1) Last year, a toy manufacturer introduced a new toy truck that was a huge success. The company invested $2.5 million for a plastic injection molding machine (which can be sold for $2.0 million) and $100,000 in plastic injection molds specifically for the toy (not valuable to anyone else). Labor and the cost of materials necessary to make each truck is about $3. This year, a competitor has developed a similar toy that has significantly reduced demand for the toy truck. Now, the original manufacturer is deciding whether they should continue production of the toy truck.
a. If the estimated demand is 100,000 trucks, what is the break-even price for the toy truck?
b. What is the specific rule (involves price) as to whether this manufacturer should shut down?
2) You work at a Gazebo company (Shady Tents) and you hire an economist to estimate the price elasticity of demand for your product, and the estimate is .9 (in absolute value) and this has been fairly stable over the last year.
a. Are you profit maximizing, or do you need more information (and if so, what information)?
b. Should you raise or lower the price of your product or do you need more information (and if so, what information)?
3) Cars are lasting longer. The expected number of miles traveled over a vehicle's life has risen to 180,000 miles in 2001 from 128,000 in 1977. However, new car buyers tend to keep their cars about the same length of time before trading them in. Using supply and demand analysis, show how this change, ceteris paribus, impacts the market for used cars and the market for new cars. (Hint: only one curve shifts in each market).
4) VetPharm has historically produced and sold drugs for animals; however, one of its products developed for animal use has recently been approved for a similar use in humans. Market research has revealed that at the current per dose price, the elasticity of demand on the part of animal owners is -2.0. The research also estimates that at this price the elasticity of demand for human use would be -.2. The current price is $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.
5) Part A.: You are considering launching a strategic alliance with a competitor to join your separate skills to develop a new jointly owned technology. Both you and your partner have the option of fully or partially supporting the alliance. Complete the payoff diagram to make this a Prisoner’s Dilemma. (Hint there is a range of values over which your answer will be correct).
You fully support alliance
You partially support alliance
Partner fully supports alliance You: 100
Partner: 100 You: 150
Partner partially supports alliance
Partner: 150 You: 50
You and a competitor are both considering the launch of a new product line, which could be made of either plastic or glass.
You fully support alliance
You partially support alliance
Competitor uses plastic You: 25
Competitor: 25 You: 100
Competitor uses glass You: 50
Competitor: 100 You: 25
a. Are there one or more Nash equilibriums to this game? Circle the equilibrium(s).
b. Is there an advantage to coordinating your choices with your competitor?
6) Pete sells used CDs at an open-air flea market on the weekends. With the open atmosphere, the weather has a large effect on the demand for his CDs. Demand under different weather conditions and Pete’s willingness to sell are listed in the following three tables.
If the weather forecast predicts a 50% chance of rain over the weekend, what is the equilibrium quantity of CDs that will be sold? (Show your work)
7) Suppose that people expect inflation to equal 3 percent, but in fact, prices rise by 1 percent. Describe how this unexpectedly low inflation rate would help or hurt the following:
a. homeowner with a fixed- rate mortgage
b. a union worker in the second year of a labor contract
c. an individual who purchased inflation-indexed Treasury bonds
8) Protectionist trade policies are often enacted with the political intention of strengthening exports, and hence GDP. Examples of protectionist trade policies include quotas and import taxes.
a. What is the impact of the protectionist trade policy on the real exchange rate (assume we are using the US as an example, and the US has enacted some protectionist policies)?
b. What is the impact on overall GDP?
9) Your company manufactures controllers used in the production of commercial air conditioning units. Your current price is $50 per controller. At that price the total quantity demanded is 4,000 spread over a large number of small customers. Fixed costs are $10,000 per month and marginal costs are $30 for production up to 10,000 units per month. Production cannot be pushed beyond 10,000 units per month. A hurricane has damaged the production facility of a company that produces a low-quality substitute controller. As a result that company has offered you a one-time $35,000 contract for 1,000 controllers to be delivered this month so they can meet the demand of their customers. Within a month the damage to that company's facility will be repaired and they will be back to normal production. Hence this event will not cause your demand curve to 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 is estimated 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 why not.
d. Does your answer to (c) change if your fixed costs are $12,000 per month? Explain why or why not.
10) An amusement park is considering changing its pricing system from a pay- per-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. The marginal value for rides for the typical entrant is listed below:
a) 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) Suppose instead the park just charges an entrance fee. What is the profit maximizing entrance fee? 3.5
c) Under which system are profits higher? Profit would be higher with single entrance fee
d) Under which system is ride usage higher? When qty is at 2.
e) If, instead, the marginal cost of providing a ride were $0.30, what revision in the pricing scheme, if any, would you suggest? (extra credit, you may skip this question without penalty)
11) 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:
Company A Decision Company B Decision Payoff to A Payoff to B
Enter Asia Enter Asia $35M $50M
Enter Asia Enter Australia $50M $90M
Enter Australia Enter Asia $85M $60M
Enter Australia Enter Australia $40M $45M
a) Construct a game that represents the entry decision.
b) What type of game is it?
c) Identify all Nash equilibriums for the game.
d) Company A has hired you as a consultant. What advice would you give them regarding this entry decision?
12) Freemont insurance sells homeowners insurance. In a recent financial review, managers discovered that company performance was lagging behind projections. They examined pricing and claims history in more detail and identified a group of about 20,000 homeowners insurance customers whose claims far exceeded the collected premiums. Members of the actuarial group, whose compensation was partially tied to profitability of the policies they priced, were particularly frustrated.
a. Who is making the bad decision? Does this group have enough information to make a good decision?
b. Does this group have an incentive to make a good decision?
c. Suppose moral hazard is at play. What is one thing that Freemont could do to reduce the problem of moral hazard?
d. Suppose adverse selection is at play. What is one thing that Freemont could do to reduce the problem of adverse selection?
The company hired a consultant to do a deep dive into the 20,000 customers whose claims far exceed the collected costs. The consultants noted that a significant number of these customers were far more likely to have had prior claims with their prior insurer. They took this information to the actuaries, but the actuaries said they were already taking into account the number of prior claims into their pricing.
e. How can we reconcile the fact that the actuaries were taking into account the number or prior claims into the pricing, but still underpricing these policies?
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