Managerial Economics

Conceptual and Computational Questions; Problem and Application

De La Salle University- Manila
Managerial Economics and Business Strategy by
Michael Baye and Jeffrey Prince
Fundamentals of Managerial Economics
______________________________________________________________________________

1. Southwest Airlines begins a “Bags Fly Free” campaign, charging no fees for the first and second
checked bags. Does this situation best representation producer-producer rivalry, consumer-
consumer rivalry, or consumer- producer rivalry? Explain.
Answer Key: Producer-Producer Rivalry
Explanation: Airline travelers seek for the best deals and promos they could get for the airfare.
They could pay for/ paid for. Competitive airlines tend to want to remain on top of the game.
Therefore, the campaign entices more consumers to choose Southwest Airlines instead of its
competitors. This gives them a competitive advantage and win more consumers.

2. What is the maximum amount you would pay for an asset that generates an income of
$250,000 at the end of each of five years if the opportunity cost of using funds is 8%?
Answer Key: PV= $ 998,177.51
Formula: Given:
𝑛
𝐹𝑉𝑡 FV= $250,000
𝑃𝑉 = ∑ n= each year Solution:
(1 + 𝑖)𝑡
𝑡=1 t= each year $250,000 $250,000 $250,000 $250,000 $250,000
or i= 8% or 0.08 𝑃𝑉 = + + + +
(1 + 0.08)1 (1 + 0.08)2 (1 + 0.08)3 (1 + 0.08)4 (1 + 0.08)5
𝐹𝑉𝑛
𝑃𝑉 =
(1 + 𝑖)𝑛

3. Suppose that the total benefit and total cost from a continuous activity are, respectively given by the
following equations: B(Q)= 100 + 360Q – 4𝑄2 and C(Q) = 80 + 12Q. [Note: MB(Q)= 36 – 8Q and MC(Q)].
Question a: Write down the equation for Net Benefits
Answer Key: 20 + 24Q - 4𝑸𝟐
Formula: Solution:
Net Benefits= Total Benefits- Total Costs = 𝐵(𝑄) − 𝐶(𝑄)
= (100 + 36𝑄 − 4𝑄2 ) − (80 + 12𝑄)
= 20 + 24𝑄 − 4𝑄2

Question b: What are the Net Benefits when Q= 1? Q=5?

Answer Key: 40
Formula: Solution: Q=1 Solution: Q=5
Net Benefits = 20 + 24(1) − 4(1)2 = 20 + 24(5) − 4(5)2
2
= 20 + 24𝑄 − 4𝑄 = 20 + 24 − 4 = 20 + 120 − 100
= 40 = 40

Question c: Write out the equation for Marginal Benefit

Answer Key: 24-8Q
Formula: Solution:
Marginal Net Benefit= Marginal Benefit – = 𝑀𝐵(𝑄) − 𝑀𝐶(𝑄)
Marginal Cost = (36 − 8𝑄) − (12)
= 24 − 8𝑄

Question d: What are the Marginal Net Benefits when Q= 1? Q=5?

Answer Key: 16 and -16
 Formula: Solution: Q=1 Solution: Q=5
Marginal Net Benefits= = 24 − 8(1) = 24 − 8(5)
= 24 − 8𝑄 = 24 − 8 = 24 − 40
= 16 = −16

Question e: What level of Q Maximizes Net Benefits?

Answer Key: Q=3
Formula: Solution:
Marginal Benefit= Marginal Cost 36 − 8𝑄 = 12
−8𝑄 = 12 − 36
−8𝑄 −24
=
−8 −8
𝑄=3

Question f: At what value of Q maximizes Net Benefits, What is the value of marginal net benefits?
Answer Key: 0
Formula: Solution:
Marginal Net Benefit= 24-8Q; Q=3 = 24 − 8(3)
= 24 − 24
=0

4. Complete the accompanying table and answer the accompanying questions

Control Total Total Net Marginal Marginal Marginal
Variable Benefits Cost Benefits Benefits Cost Net Benefit
(Q) B(Q) C(Q) N(Q) MB(Q) MC(Q) MNB(Q)
100 1200 950 250 210 60 150
101 1400 1020 380 200 70 130
102 1590 1100 490 190 80 110
103 1770 1190 580 180 90 90
104 1940 1290 650 170 100 70
105 2100 1400 700 160 110 50
106 2250 1520 730 150 120 30
107 2390 1650 740 140 130 10
108 2520 1790 730 130 140 -10
109 2640 1940 700 120 150 -30
110 2750 2100 650 110 160 -50

Question a: At what level of the control variable are not benefits maximized
Answer: 107 is the highest net benefit

Question b: What is the relation between marginal benefit and marginal cost at this level of the
variable
Answer: At Q= 107. MB9Q) > MB (C)

5. Jaynet spends $30,00 per year on painting supplies and storage space. She recently received two job
offers from a famous marketing firm— one after was for $110,000 per year and the other was for $80,000.
However, she turned both jobs down to continue a painting career. If Jaynet sells 25 paintings per year
at a price of $8,000 each,
a. What are her accounting profit? $170,000
b. What are her economic profits? $60,000 and $90,000
 Revenue $200,000
Expenses 30,000
Accounting Profit $170,000
Implicit Cost:
Job 1 110,000
Job 2 80,000
Economic Profit, Job 1 $60,000
Economic Profit, Job 2 $90,000

6. You are the human resources manager for a famous retailer and 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
Answer: Proposed Pay Structure ($330) > Current Pay Structure ($160)
Explanation: The profit share will incentivize the staff to work harder so the proposed pay structure
will be beneficial. With such calculations (Current pay structure: $20 per hour x 8 hours = $160;
Proposed Pay Structure: $10 per hour + 1% of the store’s daily profit [$25,000]— $10(8) +
(0.01)($25,00)= $330)

7. You are the manager in charge of global operations at BankGlobal—a large com- mercial bank that
operates in a number of countries around the world. You must decide whether or not to launch a new
advertising campaign in the U.S. market. Your accounting department has provided the accompanying
statement, which summarizes the financial impact of the advertising campaign on U.S. operations. In
addition, you recently received a call from a colleague in charge of foreign operations, and she
indicated that her unit would lose $8 million if the U.S. advertising campaign were launched. Your goal is
to maximize BankGlobal’s value. Should you launch the new campaign? Explain

Accounts Pre-Advertising Post- Advertising Incremental

Campaign Campaign
$ $ $
Total Revenue 18,610,900 31,980,200 13,369,300
Variable Cost
TV Airtime 5,750,350 8,610,400 11,712,850
Ad Development Labor 1,960,580 3,102,450 7,710,930
Total variable cost 7,710,930 11,712,850 4,001,920
Advertising Campaign 8,000,000 12,001,920
Direct Fixed Cost
Depreciation— Computer Equipment 1,500,000 1,500,000
Total Direct Fixed Cost 1,500,000 1,500,000 0
Indirect Fixed Cost
Managerial Salaries 8,458,100 8,458,100
Office Supplies 2,003,500 2,003,500
Total Indirect Fixed Cost 10,461,600 10,461,600 0
Profit -1,061,630 8,305,750 1,367,380
Explanation: With the calculated incremental revenue and cost, the new advertising campaign should
be launched to maximize the value of Bank Global. There is efficiency of the ad campaign in maximizing
Bank Global’s value, thus, “thumbs up”

8. Assuming that there’s no pandemic and it’s your birthday. You’re planning to travel with your friends,
either in Boracay or Palawan. You love both places but you chose Boracay over Palawan. Your
 willingness to pay for both travel packages is Php30,000. The travel package prices for Boracay and
Palawan are Php25,000 and Php27,500 respectively.

Answer: 2,500
Question a: How much is the opportunity cost (Foregone Net Benefits) of choosing Boracay?
Solution:
Opportunity Cost= ₱27,500 - ₱25,000
= ₱2,500

Answer: 2,500
Question b: Using Marginal analysis, how much is the economic profit of choosing Boracay over palawan?
Solution: ₱
Marginal Benefit= 30,000
Cost of Choosing Boracay= 25,000
Cost of Choosing Palawan= 27,500

MB- CB= 5,000

MB- CP= 2,500

Profit of choosing Boracay over Palawan

5000-2500=₱2,500

Answer: Yes, because the economic profit Is positive.

Question c: Did you make the right decision of choosing Boracay over Palawan
Explanation: I did make the right decision of choosing Boracay over Palawan for with the 30,000, I was able
to save 5,000 pesos— having a difference of 2,500 pesos if I choose Palawan.

Answer: Travel Cost

Question d. What condition will make you indifferent between Boracay and Palawan?