Managerial Economics, 3rd Edition Solution Manual

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Managerial Economics:A Problem-Solving Approach3rdEditionEnd-of-Chapter Questions and Answers

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Table of ContentsChapter 2...........................................................................................................................................................1Chapter 3...........................................................................................................................................................5Chapter 4...........................................................................................................................................................9Chapter 5........................................................................................................................................................13Chapter 6........................................................................................................................................................17Chapter 7........................................................................................................................................................21Chapter 8........................................................................................................................................................25Chapter 9........................................................................................................................................................30Chapter 10.....................................................................................................................................................34Chapter 11.....................................................................................................................................................38Chapter 12.....................................................................................................................................................41Chapter (13)-14..........................................................................................................................................45Chapter 15.....................................................................................................................................................50Chapter 16.....................................................................................................................................................55Chapter 17.....................................................................................................................................................60Chapter 18.....................................................................................................................................................65Chapter 19.....................................................................................................................................................70Chapter 20.....................................................................................................................................................74Chapter 21.....................................................................................................................................................78Chapter 22.....................................................................................................................................................82Chapter 23.....................................................................................................................................................87

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1Chapter 2MultipleChoiceQuestions1.An individual’s value for a good or service is thea.The amount of money he or she used to pay for a goodb.The amount of money he or she is willing to pay for itc.The amount of money he or she has to spend on goodsd.None of the above2.The biggest advantage of capitalism isa.Generates wealth with the help of government interventionb.That prices assists in moving assets from high valued to low value usesc.It forces involuntary exchangesd.Creates wealth by letting a person follow his or her own self-interest3.Wealth creating transactions are more likely to occura.With private property rightsb.With contract enforcementc.With black marketsd.a and b4.Government regulationa.provides incentives to conduct business in an illegal black marketb.plays norole in generating wealthc.is the best way to eliminate povertyd.does not enforce property rights5.An example of price floor isa.Minimum wagesb.Rent controls in New Yorkc.Both a and bd.None of the above6.A price ceiling:a.Is a government-set price above market equilibrium price.b.Is the equivalent of an implicit tax on producers and an implicit subsidy toconsumers.c.Will create a surplus.d.Causes an increase in consumer and producer surplus.7.Taxes:a.Impede the movement of assets to higher valued usesb.Reduce incentives to workc.Decreases the number of wealth creating transactionsd.All the above

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28.A consumer values a car at $30,000 and a producer values the same car at $20,000. If thetransaction is completed at $24,000, the transaction will generate:a.No surplusb.$4,000 worth of seller surplus and unknown amount of buyer surplusc.$6,000 worth of buyer surplus and $4,000 of seller surplusd.$6,000 worth of buyer surplus and unknown amount of seller surplus9.A consumer values a car at $525,000 and a producer values the same car at $485,000. If salestax is 8% and is levied on the seller, then the sellers bottom line price isa.$527,000b.$523,800c.$525,000d.$500,00010.Efficiency implies opportunity,a.Alwaysb.Neverc.Only if accompanied by secure property rightsd.None of the aboveMultiple Choice Key1.B2.D3.D4.A5.A6.B7.D8.C9.B10.BShort AnswerQuestions2-1 Airline DelaysHow will commercial airlines respond to the threat of new $27,500 fines for keeping passengers onthetarmac for more than 3 hours? What inefficiency will this create?2-2 Selling Used CarsI recently sold my used car. If no new production occurred for this transaction, how could it havecreated value?2-3 Flood InsuranceThe U.S. government subsidizes flood insurance because those who want to buy it live in the floodplain and cannot get it at reasonable rates. What inefficiency does this create?2-4 Goal Alignment among PhysiciansAn elderly physician has built up his own practice into a quite valuable business. Now that he is

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3thinking of retiring, he wants to take on a partner to learn the business and eventually buy thepractice in three years. Her compensation will be a salary plus 25% of the profits if they are belowthe historical average and 50% for any increase above the historical average. The eventual purchaseprice for the practice will be 5 times the average profits over the three years. Discuss the efficiencyaspects of such a contract. Are the incentives of the buyer and seller aligned?2-5 Kraft and CadburyWhen Kraft recently bid $16.7 billion for Cadbury, Cadbury’s market value rose, but Kraft’s marketvalue fell by more. What does this tell you about the value-creating potential of the deal?2-6 Price of Breast Reconstruction vs. Breast AugmentationTwo similar surgeries, breast reconstruction and breast augmentation, have different prices. Breastaugmentation is cosmetic surgery not covered by health insurance. Patients who want the surgerymust pay for it themselves. Breast reconstruction following breast removal due to cancer is coveredby insurance. The price for one of the surgeries has increased by about 10% each year since 1995while the other has increased by only 2%per year. Which of the surgeries has the lower inflationrate? Why?Short Answer Key2-1 Airline DelaysCarriers say that to avoid those fines, they will aggressively cancel flights before and during storms—even if the bad weather never materializes. The threats could foreshadow significant changes in airtravel, making it even less reliable for millions of road warriors and vacationers. By canceling flights,it could take days for all travelers to get home when storms strike.[link].2-2 Selling Used CarsThe value of my willingness-to-sell was less than the buyer's willingness-to-pay. Any transactionprice between these allows for a voluntary exchange in which we both benefit. Since we are bothbetter off, value was created.2-3 Flood InsuranceSubsidies are like taxes in this case. Taxation will keep some efficient transactions from beingconsummated because potential transactions where the difference in buyer and sellervaluation ispositive will no longer cover the amount of the tax to be paid. This prevents the asset from moving toits highest valued use. With a subsidy, transactions in which the assets moves from a higher valueduse to a lower valued use can be consummated so long as the difference is less than the amount of thesubsidy. This moves the asset to a lower valued use. With flood insurance worth an expected$20,000, homeowners would be willing to spend $120,000 to build a house that they value at only$100,000. Wealth is destroyed.2-4 Goal Alignment among PhysiciansThere are a few points:Overlapping tenure for the retiring and new physicians tends to increase the transfer ofpractice specific knowledge.Profit sharing with the new physician increases her incentives to maximize profits.However, since the sale price is a multiple of the profits during this 3 year 'probation' thenew physician has an incentive to shirk to keep the profits low. It might have been better touse a multiple of profits from the period before she began this probation.2-5 Kraft and CadburyIt means that Kraft's shareholders, and potential shareholders, think that Kraft’s profits will fall. Thiswould be the case if Kraft's $16.7 billion bid is greater than the present value of the expected futureprofits from the Cadbury unit. Essentially, the combined market value of the firms separately is

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4greater than the market value of the firms together. The market thinks that combining these assetswill destroy value.2-6 Price of Breast Reconstruction vs. Breast AugmentationMarket pressure comes from two sources: consumers who can choose not to purchase, andcompetitors who can offer lower prices. Breast augmentation is subject to both of these forces, andthus has a lower price, while breast reconstruction is covered by insurance where the consumerpressure is weaker.

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5Chapter 3Multiple Choice Questions1.A business owner makes 1000 items a day. Each day he or she contributes 8 hours toproduce those items. If hired, elsewhere he/she could have earned $250 an hour. The itemsells for $15 each. Production does not stop during weekends. If the explicit costs total$150,000 for 30 days, the firm’s accounting profit for the month equals:a.$300,000b.$60,000c.$450,000d.$240,0002.A business owner makes 1000 items a day. Each day he/she contributes 8 hours to producethose items. If hired, elsewhere he/she could have earned $250 an hour. The item sells for$15 each. Production does not stop during weekends. If the explicit costs total $150,000 for30 days, the economic profit for the month equals:a.$300,000b.$60,000c.$450,000d.$240,0003.If a firm is earning negative economic profits, it impliesa.That the firm’s accounting profits are zerob.That the firm’s accounting profits arepositivec.That the firm’s accounting profits are negatived.More information is needed to conclude about accounting profits4.Opportunity costs arise due toa.Resource scarcityb.Interest ratesc.Limited wantsd.Unlimited scarcity5.After graduating from college, Jim had three choices, listed in order of preference: (1) Moveto Florida from Philadelphia, (2) work in a car dealership in Philadelphia, or (3) play soccerfor a minor league in Philadelphia. His opportunity cost of moving to Florida includesa.The benefits he could have received from playing soccerb.The income he could have earned at the car dealershipc.Both a and bd.Cannot be determined from the given information6.Economic Value Added helps firms to avoid the hidden-cost fallacya.by ignoring theopportunity costs to using a capitalb.by differentiating between sunk and fixed costsc.by taking all capital costs into account including the cost of equityd.none of the above

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67.The fixed-cost fallacy occurs whena.A firm considers irrelevant costsb.A firm ignores relevant costsc.A firm considers overhead or depreciation costs to make short-run decisionsd.Both a and c8.Mr. D's Barbeque of Pickwick, TN produces 10,000 dry-rubbed rib slabs per year. AnnuallyMr. D's fixed costs are $50,000. The average variable cost per slab is a constant $2. Theaverage total cost per slab then isa.$7.b.$2.c.$5.d.impossible to determine.9.All the following are examples of variable costs, excepta.Labor costsb.Cost of raw materialsc.Accounting feesd.Electricity costs10.The U.S. Government bought 112,000 acres of land in southeastern Colorado in 1968 for$17,500,000. The cost of using this land today exclusively for the reintroduction of the black-tailed prairie doga.is zero, because they already own the land.b.is zero, because the land represents a sunk cost.c.is equal to the market value of the land.d.is equal to the total dollar value the land would yield if used for farming andranching.e.depends on the value to society of black-tailed prairie dogs.Multiple Choice Key1.A2.D3.D4.A5.B6.C7.D8.A9.C10.CShort AnswerQuestions3-1 Concert Opportunity Cost

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7You won a free ticket to see a Bruce Springsteen concert (assume the ticket has no resale value). U2has a concert the same night, and this represents yournext-best alternative activity. Tickets to the U2concert cost $80, and on any particular day, you would be willing to pay up to $100 to see this band.Assume that there are no additional costs of seeing either show. Based on the information presentedhere, what is the opportunity cost of seeing Bruce Springsteen?3-2 Concert Opportunity Cost 2You were able to purchase two tickets to an upcoming concert for $100 apiece when the concert wasfirst announced three months ago. Recently, you saw that StubHub was listing similar seats for $225apiece. What does it cost you to attend the concert?3-3 Housing BubbleDue to the housing bubble, many houses are now selling for much less than their selling price justtwo to three years ago. There is evidence that homeowners with virtually identical houses tend toask for more if they paid more for the house. What fallacy are they making?3-4 Opportunity CostThe expression“3/10, net 45”means that the customers receive a 3% discount if they pay within 10days; otherwise, they must pay in full within 45 days. What would the seller’s cost of capital have tobe in order for the discount to be cost justified? (Hint: Opportunity Cost)3-5 StarbucksStarbucks is hoping to make use of its excess restaurant capacity in the evenings by experimentingwith selling beer and wine. It speculates that the only additional costs are hiring more of the samesort of workers to cover the additional hours and costs of the new line of beverages. What hiddencosts might emerge?3-6 Dropping University CoursesStudents doing poorly in courses often consider dropping the courses. Many universities will onlyoffer a refund up to a certain date. Should this affect their drop decisions?Short Answer Key3-1 Concert Opportunity Cost$20. Opportunity cost is the value of your next best alternative. In this case, your next bestalternative is attending the U2 concert. Your value for this alternative is $100 with a correspondingcost of $80 leaving a net value of $20.Note:This question is adapted from Paul J. Ferraro and Laura O. Taylor (2005) "Do EconomistsRecognize an Opportunity Cost When They See One? A Dismal Performance from the Dismal Science",Contributions to Economic Analysis & Policy: Vol. 4: No. 1, Article 7.3-2 Concert Opportunity Cost 2What you paid three months ago is irrelevant to your costs now. The decision you are facing is toattend the concert or not. If you do not attend, you can sell the tickets for $225 (ignoring anybrokering fees and hassle costs). Thus, you forego $450 to attend the concert.3-3 Housing BubbleThese two homeowners have virtually identical houses that should sell at virtually identical prices.The purchase price from years ago is a sunk cost and therefore irrelevant to the pricing decision.They are committing the sunk cost fallacy.3-4 Opportunity CostThe "opportunity cost" of receiving a late payment is the foregone benefit of receiving the moneyearly.This is determined by a firm’s cost of capital.A 3% interest rate for 35 days corresponds to anannual rate of about 3%*(365/35)=31%.

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83-5 StarbucksThere could be many hidden costs. Here are a few examples:Some of Starbucks current baristas are underage and are not permitted to serve alcohol.Hiring new bartenders may raise the labor costs.The storage and preparation of cold drinks, like beer and wine, differs considerably from thestorage and preparation of hot drinks, like coffee. This suggests two separate “productionlines” at each store.The Starbucks brand is known for signaling a quiet, comfy place to linger in small groups oralone. Serving alcohol may change the atmosphere enough that traditional coffee drinkers inthe afternoon and early evening will be turned off.The Starbucks brands is also known for high quality coffees that are high quality partlybecause of the care in choosing beans, roasting them and brewing on the premises. It is notclear that there is much scope for care in 'preparing' beer and wine beverages to add similarvalue. If not, this brand extension could dilute the signal of the brand.3-6 Dropping University CoursesBefore this date, the tuition is avoidable. After this date, it is sunk. Before this date, students comparethe expected benefits to the tuition cost. After this date, they compare the expected benefits only toavoiding the hassle costs of continuing to participate in the course.

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9Chapter 4Multiple Choice Questions1.When economists speak of “marginal”, they meana.Opportunityb.Scarcityc.Incrementald.Unimportant2.Managers undertake an investment only ifa.Marginal benefits of the investment aregreater than zerob.Marginal costs of the investment are greater than marginal benefits of theinvestmentc.Marginal benefits are greater than marginal costsd.Investment decisions do not depend on marginal analysis3.A firm produces 500 units per week. It hires 20 full-time workers (40 hours/week) at anhourly wage of $15. Raw materials are ordered weekly and they costs $10 for every unitproduced. The weekly cost of the rent payment for the factory is $2,250. How do the overallcosts breakdown?a.Total variable cost is $17,000; total fixed cost is $2,250; total cost is $19,250b.Total variable cost is $12,000; total fixed cost is $7,250; total cost is $19,250c.Total variable cost is $5,000; total fixed cost is $14,250; total cost is $19.250d.Total variable cost is $5,000; total fixed cost is $2,250; total cost is $7,2504.Total costs increase from $1500 to $1800 when a firm increases output from 40 to 50 units.Which of the following are true?a.FC = $100b.FC = $200c.FC = $300d.FC = $4005.A manager of a clothing firm is deciding whether to add another factory in addition to onealready in production. The manager would comparea.The total benefits gained from the two factories to the total costs of running the twofactories.b.The incremental benefit expected from the second factory to the total costs ofrunning the two factories.c.The incremental benefit expected from the second factory to the cost of the secondfactoryd.The total benefits gained from the two factories to the incremental costs of runningthe two factories.6.A firm is thinking of hiring an additional worker to their organization who they believe canincrease total productivity by 100 units a week. The cost of hiring him or her is $1500 perweek. If the price of each unit is $12,a.The MR of hiring the worker is$1500b.The MC of hiring the worker is $1200

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10c.The firm should not hire the worker since MB<MCd.All the above7.A retailer has to pay $9 per hour to hire 13 workers. If the retailer only needs to hire twelveworkers, a wage rate of $7 per hour is sufficient. What is the marginal cost of the 13thworker?a.$117.b.$9.c.$33.d.$84.8.If a firm’s average cost is rising thena.Marginal cost is less than average cost.b.Marginal cost is rising.c.Marginal cost is greater than average costd.The firm is making an economic profit9.After the first week of his MBA Managerial Economics class, one of your pharmaceuticalsales representatives accuses you of committing the sunk cost fallacy by refusing to allowhim to reduce price to make what he considers to be a really tough sale. Which of thefollowing suggest the sales representative may be right?a.Most of the costs of drug development are sunk, not fixed.b.Sales representatives are paid a sales commission on revenue, so they want to pricewhere MR>0 instead of where MR>MC.c.Sales representatives don’t worry that a low price today may make it more difficultfor the company’s other sales representatives to charge higher prices to theircustomers.d.Sales representatives forget that P>MC does NOT imply that MR>MC.10.A company is producing 15,000 units. At this output level, marginal revenue is $22 and themarginal cost is $18. The firm sells each unit for $48 and average total cost is $40. What canwe conclude from this information?a.The company is making a lossb.The company needs to cut productionc.The company needs to increase productiond.Not enough information is providedMultiple Choice Key1.C2.C3.A4.C5.C6.C7.C8.C9.A10.C

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11Short AnswerQuestions4-1 Extent versus Discrete ProblemsIdentify which of the following are extent decisions.a. Decidewhether to expand an existing product into a new region.b. What discount should be given on products during the upcoming holiday sale?c. Should the advertising budget be changed for the upcoming year?d. Should you develop a new product for an existing product line?4-2 Game Day Shuttle ServiceYou run a game day shuttle service for parking services for the local ball club. Your costs for differentcustomer loads are 1: $30, 2: $32, 3: $35, 4: $38, 5: $42, 6: $48, 7: $57, and 8: $68. What are yourmarginal costs for each customer load level? If you are compensated $10 per ride, what customerload would you want?4-3 Paid for GradesChildren in poor neighborhoods have bleak outlooks on life and do not see much gain to studying. Arecent experiment is paying children in poor neighborhoods $100 for each“A”they earn in a six-week grade reporting cycle. How does this affect behavior?4-4 Supplier BidsYour company is contemplating bidding on an RFP (Request For Proposal) for 100,000 units of aspecialized part. Why might the amount be more than the requesting company actually wants?4-5 Processing Insurance ClaimsYour insurance firm processes claims through its newer, larger high-tech facility and its older,smaller low-tech facility. Eachmonth, the high-tech facility handles 10,000 claims, incurs $100,000 infixed costs and $100,000 in variable costs. Each month, the low-tech facility handles 2,000 claims,incurs $16,000 in fixed costs and $24,000 in variable costs. If you anticipate a decrease in the numberof claims, where will you lay off workers?4-6 Copier CompanyA copy company wants to expand production. It currently has 20 workers who share eight copiers.Two months ago, the firm added two copiers, and output increased by 100,000 pages per day. Onemonth ago, they added five workers, and productivity also increased by 50,000 pages per day.Copiers cost about twice as much as workers. Would you recommend they hire another employee orbuy another copier?Short AnswerKey4-1 Extent versus Discrete ProblemsA.Discrete decision.B.Extent decision. You must evaluate the marginal increase in sales for each level of discount.Are the profit generated from the price discount greater than the loss from the discount?C.Extent decision.If the increase in sales (revenue) is greater than the increase in budget(MR>MC), then the budget should be increased. You should also examine how sales wouldbe affected if the budget is decreased.D.Discrete decision. You must decide whether the product should be developed (yes or no).4-2 Game Day Shuttle ServiceMarginal Cost is the change in costs due to the additional customer.QTCMCTot RevProfit13010-20

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12232220-12335330-5438340-254245086486601275797013868118012Since marginal revenue is the price of $10, you will serve customers up to the point where MC > MRor you will serve 7 customers.4-3 Paid for GradesThe amount to study to earn good grades is an extent decision. For most of thesechildren, themarginal costs exceeded the marginal benefits at low levels of effort. With the cash payment, themarginal benefit rises and so they will put in more effort.4-4 Supplier BidsIt is likely that your chosen supplier will bear some fixed costs to setup for this specialized input andwill bear a marginal cost per unit. His bid will be based on his average costs = FC/Q +MC. This islower if he assumes a larger quantity. If you could get away with making him make this calculationfor more than 100,000 units, you might get a lower bid price.4-5 Processing Insurance ClaimsWhat costs would be avoided under the two options? The fixed costs at each facility must be incurred(unless the reduction is so big that you can close a facility). Only the variable costs can be avoided. Inthe high-tech facility, the average variable cost per claim-an approximation of the marginal costs-is$100,000/10,000 = $10 per claim. In the low-tech facility, the average variable cost per claim is$24,000/2,000 = $12 per claim. Therefore, by reducing the work apportioned to the low-tech facilitywill help you avoid more costs.4-6 Copier CompanyThis is an extent decision, so we have to measure the marginal benefit of adding a copier and themarginal benefit of adding a worker. The marginal productivity of a copier is 50,000 pages per day(100,000 pages/2 copiers). The marginal productivity of a worker is 10,000 pages per day (50,000pages/5 workers). An extra copier will add five times much as an extra worker, but will cost lessthan five times as much. Buy a copier.

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13Chapter 5Multiple Choice Questions1.Which of the following will increase the break-even quantity?a.A decrease in overall fixed costsb.A decrease in the marginal costsc.A decrease in the priceleveld.A increase in price level2.The higher the interest ratesa.the more value individuals place on future dollarsb.the more value individuals place on current dollarsc.less investments will take placed.does not affect the investment strategy3.Assume afirm has the following cost and revenue characteristics at its current level ofoutput: price=$10.00, average variable cost=$8.00 and average fixed cost =$4.00. This firmisa.incurring a loss of $2.00 per unit and should shut down.b.realizing only a normal profit.c.realizing an economic profit of $2.00 per unit.d.incurring a loss per unit of $2.00, but should continue to operate in the short run.4.Sarah’s Machinery Company is deciding to dump their current technology A for a newtechnology B with small fixed costs but big marginal costs. The current technology has fixedcosts of $500 and marginal costs of $50 whereas the new technology has fixed costs of $250and marginal costs of $100At what quantity is Sarah Machinery indifferent between twotechnologies?a.5b.6c.7d.85.What is the net present value of a project that requires a $100 investment today and returns$50 at the end of the first year and $80 at the end of the second year? Assume a discountrate of 10%.a.$10.52b.$11.57c.$18.18d.$30.006.You expect to sell 500 cell phones a month, which have a marginal cost of $50. If your fixedcosts are $5,000 per month, what is the break-even price?a.$10b.$50c.$60

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