Please answer the following short answer questions (5 pts each):18. As a budding entrepreneur, you have purchased a small bagel shop. You haveengaged in a market study to categorize your customers’ willingness to pay for a meal(coffee+bagel) into 8 equal sized groups: ($5.00, $4.50, $4.00, $3.50, $3.00, $2.50,$2.00, $1.50). All of your costs are fixed except labor and materials, which cost $2.25per meal sold.a. What price should you charge for a meal? Does your answer depend on the totalnumber of consumers?b. Suppose your market research tells you that the four lowest value groups are allstudents. Should you offer a student discount? If so, how much?19. Concert price have increased coincidentally with illegal downloading of music offthe internet. What is the causal link?20. VetPharm has historically produced and sold drugs for animals; however, one of itsproducts developed for animal use has recently been approved for a similar use inhumans. Market research has revealed that that at the current per dose price, theelasticity of demand on the part of animal owners is -2.0. The research also estimatesthat at this price the elasticity of demand for human use would be -.2. The current priceis $5.00 per dose. If the MC of production is $1, what should the company do?a. reduce animal price; reduce human price.b. raise animal price; raise human price.c. reduce animal price; raise human price.d. raise animal price; reduce human price.21. Ivan loves classical music, and his favorite composer wrote ninesymphonies. Ivan just happens to the 9 symphonies in exactly the order inwhich they were written. The table below shows the values that Ivan places onhaving these symphonies which he does not currently yet own:Rank Total Personal Value1_______________19 2_______________36 3_______________514_______________64 5_______________75 6_______________847_______________91 8_______________96 9_______________99 You can interpretthe above to mean, for example, that Ivan values her favorite Symphony at $19, and thatthe total value of the first Symphony plus Symphony # 2 (his second favorite) is $36,etc. If the symphonies were sold individually on CDs – one symphony per disc – and theprice per CD was $10.00, how many CDs would he buy?22. Referring to the question above: If the symphonies were also offered as a completeset of 9 CDs and the price of the entire set was $79.00, would he rather buy theindividual CDs or the box set? HINT: WHICH OPTION GIVES HIM MORECONSUMER SURPLUS?34. The following represents the potential outcomes of your first salary negotiation aftergraduation:EmployerAssuming this is a sequential move game with the employer moving first, circle themost likely outcome. Does the ability to move first give the employer an advantage? Ifso, how? As the employee, is there anything you could do to realize a higher payoff?35. You areconsideringlaunching a strategicalliance with acompetitor to joinyour separate skills todevelop a new jointlyowned technology.Both you and yourpartner have theoption of fully orpartially supportingthe alliance.Complete the payoffdiagram to make thisa Prisoner’sDilemma. You fullysupport alliancePartner fullysupports alliancePartner partiallysupports alliance37. Suppose that you are a seller bargaining with a buyer. Your bottom line is zero, andyou think the buyer’s top dollar is either $5 with probability .25, or $6 with probability .75. Suppose further that you can commit to a posted price. What is the price thatmaximizes expected profitability?39. You take a position with a large real estate development company as your first jobafter graduation. Your first big assignment is to sell an office building – you have beeninformed the company’s cost into the building (and the bottom line price it is willing toaccept) is $400,000. You have identified a likely buyer and you assess that his top priceis either $500,000 with a probability of .3, $600,000 with a probability of .5, or$1,000,000 with a probability of .2. You have to commit to a posted price – what pricewill maximize your profitability?40. You start an insurance company as your first entrepreneurial venture aftergraduation. Your main product line is malpractice insurance for dentists. Afterexhaustive research, you learn that settling malpractice claims against careful dentistscosts $2,000 and settling malpractice claims against reckless dentists costs $7,500.Individual dentists know whether they are reckless or careful, and your research showsthat approximately 20% of dentists are reckless. How much do should you charge formalpractice insurance to break even? Why?41. Research has shown that the majority of strategic alliance joint ventures betweencompanies are not successful. Provide an adverse selection and moral hazardexplanation for this lack of success.42. Botulinum toxin, marketed under the brand name “Botox” is a drug that paralyzesmuscles into which it is injected. It is one of the few promising treatments for migraineheadaches, which affect about 10% of the population. Migraine headaches aredebilitating, but there is no objective way to diagnose them. Thus migraine headachesare relatively easy to fake. Botox is also very popular as a cosmetic treatment to get ridof wrinkles. If you are a small business, should you offer insurance coverage for Botoxtreatments for migraine headaches? (HINT: moral hazard.)43. In the Oct 29, 2005 NY Times Article, Wal-mart’s Health Care Struggle is CorporateAmerica’s too, an internal Wal-Mart Memo, suggested redefining jobs to requirephysical activity, and to offer health care insurance plans that allowed workers whohave low medical costs to spend the unused benefits on other items, like housing oreducation. Give an adverse selection explanation and a moral hazard explanation of howthese actions can help reduce Wal-Mart’s health care costs.44. Assume you paid $3,000 for your notebook computer. The probability of thecomputer being stolen is .02 if you are careful and .05 if you are not. How much (indollar terms) are you willing to expend in caring for the computer? If you had purchasedinsurance that replaced the computer if it were stolen, how much would you be willingto spend in taking care of it (ignore the “costs” of lost data and time in getting areplacement)? Why?6. You have an opportunity to invest in a new plant. The fixed costs are $100,000 peryear. The marginal cost of production is $2 for a quantity up to 10,000 units per year.The marginal cost of production is $4 for a quantity between 10,001 and 30,000 unitsper year (an additional 20,000 units per year) and $10 for production above 30,000 peryear. What is the break even quantity if the market is competitive and the market priceis $8 per unit? Show all calculations.7. According to a study of U.S. cigarette sales between 1955 and 1985, whenthe price of cigarettes was 1% higher, consumption would be 0.4% lower in theshort run and 0.75% lower in the long run (Becker et al., 1994)a. Calculate the short-and long-run price elasticities of the demand forcigarettes.b. Is demand more or less elastic in the long run than in the short run? Explainyour answer.c. If the government were to impose a tax that raised the price of cigarettes by 5percent, would total consumer expenditure on cigarettes rise or fall in the shortrun? What about in the long run?8. Your company manufactures a high-efficiency natural gas furnace. Thecurrent price is $2000 per unit. The price elasticity of demand is -2.5 for pricesbetween $1500 and $2500. Your CEO has asked you to predict the net effect ondemand for various scenarios. You have determined that there are three majorfactors that will affect your demand: the price of competitors’ products, income,and the price of natural gas. You have hired a consulting company to estimatethe effects of these factors. The results are as follows: (1) the cross priceelasticity of demand between your product and your competitors’ products isconstant at +.5, (2) income elasticity of demand for your products is constant at+1.6, and (3) the cross price elasticity of demand between your product andnatural ga
s is constant at +.3.a) By what percent would your demand change if you increased price by 5%and all other factors remained constant?b) By what percent would your demand change if you did not increase price butyour competitors increased their prices by 8% and all other factors remainedconstant?c) By what percent would your demand change if you did not increase price butincome decreased by 2% and all other factors remained constant?d) By what percent would your demand change if you did not increase price butthe price of natural gas fell by 20% and all other factors remained constant?e) What is the net effect on your demand of all changes taken together (youincreased price by 5% and competitors increased price by 8% and incomedecreased by 2% and the price of natural gas fell by 20%)? Assume the effectsof each change are independent and cumulative.9. Suppose the chairman and chief executive officer of General Motors hasdecided to a) raise the company’s auto prices by 5%. In addition, suppose thatthe following events have been forecast for the next year: b) the price ofcompetitors cars are due to rise by 8%; d) consumers’ incomes will rise by 2%;and d) the price of gasoline is due to fall by 20%. You, as head of production,must decide what all of these events mean for GM’s car sales so that you canplan production accordingly. You hire an economics consulting firm thatprovides you with these estimates based on econometric studies:Price elasticity of demand for GM cars is 2.0 (in absolute value terms)Cross price elasticity between GM cars and those of its competitors is +.5Cross price elasticity between GM cars and gasoline is -.3Income elasticity of demand for GM cars is +1.6Calculate the effect of each of these four changes on demand based on theestimates provided. What is the net effect of all the changes taken together?a. Increase the company’s auto prices by 5%.b. the price of competitors cars are due to rise by 8%;c. consumers’ incomes will rise by 2%; andd. the price of gasoline is due to fall by 20%.e. Net effect to demand10. Your company manufactures controllers used in the production ofcommercial air conditioning units. Your current price is $50 per controller. At thatprice the total quantity demanded is 4,000 spread over a large number of smallcustomers. Fixed costs are $10,000 per month and marginal costs are $30 forproduction up to 10,000 units per month. Production cannot be pushed beyond10,000 units per month. A hurricane has damaged the production facility of acompany that produces a low-quality substitute controller. As a result thatcompany has offered you a one-time $35,000 contract for 1,000 controllers tobe delivered this month so they can meet the demand of their customers. Withina month the damage to that company’s facility will be repaired and they will beback to normal production. Hence this event will not cause your demand curveto shift.a) Before deciding on the contract you want to analyze your current market.What is the optimal price of your controller if the price elasticity of demand isestimated to be -2 for prices between $45 and $65 per controller?b) Would you recommend setting your price to that determined in part (a)?Explain why or why not.c) Would you recommend accepting the offered contract? Explain why or whynot.d) Does your answer to (c) change if your fixed costs are $12,000 per month?Explain why or why not.11. An amusement park is considering changing its pricing system from a payper-ride system to a single entrance fee entitling the entrant to unlimited rides.Assume that the park is not close to approaching the attendance capacity. Themarginal value for rides for the typical entrant is listed below:Quantity Marginal valuea) Assuming that the marginal cost is zero to provide the rides to those in attendance, what is the best pay-per-ride price (consider only 50 cent increments)?b) What is the profit maximizing entrance fee?c) Under which system are profits higher?d) Under which system is ride usage higher?e) If, instead, the marginal cost of providing a ride were $0.30, what revision in thepricing scheme, if any, would you suggest?12. Suppose there are 9 sellers and 9 buyers in a market, each willing to buy orsell one unit of a good. Their values are {$15, $14, $13, $12, $11, $10, $9, $8,$7}. That is, there is one buyer and one seller each valuing the good at $15,one buyer and one seller each valuing the market good at $14, etc.a) Assuming no transactions costs and a competitive market, what is theequilibrium price and quantity of goods traded in this market?b) Suppose there is a single market maker in this market and no price controls.Calculate the bid-ask prices that maximize the market maker’s profit when themarginal cost of a transaction is $1.c) If the government imposes a maximum spread of $2 (i.e., controlling themarket maker’s per transaction profit), what are the bid-ask prices thatmaximize the market maker’s profit when the marginal cost of a transaction is$1? What number of goods will be traded?13. You are considering an investment that will enable you to produce a new product.Your market research has indicated that the probability that the new product will beextremely successful is .6 and the probability that it will only be moderately successfulis .4. The estimated demand curve if the product is extremely successful indicates 100units per week at a price of $10 and 300 units per week at a price of $8. If it is onlymoderately successful your demand curve indicates 50 units per week at a price of $10and 70 units per week at a price of $8. Your fixed costs are $200 per week and yourmarginal costs are constant at $5 in this production range. Should you invest in the newproduct? If so, how should you price? What quantity do you expect to sell at that price?What is the expected profit?14. You are considering an investment that will enable you to produce a new product.Your market research has indicated that the probability that the new product will beextremely successful is .2 and the probability that it will only be moderately successfulis .8. The estimated demand curve if the product is extremely successful indicates 100units per week at a price of $12 and 300 units per week at a price of $8. If it is onlymoderately successful your demand curve indicates 50 units per week at a price of $12and 80 units per week at a price of $8. Your fixed costs are $200 per week and yourmarginal costs are constant at $5 in this production range. What is the expected profitfor each price? Should you make this investment assuming that you are risk neutral? Ifso, which price would you select ($12 or $8)?15. Doctors routinely ask patients about their occupation, employer, homeaddress, and scope of insurance coverage. How do the following factors affectthe ability of doctors to price discriminate?a. Characteristics such as occupation and home address are quite fixed.b. It is physically impossible to transfer medical treatment from one person toanother.c. Doctors treat patients on an individual basis.16. You have 10 individuals with values {$1, $2, $3, $4, $5, $6, $7, $8, $9, $10},and suppose you find a way to charge one price to the consumers whosevalues are {$1, $2, $3, $4, $5}, and a different price to those consumers whosevalues are {$6, $7, $8, $9, $10}. MC of production is $2.50.a. What price should you charge to the second group?b. What are your expected profits from selling to the second group?c. What price should you charge to the first group?d. If it costs $5 to implement this price-discrimination scheme (to identify the twogroups and prevent arbitrage between them), should you do it?17. Your company has developed a drug called Matrox that is an effective treatment formigraine headaches. You have just discovered that it can also be used for organtransplant patients to reduce the risk of organ rejection. The demand for migrainemedications is considerably more elastic than the demand for drugs to reduce the risk oforgan rejections. A study has indicated that the elasticity of demand for Matrox as amigraine medication is -4.0 but as a transplant drug it is -1.5. The current price ofMatrox is $10 per dose; the m
arginal cost is $5 per dose. Should you use a pricediscrimination scheme for this product in these two markets? If so, how should youprice Matrox in each market? If not, why not? Show all calculations.18. Read the following summary for the article from the Wall Street Journal titled“How Detroit is Ruining Your Car’s Value”The zero percent financing deals and rebates on domestic new car purchaseshave triggered sharp declines in the values of both these cars the minute theydrive off the lot and used cars in general. There are two reasons for the declinein the price of used cars. The first is the increase in the supply of used cars.With more people trading in used cars, there are more used cars on the market.The second is the decrease in demand for used cars. With financing deals onnew cars, more people are buying new cars instead of used cars. The articlenicely describes a cascade effect in the prices of used cars. “The financingdeals are accelerating the rate cars lose their value as they age. It works likethis: Buying a $20,000 car with a $2,000 rebate lowers your out-of-pocket costto $18,000. But the rebate instantly shrinks the new car’s value by the sameamount. It also lowers the trade-in price of the previous year’s model. The effectthen cascades through older versions of the vehicle.” The article notes that aone-year old car loses in value somewhere between 70 and 85 percent of theamount of the rebate on the new model of the car.a. Use supply and demand to analyze the effect of a $2000 new-car rebate onthe price and quantity of used cars. Explain in words the effects of the rebate onsupply and/or demand and its effects on quantity and price.b. Why does a rebate reduce the value of a one-year old used car by only 7085% of the amount of the rebate? That is, why not the full amount of the rebate?c. Suppose the owner of a one-year old Ford sedan is going to purchase a new ToyotaSUV. Is the Taurus owner better off if he goes to purchase the Toyota after Fordintroduces a rebate on the purchase of a new sedan?19. There are two niches in a market of electronic sensors, one is SIZE(where smaller sensors are preferred) and the other is PERFORMANCE(where high performance sensors are preferred). Two firms, A and B,must simultaneously choose which niche to target their product to. Thepayoff matrix is shown below, where profits are listed in millions ofdollars.20. Suppose two companies, Rosencrantz and Guildenstern, are both sellingthe same software technology, Alpha. They have an equal share in the market,which is worth a total of $100,000. However, both companies are decidingwhether to develop the next generation software, Beta, which has huge marketpotential. Beta’s probability of success is 0.60. If only one company enters theBeta market, the entire market is worth $250,000. On the other hand, if bothcompanies introduce Beta, the successful market value would be only $150,000since competition would reduce the price. If both succeed, both would hold anequal share in the Beta market as well.If Beta fails, the total market would only be $20,000 regardless of how manycompanies enter the market.In addition, the company not entering the Beta market could capture Alpha’smarket all to themselves (launching Beta means a loss of all Alpha sales)Should either company continue to develop Beta? How could one company gain anadvantage?21. Two companies, A and B, are considering entry into the same two markets:Asia or Australia. Due to financial constraints each company can only enter one of the two markets.The expected payoffs to each company for each possible entry scenario are as follows:23. An insurance company would like to offer theft insurance for renters. The policy would pay the full replacement value of any items that were stolen from the apartment. Some apartments have security alarms installed. Such systems detect a break-in and ring an alarm within the apartment. The insurance company estimates that the probability of a theft in a year is .05 if there is no security system and .01 if there is a security system (there cannot be more than one theft in any year). An apartment with a security system costs the renter an additional $50 per year. Assume that the dollar loss from a theft is $10,000 and that the insurance company is risk neutral and the renter would be willing to pay more than the expected loss to insure against the loss of theft.a. What is the insurance company’s breakeven price for a one year theft insurance policy for an apartment without a security system?b. Does a renter have incentive to pay for a security system if he does not have insurance? To answer this question you must calculate the expected cost to the renter with and without a security system.c. For a security system to be effective the renter must turn it on whenever he or she leaves the apartment. Suppose it costs the renter $10 per year in expended effort to turn on the alarm system. What is the insurance company’s breakeven price for a one year theft insurance policy for an apartment with a security system? (HINT: Moral Hazard)d. What deductible amount would provide sufficient incentive for the renter to turn on the alarm system each time he or she leaves the apartment? e. What is the insurance company’s breakeven price for a one year theft insurance policy with that deductible amount for an apartment with a security system?24. A corn farmer is considering two alternatives for selling his crop. The first is a contract where he can sell the rights to the future crop at planting. The second  is to sell the crop after harvest. At harvest the farmer estimates that the price of corn will be $10 per bushel with probability .5 and $12 per bushel with probability .5. The farmer is averse to risk, and is willing to pay $50,000 to avoidthe risk of damage to the crop while it is growing (e.g., from a tornado or flood). If the farmer uses pesticides he expects a crop of 60,000 bushels; if he does notuse pesticides he expects a crop of 55,000 bushels. The cost of pesticides is$20,000. The other costs associated with planting and harvesting the crop total$450,000.a. If the farmer decides to sell the crop at harvest will he be better off usingpesticides or not using them? What is the farmer’s expected profit in each case?b. What is the maximum a purchaser would be willing to pay to the farmer forthe rights to the future corn crop assuming they cannot monitor the farmer afterpurchasing the contract? Defend your answer.c. Which alternative: (1) sale of rights prior to planting or (2) selling the cropafter harvest yields the maximum expected benefit for the farmer consideringhis level of risk aversion?