National Chengchi University



Answer for Homework 1 of Managerial Economics

1.In each of the following instances, discuss whether horizontal or vertical boundaries have been changed, and whether they were extended or shrunk.

(A)The acquisition of Motorola Mobility, a dedicated Android partner, will enable Google to supercharge the Android ecosystem and will enhance competition in mobile computing. Motorola Mobility will remain a licensee of Android and Android will remain open. Google will run Motorola Mobility as a separate business.

(B)Taiwanese hardware maker Acer, the world's second largest PC manufacturer, has just joined the ranks of the sky-high elite, purchasing Silicon Valley-based iGware for $320 million. Acer's acquisition of the little-known cloud computing firm will reportedly allow it to launch a cloud product next year, and is seen as a long-term strategic move for the tech giant.

(C)Hewlett-Packard said it is exploring a spinoff of its PC business and has bid $10.25 billion to acquire software maker Autonomy.

(D)HTC Corporation, a global designer of mobile phones and devices, announced the acquisition of all outstanding shares of S3 Graphics Co., Ltd. (“S3 Graphics”) for an aggregate consideration of US$300 million, payable in cash. The acquisition strengthens HTC’s technology leadership and extends its IP portfolio with the addition of 235 patents and the pending applications, including those related to graphics visualization technologies.

Answer:

(A)Vertical boundary is extended. Horizontal boundary may be extended (G2 +Motorola)

(B)Horizontal boundary is extended

(C)Horizontal boundary is shrunk. Vertical boundary is extended.

(D)Vertical boundary is extended.

2.The price of Chanel perfume is around $200 per fluid ounce, while the price of Arrowhead bottled water is $1 per gallon. Nancy buys 2 fluid ounces of Chanel and 10 gallons of bottled water a month.

(A).Using relevant demand curves, illustrate Nancy's choices. Illustrate how the following changes will affect Nancy's demand for Chanel perfume: (i) price increase to $220 per fluid ounce, and (ii) cut in price of another of Nancy's favorite perfumes.

(B)..Nancy spends more money each month on perfume than bottled water. Does this necessarily mean that perfume gives her more total benefit than water? Use appropriate demand curves to address this question.

Answer:

(A) (i) This will decrease the quantity demanded of Chanel perfume -- movement down along the demand curve; (ii) This will decrease the demand for Chanel perfume -- the demand curve shifts to the left.

(B) No. Total benefit is the area under the demand curve (which is not the same as expenditure). The area under the demand curve for perfume could be much smaller than that for water. Implication: Nancy is getting much more buyer surplus from her purchases of water than from her purchases of perfume.

3.PCCW provides broadband Internet access in Hong Kong under the brand name, Netvigator. Table 1 lists several of the plans offered in April 2004.

|Table 1: Netvigator Broadband Internet Access Plans |

|Plan |Monthly Subscription |Included Hours |Charge per additional hour|Bandwidth |

|Basic |HK$198 |20 |HK$2 |Up to 1.5 Mbps |

|3M Single User Plan |HK$298 |100 |HK$2 |Up to 3.0 Mbps |

|6M Single User Plan |HK$398 |200 |HK$2 |Up to 6.0 Mbps |

(A). Ms. Wong subscribes to the 6M plan and uses 150 hours a month. Suppose that Wong's demand curve is a straight line such that if the price of access were HK$20 per hour or higher, she would buy nothing. Draw her demand curve, and calculate her buyer surplus.

(B).Suppose that Wong switches to the 3M plan. Referring to her demand curve, how many hours would she use each month? Calculate her buyer surplus.

(C). Suppose that Wong switches to the basic plan. Referring to her demand curve, how many hours would she use each month? Calculate her buyer surplus.

Answer:

(A)Refer to the following diagram for Wong’s demand curve. Her buyer surplus with the 6M plan is ½ x 20 x 150 – 398 = $1,102.

[pic]

(B)With the 3M plan, she would use 135 hours a month (35 hours in excess of the “included time”). Her buyer surplus would be ½ x [20 + 2] x 135 – 298 -70= $1,117.

(C) With the basic plan, she would use 135 hours a month (115 hours in excess of the “included time”). Her buyer surplus would be ½ x [20 + 2] x 135-198-230=$1,057.

4.A study of the demand for gasoline at Boston-area service stations reported that the elasticity with respect to price (combining the pure price effect with the effect on waiting times) was -3.3, the elasticity with respect to station fueling capacity was 0.7, and the elasticity with respect to the average price at nearby stations was 1.2 (Png & Reitman, 1984).

(A).Explain why the elasticity with respect to the average price at nearby stations is a positive number.

(B).Amy’s station is the only competitor to Al’s. Al's station has 2% more fueling capacity. Originally, both stations charged the same price. Then Amy reduced her price by 1%. What will be the difference in quantity demanded between the two stations?

(C).If Amy raises capacity from 5 to 6 fueling places, by how much could she increase price without affecting sales?

Answer:

(A)Because they are substitutes---an increase in the price at nearby stations (e.g. by 1%) will raise the quantity demanded at the service station under consideration (e.g. by 1.2 %).

(B)Al's Q%=2%*0.7-1%*1.2=0.2%, Amy's Q%=(-1%)*(-3.3)=3.3%, the difference in Q%=3.1%.

(C) Amy's Q%=20%*0.7+P%*(-3.3)=0, P%=4.2%

5.Barrick Gold owns the Bulyanhulu mine in Tanzania and the Karlgoolie mine in Australia. Table 2 reports information on selling prices and costs for the two mines. Barrick’s selling price of gold differs from the spot price as some production is sold through long-term contract and also owing to the company’s use of hedging. The “average cash cost” includes operating cost, royalties, and taxes, while the “average cost” includes the cash cost as well as amortization.

(A).Suppose that the Bulyanhulu mine always produces at the scale where its marginal cost equals the selling price of gold. Its marginal cost curve, however, shifts with changes in electricity prices, wages, and other factors. Using the data from table 2, illustrate the shifts in Bulyanhulu’s marginal cost curve, the selling price, and profit-maximizing scale of production between 2002 and 2004.

(B)In 2003, Barrick continued to produce from the Bulyanhulu mine even though the selling price of gold, $366 per ounce, was less than its average production cost of $369 per ounce. Was this a mistake?

(C)Use Barrick’s 2004 data to compare the (i) short-run break even conditions for Bulyanhulu and Karlgoolie; and (ii) the long-run break even conditions for the two mines.

Table 2: Barrick Gold

| |Bulyanhulu |Karlgoolie |

| |2002 |2003 |2004 |2004 |

|Production (thousand ounces) |356 |314 |350 |444 |

|Selling price ($ per ounce) |339 |366 |391 |391 |

|Average cash cost ($ per ounce) |198 |246 |284 |234 |

|Average cost ($ per ounce) |300 |369 |384 |278 |

Source: Barrick Gold Corporation, Annual Reports

Answer:

(A)

[pic]

(B)Not necessarily. It makes sense to produce provided that the price, $366 per ounce, exceeds average variable cost. Assuming that cash cost represents variable cost, the average variable cost was $246 per ounce, which was less than the price.

(C)Assuming that cash cost represents variable cost, both the short- and long-run breakeven prices were lower at Karlgoolie than Bulyanhulu: $234 compared with $284 per ounce, and $278 compared with $384 per ounce.

6.In January 2005, the world’s total supply of oil tankers amounted to 304.1 million deadweight tons (dwt). During 2005, 28.0 million dwt of new tankers were delivered into service, while 5.1 million dwt were scrapped or otherwise removed from service. Hence, at the end of the year, the world’s total supply was 326.9 million dwt. Among tankers and chemical carriers in operation of 200,000 dwt or larger, 60% by tonnage was less than 10 years old, 37% was 10–20 years old, and the remainder was more than 20 years old. (Source: Platou Report, 2006.) Typically, older tankers are more costly to operate.

(A). Identify the following as either a short- or long-run decision: (i) lay-up (idling the vessel); (ii) scrapping.

(B). Explain how the owner of a tanker should decide whether to continue to operate, lay-up, or scrap a vessel.

(C). The marginal cost of keeping a tanker in service (“lay-up equivalent”) is the tanker’s operating cost minus the cost of lay-up. When tanker rates fall, identify which tanker owners would first lay up.

Answer:

(A)Lay-up is a short-run decision; scrapping is a long-run decision.

(B)Operate if short-run price > average variable cost; Lay up if short-run price < average variable cost and long-run price > average cost; Scrap if long-run price < average cost. [More sophisticated answer using concepts of net present value, operating cost (continuing), and lay-up cost (one-off): Operate if NPV(short-run price – operating cost) > - lay-up cost; Lay up if NPV(short-run price – operating cost) < - lay-up cost and NPV(long-run price – operating cost – repair/refitting cost) > - scrapping cost; scrap if NPV(long-run price – operating cost – repair/refitting cost) < - scrapping cost.]

(C)Those with relatively highest operating cost or lowest cost of lay-up.

7.A survey shows an increase in drug use by young people. In the ensuing debate, two hypotheses are proposed:

Hypothesis I: Reduced police efforts have increased the availability of drug on the street.

Hypothesis II: Cutbacks in education efforts have decreased awareness of the dangers of drug addiction.

(A). Use supply-and-demand diagrams to show how each of these hypotheses could lead to an increase in the quantity of drugs consumed.

(B). How could information on what has happened to the price of drugs help us to distinguish between these explanations?

Answer:

(A) Hypothesis I: Supply increases and the supply curve shifts to the right, so the price falls and the quantity rises. Hypothesis II: Demand increases and the demand curve shifts to the right, so the price rises and the quantity rises.

(B) Hypothesis I: the price falls; Hypothesis II: the price rises.

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