honors from Canadian Trucking Academy

Q1. When Burton Cummings graduated with honors from Canadian Trucking Academy his father gave him a $350,000 tractor-trailer rig. Recently, Burton was boasting to some fellow truckers that his revenues were typically $25,000 per month, while his operating costs (fuel, maintenance, and depreciation) amounted to only $18,000 per month. Tractor-trailer rigs identical to Burton’s rig rent for $15,000 per month. If Burton were driving trucks for one of the competing trucking firms, he would earn $5,000 per month.

a. How much are Burton’s explicit costs per month? How much are his implicit costs per month?

b. What is the dollar amount of opportunity cost of resources used by Burton Cummings each month?

c. Burton is proud of the fact that he is generating a net cash flow of $7000 ($25,000 – $18,000) per month since he would be earning only $5,000 per month, if he were working for a trucking firm. What advice would you give Burton Cummings?

Q2. Business Week recently declared, “We have entered the Age of the Internet” and observed that when markets for goods or services gain access to Internet, more consumers and more businesses participate in the market. Use supply and demand analysis to predict the effect of e-commerce on equilibrium output and equilibrium price of products gaining a presence on the Internet.

Q3. Determine the effect upon equilibrium price and quantity sold if the following changes occur in a particular market:

a. Consumers’ income increases and the good is normal.

b. The price of a substitute good (in consumption) increases.

c. The price of a substitute good (in production) increases

d. The price of a complement good (in consumption) increases

e. The price of inputs used to produce the good increases.

f. Consumers expect that the price of the good will increase in the near future.

g. It is widely publicized that consumption of the good is hazardous to health.

h. Cost reducing technological change takes place in the industry.

For each of the pair of events indicated below, perform qualitative analysis to predict the direction of change in either the equilibrium price or equilibrium quantity. Explain why the change is indeterminate.

a. Both a and h conditions occur simultaneously.

b. Both d and e conditions occur simultaneously.

c. Both d and h conditions occur simultaneously.

d. Both f and c conditions occur simultaneously.

Q4. At the beginning of the year, an audio engineer quit his job and gave up a salary of $175,000 per year to start his own business Sound Devices, Inc. The new company builds, installs and maintains custom audio equipment for businesses that require high-quality audio systems. A partial income statement for the first year of operation for Sound Devices Inc. is shown below:

To get started the owner of Sound Devices, Inc. spent $100,000 of his personal savings to pay for some of the capital equipment used in the business. During the first year of operation, the owner of Sound Devices, Inc. could have earned a 15% return by investing in stocks of other new businesses with risk level similar to the risk level at Sound Devices, Inc.

a. What are the total explicit, and total implicit, and total economic costs for the year?

b. What is accounting profit?

c. What is economic profit?

d. Given your answer in part c, evaluate the owner’s decision to leave his job to start Sound Devices Inc.

Q5. Construct a graph showing equilibrium in the market for movie tickets. Label both axes and denote the initial equilibrium price and quantity as P0 and Q0. For each of the following events, draw an appropriate new supply or demand curve for movies, and predict the impact of the event on the market price of a movie ticket and the number of tickets sold in the new equilibrium situation:

a. Movie theatres double the price of soft drinks and popcorn.

b. A national video rental chain cuts its rental rate by 25%.

c. Cable television begins offering pay-per-view movies.

d. The Screen Writers’ Guild ends a 10-month strike.

e. Kodak reduces the price it charges Hollywood producers for motion picture films.

Q6. The manager of Collins Import Autos believes the number of cars sold in a day (Q) depends on two factors: (1) the number of hours the dealership is open (H) and (2) the number of salespersons working that day (S). After collecting data for two months (53 days), the manager estimates the following log-linear model:

a. Explain, how to transform the log-linear model into linear form that can be estimated using multiple regression analysis.

The computer output for the multiple regression analysis is shown below:

b. How do you interpret coefficients b and c? If the dealership increases the number of salespersons by 20%, what will be the percentage increase in daily sales?

c. Test the overall model for statistical significance at the 5% significance level.

d. What percent of the total variation in daily auto sales is explained by this equation? What could you suggest to increase this percentage?

e. Test the intercept for statistical significance at the 5% level of significance. If H and S both equal 0, are sales expected to be 0? Explain why or why not?

f. Test the estimated coefficient b for statistical significance. If the dealership decreases its hours of operation by 10%, what is the expected impact on daily sales? 

Q7. Using the optimization theory, analyze the following quotations:

a.The optimal number of traffic deaths in the United States is zero.

b. Any pollution is too much pollution.

c. We cannot pull US troops out of Afghanistan. We have committed so much already.

d. If Congress cuts out the International Space Station (ISS), we will have wasted all of the resources that we have already spent on it. Therefore, we must continue funding the ISS.

e. Since JetGreen Airways has experienced a 25% increase in its insurance premiums, the airline should increase the number of passengers it serves next quarter in order to spread the increase in premiums over a larger number of tickets.

Q8. You are interviewing three candidates for one sales job position. On the basis of your experience and insight, you believe Jane can sell 600 units a day, Joe can sell 450 units a day, and Joan can sell 400 units a day. The daily salary each person is asking is as follows: Jane $200; Joe $150; and Joan $100. How would you rank the three applicants?

Q9. Bavarian Crystal Works designs and produces lead crystal wine decanters for export to international markets. The production manager of Bavarian Crystal Works estimates total and marginal production costs to be

and

where costs are measured in U.S. dollars and Q is the number of wine decanters produced annually. Because Bavarian Crystal Works is the only one of many crystal producers in the world market, it can sell as many of the decanters as it wishes for $70 apiece. Total and marginal revenue are TR = 70Q and MR = 70 where revenues are measured in U.S. dollars and Q is the annual decanter production.

a. What is the optimal level of production of wine decanters? What is the marginal revenue from the last wine decanter sold?

b. What are the total revenue, total cost, and net benefit (profit) from selling the optimal number of wine decanters?

c. At the optimal level of production of decanters, an extra decanter can be sold for $70, thereby increasing the total revenue by $70. Why does the manager of this firm not produce and sell one more unit?

Q10. A decision maker wishes to maximize total benefit, B = 3x + xy + y subject to the cost constraint, C = 4x + 2y = 70. Setup the Lagrangian and then determine the values of x and y at the minimum level of benefit, given the constraint. What are the maximum benefits?

Q11. Bridget has a limited income and consumes only wine and cheese. Her current consumption choice is four bottles of wine and 10 pounds of cheese. The price of wine is $10 per bottle and the price of cheese is $4 per pound. The last bottle of wine added 50 units to Bridget’s utility, while the last pound of cheese added 40 units.

a. Is Bridget making the utility maximizing choice? Why or why not?
b. If not what should she do instead? Why?

Q12. The owner-manager of Good Guys Enterprises obtains utility from income (profit) and from having the firm behave in a socially conscious manner, such as making charitable contributions or civic expenditures. Can you set up the problem and derive the optimization conditions if the owner-manager wishes to obtain a specific level of utility at the lowest possible cost? Do these conditions differ from the utility maximizing conditions?

Q13. The Dallas Morning News reported the findings of a study by the Department of Transportation that examined the effect on average airfares when new, low priced carriers, such as Southwest Airlines or Vanguard Airlines, entered one of the three city-pair markets: Baltimore-Cleveland, Kansas City-San Francisco, or Baltimore-Providence. Use the following excerpts from the newspaper article to calculate the arc elasticity of demand for each of the three city-pairs. How do the three computed elasticizes compare? Based on the computed elasticizes, describe travelers” responsiveness to the reduction in airfares.

  • “(In) Baltimore and Cleveland for example, …just 12,790 people between those cities in the last three months of 1992, at an average fare of $233. Then Dallas-based Southwest Airlines entered the market. In the last three months of 1996, 115,040 people flew between the cities at an average fare of $66.”
  • “(On) Kansas City-San Francisco connection… during the last quarter of 1994 some 35,960 people made the trip at an average fare of $165. Two years later, after the arrival of Vanguard Airlines, fares had dropped to an average of $107 and traffic had nearly doubled to 68,100.”
  • On the Baltimore-Providence, R. I., route, where the average fare fell from $196 to $57, …the number of passengers carried jumped from 11,960 to 94,116.”

Q14. Rubax, a U.S. manufacturer of athletic shoes, estimates the following linear trend model for shoe sales.

  • Is there sufficient statistical evidence of an upward trend in shoe sales?
  • Do these data indicate a statistically significant seasonal pattern of sales for Rubax shoes? If so, what is the seasonal pattern exhibited by the data?
  • Using the estimated forecast equation, forecast sales of Rubax shoes for 2014(III) and 2015(II)
  • How might you improve this forecast equation?

Q15. Cite the three major problems with consumer interviews or surveys and provide an example of each.

16. An article in Business Week warned of the dangers of deflation as the collapse of numerous Asian economies was creating worries that Asia might try to “export its way out of trouble” by oversupplying everything from automobiles to semiconductors. Evidence that deflation had become a genuine concern for managers was provided by a statement in the article by John Smith, chairman and CEO of General Motors Corporation: “Fundamentally, something has changed in the economy. In today’s age, you cannot get price increases.” The article offers advice to managers: “Productivity growth lets companies boost profits even as prices fall.” Using short-run production and cost theory comment on this advice.

Q17. Oversize Transport Inc. supplies custom delivery service for very large construction equipment in the southeast region of United States. The most common lead of the specialty trucker is the Caterpillar model 740 dump truck, which is about 258 feet long. The owner of Oversize Transport, who also drives the firm’s single 275-foot long tractor-trailer rig, chooses to lease this huge piece of capital equipment under a five-year contract requiring monthly lease payments of $5,500 per month. Oversize Transport could not service this profitable market with any rig shorter than 275 feet. A typical delivery takes about a day and a half, so Oversize Transport can make at the most only 20 deliveries per month with its one tractor-trailer rig. Under what circumstances is the tractor-trailer a fixed input? A quasi fixed input?

Q18. Explain the following terminologies in economics

  • Spreading the overhead.
  • A break-even level of production.
  • The efficiency of mass production?
  • How does the theory of efficient production apply to managers of government bureaus or departments that are not run for profit? How about non-profit clubs that collect just enough dues from their members to cover the cost of operation?

Q19. The production function is:

where a > 0 and b > 0.

a. The marginal product of labor is:

b. The marginal product of labor is:

c. The marginal rate of technical substitution is

d. Show that the isoquants for this production function are convex. (Show that MRTS diminishes as L increases. Why?)
e. Derive the equation for the long-run expansion path.

Q20. You are planning to estimate a short run production function for your firm, and you have collected the following data on labor usage and output:

a. Does a cubic equation appear to be suitable specification given these data? You may wish to construct a scatter diagram to help you answer this question.

b. Using a computer for regression analysis, estimate your firm’s short run production function using the data given here. Do the parameter estimates have the appropriate algebra signs? Are they statistically significant at the 5% level?

c. At what point do you estimate marginal product begins to fall?

d. Calculate estimates of total, average and marginal products when the firm employs 23 workers.

e. When the firm employs 23 workers, is short-run marginal cost (SMC) rising or falling? How can you tell?

Q21. Insurance agents receive a commission on the policies they sell. Many states regulate the rates that can be charged for insurance. Would higher or lower rates increase the incomes of agents? Explain, distinguishing between the short-run and the long-run.

Q22. During a coffee-room debate among several young MBAs who recently graduated, one of the young executives flatly stated, “The most this company can lose on its Brazilian division is the amount it invested (its fixed costs).” Not everyone agreed with this statement. In what sense is this statement correct? Under what circumstances could it be false? Explain.

Q23. Even if firms in a monopolistically competitive market collude successfully and fix price, economic profit will still be competed away if there is unrestricted entry. Explain. Will price be higher or lower under such an agreement in long-run equilibrium than would be the case if firms didn’t collude? Explain.

Q24. Antitrust authorities at the Federal Trade Commission are reviewing your company’s recent merger with a rival firm. The FTC is concerned that the merger of the two rival firms in the same market will increase market power. A hearing is scheduled for your company to present arguments that your firm has not increased its market power through the merger. Can you do this? How? What evidence might you bring to the hearing?

Q25. Dr. Leona Williams, a well-known plastic surgeon, has a reputation for being one of the best surgeons for reconstructive nose surgery. Dr. Williams enjoys a rather substantial degree of market power in this market. She has estimated demand for her work to be:

where Q is the number of nose operations performed monthly and P is the price of a nose operation.

a. What is the inverse demand function for Dr. Williams’ services?
b. What is the marginal revenue function?

The average variable cost function for reconstructive nose surgery is estimated to be: 

where AVC is the average variable cost (measured in dollars), and Q is the number of operations per month. The doctor’s fixed cost per month is $8,000.

c. If the doctor wishes to maximize her profit, how many nose operations should she perform each month?
d. What price should Dr. Williams charge to perform a nose operation?
e. How much profit does she earn each month?

Q26. Find the solution to the following advertising decision game between Coke and Pepsi by using the method of successive elimination of dominated strategies.

Pepsi’s Budget

Coke’s Budget

Q27. Alpha and Beta, two oligopoly rivals in a duopoly market, choose prices of their products on the first day of the month. The following payoff table shows their monthly payoffs resulting from the pricing decisions they make.

Alpha’s Price

Beta’s Price

  • Is the pricing decision facing Alpha and Beta a Prisoner’s Dilemma? Why or why not?
  • What is the cooperative outcome? What is the non-cooperative outcome?
  • Which cells represent cheating in the pricing decision? Explain.
  • If Alpha and Beta make their pricing decision just one time, will they choose the cooperative outcome? Why or why not?
  • Can Alpha make a credible threat to punish Beta with a retaliatory price cut? Can Beta also adopt a similar retaliatory price cut?

Q28. The secretary general of OPEC, Ali Rodriquez, stated that it would be easier for OPEC nations to make future supply adjustments to fix oil prices that are too high, than it would be to rescue prices that are too low. Evaluate this statement.

Q29. Two firms A and B produce goods A and B, respectively. The linear demands for the two goods are, respectively,

Production costs are constant but not equal:

  • Using calculus, derive the equations for best response curves.
  • Sketch a graph of the two best-response curves. Label both axes and response curves.
  • If firm A expects firm B to set its prices at $20, what is firm A’s best response? If firm B predicts firm A will price good A at $36, what is firm B’s best response?
  • What is the Nash equilibrium price and quantity for each firm?
  • How much profit does each firm earn in Nash equilibrium?
  • If firm A and firm B set prices of $22 and $35 respectively, how much profit does each firm earn? Why don’t they choose these prices then?

Q30. Thomas Selling, an expert on nuclear strategy and arms control, observed in his book The Strategy of Conflict (Cambridge, MA: Harvard University Press, 1960), “The power to constrain an adversary depends upon the power to bind oneself.” Explain this statement using the concept of strategic commitment.

Q31. Price discriminate sounds like a socially “bad” thing. Can you think of any reasons why price discrimination could be viewed as a socially “good” thing?

Q32. As markets for some products and services experience greater global competition, what is the likely consequence for the incidence of price discrimination? Do you think global competition fosters or impedes price discrimination? Can you give any examples from your own work experience?

Q33. Although there is relatively little difference in the cost of producing hardcover and paperback books, these books sell for very different prices. Explain this pricing behavior.

Q34. A bar offers female patrons a lower price for a drink than male patrons. The bar will maximize profits by selling a total of 200 drinks (a night). At the current prices, male customers buy 150 drinks, while female customers buy 50 drinks. At this allocation between markets, the marginal revenue from the last drink sold to a female customer is $0.50.

  • What should the bar do about its pricing?
  • If the bar sells 151 drinks to males and 49 to females, what will be the increase (decrease) in total revenue?

Q35. EZ Sharp Industries, Inc., manufactures the Kleen Edge(TM) line of diamond-abrasive cutlery sharpeners for home use. EZ Sharp holds a patent on its unique design and can earn substantial economic profit if it prices its Kleen Edge(TM) products wisely. EZ Sharp sells two models of its Kleen Edge(TM) sharpeners: the Classic, which is the entry-level model, and the Professional, which has a sonic sensor that controls the speed of the sharpening wheels.

Short run production of sharpeners is subject to constant costs: AVC = SMC for both models. The constant costs of production at EZ Sharp Industries are estimated to be:

Total fixed costs each month are $10,000. The sole owner of EZ Sharp also manages the firm and makes all pricing decisions. The owner-manager believes in assuring himself a 200% profit margin by using the cost-plus pricing methodology to set prices for his two product lines. At these prices, EZ Sharp is selling 3,750 units of Classic model per month and 2,000 units of the Professional model per month.

a. Using the cost-plus technique, compute the prices the owner-manager charges for the Classic and the Professional models, based on his required 200% profit margin.

b. How much profit is EZ Sharp earning each month using the cost-plus prices in part a?

The owner-manager is ready to sell the firm, but he knows the value of the firm will increase if he can increase the monthly profit somehow. He decides to hire Andrews Consulting to recommend ways for EZ Sharp to increase its profits. Andrew reports that production is efficient, but pricing can be improved. Andrews argues a new pricing plan based on optimal pricing techniques (i.e., the MR = MC rule).

To implement the MR = MC methodology, Andrews undertakes a statistical study to estimate the demands for two Kleen Edge (TM) products. The estimated demands are:

Where QC and QP are the monthly quantities demanded of Classic and Professional models, respectively, and PC and PP are prices of Classic and Professional models, respectively. Andrews Consulting solved the demand equations simultaneously to get the following inverse demand functions, which is why Anderson gets paid the “big bucks”:

c. Find the two marginal revenue functions for the Classic and Professional model sharpeners.

d. Set each marginal revenue function in part c equal to the appropriate cost and solve for the profit-maximizing quantities.

e. Using the results from part d, what prices will Andrews Consulting recommend for each model?

f. When the owner-manager sees the prices recommended by Andrews Consulting, he brags about how close his simple cost-plus pricing method had come to their suggested prices. Compute the profit EZ Sharp can earn using the consultants’ prices in part d. Is there any reason for the owner-manager to brag about his cost-plus pricing skills?

Q36. Suppose your company’s method of making decisions under risk is “making the best out of the worst possible outcome.” What rule would you be forced to follow?

Q37. “A portfolio manager needs to pick winners—assets or securities with high expected returns and low risk.” What is wrong with this statement?

Q38. Do you favor anti-gouging laws as a means of protecting consumers from high prices following natural disasters, such as Hurricane Katrina in New Orleans? If so, why? If not, why not?

Q39. How does a price ceiling undermine the rationing function of market-determined prices? How could rationing coupons insure that consumers with the highest values get the limited amount of a good supplied when government prices ceilings create shortages?

Q40. Suppose the manager of a firm has a utility function for profit of:

The manager is considering a risky project with the following profit payoffs and probabilities.

a. Calculate the expected profit.

b. Calculate the expected utility of profit.

c. Fill the blanks in the table showing the marginal utility of an additional $1,000 of profit.

d. The manager is risk ______ because the marginal utility of profit is _______.

The manager receives an offer from another party to buy the rights to the risky project described above. This party offers the manager $3,200, which the manager believes will be paid with certainty.

e. The utility of $3,200 is __________.

f. Comparing the utility of $3,200 with the expected utility of the risky project, what should the manager do if the manager wishes maximize expected utility of profit? Explain.

g. Is your decision in f. consistent with the manager’s attitude toward risk as it is reflected by the utility function for profit? Explain.

h. Is the decision consistent with the mean-variance rules for decision making under risk? Explain.

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