The University of Poonch

Rawalakot Azad Kashmir

(Department of Business Administration) MBA-IV

Mid-Term

Managerial Economics

Total Marks 30

Time

2.00hrs
Note: All questions carry equal marks to the final exam

Question No 1 (5)
Y=

Y=

Y=

Question No 2(5)
Solve by using Lagrange Multiplier Max XY

Subject to: X+Y 12 OR

Question No 3 (5) If f( x,y,z)=Z=5xy=8xz=3yz Subject to: 2xyz=1920 Question No 4 (5)

From each of the following Total Cost functions find (1) the AC function(2) the critical value at which AC is minimized and the (3) minimum AC

Question No 5(10) Information Technology Inc, is a supplier of math coprocessors (Computer Chips) used to speed the processing of the data for analysis on personal computers. Based on analysis of monthly cost and output data, the company has estimated the following relation between the marginal cost of production and monthly output: MC= $100+$0.004Q A. Calculate the marginal cost of production at 2500, 5000 and 7500 units of output. B. Express output as a function of marginal cost. Calculate the level of output when MC=$100, $125 and $ 150. C. Calculate the profit maximizing level of output if whole sale price is stable in the industry at $ 150 per chip and therefore, P=MR=$150 D. Derive the company Supply Curve for chips assuming P=MR. Express Price as a function of quantity and quantity as a function of price.

ST4.2 Solution A. Marginal production costs at each level of output are Q = 2,500: MC = $100 + $0.004(2,500) = $110 Q = 5,000: MC = $100 + $0.004(5,000) = $120 Q = 7,500: MC = $100 + $0.004(7,500) = $130 B. When output is expressed as a function of marginal cost MC = $100 + $0.004Q 0.004Q = 100 + MC Q = 25,000 + 250MC MC = $100: Q = 25,000 + 250($100) = 0 MC = $125: Q = 25,000 + 250($125) = 6,250 MC = $150: Q = 25,000 + 250($150) = 12,500 C. Note from part B that MC= $150 when Q = 12,500. Therefore, when MR= $150, Q = 12,500

will be the profit-maximizing level of output. More formally, MR = MC $150 = $100 + $0.004Q 0.004Q = 50 Q = 12,500 D. Because prices are stable in the industry, P = MR, this means that the company will supply chips at the level of output where MR = MC and, therefore, that P = $100 + $0.004Q This is the supply curve for math chips, where price is expressed as a function of quantity. When quantity is expressed as a function of price P = $100 + $0.004Q 0.004Q = 100 + P Q = 25,000 + 250P

Question No 6 The House Products Division of Acme Corporation manufactures and sells digital clock radios. A major component is supplied by the electronics division of Acme. The cost functions for the radio and the electronic component divisions are, respectively,
TCr = 30 + 2Qr
2 TCc = 70 + 6Qc + Qc

Note that TCr does not include the cost of the component. Manufacture of one radio set requires the use of one electronic component. Market studies show that the firms demand curve for the digital clock radio is given by Pr = 108 Qr a. If there is no outside market for the components, how many of them should be produced to maximize profits for Acme as a whole? What is the optimal transfer price?

b.

If other firms are willing to purchase in the outside market the component manufactured by the electronics division (which is the only supplier of this product), what is the optimal transfer price? Why? What price should be charged in the outside market? Why? How many units will the electronics division supply internally and to the outside market? Why? (Note: The demand for components in the outside market is Pc = 72 1.5Qc.)

GoodLuck!

4. The House Products Division of Acme Corporation manufactures and sells digital clock radios. A major component is supplied by the electronics division of Acme. The cost functions for the radio and the electronic component divisions are, respectively,
TCr = 30 + 2Qr
2 TCc = 70 + 6Qc + Qc

Note that TCr does not include the cost of the component. Manufacture of one radio set requires the use of one electronic component. Market studies show that the firms demand curve for the digital clock radio is given by Pr = 108 Qr a. If there is no outside market for the components, how many of them should be produced to maximize profits for Acme as a whole? What is the optimal transfer price? Radios require exactly one component and assembly. Radio assembly cost: Radio demand:
TC r = 30 + 2Qr

2 Component cost: TC C =70 +6Q C +Q C

Pr = 108 Qr

First we must solve for the profit-maximizing number of radios to produce. We must then set the transfer price Pt that induces the internal supplier of components to provide the profit-maximizing level of components.
2 ). Profits are given by: = (108 Qr )Qr (30 + 2Qr ) (70 + 6Qc + Qc

Since one and only one component is used in each radio, we can set Qc = Qr:
2 = (108 Qc )Qc (30 + 2Qc ) (70 + 6Qc + Qc ).

Profit maximization implies: d/dQc = 108 2Qc 2 6 2Qc = 0 or Qc = 25. We must now calculate the transfer price that will induce the internal supplier to supply exactly 25 components. This will be the price for which MCc(Qc = 25) = Pt or Pt = MCc (Qc = 25) = 6 + 2Qc = $56.

We can check our solution as follows: Component division: Max c = 56Qc (70 + 6Qc + Qc2) dc/dQc = 0 56 6 2Qc = 0 Qc = 25. Radio assembly division: Max r = (108 Qr)Qr (30 + 2Qr) 56Qr dr/dQr = 0 108 2Qr 2 56 = 0 Qr = 25. b. If other firms are willing to purchase in the outside market the component manufactured by the electronics division (which is the only supplier of this product), what is the optimal transfer price? Why? What price should be charged in the outside market? Why? How many units will the electronics division supply internally and to the outside market? Why? (Note: The demand for components in the outside market is Pc = 72 1.5Qc.) We now assume there is an outside market for components; the firm has market power in this outside market where market demand is: Pc = 72 3(Qc/2) First we solve for the profit-maximizing level of outside and internal sales. Then, we set the transfer price that induces the component division to supply the total output (sum of internal and external supply). We define Qc as the outside sales of components and Qi = Qr as components used inside the firm to produce digital clock radios. Total profits for the company are given by: = (108Qi)Qi + (72(3/2)Qc)Qc (30+2Qi) (70+6(Qi+Qc)+(Qi+Qc)2).

Profit maximization implies: /Qi = 108 2 Qi 2 6 2 (Qi + Qc) = 0 /Qc = 72 3Qc 6 2(Qi + Qc) = 0 which yields: Qi + Qc/2 = 25 5Qc + 2Qi = 66 and

Qc = 4 Qi = 23. Thus, total components will be 23 + 4, or 27. As in part (a), we solve for the transfer price by finding the marginal cost of the component division of producing the profitmaximizing level of output: Pt = MCc = 6 + 2(Qi* + Qc* ) = 6 + 2(27) = $60. The outside price for the component will be: Pc = 72 (3/2)Qc = $66, which is greater than the internal transfer price, as it should be. The outside price is greater than the transfer price (Pt < Pc) because the firm has market power in the external market, and therefore, Pt = MCc = MRc < Pc.