< DOCTOR OF BUSINESS ADMINISTRATION >

< MAY / 2020 >

< BPME7103 >

< ADVANCED MANAGERIAL ECONOMICS >

MATRICULATION NO : <CGS02041829>
IDENTITY CARD NO. : <820217105123>
TELEPHONE NO. : <+6017 237 2000>
E-MAIL : <jwphuah@oum.edu.my>
LEARNING CENTRE : <OUM GRADUATE CENTRE>
INSTRUCTIONS
 Do not copy the assignment question and instructions to your answer.
 Prepare your assignment answer following the layout of the ASSESSMENT
CRITERIA shown in the RUBRICS provided for the course. Where RUBRICS are
not provided, follow the instructions/guidelines specified by the Open University
Malaysia (OUM) for the assignment concerned.
 Your assignment should be written according to the number of words outlined
in the assignment instruction EXCLUDING references.
 Type your answer using 12 point Times New Roman font and 1.5 line spacing.
 Show the number of words at the end of your assignment.
 Tables and figures where provided, should be appropriately titled.
 List your references separately in the APPENDIX page.

1
TASK 1

PART 1

QUESTION 1

In economics, a complete market defines a market with two conditions: 1) Negligible

transaction costs (Buckle et al., 2018) and therefore also perfect information as known as

no significant in asymmetric information, then 2) a financial market place is said to be

complete when a market exists with an equilibrium price for every asset in every possible

state of the world (OECD, 2003). Together with knowing re-contracting costs,

organisation managers shall able to maximise shareholder value. However, the market is

not perfect in the real world, no serious economist believes that a perfectly competitive

market could ever arise, and very few consider such a market desirable (Kenton, 2019).

The market imperfection has been a challenging issue to organisation managers. The

principal-agent problem, in economics (also known as agency dilemma or the agency

problem) occurs when one person or entity (the “agent”, or the “manager” in this

context), is able to make decision and/or take actions on behalf of, or that impart, another

person or entity; the “principal”, or “manager” in this context (Eisenhardt, 1989). The

problem arises where the two parties have different interests and asymmetric information

(the manager having more information), such that the principal cannot directly ensure

that the agent is always acting in their (the shareholder) best interest (Bebchuk & Fried,

2004), particularly when activities that are useful to the shareholder are costly to the

manager, and where elements of what the manager does are costly for the shareholder to

observe. So the next question is how organisation managers deal with such a complicated

and challenging environment in decision making?

2
Decision making is a crucial task that is applicable in business and organisations.

Typically, decision making involves choosing the ideal solution or alternative to ensure

the activity goes smoothly as planned. According to the Management Study Guide

(2017), the following six steps should be carried out when making a decision:

Defining the problem

Gathering information and

collecting data

Developing and weighing the

options

Choosing the best possible

option

Plan and execute

Take follow-up action

Figure 1.1. 6-Steps of Decision-Making

We need to determine what the issue is and how much it is going to affect our activities.

Then assess all aspects to avoid any lag in information. The next step is to gather as much

data and information as possible about the issue. This degree will enable us to have a

3
clear view of the issue and understand it better. The next thing is to develop and weigh

the options that linked and cover all the issues that exist. The next task is to choose the

best possible option. This particular step has to be carried out carefully because the

choices that will be selected will later on become the benchmark in order to resolve other

issues. We need to be mindful in order to plan and execute the option to ensure the option

fits the problem. Lastly, after we have planned and executed the option, we have to take

follow-up actions on the option we have selected. These measures can be followed

continuously as long as the issue|dilemma occur.

Another of the most critical functions of management is forecasting future business.

Forecasting is an act of making a detailed analysis of the future; planning is impossible

without predicting the future as accurately as possible, or, making wise assumptions

about it. Usually, forecasting might be in the form of intentional and considered decisions

based on feelings, opinions, experiences and judgements (Chand, 2016). Forecasting

demand or even input costs is very challenging, it has become one of the vital concerns

for all managers because the shareholder's value of a firm depends on accurately

forecasting these components for expected future cash flows. It is among the essential

processes that need to be carried out to ensure smooth operations of the business as well

as to make sure the goals for the future can be achieved successfully. According to

Kamarulzaman (2020), a good forecast should have the following requirements:

4
 Be consistent with Consider the
other parts of the economic and
business political environment

Good
Forecas
t

Be based on adequate
knowledge of the Be timely
relevant past

Figure 1.2. Requirements of good forecast

Managers use economics forecasts to help them determine organisation budgets, strategy

and multi-year plans for the upcoming year. Managers select which variables are

essential to the subject content under discussion. Managers may use statistical analysis of

historical data to figure out the apparent relationships between specific independent

variables and their relationship to the dependent variable under study. Managers conducts

statistical tests and develops statistical models (often using regression analysis) to

determine which relationships best describe or anticipate the behavior of the variables

under study. Historical data and assumptions about the future are applied to the model in

arriving at a forecast for particular variables (Ramanathan, 1995).

In conclusion, organisation managers require practical decision-making and business

forecasting skill to overcome the market challenge and maximise shareholder value.

Additionally, an effective communication plan between management and shareholders is

essential too.

5
QUESTION 2

a. There are 3 alternative decision in the scenario: the person can decide either invest

$6000 in a new product, or invest in another venture that is certain to yield a net profit of

$1,500, or call off investment decision.

b. The possible outcomes for each decision alternative as the following: if the person

decides to invest $6,000 in a new product, there are 3 possibilities of outcomes, namely

earn net profit of $24,000 with 10% success rate, earn net profit of $12,000 with 20%

success rate and up to 70% risk rate of investment failure. Alternatively, there will be

certain $1,500 net profit yield if the person decides to invest $6,000 in another venture.

The last option is to call off the investment decision.

c. The possible outcomes for each decision alternative as below:

Decision Net Profit Success Rate

Investment in New Product $24,000 10% (0.10)

I1
I2 $12,000 20% (0.20)
I3 -$6,000 70% (0.70)
Another Venture $1,500 100% (1.0)
Call Off 0 100% (1.0)
Table 1.1. Possible Outcomes of Each Decision Alternatives

d. The expected net profit of each decision alternative as the following: if the person

decides to invest $6,000 in a new product, there are 3 possibilities of outcomes, namely

earn net profit of $24,000 with 10% success rate, earn net profit of $12,000 with 20%

success rate and up to 70% risk rate of investment failure. Alternatively, there will be

6
certain $1,500 net profit yield if the person decides to invest $6,000 in another venture.

The last option is to call off the investment decision in which no gain no loss in

accounting aspect but there is a loss in opportunity cost of $1,500 in economics point of

view.

e. In order to maximise expected monetary payoff, it is suggested that the person should

choose to invest $6,000 in another venture for the reason of 100% possibility yield a net

profit of $1,500. It is the highest success rate amongst all alternatives in order to

maximise the investment return.

PART 2

QUESTION 3

a. The restaurant Olive Garden make less production since there is fewer order demand

than their forecasted plan, it saves the production cost and food wastage. On the other

7
 hand, assuming the prepared lasagnas cannot be kept for next use, the restaurant increase

the size of their servings in order to impress their diners. On the other way of thinking,

Olive Garden can’t change the price in flexibility but it can change or adjust lasagna

supply easily. Whereas a motor-dealer cannot adjust its supply in flexibility but can

adjust its price by giving discount to create customer demand. In short, the restaurant is in

a position of demand is price insensitive and supply is quite flexible, motor-dealers tend

to in a position of quantity demanded is price sensitive and quantity supplied is not.

b. The equilibrium or market clearing price is that the price where the amount that

consumers want to buy is equal to the amount that producers want to sell (Keat & Young,

2003). Equilibrium is the state in which market supply and demand balance each other,

and as a result, prices start to be stable. In general, an over-supply of goods or services

causes prices to go down, which results in higher demand. The balancing effect of supply

and demand leads to a state of equilibrium. A shortage is a situation that results when

quantity demanded for a product exceeds the quantity supplied. In contrast, a surplus is a

situation that result when the quantity of a product supplied exceeds the quantity

demanded. Refer figure 1.3.

Price
Supply

Total Surplus
=
Consumer
Consumer
Surplus
Surplus
+ 8
Producer
Surplus
 Market Price
Producer (Equilibrium)
Surplus

Demand

Quantity

Figure 1.3. Consumers’ and producers’ surplus curve (Source:

http://thismatter.com/economics/total-surplus.htm

In the event the market price is greater than the equilibrium price, the amount that firms

are able and willing to supply to the market will surpass the amount that consumers are

able and willing to purchase. There will be a surplus. This surplus will cause the market

price to fall until it gets to the equilibrium price. Equilibrium can be seen in terms of two

important economic concepts, consumers' surplus and producers' surplus. Consumers'

surplus is the difference between the maximum buying price and price paid by the buyer;

Producers' surplus is the difference between the prices received by the producer or seller

and the minimum selling price. Total surplus is the sum of the consumers' surplus and

producers' surplus. In the event the market price is lower than the equilibrium price, the

amount that firms are able and willing to supply to the market will be less than the

amount that consumers are able and willing to purchase. There will be a shortage. This

shortage will cause the market price to increase until it gets to|arrives at the equilibrium

price. The following are the effects of the rise and fall in demand and supply respectively:

a) Effect of a Rise in Demand

9
 An increase in demand shifts the demand curve to the right. After an increase in

demand, there will be a shortage at the old price. This shortage will drive the price

up to a new market clearing price. The quantity demanded and supplied will both

rise.

b) Effect of a Fall in Demand

A fall in demand shifts the demand curve to the left. After the fall in demand,

there will be a surplus at the old price. This surplus will drive the price down to a

new market clearing price. The quantity demanded and supplied will both fall.

c) Effect of a Rise in Supply

After an increase in supply, there will be a surplus at the old price. This surplus

will drive the market clearing price. The quantity demanded and supplied will

both rise.

d) Effect of a Fall in Supply

After a fall in supply, there will be a shortage at the old price. This shortage will

drive the price up to a new market clearing price. The quantity demanded and

supplied will both fall.

QUESTION 4

a. In order to discover important factors that affecting the product demand, the economist

shall conduct market research to gain relevant data and later on to run statistical

techniques analyse the data and identify the demand factors. According to McGuigan,

Identification of the Collection of the Data: Formulation of the

Variables:
Dependent variable and
Independent variables
Conduct data collection Demand Model:
10
To specify equation or
of the variables. Price &
sales data from past model with relationship
records. of variables
Moyer and Harris (1999), there are four different marketing research methods can be

used to estimate and analyse demand and demand factors. The four methods are a)

consumer surveys, b) consumer clinics (or consumer focus groups), c) market

experiments and d) historical data. Each research method has pros and cons, and the

economist shall select the one that is the best or suitable to implement. During the

process, the economist shall perform statistical estimation of demand function and the

steps in the estimation of demand function based on McGuigan et al. (1999): a)

Identification of the variables, b) Collection of the data, c) Formulation of the demand

model, d) Estimation of parameters, e) Development of forecast or estimation from the

model. After the above steps have been taken, the economist shall able to identify factors

that affecting the demand for the firm’s main product.

Figure 1.4. Steps in Estimation of Demand Function

Development of Estimation of
Forecast or Estimate Parameters:
from the Model: Determine values in
Forecasting & Decision- demand functions with
Making regression technique.

b.

i.

Below is the linear equation found via analysis through SPSS:

Coefficientsa

11
 Standardised
Unstandardised Coefficients Coefficients
Model B Std. Error Beta t Sig.
1 (Constant) 205.862 19.354 10.636 .000
Price (P) -12.242 1.407 -.953 -8.700 .000
Income (M) 1.414 .422 .297 3.349 .015
Advertising (A) -3.344 1.798 -.214 -1.860 .112
a. Dependent Variable: Quantity (Q)
Table 1.2. Coefficients of Linear Regression Model

Q = Quantity

P = Price

M = Income

A = Advertisement

Linear regression equation = 205.862 (Q) – 12.242 (P) + 1.414 (M) – 3.344 (A)

= 191.69

ii.

Model Summary
Adjusted R Std. Error of the
Model R R Square Square Estimate
1 .986a .973 .959 6.987
a. Predictors: (Constant), Advertising (A), Income (M), Price (P)

Table 1.3. Result of Linear Regression Model

Coefficient of determination is R Square. Refer to table 1.2, R Square is 0.973 means

97.3% of the dependent variable (means quantity) has been explained by the independent

variables (Advertising, Income and Price), therefore it is an excellent model.

iii.

12
Both Price and Income variables are coefficiently made economic sense except

Advertising variable. In term of significance, The cut-off point in the economic &

management, it is always used 95% level of confidence which is 0.05. If the result is

lower than 0.05, it means the result is significant. Vice versa, if it is greater than 0.05, it

means the result is not significant. Refer to table 1.1, under Significance column both

Price and Income resulted lower than 0.05, meaning they are significant whereas

Advertising is more than 0.05 therefore it is not significant.

iv.

Period Quantity (Q) Price (P) Income (M) Advertising (A)

10 200 2 35 9.5

Price Elasticity of Demand

%∆Q = Percentage change in Quantity demanded

%∆P = Percentage change in Price

ED = %∆Q / %∆P * P/Q

= (200 / 2) * (2 / 200)

= 100 * 0.01 = 1 (Unit elastic)

The price change results in an equal change in quantity demanded.

Income Elasticity of Demand

%∆Q = Percentage change in Quantity demanded

%∆M = Percentage change in Income

EY = %∆Q / %∆M * M/Q

= (200 / 35) * (35 / 200)

13
 = 5.7143 * 0.175 = 1.0000025 (Positive Income Elasticity of Demand)

There is a direct relationship between the income of the consumer and the demand for the

product. Income increase results increase in quantity demanded. It is a normal goods.

v.

Econometrics is a combination of theory, statistical analysis and mathematical model

building to explain economic relationships. One of the two equation models in

econometrics is the single-equation model. This is the simplest form of an econometric

model. According to McGuigan et al. (2011), as the parameters of the demand equation

are estimated, the model can be used to forecast the demand. The single equation model

of the demand for the product as below:

Q = a + aP + aM + aA + aN

Q = Quantity

P = Price

M = Income

A = Advertising

N = Period

TASK 2

PART 1

QUESTION 1

a.

14
The short run is the period of time in which one (or more) of the resources employed in a

process of production is fixed or unable to be varied. In constract, the time period in

which all the resources employed in a process of production can be varied.

Short Run Long Run

Eg. For a company it is easy to add new Eg. Adding new equipments to the existing

labour than add new equipments. So labour setup to increase the production.

as a factor of input can be varied in short

run and thus it impacts the production.

Table 2.1. Example of Short Run and Long Run in Production Functions

b.

Diminishing returns is the reduction in the marginal (incremental) output of a production

process as the quantity of a single variable of production is incrementally increased,

while the quantities of all other variables of production stay constant. The law of

Stage 2 adding more of oneStage

diminishing returns states that in all productive processes, factor3 of

production, while holding all others constant ("ceteris paribus"), will at some point yield

lower incremental per-unit returns (Samuelson, 2001). For instance, a factory employs

workers to produce its products, and, at some point, the company works at an optimum

level. With other production factors constant, adding extra workers beyond this optimum

level will lead to less efficient in operations. Diminishing returns occur in short run when

one factor is fixed (e.g. capital) and it is only applies in the short run because, in the long

run, all factors are variable.

Stage 1
15
 Output

Total Product

Average Product

Output

Marginal
Product

L1 L2 Unit of Labour
Figure 2.1 Diminishing returns in 3 stages of production L3

The law of diminishing returns can be explained in 3 stages of production.

1. Stage 1 is the period of most growth in a company’s production.

2. Stage 2 is the period where average productivity starts to decrease.

3. Stage 3 is marginal returns start to turn negative.

c.

Productivity describes various measures of the efficiency of production. Often, a

productivity measure is expressed as the ratio of an aggregate output to a single input or

an aggregate input used in a production process, i.e. output per unit of input, typically

over a specific period of time (Kaliski, 2001). Productivity can be measured in a number

16
of ways. The challenge which is commonly seen regarding measuring productivity is

tangible versusintangible measurable. For example, in industries that focus on goods, it is

better to assess the productivity as described by output produced split by the labor

required to produce the goods. In the service industry this is not as clearly outlined. For

example, on long projects that involve a number of highly skilled employees, it could be

hard to establish total input of each employee, rather by just looking at the total input of

hours.

i. In education sector, the productivity can be based on inputs in terms of labour

productivity such as teacher and lecturer employed or multifactor productivity (total

money spent), and number of full time students as an output measure.

ii. In Government sector, the productivity can be based on inputs in terms of labour

productivity and inland revenue collection, and yearly GDP growth, infrastructure

development etc as an output measure.

iii. In Manufacturing sector, labour, capital and material as input, and number of units

produced as output measure.

iv. In Finance and insurance sector, capital as input, and total amount of transaction as

output measure.

QUESTION 2

a.

Coefficientsa
Standardised
Unstandardised Coefficients Coefficients
Model B Std. Error Beta t Sig.
1 (Constant) -4.749 .809 -5.870 .000

17
 LnCap .415 .135 .418 3.070 .010
LnLab 1.078 .250 .586 4.303 .001
a. Dependent Variable: LnProd

Table 2.2. Coefficients of Linear Regression Model

According to the result above analysed by SPSS, the multiplicative exponential Cobb-

Douglas function can be estimated as a linear regression relation by taking the logarithm

to obtain as below:

Log Q = log α + β1 log L + β2 log K

= log -4.749 + 0.415 log L + 1.078 log K

Then perform anti logarithm calculation in order to obtain the value of “α”.

Figure 2.2 Calculation of Anti-logarithm for “α”.

α = 0.000017823787674

β1 = 0.415

β2 = 1.078

Therefore Cobb-Douglas production function in this case is as per the following:

18
Q = αLβ1Kβ2

= 0.000017823787674 + L0.415 + K1.078

= 1.49301782379 unit.

b.

In term of significance, The cut-off point in the economic & management, it is always

used 95% level of confidence which is 0.05. If the result is lower than 0.05, it means the

result is significant. Vice versa, if it is greater than 0.05, it means the result is not

significant. According to Table 2.1, both capital and labour variables are statistically

significant (0.010 and 0.001 respectively).

c.

Model Summary
Adjusted R Std. Error of the
Model R R Square Square Estimate
1 .974a .948 .939 .08998
a. Predictors: (Constant), LnLab, LnCap

19
Table 2.3 Model Summary

ANOVAa
Model Sum of Squares df Mean Square F Sig.
1 Regression 1.763 2 .881 108.856 .000b
Residual .097 12 .008
Total 1.860 14
a. Dependent Variable: LnProd
b. Predictors: (Constant), LnLab, LnCap

Table 2.4 ANOVA

R Square is .948 means 94.8% of the dependent variable (means production) has been

explained by the independent variables (capital and labour), therefore it is an excellent

model. The regression model significance value is less than 0.05 therefore it is highly

significant (Refer table 2.4).

d.

The capital and labour production elasticities are 0.415 and 1.078 respectively. From the

coefficients analysis result (refer to table 2.1), it has been explained that capital input

increased by 1%, the production will increase by 0.415%; If labour input increased by

1%, the production will increase by 1.078%.

20
e.

When n = β1 + β2 is less than, equal to or greater than 1, the Cobb-Douglas production

function will exhibit decreasing, constant or increasing returns to scale.

β1 = 0.415

β2 = 1.078

β1 + β2 = 0.415 + 1.078 = 1.493 unit

In this particular case, the result is greater than 1 which means the production function

has exhibits increasing returns to scale.

PART 2

QUESTION 3

According to the statement, if Francesca decides to TAKE THE JOB, she will get:

 $30,000 salary for the first year

21
  Then $4,000 salary increment over the next FIVE (5) years (We assume the “next

FIVE years” does not include the first year)

 We assume there is no increment after 5-years increment ends.

Therefore,

Earning of the Year = Salary + (Year * Increment)

Growth Rate refers to the percentage change of a specific variable within a specific time

period (Chen, 2020).

Growth Rate of the Year = Increment / Earning of the Previous Year

Number of Year Salary Return Accumulation Growth Rate

1 $30,000 $30,000 N/A
2 (Increment Begin) $34,000 $64,000 13.33%
3 $38,000 $102,000 11.76%
4 $42,000 $148,000 10.53%
5 $46,000 $194,000 9.52%
6 (The final year of $50,000 $244,000 8.70%

$4,000 increment)
7 $50,000 $294,000 0%
8 $50,000 $344,000 0%
9 $50,000 $394,000 0%
10 $50,000 $444,000 0%
11 $50,000 $494,000 0%
Table 2.5 Salary Return Calculation of Francesca Takes Job

If Francesca decides to pursue PhD study then work as teaching, she will get:

 Yearly assistantship pay from 1st to 5th Year - $9,500

 Yearly study cost from 1st to 5th Year - $1,500

22
  After graduation, 1st year income - $45,000

 Growth rate equals to the calculation on Table 2.4

Therefore,

Number of Year Salary Return Accumulation Growth Rate

1 $9,500 - $1,500 = $8,000 0%

$8,000
2 $8,000 $16,000 0%
3 $8,000 $24,000 0%
4 $8,000 $32,000 0%
5 $8,000 $40,000 0%
6 $45,000 $85,000 0%
7 (Increment begin $50,998.50 $135,998.50 13.33%

based on expected

Growth Rate)
8 56,995.92 192,994.42 11.76%
9 62,997.59 255,992.01 10.53%
10 68,994.96 324,986.97 9.52%
11 (Final year of 74,997.52 399,984.49 8.70%

expected growth rate)

Table 2.6 Salary Return Calculation of Francesca Pursue PhD and Teaching

Opportunity cost, when an option is chosen from alternatives, the opportunity cost is the

“cost” incurred by not enjoying the benefit associated with the best alternative choice

(Kenton, 2019). In simple terms, the opportunity cost is the benefit that forgoes as a result

of not selecting the next best option. Refer the comparison on both table 2.5 and 2.6, in

short run, if Francesca pursues income as objective, Francesca should choose take the job

after master’s degree graduation. Furthermore, Francesaca would accumulate more

income on 11th year which is $494,000 compare to $399,984.49. However, in long run,

Francesca would earn more in the 7th year onward in annual salary if she pursues PhD

23
then teaching, which is $50,998.50 compared to $50,000. Furthermore, pursuing PhD

then teaching choice will make Francesca accumulates more wealth in long run as the

final yearly salary is $74,997.52 compared to $50,000. Lastly, it will not be a simple

calculation as well as a prediction in reality as there are many future possibilities and

other costs that we does not take into account such as job security and stability, living

cost etc.

QUESTION 4

Pure or perfect competition is a theoretical market structure in which the following

criteria are met: All firms sell an identical product (the product is a "commodity" or

"homogeneous"); All firms are price takers (they cannot influence the market price of

their product); Market share has no influence on prices; Buyers have complete or

"perfect" information—in the past, present and future—about the product being sold and

the prices charged by each firm; Resources for such a labor are perfectly mobile; Firms

can enter or exit the market without cost (Hayes, 2020).

a.

Total Cost Function in Short Run

SRTC = a + bQ + cQ2

SRTC = 5,000 + 150Q – 12Q2 + (1/3)Q3

MC = d(SRTC) / dQ = b + 2cQ + 3dQ2

MC = d(SRTC)/dQ = 150 – 24Q + Q2

24
P = $330

Equilibrium at P = MC, therefore

330 = 150 – 24Q + Q2

Q2 – 24Q – 180 = 0

Q2 – 30Q + 6Q – 180 = 0

Q(Q – 30) + 6(Q – 30) = 0

(Q – 30)(Q + 6) = 0

Q = – 6 or Q = 30

We reject Q = – 6 because Q cannot be negative or quantity sold will always be positive.

Q = 30 units.

The firm has profit maximising output at 30 units.

b.

Total Revenue = TR = P*Q

TR = 330*30 = $9900

SRTC = 5,000 + 150Q – 12Q2 + (1/3)Q3

SRTC = 5,000 + 150*30 – 12*302 + (1/3)303

SRTC = 5,000 + 150*30 – 12*302 + (1/3)303

SRTC = 5,000 + 4,500 – 10,800 + 9000

SRTC = $7700

Therefore,

Profit in short run = Total Revenue – Total Cost

25
 = $9900 - $7700

= $2200

c.

i.

Long Run Cost Function

LRTC = aQ + bQ2 + cQ3

LRTC = 660Q – 9Q2 + 0.05Q3

LRTC / Q = 660 – 9Q + 0.05Q2 (Equation for Long Run Average Cost)

ii.

The firm produces at a point where Price = min ATC in the long run and earns only

normal profits. For min ATC,

dATC / dQ = – 9 + 0.10Q = 0

0.10Q = 9

Q = 9 / 0.1 = 90 units

P = ATC at Q = 90 is = 660 – 9*(90) + 0.05*902 = 255

Therefore long run price is P = $255

Profit in the long run = (P – ATC)*Q

= (255 – 255)*90

=0

26
PART 3

QUESTION 5

a.

The following is the demand function:

P = a – bQ

P = $250 – $0.15Q

Total Revenue = TR = P x Q = aQ – bQ2 therefore

TR = $250 - $0.15Q2

The total revenue function is differentiated to know the marginal revenue (MC), the

function which is:

Marginal Revenue = MR = dTR / dQ = a – 2bQ, therefore

MR = d($250 – $0.15Q2) / dQ

= $250 – $0.3Q

The following is the cost function:

Total Cost = Fixed Cost + Variable Cost

27
TC = FC + VC therefore

TC = $25,000 + $10Q

On differentiating the total cost function:

Marginal Cost = MC = d(TC) / dQ therefore

MC = d($25,000 + $10Q) / dQ

= 10

The following is condition for profit maximization:

MR = MC

$250 – $0.3Q = 10

0.3Q = 240

Q = 240 / 0.3

= 800 units

The profit maximizing output is 800 units.

Substituting the value of output in the demand function:

P = $250 – $0.15Q

= $250 – $0.15(800)

= $250 – $120

= $130

The profit maximizing price is $130.

28
Total Profit = Total Revenue – Total Cost

TP = TR – TC therefore

= 130*800 – 25,000 – 8,000

= $71,000

The total profit is $71,000.

Rate of Return = (Profit / Assets)100 therefore

Rate of Return = ($71,000 / $500,000)100

= 14.2%

The rate of return of the firm earn on its asset base is 14.2%.

b.

Proposed price change as $100 per unit:

P = $250 – $0.15Q

100 = 250 – $0.15Q

$0.15Q = 150

Q = 150 / 0.15

= 1,000 unit

Total Profit = Total Revenue – Total Cost

TP = TR – TC therefore

= 100*1000 – [25,000 + $10(1,000)]

29
 = 100,000 – 35,000

= $65,000

The total profit is $65,000, which it has been reduced $6,000 compare to previously total

profit of $71,000.

Rate of Return = (Profit / Assets)100 therefore

Rate of Return = ($65,000 / $500,000)100

= 13%

The rate of return of the firm earn on its asset base is 13%.

c.

The price that allows the profit not more than the 10 percent of asset value:

Price = Average Total Cost + Average Profit / Unit therefore

250 – 1.5Q = (25,000 / Q) + 10 + [0.10(500,000) / Q]

0.15Q2 – 240Q + 75,000 = 0

Solving for quadratic equation:

Q = –b ± √b2 – 4ac / 2a

= 240 ± √2402 – 4(0.15)(75,000) / 2(0.15)

= 1174.16 or 425.83

The value of output in the demand function:

P = $250 – $0.15Q

30
 = $250 – $0.15(1174.16)

= 250 – 176.124

= $73.87

The price is $73.87.

Total Profit = Total Revenue – Total Cost

TP = TR – TC therefore

= 73.87*1174.16 – [25,000 + $10(1174.16)]

= 86,735.19 – 36,741.60

= $49,993.59

The total profit is $49,993.59.

31
QUESTION 6

Managerial economics refers to the application of economic theory and the tools of

analysis of decision science to examine how an organization can achieve its objectives

most effectively (Salvatore, 2012). According to Murphy (2019), the theory of the firm is

the microeconomic concept founded in neoclassical economics that states that a firm

exists and make decisions to maximize profits. The theory holds that the overall nature of

companies is to maximize profits meaning to create as much of a gap between revenue

and costs. The firm's goal is to determine pricing and demand within the market and

allocate resources to maximize net profits. According to McGuigan, Moyer and Harris

(2005), shareholder wealth is equal to the value of a firm’s common stock which, in turn,

is equal to the present value of all future cash return expected to be generated by the firm

for the benefit of its owners. In short, the basic goals of a firm are usually two-fold as

Profit Maximisation and Shareholder Wealth Maximisation.

GM was once bankruptcy and the US government with American taxpayers rescued it

from bankruptcy with a $49.5 billion federal bailout in 2009. On 26th November 2018,

32
GM announced it would cut roughly 14,000 jobs and idle five factories in North

America, including the Lordstown plant, which employs 1,600 workers (The Guardian,

2018) as it deals with slowing sedan sales and the impact of Donald Trump’s tariffs. The

car plants – Lordstown Assembly in Ohio, Detroit-Hamtramck Assembly and Oshawa

Assembly – all build slow-selling cars (The Guardian, 2018). GM Chairman and CEO

Mary Barra said the company was reacting to slow sales of sedans and rising costs from

Donald Trump’s steel and aluminium tariffs (The Guardian, 2018); the need to allocate

investments in developing autonomous vehicles and electric vehicles (Wharton Business

Daily, 2018). GM said in a statement that the move is part of its 2015 strategy “to

strengthen its core business, capitalize on the future of personal mobility and drive

significant cost-efficiencies”. The plant closures and layoffs are contributing to the cash

savings of approximately $6 billion are cost reductions of $4.5 billion and a lower capital

expenditure annual run rate of almost $1.5 billion. (Putre, 2018; General Motors, 2018).

I strongly agree GM Chairman and CEO Mary Barra’s decision. I believe it was not her

alone who made the decision solely but also from the support & mass agreement from

GM top management team. In long run, the five plants which manufacturing slow-selling

sedan were the huge fixed cost, including the workers who worked in these plants. In this

case, high fixed cost but low variable cost had GM under financial pressure. Like what

Shih (2018) commented, capital-intensive factories have a high-fixed-cost, low-variable-

cost operating model. If you greatly reduce the production volume, the cars that do come

out have to absorb more of the fixed costs, and that eventually sends the product into a

profitability death spiral. Every day GM operates such factories, it expends more

33
resources that could be redeployed elsewhere. On the other hand, it was far better for GM

to reallocate resources to better demanded and future potential products like autonomous

vehicles and electric vehicles. There was a statement reported by Chapman from Chicago

Tribune on 30th April 2019, for the three months ended March 31st, GM earned $2.12

billion, or $1.48 per share. A year earlier it earned $1.03 billion, or 72 cents per share.

Lastly, I reckon GM must always stay with its basic goal in business: To Achieve Profit

Maximisation and Shareholder Wealth Maximisation.

PART 4

QUESTION 7

a.

Manufactured Items = Q1

Manufactured Raw Materials = Q2

Demand function for two classes of goods,

P1 = 100 – 2Q1

Total Revenue for manufactured item:

TR1 = Price*Quantity

= (100 – 2Q1)Q1

= 100Q1 – 2Q12

Total Revenue for semimanufactured raw materials:

P2 = 80 – Q2

TR2 = Price*Quantity

= (80 – Q2)Q2

= 80Q2 – Q22

34
Total Cost Function:

TC = 20 + 4(Q1 + Q2)

= 20 + 4Q1 + 4Q2

Total Profit Function:

Total Revenue (TR) – Total Cost

= TR1 + TR2 – TC

= (100Q1 – 2Q12) + (80Q2 – Q22) – (20 + 4Q1 + 4Q2)

= – 20 + 96Q1 + 76Q2 – 2Q12 – Q22

b.

Profit maximizing price and output

Differentiating the total profit function with respect to the Q1:

Mπ1 = d / dQ1 * (TPF)

= d / dQ1 * (– 20 + 96Q1 + 76Q2 – 2Q12 – Q22)

= 96 – 4Q1

96 – 4Q1 = 0

4Q1 = 96

Q1 = 96 / 4

= 24 units

P1 = 100 – 2Q1

= 100 – 2(24)

= $52

35
The profit-maximizing level of price and output for manufactured items are at $52 and 24

units respectively.

Differentiating the total profit function with respect to the Q2:

Mπ2 = d / dQ2 * (TPF)

= d / dQ2 * (– 20 + 96Q1 + 76Q2 – 2Q12 – Q22)

= 76 – 2Q2

76 – 2Q2 = 0

2Q2 = 76

Q2 = 76 / 2

= 38 units

P2 = 80 – Q2

= 80 – 38

= $42

The profit-maximizing level of price and output for semimanufactured raw materials are

at $42 and 38 units respectively.

c.

Marginal Revenue in each market:

Total Revenue (TR) = TR1 + TR2

= (100Q1 – 2Q12) + (80Q2 – Q22)

MR1 = d / dQ1 * TR

MR1 = d / dQ1 * (100Q1 – 2Q12) + (80Q2 – Q22)

36
 = – 4Q1 + 100

= – 4(24) + 100

= – 96 + 100

= $4

Marginal Revenue = Marginal Cost, therefore

The marginal cost for manufactured good is $4.

MR2 = d / dQ2 * TR

MR2 = d / dQ2 * (100Q1 – 2Q12) + (80Q2 – Q22)

= – 2Q2 + 80

= – 2(38) + 80

= – 76 + 100

= $4

Marginal Revenue = Marginal Cost, therefore

The marginal cost for semimanufactured raw material is $4.

d.

Total Profit if different prices are charged in market

Total Profit Function:

Total Revenue (TR) – Total Cost

= – 20 + 96Q1 + 76Q2 – 2Q12 – Q22

= – 20 + 96(24) + 76(38) – 2(24)2 – (38)2

= – 20 + 2,304 + 2,888 – 1,152 – 1,444

37
= $2,576

Total Profit if different prices are charged in market is $2,576

e.

Assume the price of both manufactured items and semi-manufactured raw materials are

the same:

P1 = P2

100 – 2Q1 = 80 – Q2

Q2 = – 20 + 2Q1

Total Profit Function:

Total Revenue (TR) – Total Cost (TC)

– 1940 + 328Q1 – 6Q12

Differentiating it with respect to Q1

Mπ1 = d/dQ1*(– 1940 + 328Q1 – 6Q12)

= 328 – 12Q1

Equation the marginal profit with zero

328 – 12Q1 = 0

Q1 = 328 / 12

= 27.33

38
Substituting the value of Q1

Q2 = – 20 + 2Q1

Q2 = – 20 + 2(27.33)

= 34.66

Total Production = 27.33 + 34.66

= 61.99

Following is the price of manufactured items:

P1 = 100 – 2Q1

= 100 – 2(27.3)

= $45.4

Profit at equalized price

π = Price * Quantity – Total Cost

= (45.4) * (61.99) – 20 – 4(61.9)

= 2814.346 – 20 – 247.6

= $2,546.746

f.

Elasticity of demand manufactured good (E1)

= (∂Q1 / ∂P1) * (P1 / Q1)

P1 = 100 – 2Q1

Q1 = 50 – (1 / 2) * P1

39
Differentiating with respect to the price

(∂Q1 / ∂P1) = – 1 / – 2

E1 = (– 1 / – 2) * (45.4 / 27.3)

= -0.83

Elasticity of demand manufactured good (E2)

= (∂Q2 / ∂P2) * (P2 / Q2)

P2 = 80 – Q2

Q2 = 50 – P2

Differentiating with respect to the price

(∂Q2 / ∂P2) = – 1

E2 = – 1 * (45.4 / 34.6)

= -1.3

40
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