Managerial Economics

Mr. Upton

Spring, 1999

First Midterm Examination
March 4, 1999

First Part (10 point questions). Explain whether you agree or disagree with these statements.

1.      Even the best-made paper plates don't last as long as china plates. Therefore it is clear that paper plates are inferior goods. Disagree. Do not confuse some measure of technical inferiority with real inferiority. The question is whether demand rises or falls with income, and, the rich may have more picnics, Super Bowl parties, etc. Thus the demand for paper plates may rise with income.

2.      If 1,000 people who now purchase $100 a year of Brie Cheese, are given a $50 gift certificate good only for Brie by the Brie Cheese Institute, then the demand for Brie will go up, and will go up by $50,000 a year. Disagree. This is equivalent to a $50 increase in income. If Brie is an inferior good, demand may go down. And, even if it is a superior good, then it may - indeed probably - will go up by less than $50 per person per year.

3.      You submit a new book about the Internet to a publisher. The publisher agrees to publish the book and offers you two payment alternatives: (1) you will receive a fixed fee of $180,000 independent of how well the book does or (2) you will receive $400,000 if the book sells 10,000 or more copies and nothing if fewer than 10,000 copies are sold in its first three years on the market. If the probability of selling 10,000 or more copies is 0.5, and you accept the second alternatives, this demonstrates that you are a risk taker. Disagree. Expected income is higher, and, while you may be a risk averter, you may still go for the higher expected income cum risk.

4.      If the supply curve shifts to the right, then price will fall and demand will increase. Disagree. There may be a movement along the demand curve, but I see no basis for an increase in demand.

Second Part (20 point questions)

Directions: Work any two (2) of the following three (3) questions. In the boxes below, check which problems you have worked:

I have worked(Check 2)

Problem 1

 

Problem 2

 

Problem 3

 

1.       The demand functions for two products A and B are:

QA = 600 - 10PA

PB = 60 - (1/10)QB

For each demand function,

(a) compute the point price elasticity (h ) at P = 15.

These are really the same demand functions, as you can see by reversing the second equation and putting QB on the left-hand side. When P = 15, Q = 450, and Delta Q/Delta P = -10. Thus the elasticity is given by

h = (P/Q)(Delta Q/Delta P ) = (15/450)(-10) = -1/3

(b) compute the arc price elasticity when the price changes from P =15 to P = 25.

The average value of P is 20. The Average value of Q = 400. DeltaQ/Delta P is unchanged. Thus the arc price elasticity is

h = (P/Q)(Delta Q/Delta P ) = (20/400)(-10) = -1/2

2. Spring is coming to the town of Lake Elmore, and with it, the fishing season begins. Given the mild winter, the fishing is expected to be great this year. Every one of the town's 100 citizens is an avid fisherman and very public spirited. The town council regards this as good news, for they face a budget deficit and must raise an additional $5,000 this year. Fortunately, the town has arranged for Warren's Traveling Amusement Park to visit on opening day for the fishing season. No doubt you have seen similar amusement rides at shopping malls from time to time.

For reasons we need not go into, the Traveling Amusement Park has agreed to appear for free. The town is free to charge for rides, and pocket the proceeds. They know that all the 100 citizens will show up.

A team of eminent econometricians from the local State University has determined that the demand for rides this year by each of the citizens is

Q = 20-2p

where p is the price in (dollars) charged for each ride. Two plans are under consideration. One is to charge fixed price for admission, with the rides to then be free. The other plan is to have no admission charge, but charge $4 a ride.

    1. What is the maximum amount the town could charge each inhabitant for admission and still get customers? If the town goes this route, how many rides will each citizen take? Explain your answers. This is a simple calculation in consumer surplus. The area under the demand curve is (1/2)(20)(10) = $100. If rides cost nothing on the margin, each citizen will take 20 rides.
    2. If the town decides to charge $4 per ride, how much money will it collect? And how many rides will each person take? Explain your answers. Each citizen will take 12 rides, since Q = 20 - 2(4).

C.     Helen Smith, an unsuccessful candidate for town council, and known troublemaker, has taken some economics courses. The town council knows that she will compute the dead weight loss of proposals "A" and "B". To be prepared, they have asked that you compute the answers before she does. Be sure to explain your answers. Proposal A has no deadweight loss. Proposal B has a loss from the eight forgone rides equal to (1/2(8)(4) =$16.

3. John Smith now works 40 hours a week at United Rowboats at a job paying $10 per hour. He could work more or less hours, but he chooses to work 40 hours a week. Federated Rowboats offers John a job similar to that he performs at United Rowboats. Because of complicated work rules, Federated can only offer John $8 an hour. But they promise John, that, if he takes the job, they will give him a weekly bonus of $80 a week if he works at least 30 hours a week. John has a very simple philosophy. He always changes jobs if he is better off, but will never change just to change,

    1. Will John Take the job at Federated Rowboats? Why or why not? In answering this question, remember the old Chinese Proverb that a well-labeled graph is worth a thousand words. And, if he takes it, will he work more or fewer hours a week? John will take the job. If he takes the new job, he can still earn $400 for working 40 hours a week, but the MRS between work and leisure will now be 1 hour for $8, allowing him to work less, substitute leisure for goods purchased, and move to a higher indifference curve.
    2. How would John respond if Federated made the offer of the $80 bonus conditional on his working 40 hours a week? Explain your answer. He wouldn't take this job. Or, if he took it, he would continue to work the same number of hours. The only way he could get the bonus would be to continue to work 40 hours a week. Thus he could not take advantage of the lower cost of leisure.