16

Market shares of chocolate makers are in the table

.a.Calculate the Herfindahl-Hirschman Index.The Herfindahl-Hirschman Index is
1,800. TheHerfindahl-Hirschman Index equals the sum of the squares ofthe market
shares of the 50 largest firms or of all firms if thereare less than 50 firms. The
Herfindahl-Hirschman Index equals152+ 102+ 202+ 152+ 252+ 152, which equals
1,800
.b.What is the structure of the chocolate industry?This industry is moderately
competitive because theHerfindahl-Hirschman Index lies in the range 1,000 to
1,800.

17.Two leading design firms, Astro Studios of San Francisco and Hers
Experimental Design Laboratory,Inc. of Osaka, Japan, worked with Microsoft to
design the Xbox 360 video game console. IBM, ATI, andSiS designed the Xbox
360s hardware. Two firms, Flextronics & Wistron, and Celestica, manufacturethe
Xbox 360 at their plants in China and Taiwan.a.Describe the roles of market
coordination and coordination by firms in the design, manufacture, andmarketing of
the Xbox 360.Microsoft entered the market to hire various firms, Astro Studios and
Hers Experimental DesignLaboratory to design the Xbox 360 and then entered the
market again to hire IBM, ATI, and SiS todesign the hardware of the Xbox 360.
Finally, Microsoft once again entered the market to hireFlextronics and Wistron,
and Celestica to produce the Xbox 360. Once Microsoft had contractedwith these
firms, the design, manufacture, etc. takes place within the firm.b.Why do you think
Microsoft works with a large number of other firms to bring the Xbox to market,
ratherthan performing all the tasks at its headquarters in Seattle?Microsoft works
with a large number of firms rather than doing everything in-house because it is
lessexpensive for Microsoft to work with other firms. These other firms have
specialized in various tasksand so have gained economies of scale that Microsoft
does not possess. Therefore it is cheaper forMicrosoft to enter the market and hire
the expertise it needs than to do it all itself.c.What are the roles of transactions
costs, economies of scale, economies of scope, and economies ofFirmMarket
share(percent)Mayfair, Inc15Bond, Inc10Magic, Inc20All Natural, Inc15Truffles,
Inc25Gold, Inc15

11. Federal Express enters into contracts with independent

truckoperators who offer FedEx service and who are rewarded by
thevolume (cubic meters) of packages they carry.a. Why doesnt FedEx
buy more trucks and hire more drivers?FedEx faces a principal-agent
problem. In particular, it is not easyto monitor its drivers and insure that
they are working hard toefficiently deliver packages. FedEx overcomes
this problem by hiringindependent contactors and then paying them
based on the amount ofpackages they deliver. Essentially, FedEx uses a
piecework method ofpayment.b. What incentive problems might arise
from the arrangement thatFedEx uses?FedEx pays its drivers based on
the volume of packages they deliver.This method of payment creates a
few potential problems for FedEx.First, FedEx must worry about the
quality of its service. Inparticular, unless FedEx bases part of the
payment on quality, itsdrivers have an incentive to drop the package
and race off to thenext delivery with no concern for how the packages
are handled.Second, FedEx must take care that drivers do not attempt to
selectonly packages that are close to the FedEx location and
avoidpackages that have a greater than average driving time.
Finally,FedEx also must worry that its drivers do not take undue risks
whiledriving(in order)to deliver as many packages as possible. If
FedExtrucks were involved in too many accidents, FedEx would suffer
badpublicity and, presumably, would lose some business

12. Lee is a computer programmer who earned $35,000 in 2007. But on January 1,
2008 Lee opened a body board manufacturing business. At the end of the first year
of operation, he submitted the following information to his accountant: He stopped
renting out his cottage for $3,500 a year and used it as his factory. The market
value of the cottage increased from $70,000 to $71,000. He spent $50,000 on
materials, phone, utilities, etc. He leased machines for $10,000 a year. He paid
$15,000 in wages. He used $10,000 from his savings account, which earns 5
percent a year interest. He borrowed $40,000 at 10 percent a year from the bank.
He sold $160,000 worth of body boards.7 Normal profit is $25,000 a year. a.
Calculate Lees opportunity cost of production and economic profit.

Lee has costs of $50,000 paid for materials, phone, utilities, etc; $15,000 for
wages; $10,000 paid for the machine lease; $4,000 paid for interest expense on
the loan; $3,500 of forgone rent for the cottage plus $1,000 for the depreciation
of the cottage (the cottage actually appreciated); $500 in forgone interest from the
savings account; and, $25,000 for normal profit. These give a total opportunity cost
of $107,000. Lees economic profit is the total revenue, $160,000, minus the total
opportunity cost, $107,000, for an economic profit of $53,000. b. Lees accountant
recorded the depreciation on his cottage during 2007 as $7,000. According to the
accountant, what profit did Lees make? Lees accountant will include Lee has
costs of $50,000 paid for materials, phone, utilities, etc; $15,000 for wages;
$10,000 paid for the machine lease; $4,000 paid for interest expense on the loan;
and, 7,000 of depreciation expense for a total opportunity cost of $86,000. The
total profit according to the accountant will equal total revenue, $160,000, minus
total cost, $86,000, for a profit of $74,000

13. In 2007, Toni taught music and earned $20,000. She also earned $4,000 by
renting out her basement. On January 1, 2008, she quit teaching, stopped renting
out her basement, and began to use it as the office for her new Web site design
business. She took $2,000 from her savings account to buy a computer. During
2008, she paid $1,500 for the lease of a Web server and $1,750 for high-speed
Internet service. She received a total revenue from Web site designing of $45,000
and earned interest at 5 percent a year on her savings account balance. Normal
profit is $55,000 a year. At the end of 2008, Toni could have sold her computer for
$500. Calculate Tonis opportunity cost of production and economic profit in 2008.

Toni has costs of $1,500 for the lease of a Web server; $1,750 for high-speed
Internet service; $55,000 for normal profit; $20,000 of forgone earnings from
teaching; $4,000 of forgone rent from renting her basement; $100 of forgone
interest from her saving account; and $1,500 for the depreciation of her computer
(which equals the $2,000 paid for it minus the $500 for which she could have sold
it). These various costs sum to a total opportunity cost of $83,850. Tonis economic
profit is her total revenue, $45,000, minus her total opportunity cost, $83,850, for
an economic loss of $38,850.

18.The Colvin Interview: ChryslerThe key driver of profitability will be that the focus
of the company isnt on profitability. Ourfocus is on the customer. If we can find a way to
give customers what they want better thananybodyelse, thenwhat can stop us?Fortune, April 14,
2008
a.In spite of what Chryslers vice chairman and co-president claims, why is Chryslers
focusactually on profitability?Chryslers actual focus is on its profit because if Chrysler
continues to incur losses Chrysler eventuallywill shut down.
b.What would happen to Chrysler if they didnt focus on maximizing profits, but instead
onlyfocused their production and pricing decisions to give customers what they want?In general
customers want very elaborate, very costly automobiles sold for an exceptionally low price.In
particular, customers want to pay the lowest price possible regardless of the companys profit.
IfChrysler focused on only giving customers want they want, Chrysler would continue incur a
loss andultimately would either close or be purchased by another company.

19

Must WatchesStocks too volatile? Bonds too boring? Then try an

alternative investmentone you can wearon your wrist. [The] typical
return on a watch over five to ten years is roughly 10%. [Onecould] do
better in an index fund, but what other investment is so wearable?
Fortune, April 14, 2008
a.What is the cost of buying a watch?The (opportunity) cost of buying a
watch is the loss of whatever else would have been purchased with
thefunds.

b.What is the opportunity cost of owning a watch?The opportunity cost

of owning a watch is the annual forgone return, such as the forgone
interest frombuying a watch rather than placing the funds in a saving
account, and the depreciation of the watch.

c.Does owning a watch create an economic profit opportunity?Yes,

owning a watch creates an economic profit opportunity. If the watch
appreciates at a rapid clip, sothat the gain in the value of the watch over
time exceeds the normal profit from the funds used to purchasethe
watch, then owning the watch has lead to an economic profit

10team production in the design, manufacture, and marketing of the Xbox?

Microsoft needed to determine what part of designing, building, and marketing the
Xbox would takeplace inside of Microsoft and what would take place in other
companies that Microsoft hired. Hiringother companies means that Microsoft incurs
the transactions costs of using markets. However,other companies that specialized
in different tasks have economies of scale, economies of scope,and/or economies
of team production that lower the cost to Microsoft of hiring them. So Microsofthad
to determine which parts of the Xbox 360 would be cheaper to undertake inside of
Microsoft andwhich parts would be cheaper to enter the market to contract with
other firm

20.Where Does Google Go Next?He made full use of his 20% time, that
famous one day a week that Google gives itsengineers to work on
whatever project they want . He and a couple of colleagues did
whatmany of the young geniuses do at Google: They came up with a
cool idea. At Google, whatyou often end up with instead of resource
allocation is a laissez-faire mess Fortune, May 26, 2008
a.Describe Googles method of organizing production with their software
engineers.In some sense Google is using a command system because
Google orders its engineers to use the 20percent time. But in a
larger sense Google is using an incentive system. If one of the engineers
comes up with a wildly profitable idea, the engineer will benefit by
gaining stature and probably income withinGoogle.
b.What are the potential gains and opportunity costs associated with this
method?The potential gain is that the creative people working for Google
will apply their creativity to develop newand better products for Google.
The potential drawback is the principal-agent problem. The
engineersmight use their 20% time for on-the-job leisure rather than for
new, cutting edge research.

21.A Medical Sensation... hospitals continue to splurge on da Vinci

surgical robots. Sitting comfortably at a da Vinci console, surgeons
could usevarious robotic attachments to perform even the most
complexprocedures. Fortune, April 28, 2008
a. Assume that performing a surgery with a surgical robot requiresfewer
surgeons and nurses. Is using the surgical robottechnologically efficient?
Using the surgical robot is technology efficient because theproduction
technique uses less labor (and more capital) than thenon-robotic
technique.
b. What additional information would you need to be able to saythat
switching to surgical robots is economically efficient fora hospital?
To determine if the production technique is economically
efficient,information about the cost of the robot and the cost of the
nursesand doctors and about the number of doctors and nurses
eachproduction technique uses is needed.

22.Long Reviled, Merit Pay Gains Among Teachers school districts in

dozens of states experiment with plans thatcompensate teachers partly
based on classroom performance rather than their years on the job
and coursework completed. Work with mentors to improve their
instruction and get bonusesfor raising student achievement
encourages efforts to raiseteaching qualityThe New York Times, June 18,
2007How does merit pay attempt to cope with the principal-
agentproblem in public education?

The principal-agent problem with teachers in public education is

theconcern that teachers will not work hard in the class room.Teachers
efforts are difficult to monitor and so teachers have theincentive to shirk
by working less diligently and teaching theirstudents less. Merit pay links
the teachers pay to their studentsachievement, presumably
performance on standardized exams. With thislinkage teachers will be
paid more the better their studentsperformance which gives the
teachers the self-interested incentiveto work diligently to instruct their
students
23. StudyReading Between the Linesabout Google and Yahoo! on
pp.244245, and then answer the following questions:a. What are the
products that Google and Yahoo! sell?Yahoo! and Google provide search
services for consumers.b. How do Internet search engine providers
generate revenue andearn a profit?Yahoo! and Google generate revenue
from advertising.c. What is the distinction between paid search
advertising anddisplay advertising? What types of firms use the latter?If
a consumer clicks on an advertising search link, the companydoing the
advertising pays the Internet search provider. Thispayment is called
paid search advertising. Google specializes inpaid search advertising.
Display advertising refers toadvertisements that appear on the web
page of the Internet searchprovider. Yahoo! specializes in display
advertising. Large, wellknown companies, such as Ford Motor, tend to
use displayadvertising.d. Why do you think Google has bought YouTube?
How will this

23

ReadingBetweenthe Lines about GoogleandYahoo! on pp. 244245, andthenanswerthe following

questions:

a. What are the products that Google and Yahoo! sell? Yahoo! and Google provide search
services for consumers. b. Howdo Internet searchengine providers generate revenueandearn a
profit? Yahoo! and Google generate revenue from advertising. c. What is the distinction between
paid search advertising and display advertising? What types of firms use the latter? If a
consumer clicks on an advertising search link, the company doing the advertising pays the
Internetsearch provider. This payment is called paid search advertising. Google specializes in
paid search advertising. Display advertising refers to advertisements that appear on the web
page of the Internet search provider. Yahoo! specializes in display advertising. Large, well known
companies, such as Ford Motor, tend to use display advertising. d. Why do you think Google
has bought YouTube? How will this purchase enable Google to increase its revenue and
profit? Google purchased YouTube because Google wanted to gain advertising revenue from
display advertising on YouTubes web site. Google also wanted to attract new users and gain
new technologies for advertising. Such technologies might become increasingly important
because big companies often use online video advertising.