , the director of alses. Fajar told Jojo who Amatil Cola
was and the type of cans that it would need. Lawrence had the right specifications on the can and
actually had a little higher grade of quality in the alumunium. She continued to tell him their needs
and asked how it would work to get Shayna’s logo and artwork on the cans. Jojo explained that
they could do the logo and artwork with no problem, but Shayna would need to pay a one time fee
to set up the specification. Moreover, the base price of the cans would go up 10 percent due to the
eztra coloring and production time. Fajar quickly figured that even with increase, the cost would
be lower than Kayla Containers’ product.
“OK,” Fajar continued. “What about delivery?”
“Delivery is no problem,” Jojo responded. “We have trucks that deliver in your area once a
week. We should get your order in and out it in the next truck going out. Any by the way, if you
need to change the delivery date and request it in time, we can do it for you but we chage a bit
more. If you want our base delivery fee, you must take delivery when we schedule it.”
“Is it a flat fee or by the mile?” Fajar asked.
“It’s by the mile.”
Fajar began to concern with the delivery aspect of the offer. “What about lead time? What do
you require?”
“We have a pretty good turnaround time, so we only need five days.” Jojo replied.
“Five days!” Fajar shot back. “That’s not great.”
“Well, to be honest, most of the time we can giv that, but sometime we may be able to meet
your needs sooner, if we know your general plans in advance.” Jojo continued. “Ideally, we like
to have a monthly forecast. In fact, we can offer you a discount if you integrate with our current

20
 technology for submitting forecasts and purchase orders and you make payment through the
automated clearinghouse.”
What Jojo was saying now really began to pique Fajar’s interest because the company was
planning on improving its supply chain management anyway, particularly the procurement link of
the chain.
“What would be the cost of that?’Fajar asked.
“Well, you would need to purchase the software and the necessary support to set it up and
integrate it with ours.” Jojo stated nonchalantly.
“You don’t help with any of the costs?”Fajar asked.
“No, that would be your responsibility. But we can refer you to the contractors that helped us
and offer any advice along the way. It would be of benefit to you in the long run, though. Just think
of the efficiencies you could have.”
Jojo concluded the conversation by giving Fajar al the numbers to do the necessary
calculations. Fajar spent the next couple of days figuring out all the aspects of the calculations.

Pricing and Output Decisions : Perfect Competition and Monopoly

Taufik Pradana, the plant manager at Amatil Cola Company, wa going through his daily routine
of opening his mail on Monday morning when he came across a marketing flyer from Lawrence
Alumunium Products, a company he had never heard of. The Company was in Padalarang, about 400
miles away from his plant in upstate Jakarta. At first he didn’t pay too much attention to it, but it then
he saw that the base cost of soda cans was almost 30 percent lower than what he was now paying. He
read on about the company and was impressed with its offer. The company offered an even higher
discount if you integrated with their technology and took advantage of electronic purchase orders.
Amatil Cola Company requires technological upgrades, so maybe this would be a perfect opportunity
to switch both suppliers and computer systems. Opik was always under pressure from Corporate to
increase the profitability of its soda production so his excitement on the potential of this change was
high.
Opik called in Fajar Triadi, the products availability manager, an told her of hos discovery. “Fajar
this sounds like a great opportunity for us and I want you to investigate this company a little more
and llet me know what we need to do to get supply from them.” Fajar did not look excited about the
project.
“But. Opik.” She replied, “what about it Keysha , we need to stay in business too. Please get on it
and give me a report by Friday.
Fajar went back to her office and picked up the phone to call Lawrence Alumunium Products. She
was directed to Jojo Suherman, he director of sales. Fajar told Jojo who Amatil Cola was and the type
of cans that it would need. Jojo , the director of alses. Fajar told Jojo who Amatil Cola was and the
type of cans that it would need. Lawrence had the right specifications on the can and actually had a
little higher grade of quality in the alumunium. She continued to tell him their needs and asked how
it would work to get Shayna’s logo and artwork on the cans. Jojo explained that they could do the
logo and artwork with no problem, but Shayna would need to pay a one time fee to set up the
specification. Moreover, the base price of the cans would go up 10 percent due to the eztra coloring
and production time. Fajar quickly figured that even with increase, the cost would be lower than
Kayla Containers’ product.
“OK,” Fajar continued. “What about delivery?”
“Delivery is no problem,” Jojo responded. “We have trucks that deliver in your area once a week.
We should get your order in and out it in the next truck going out. Any by the way, if you need to
change the delivery date and request it in time, we can do it for you but we chage a bit more. If you
want our base delivery fee, you must take delivery when we schedule it.”
“Is it a flat fee or by the mile?” Fajar asked.
“It’s by the mile.”
Fajar began to concern with the delivery aspect of the offer. “What about lead time? What do you
require?”

21
 “We have a pretty good turnaround time, so we only need five days.” Jojo replied.
“Five days!” Fajar shot back. “That’s not great.”
“Well, to be honest, most of the time we can giv that, but sometime we may be able to meet your
needs sooner, if we know your general plans in advance.” Jojo continued. “Ideally, we like to have a
monthly forecast. In fact, we can offer you a discount if you integrate with our current technology for
submitting forecasts and purchase orders and you make payment through the automated
clearinghouse.”
What Jojo was saying now really began to pique Fajar’s interest because the company was
planning on improving its supply chain management anyway, particularly the procurement link of the
chain.
“What would be the cost of that?’Fajar asked.
“Well, you would need to purchase the software and the necessary support to set it up and integrate
it with ours.” Jojo stated nonchalantly.
“You don’t help with any of the costs?”Fajar asked.
“No, that would be your responsibility. But we can refer you to the contractors that helped us and
offer any advice along the way. It would be of benefit to you in the long run, though. Just think of the
efficiencies you could have.”
Jojo concluded the conversation by giving Fajar al the numbers to do the necessary calculations.
Fajar spent the next couple of days figuring out all the aspects of the calculations.

Break-Even Analysis (Volume Cost Profit)

October and November of each year are extremely busy months for the department of
financial planning at Kuliner Sejahtera, Inc. It is during this period that the financial plan for the next
2 years is prepared. As is customary in business, greater emphasis is always placed on the first of the
2 years. Planning data are collected from all departments—covering projected sales, costs and
expenses. After checking as much as possible to ensure reasonability and accuracy, the department
consolidates the numbers to obtain a planned income and expense statement. The plans are prepared
along profit center lines, usually by specific flavors of the products.
Nurul Fachria is the senior analyst responsible for the company’s new bottled water product.
Waterpure. She and her assistant have worked on this project for 2 weeks and have completed the
profit plan, which she will present to the manager of the financial planning department. The first page
of the long and detailed presentation shows the summary income statement for the Waterpure profit
center for the year 2018.
Nurul has kept her manager, Dorama Insani, informed regarding the progress of the plan. As
is quite common during a corporate planning cycle, their final discussion has been delayed several
times due to late data, changed numbers, and missed schedules. Thus Nurul and Doroma are meeting
just 1 day before are to result are to be presented to the company’s controller. Doroma agrees with
the method with which the plan has been out together and with the results Nurul has presented. But
she expects that the controller will require additional information. She ask Nurul whteher she has
perfomed sensitivity analysis calculating profit results if sales were to be 10 percent lower or 10
percent higher than planned. She is also interested in the level of sales at which profit would be zero
to establish the “worst case.” Nurul admits that this analysis is incomplete due to lack of time. Because
the presentation must be ready the next day, there is no enough time to rework the complete plan to
otain the alternative results. Nurul will therefore have to devise a method by which she can obtain
some good estimates for the “what-if” cases, estimates sufficiently reliable to show the controller.
She called brakeven or volume-cost-profit analysis. Fortunately, she happens to have a few old
textbooks in her office.

Pricing and Output Decisions : Monopolistics Competition and Oligopoly

22
 In a meeting with Nicky tirta, Fajar triadi explained the results of his price analysis. “My
concern is that we know our optimal price, but do we really know how our competitors are going to
react when we launch our product at this price point? Furthermore, I’m not sure the major players
really consider us as a threat to their business, at least not yet. Therefore, can we assume they will
take us seriously?”
Nicky agreed and suggested conducting further research. “One thing that we need is a
complete list of prices of the major brands as well as the smaller brands,” she began, “I was at a
marketing conference in southern California last week, and I noticed that the hotel that I stayed in
had bottled water with the hotel name on the label in its minibar right next to one of the national
brands.”
“Leave it to California to come out with the trendiest product,” Fajar retorted.
“Not necessarily,” said Nicky. “I heard that private labels are proliferating throughout the
country. For example, there is even bottled water with the labels of cities and countries. And you
might have heard that even McDonald’s has its own bottled water that I understand is selling well in
some markets. The other key information that we could use in making our pricing decision is the
perception of our product by potential consumers and their view of how much value our product
provides them relative to our price. Perhaps it would be worthwhile to hold a few focus groups to find
this out.”
“Good Idea,” said Fajar, “I’ll get on this right away and have a report for you in a couple of
weeks.”

Special Pricing Practices

One of the most difficult challenges in the food and beverages industries is the establishment
of effective channels of distribution. Many food-processing and beverage companies rely on food
brokers to sell their products to retail outlets such as supermarkets and grocery stores. In the case of
bottled water, the product is shipped from the bottling plants to the individual retail establishments.
Obviously, there must first be a willingness on the part of these retail businesses to carry a particular
product line.’’
The task of establishing the relationship between Kuliner Sejahtera, Inc., and the retail stores
was given to Reni Marlina, assistant vice president of marketing of the beverages division. Because
the product, Waterpure, was so new, she found considerable resistance among the major supermarket
chains to carrying Global’s line of bottled water. Thus far, she had ben able to sell relatively small
volumes to smaller grocery stores, delicatessens, and sandwich shops. Then she learned that a large
catering company that provided food services in major airports all across the Indonesia wants to carry
an additional line of bottled water. This firm had put out a request for bids to all the major beverage
companies and also to Kuliner Sejahtera. After all, Kuliner had an established reputations in the food
business.

Reni was eager to land this major account. But she also realized that her bid would have to
be considerably lower than that offered to her present customers. However, this lower price would be
more than made up by the potential volume of sales, as well as by the creation of a base from which
to further penetrate the market for bottled water. But she was not quite sure how to decide on the price
she should recommend. She decided to consult with Jaja Misara, and executive in the company’s
foods service division. Jaja had considerable experience in preparing bids for large customer
contracts.

Game Theory and Asymetric Information

Heri Herlana did not want to lower the price of his soft drinks even further because he knew
it would start a vicious price war between him and the other two store owners in the vicinity. But he
believed that this might be the only way he could restore his share of the market for a product that
was an important part of his business’s profitability.

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 To his surprise, his daughter Erika wanted to stay at home and work in the family store over
the summer to gain some practical business experience. She had just decided to switch her major from
art to economic, so she believed that working in her dad’s store would be a useful complement to her
studies. But when he confided in her about his dilemma regarding the pricing of his soft drinks, he
was a bit puzzled by her reaction. “Dad, what you’re faced with is a classic game theory problem,”
she responded.
“I’m not so sure what you mean, Erika. This is not a game we’re talking about. This is the
real world of business, and the future of my business could well depend on the outcome of this
potential price war over soft drinks. If my competitors get the best of me in the pricing of this product,
who knows what they’ll do in the pricing of coffee, snacks, and gasoline?”
“don’t’ worry, Dad, I know this is serious. I know that you probably didn’t study this topic
when you were in college, but when my professor introduced game theory to us in my managerial
economics course, I was fascinated. Moreover, I do believe there are some practical applications of
the concepts that may be of help to you in this situation.”
“Okay, Erika, what’s this game theory stuff all about and how can it help me?”

Capital Budgeting and Risk

Gian Astama, the manager of Global Food’s capital planning department, is responsible for
analyzing capital budgeting projects. When the analysis is completed, Gian and his staff of five make
presentations up the company hierarchy— to the treasure (Gian’s boss) and the vice president of
finance. If the proposal is large enough, it may finally have to be approved by the Corporate
Management Committee (a group composed of top executives).
Gian has in front of him a new project proposal that requires extensive analysis by his staff.
It is the proposed expansion of company activities into a new geographic region. Global is
investigating the possibility of entering a new region where its soft drink and bottled water products
have not been marketed previously. Potential annual sales for this area have been estimated at
100,000,000 cases. A 4 percent annual increase in total consumption is forecast. The market research
people have estimated that, given an extensive advertising campaign, the first year’s market share
could reach 1 percent, and it might grow to some 5 percent 4 years later.
For the company to compete in this new area, it must establish a plant. An unused, somewhat
obsolete bottling plant is available in the area for $5 million. The total costs of rebuilding and
renovating the plant, and purchasing and installing the new equipment, are expected to amount to $2
million. During the first year, the company will incur expenses of recruiting a new workforce and an
extensive advertising and promotion campaign. These expenses are estimated at $750.000.
If Kuliner Sejahtera actually achieves a 1 percent share of the market, it will sell 1 million
cases. Each case sells for $5. Production costs will be $2.50 per case. General and administrative
expenses will be $650.000 during the first year. Of this amount, $500.000 is fixed; the remainder is
a function of sales revenue. Distribution and selling expenses will be 60 cents per case. Advertising
expenses will be 5 percent of sales.
The total cost of the plant, renovation, and new equipment and their depreciation schedule is
as follows:
• Land—$500,000, not depreciable
• Plant—$3,500,000, depreciated straight-line over 31 ½ years
• Machinery—$3,000,000, depreciated by the Modified Accelerated Cost Recovery System
(MACRS) over 7 years
Global also expects that it will have to increase the size of its working capital by $750,000 to
cover the additional inventory, accounts receivable, and cash for transactions.
The analysis will span 7 years, including the first year of expenditures and 6 years of
operations. This is a relatively conservative assumption—if the company cannot make a viable
business of this plant over a 7-year time period, it would consider the operation too risky to undertake.
Two other important pieces of information needed to complete the analysis are the following:
• The company’s marginal income tax rate (federal, state, and local) is 40 percent
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 • The cost of capital for this project will be 15 percent

After Gian completes the evaluation, he will perform a risk analysis to consider potential
upside and downside risk. Gian knows that there are various ways to account for risk. He decides
that, although he will make an extensive assessment, he will keep it relatively simple so management
will be comfortable in making the final decision.

The Multinational Corporation and Globalization

Kuliner Sejahtera has ceased to be a strictly domestic corporation. It has opened production
facilities that produce both its soft drinks and its bottled water in several countries in Western
Europe and the Pasific Rim. It is now ready to make an investment in one of the countries that was
formerly part of the Soviet sphere. Management has been investigating in which of the countries to
locate. It turned out that it favored the Czech Republic. This country is centrally located, has a
skilled labor force, has been very active in privatizing industry, and has a fairly stable government.
Its labor costs are relatively low.
After an investigation of various locations within the Czech Republic, the company found a
plant notpresently in use but rather well maintained just outside just outside the town of Pelhrimov,
in southeastern Bohemia, not too far from the border of Moravia. It is about 115 kilometers from
Prague, the capital city. The town itself has about 17,000 inhabitants. Pelhrimov has some light
industry including wood processing, food, textile, and clothing.
Gian Astama, manager of Kuliner Sejahtera capital planning (we met Gian earlier), has been
given the task of preparing a capital budgeting evaluation. He consults with the marketing and
manufacturing departements. He discusses the Czech economic situation with the company’s
economist. He obtains estimates of Czech and U.S. inflation rates, and the exchange rate of the
Koruna (KCZ) against the U.S. dollar. He further acquaints himself with the corporate tax rate in
the Czech Republic. Armed with this information, he begins to put down the assumptions with
which he will work.
He expects that the fixed invesement by Kuliner Sejahtera, U.S.A., will be $4 million, and
that another $400,000 will be invested in working capital. The fixed investment will be depreciated
straight-line over 8 years. Because the plant is in very good condition, only the installation of
machinery will be needed for the plant to begin operating rather quickly.
To be very conservative, cash flows for only 4 years will be estimated, with a terminal value
estimated at the end of the 4 years. His marketing people think that first year’s sales will be 400
million KCZ and that the volume will increase by 6 percent each year. Production costs in the first
year will be 190 million KCZ. The parent company will be providing various supplies and services
to the subsidiary starting at 110 million KCZ and will grow at the same rate as volume.
A license fee of 3 percent of sales will be paid by the Czech subsidiary to the parent
corporation. General and administrative expenses will be 12 percent of sales revenue. The following
are estimates of annual price level changes in the United States and the Czech Republic:
General price level in the United States 2.0%
General Price level in the Czech republic 3.5%
Sales price in Czech Republic 4.0%
Cost of production in Czech Republic 4.0%
Today’s exchange rate is 27 KCZ/$1. The exchange rate is expected to change in relation to
the inflation rates in the two countries. The income tax rate in the Czech Republic is 31 percent,
whereas it is 35 percent in the United States. After the initial infusion of working capital into the
project, the subsidiary will require that working capital be 10 percent of sales. Fifty percent of this
additional requirement will be financed internally (profits and increase in current liabilities), and the
other 50 percent will be financed externally by the subsidiary.
Kuliner Sejahtera’ cost of capital for projects of average risk is 15 percent. However, to
account for the additional risk faced by operating in a foreign country that just recently embraced free
trade (although still regulated), a 4 percent risk margin will be added so the discount rate for the

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parent company will be 19 percent. The cost of capital for similar enterprises in the Czech Republic
is 22 percent.
The profit calculated on the parent’s shipments of supplies to its subsidiary will be computed
at 5 percent. This appears reasonable and should not be questioned by U.S. or Czech tax authorities.
The subsidiary will remit 50 percent of its aftertax profits to the parent.
With all this information, Gian will now input the data into an Excel spreadsheet that he
specifically prepared for this project. He will have to organize his work into five separate exhibits.
First, he will calculate the profit of the subsidiary. Second, he must compute the additional working
capital investment made by the subsidiary. The third exhibit will be a cash flow statement for the
subsidiary with a calculation of the NPV and IRR. The fourth exhibit may appear somewhat
complicated. It translates the dividend by the subsidiary to the parent from KCZ into U.S. dollars;
this involves a process called “grossing up” to ascertain the tax for which the parent may be liable
because the Czech tax rate is lower than that in the United States. Last, the parent company must
compute the NPV and IRR of all cash flows received from the subsidiary.

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