ASSIGNMENTS IN BA 245

Managerial Economics

Master in Business Administration Dr. Gilchor P. Cubillo

First Semester AY 2022-2023 Professor

DUE DATE: NOVEMBER 5, 2022

Crea Criselda Madula-Sedano

MBA 2

CHAPTER 1

1. As a marketing manager for one of the world’s largest automakers, you are
responsible for the advertising campaign for a new energy-efficient sports utility vehicle.
Your support team has prepared the following table, which summarizes the (year-end)
profitability, estimated number of vehicles sold, and average estimated selling price for
alternative levels of advertising. The accounting department projects that the best
alternative use for the funds used in the advertising campaign is an investment returning
10 percent. In light of the staggering cost of advertising (which accounts for the lower
projected profits in years 1 and 2 for the high and moderate advertising intensities), the
team leader recommends a low advertising intensity in order to maximize the value of the
firm. Do you agree? Explain. (10 points)

Answer:
Disagree. In particular, the optimal strategy is the high advertising strategy. To see
this, note that the present value of the profits from each advertising strategy are as follows:

Since the high advertising results in profit stream with the greatest present value, it
is the best option.

2. You’ve recently learned that the company where you work is being sold for
$275,000. The company’s income statement indicates current profits of $10,000, which
have yet to be paid out as dividends. Assuming the company will remain a “going concern”
indefinitely and that the interest rate will remain constant at 10 percent, at what constant
rate does the owner believe that profits will grow? Does this seem reasonable? (10 points)
Answer:
Using the equation for the value of a firm:
3. You are in the market for a new refrigerator for your company’s lounge, and you
have narrowed the search down to two models. The energy efficient model sells for $500
and will save you $25 at the end of each of the next five years in electricity costs. The
standard model has features similar to the energy efficient model but provides no future
saving in electricity costs. It is priced at only $400. Assuming your opportunity cost of funds
is 5 percent, which refrigerator should you purchase? (10 points)

Effectively, this question boils down to the question of whether it is a good

investment to spend an extra $100 on a refrigerator that will save you $25 at the end of
each year for five years. The net present value of this investment is

You should buy the energy efficient model, since doing so saves you $8.24 in
present value terms.

CHAPTER 2

1. You are the manager of a firm that produces and markets a generic type of soft drink in
a competitive market. In addition to the large number of generic products in your market,
you also compete against major brands such as Coca-Cola and Pepsi. Suppose that, due
to the successful lobbying efforts of sugar producers in the United States, Congress is
going to levy a $0.50 per pound tariff on all imported raw sugar—the primary input for your
product. In addition, Coke and Pepsi plan to launch an aggressive advertising campaign
designed to persuade consumers that their branded products are superior to generic soft
drinks. How will these events impact the equilibrium price and quantity of generic soft
drinks? (10 points)

The tariff reduces the supply of raw sugar, resulting in a higher equilibrium price of
sugar. Since sugar is an input in making generic soft drinks, this increase in input prices
will decrease the supply of generic soft drinks (putting upward pressure on the price of
generic soft drinks and tend to reduce quantity). Coke and Pepsi’s advertising campaign
will decrease the demand for generic soft drinks (putting downward pressure on the price
of generic soft drinks and further reducing the quantity). For these reasons, the equilibrium
quantity of generic soft drinks sold will decrease. However, the equilibrium price may rise
or fall, depending on the relative magnitude of the shifts in demand and supply.
2. You are the manager of a mid-sized company that assembles personal computers. You
purchase most components—such as random access memory (RAM)—in a competitive
market. Based on your marketing research, consumers earning over $75,000 purchase 1.3
times more RAM than consumers with lower incomes. One morning, you pick up a copy of
The Wall Street Journal and read an article indicating that a new technological
breakthrough will permit manufacturers to produce RAM at a lower unit cost. Based on this
information, what can you expect to happen to the price you pay for random access
memory? Would your answer change if, in addition to this technological breakthrough, the
article indicated that consumer incomes are expected to grow over the next two years as
the economy pulls out of recession? Explain. (10 points)

A technological breakthrough that reduces production costs will lead to a rightward

shift in the supply curve for RAM chips, resulting in a lower equilibrium price of RAM chips.
If in addition, income increases, the demand for RAM chips will also increase since they
are a normal good. This increase in demand would tend to increase the price of RAM
chips. The ultimate effect of both of these changes in supply and demand on the
equilibrium price of RAM chips is indeterminate. Depending on the relative magnitude of
the increase in supply and demand, the price you will pay for chips may rise or fall.

CHAPTER 3

1. Revenue at a major cellular telephone manufacturer was $1.4 billion for the nine months
ending March 2, up 97 percent over revenues for the same period last year. Management
attributes the increase in revenues to a 137 percent increase in shipments, despite a 17
percent drop in the average blended selling price of its line of phones. Given this
information, is it surprising that the company’s revenue increased when it decreased the
average selling price of its phones? Explain. (10 points)
The result is not surprising. Given the available information, the own price elasticity
of demand for major cellular telephone manufacturer is EQ,P = 137/−17 = −8.06. Since
this number is greater than one in absolute value, demand is elastic. By the total revenue
test, this means that a reduction in price will increase revenues.

2. You are a manager in charge of monitoring cash flow at a company that makes
photography equipment. Traditional photography equipment comprises 80 percent of your
revenues, which grow about 2 percent annually. You recently received a preliminary report
that suggests consumers take three times more digital photographs than photos with
traditional film, and that the cross-price elasticity of demand between digital and
disposable cameras is 0.2. In 2009, your company earned about $400 million from sales of
digital cameras and about $600 million from sales of disposable cameras. If the own price
elasticity of demand for disposable cameras is 2.5, how will a 1 percent decrease in the
price of disposable cameras affect your overall revenues from both disposable and digital
camera sales? (10 points)
Using the change in revenue formula for two products,
ΔR = [$600(1− 2.5) + $400(− 0.2)] × (− .01) = $9.8million,
So revenues will increase by $9.8 million.
Using the change in revenue formula for two products,
ΔR = [$600(1+2.5) + $400(+0.2)] × (− .01) = -$21.8million,
So revenues will decrease by $21.8 million.
3. Recently, Pacific Cellular ran a pricing trial in order to estimate the elasticity of demand
for its services. The manager selected three states that were representative of its entire
service area and increased prices by 5 percent to customers in those areas. One week
later, the number of customers enrolled in Pacific’s cellular plans declined 4 percent in
those states, while enrollments in states where prices were not increased remained flat.
The manager used this information to estimate the own-price elasticity of demand and,
based on her findings, immediately increased prices in all market areas by 5 percent in an
attempt to boost the company’s 2021 annual revenues. One year later, the manager was
perplexed because Pacific Cellular’s 2021 annual revenues were 10 percent lower than
those in 2020—the price increase apparently led to a reduction in the company’s
revenues. Did the manager make an error? Explain. (10 points)

The manager of Pacific Cellular estimated that the short-term price elasticity of
demand was inelastic. In the market for cellular service, contracts prevent many customers
from immediately responding to price increases. Therefore, it is not surprising to observe
inelastic in the short-term. However, as contracts expire and customers have more time to
search for alternatives, quantity demanded is likely to drop off much more. Given a year or
two, the demand for cellular service is much more elastic. The price increase has caused
Pacific to lose more customers than they initially estimated.

CHAPTER 4

1. A consumer must spend all of her income on two goods (X and Y). In each of the
following scenarios, indicate whether the equilibrium consumption of goods X and Y will
increase or decrease. Assume good X is an inferior good and good Y is a normal good.
(10 points)
a. Income doubles.
Consumption of good X will decrease and consumption of good Y will increase.
b. Income quadruples and all prices double.
Consumption of good X will decrease and consumption of good Y will increase.
c. Income and all prices quadruple.
Nothing will happen to the consumption of either good.
d. Income is halved and all prices double.
Consumption of good X will increase and consumption of good Y will decrease.

2. A recent newspaper circular advertised the following special on tires: “Buy three, get the
fourth tire for free—limit one free tire per customer.” If a con summer has $500 to spend on
tires and other goods and each tire usually sells for $50, how does this deal impact the
consumer’s opportunity set? (10 points)

Budget Set with and without Buy 3, Get 4th Free Offer
The offer expands the consumer's budget set and allows her to purchase more
tires.

3. Upscale hotels in Makati City recently cut their prices by 20 percent in an effort to
bolster dwindling occupancy rates among business travelers. A survey performed by a
major research organization indicated that businesses are wary of current economic
conditions and are now resorting to electronic media, such as the Internet and the
telephone, to transact business. Assume a company’s budget permits it to spend $5,000
per month on either business travel or electronic media to transact business. Graphically
illustrate how a 20 percent decline in the price of business travel would impact this
company’s budget set if the price of business travel was initially $1,000 per trip and the
price of electronic media was $500 per hour. Suppose that, after the price of business
travel drops, the company issues a report indicating that its marginal rate of substitution
between electronic media and business travel is 1. Is the company allocating resources
efficiently? Explain. (10 points)
The initial market rate of substitution is -0.5. Since, after the price decrease the

(Where EM P is the price of electronic media and T P the price of travel) equilibrium
has not been achieved. To reach equilibrium, the business should increase its use of
electronic media and decrease travel.

CHAPTER 5

1. You were recently hired to replace the manager of the Roller Division at a major
conveyor-manufacturing firm, despite the manager’s strong external sales record. Roller
manufacturing is relatively simple, requiring only labor and a machine that cuts and crimps
rollers. As you begin reviewing the company’s production information, you learn that labor
is paid $8 per hour and the last worker hired produced 100 rollers per hour. The company
rents roller cutters and crimping machines for $16 per hour, and the marginal product of
capital is 100 rollers per hour. What do you think the previous manager could have done to
keep his job? (10 points)
Since , the firm was not using the cost minimizing combination of labor and capital.
To achieve the cost minimizing combination of inputs, the previous manager should have
used fewer units of capital and more units of labor, since

2. You are a manager for Herman Miller—a major manufacturer of office furniture. You
recently hired an economist to work with engineering and operations experts to estimate
the production function for a particular line of office chairs. The report from these experts
indicates that the relevant production function is where K represents capital equipment and
L is labor. Your company has already spent a total of $10,000 on the 4 units of capital
equipment it owns. Due to current economic conditions, the company does not have the
flexibility needed to acquire additional equipment. If workers at the firm are paid a
competitive wage of $100 and chairs can be sold for $200 each, what is your profit
maximizing level of output and labor usage? What is your maximum profit? (10 points)
The profit-maximizing level of labor and output is achieved where VMPL = w. Here,
VMPL = 2 ($100) (4)½ (L) – ½ = $400 (L) – ½ and w = $100 per day.
Solving yields L = 16. The profit-maximizing level of output is Q = 2(4) ½ (16) ½ =
16 units. The firm’s fixed costs are $10,000, its variable costs are $100(16) = $1,600, and
its total revenues are $200(16) = $3,200. Profits are $3,200 – $11,600 = – $8,400. The firm
is suffering a loss, but the loss is lower than the $10,000 that would be lost if the firm shut
down its operation.

3. You are the manager of a large but privately held online retailer that currently uses 17
unskilled workers and 6 semiskilled workers at its ware- house to box and ship the
products it sells online. Your company pays its unskilled workers the minimum wage but
pays the semiskilled workers $7.75 per hour. Thanks to government legislation, the
minimum wage will increase from $6.55 per hour to $7.25 per hour on November 30, 2022.
Discuss the implications of this legislation on your company’s operations and in particular
the implications for your optimal mix of inputs and long-run investment decisions. (10
points)

Assuming that the optimal mix of unskilled and semi-skilled labor were being utilized
at the time the legislation passed, in the short run, a higher minimum wage paid to
unskilled labor implies that to minimize costs the retailer should increase its use of semi-
skilled worker and decrease its use or unskilled workers. In the longer run, the retailer may
want to consider substituting capital for labor (invest in some machines to automate a
portion of your boxing needs). Obviously, additional information would be required to
conduct a net present value analysis for these long-run investments, but it is probably
worth getting this information and running some numbers.