Microeconomics for Managers

Problem Set 12
Sherif Khalifa

Question 1
Consider the two options on the following table, both of which have random outcomes

Option 1

Option 2

Probability

Outcome

Probability

Outcome

1/15

100

1/6

50

3/15

250

2/6

200

4/15

500

1/6

1000

2/15

750

1/6

75

5/15

800

1/6

10

Determine the expected value of each option. Determine the variance and standard deviation
of each option. Which option is more risky?

Question 2
You are the manager of a firm that sells a commodity in a market that resembles perfect
competition, and your cost function is given by

C (Q) = 4Q2
Due to production lags, you must make your output decision prior to knowing for certain the
price that will prevail in the market. You believe that there is 40% chance the market price
will be $100 and a 60% chance it will be $200. Calculate the expected market price? What
output should you produce in order to maximize expected profits? What are your expected
profits?

Question 3
The consumer is using an optimal search strategy. Consider the following graph which
shows the consumers expected benefits and costs of searching for a lower price.

Expected Benefits
and Costs
EB

14

10

Price

According to the graph, what is the consumers reservation price if the search cost is $9? If
your price is $4 and the consumer visits your store, will the consumer purchase the item or
continue to search? Suppose the consumers cost of search rises to $14, what is the highest
price you can charge and still sell the item to the consumer if he visits your store?

Question 4
You are one of ten bidders participating in an independent private values auction. Each
bidder perceives that all the other bidders valuations for the items are evenly distributed
between $25,000 and $100,000.

For each of the following auction types, determine your

optimal bidding strategy if you value the item at $75,000: First price sealed bid auction, and
Second price sealed bid auction?