MANGERIAL ECONOMICS AND BUSINESS STRATEGY

BE 401
Winter 2022
Selected Solutions to Homework Problems

Chapter 1:

2. The maximum you would be willing to pay for this asset is the present value, which is

250,000 250,000 250,000 250,000 250,000

PV = + + + +
(1+0.08) (1+ 0.08) (1+0.08) (1+ 0.08) (1+0.08)5
2 3 4

¿ $ 998,177.51

3.
a. Net benefits are N(Q) = 20 + 24Q – 4Q2.
b. Net benefits when Q = 1 are N(1) = 20 + 24 – 4 = 40 and when Q = 5 they are N(5) = 20 +
24(5) – 4(5)2 = 40.
c. Marginal net benefits are MNB(Q) = 24 – 8Q.
d. Marginal net benefits when Q=1 are MNB(1) = 24 – 8(1) = 16 and when Q=5 they are
MNB(5) = 24 – 8(5) = -16.
e. Setting MNB(Q) = 24 – 8Q = 0 and solving for Q, we see that net benefits are maximized
when Q = 3.
f. When net benefits are maximized at Q = 3, marginal net benefits are zero. That is, MNB(3) =
24 – 8(3) = 0.

12. Effectively, this question boils down to the question of whether it is a good investment to spend
an extra $250 on a refrigerator that will save you $40 at the end of each year for five years. The
net present value of this investment is

$ 40 $ 40 $ 40 $ 40 $ 40
NPV = + + + + −$ 250
1.06 ( 1.06 ) ( 1.06 ) ( 1.06 ) ( 1.06 )5
2 3 4

¿ $ 168.49−$ 250

¿−$ 81.51.

You should buy the standard model, since doing so saves you $81.51 in present value terms.
Chapter 2:
2.
a. The supply of good X will increase (shift to the right).
b. The supply of good X will decrease. More specifically, the supply curve will shift vertically up
by exactly $3 at each level of output.
c. The supply of good X will decrease. More specifically, the supply curve will rotate counter-
clockwise.
d. The supply curve for good X will increase (shift to the right).

5.
a. Solve the demand function for Px to obtain the following inverse demand function:
1 d
P x =125− Q x.
4
d
b. Notice that when Px = $50, Q x =500−4 ( 50 ) =300 units. Also, from part a, we know the
vertical intercept of the inverse demand equation is 125. Thus, consumer surplus is $11,250
(computed as (0.5)($125-$50)300 = $11,250).
c. When price decreases to $35, quantity demanded increases to 360 units, so consumer
surplus increases to $16,200 (computed as (0.5)($125-$35)360 = $16,200).
d. So long as the law of demand holds, a decrease in price leads to an increase in consumer
surplus, and vice versa. In general, there is an inverse relationship between the price of a
product and consumer surplus.

6.
e. Equating quantity supplied and quantity demanded yields the equation 60−P=P−20.
Solving for P yields the equilibrium price of $40 per unit. Plugging this into the demand
equation yields the equilibrium quantity of 20 units (since quantity demanded at the
equilibrium price is Qd =60−( 40 ) =20).
f. A price floor of $50 is effective since it is above the equilibrium price of $40. As a result,
quantity demanded will fall to 10 units (Qd =60−50), while quantity supplied will increase
to 30 units (Qs =50−20 ). That is, firms produce 30 units but consumers are willing and able
to purchase only 10 units. Therefore, at a price floor of $50, 10 units will be exchanged.
Since Qd < Qs there is a surplus amounting to 30-10 = 20 units.
g. A price ceiling of $32 per unit is effective since it is below the equilibrium price of $40 per
unit. As a result, quantity demanded will increase to 28 units ( Q d =60−32=28 ), while
quantity supplied will decrease to 12 units (Qs =32−20=12). That is, while firms are
willing to produce only 12 units consumers want to buy 28 units at the ceiling price.
Therefore, at the price ceiling of $32, only 12 units will be available to purchase. Since Q d >
Qs, there is a shortage amounting to 28-12 = 16 units. Since only 12 units are available at a
price of $32, the full economic price is the price such that quantity demanded equals the 12
available units: 12 = 60 – PF. Solving yields the full economic price of $48.
Chapter 3:

1.
h. When P = $12, R = ($12)(1) = $12. When P = $10, R = ($10)(2) = $20. Thus, the price decrease
results in an $8 increase in total revenue, so demand is elastic over this range of prices.
i. When P = $4, R = ($4)(5) = $20. When P = $2, R = ($2)(6) = $12. Thus, the price decrease
results in an $8 decrease in total revenue, so demand is inelastic over this range of prices.
j. Recall that total revenue is maximized at the point where demand is unitary elastic. We also
know that marginal revenue is zero at this point. For a linear demand curve, marginal
revenue lies halfway between the demand curve and the vertical axis. In this case, marginal
revenue is a line starting at a price of $14 and intersecting the quantity axis at a value of Q =
3.5. Thus, marginal revenue is 0 at 3.5 units, which corresponds to a price of $7 as shown
below.

Price $14

$12

$10

$8

$6

$4

$2
Demand
$0
0 1 2 3 MR 4 5 6 Quantity

Figure 3-1

3.
a. The own price elasticity of demand is simply the coefficient of ln Px, which is – 1.5. Since
this number is more than one in absolute value, demand is elastic.
b. The cross-price elasticity of demand is simply the coefficient of ln Py, which is 2. Since this
number is positive, goods X and Y are substitutes.
 c. The income elasticity of demand is simply the coefficient of ln M, which is -0.5. Since this
number is negative, good X is an inferior good.
d. The advertising elasticity of demand is simply the coefficient of ln A, which is 1.

Chapter 4:

1.
−Px −15
k. The market rate of substitution is = =−3.
Py 5
l. See Figure 4-1.
m. Increasing income to $600 (by $300) expands the budget set, as shown in Figure 4-1. Since
the slope is unchanged, so is the market rate of substitution.

Budget Set

140

120

100

80
Y Increase in
60
Income
40

20

0
0 5 10 15 20 25 30 35 40
X

Figure 4-1

2.
−20
a. Since the slope of the line through point A is =−1and the price of good X is $5, it
20
follows that Py = 5.
b. If the consumer spends all her income on good X she can purchase 20 units. Since these
units cost $5 each, her income must be $100.
c. At point A, the consumer spends ($5)(10) = $50 on good Y, which means that the remaining
$100 - $50 = $50 is being spent on good X. Since good X costs $5 per unit, point A
corresponds to 10 units of good X.
d. The price of good Y decreased to $2.50. The consumer achieves a higher level of satisfaction
at point B.
Chapter 5:

2. See Table 5-1.

(1) (2) (3) (4) (5) (6) (7)
Marginal Average Average Value Marginal
Capital Labor Output Product of Product of Product of Product of Capital
Capital MPK Capital APK Labor APL VMPK
0 20 0 - - - -
1 20 50 50 50 2.50 200
2 20 150 100 75 7.50 400
3 20 300 150 100 15 600
4 20 400 100 100 20 400
5 20 450 50 90 22.50 200
6 20 475 25 79.17 23.75 100
7 20 475 0 67.86 23.75 0
8 20 450 -25 56.25 22.50 -100
9 20 400 -50 44.44 20 -200
10 20 300 -100 30 15 -400
11 20 150 -150 13.64 7.50 -600

Table 5-1

a. Labor is the fixed input while capital is the variable input.

b. Fixed costs are 20($30) = $600.
c. To produce 475 units in the least-cost manner requires 6 units of capital, which cost $25
each. Thus, variable costs are ($25)(6) = $150.
d. Using the VMPK = r rule, K = 6 maximizes profits.
e. The maximum profits are $4(475) - $30(20) - $25(6) = $1,150.
f. There are increasing marginal returns when K is between 0 and 3.
g. There are decreasing marginal returns when K is between 3 and 11.
h. There are negative marginal returns when K is greater than 7.

w
12. Since MRTS KL ≠ , the firm was not using the cost minimizing combination of labor and
r
capital. To achieve the cost minimizing combination of inputs, the previous manager should
MP L 110 MP K 120
have used more units of labor and fewer units of capital, since = > = .
w 9 r 14

18. Facility “L” produces 6 million kilowatt hours of electricity at the lowest average total cost, so
this is the optimal facility for South-Florida. Facility “M” produces 2 million kilowatt hours of
electricity at the lowest average total cost, so this is the optimal facility for the Panhandle.
There are economies of scale up to just below 3 million kilowatts per hour for facility “M,” and
diseconomies of scale thereafter. There are economies of scale up to just below 4 million
 kilowatts per hour for facility “L,” and diseconomies thereafter. Therefore, facility “M” will be
operating in the range of economies of scale while facility “L” will be operating in the range of
diseconomies of scale.

Chapter 6:

3.
a. Contract.
b. Vertical Integration.
c. Spot exchange (or possibly contract if a specific investment in many motors is required).
d. Spot exchange

10.
a. When the MB = 130, the optimal contract length sets this equal to MC, yielding L =
30.
b. When the MB = 170, the optimal contract length sets this equal to MC, yielding L =
43.33.
c. Increases in the marginal benefit to writing a contract increase the contract length.
Decreases in the marginal benefit to writing a contract decrease the contract length.

Chapter 7:

1. The four-firm concentration ratio is:

$ 425,000+ $ 385,000+ $ 320,000+$ 290,000

C 4= =0.47 .
$ 3,000,000

[( ) ( ) ( ) ]=4,438.
2 2 2
$ 225,000 $ 45,000 $ 315,000
a.The HHI is HHI =10,000 + +
585,000 $ 585,000 $ 585,000
b. The four-firm concentration ratio is 100 percent.
C. If the firms with sales of $225,000 and $315,000 were allowed to merge, the resulting HHI
would increase by 4,142 to 8,580. Since the post-merger HHI exceeds that under the Guidelines
(2,500) and the HHI increases by more than that permitted under the Guidelines (200), the
merger is likely to be challenged.

3. The elasticity of demand for a representative firm in the industry is –1.6, since
−0.8 −0.8
0.5= ⇒ EF= =−1.6.
EF 0.5
Chapter 8:

1.
a. The point where marginal revenue equals (intersects) marginal costs: 7 units.
b. The firm is a price taker at $28, which is why the demand curve is flat.
c. At 7 units, average total cost is $32. Therefore, total cost is $224, since $32 × 7 = $224.
d. At 7 units, average fixed cost is $14. Therefore, total fixed cost is $98, since $14 × 7 = $98.
e. $126 (the difference between total cost and variable cost).
f. It is earning a loss of $28, since ($28 -$32) x 7 = - $28.
g. - $126, since its loss will equal its fixed costs.
h. Shut down.

2.
a. Set P = MC to get $110 = 14 + 4Q. Solve for Q to get Q = 24 units.
b. $110.
c. Revenues are R = ($110)(24) = $2640, costs are C = 70 + 14(24) + 2(24) 2 = $1558, so profits
are $1082.
d. Entry will occur, the market price will fall, and the firm should plan to reduce its output. In
the long-run, economic profits will shrink to zero.

5
e. A perfectly competitive firm’s supply curve is its marginal cost curve above the minimum of
2 58 qi−6 q2i +q 3i 2
its AVC curve. Here, MC i=58−12q i +3 q i and AVC i= =58−6 qi +qi . Since
qi
MC and AVC are equal at the minimum point of AVC, set MC i = AVCi to get
58−12q i+ 3 q2i =58−6 q i+ q2i , or qi = 3. Thus, AVC is minimized at an output of 3 units, and
2
the corresponding AVC is AVC i=58−6 ( 3 ) + ( 3 ) =49. Thus the firm’s supply curve is
described by the equation MC i=58−12q i +3 q2i if P ≥ $49; otherwise, the firm produces
zero units.
f. A monopolist produces where MR = MC and thus does not have a supply curve.
g. A monopolistically competitive firm produces where MR = MC and thus does not have a
supply curve.
Chapter 9:

2
a−c 1 1 200−26 1
a. Q1= − Q2 = − Q2=29−0.5 Q2 and
2b 2 2(3) 2
a−c 2 1 200−32 1
Q 2= − Q 1= − Q1=28−0.5Q 1
2b 2 2(3) 2
b. Q1 = 29 – 0.5(28 – 0.5Q1) = 15 – 0.25Q1. Solving for Q1 yields Q1 = 20. A similar process yields
Q2 = 18.
c. P = 200 – 3(20 + 18) = $86.
d. Π1 = (86-26)20 = $1200; Π2 = (86-32)18 = $972.

4
a−c F 1 16,000−6,000 1
e. Q F= − QL= − Q L=1,250−0.5 Q L
2b 2 2(4) 2
a+ c F −2 c L 16,000+6,000−2(4,000)
f. Q L= = =1,750; QF = 1,250 – 0.5(1,750) = 375.
2b 2(4)
g. P = 16,000 – 4(2125) = $7,500.
h. ΠL = $6.125 million; ΠF = $562,500.

Chapter 10:

1.
a. Neither player has a dominant strategy.
b. Player 1’s secure strategy is B. Player 2’s secure strategy is E.
c. (B, E).

2.
a.

Player 2

Strategy A B

Player 1 A $400, $400 $100, $600

B $600, $100 $200, $200

 b. B is dominant for each player.
c. (B, B).
d. Joint payoffs from (A, A) > joint payoffs from (A, B) = joint payoffs from (B, A) > joint payoffs
from (B, B).
e. No; each firm’s dominant strategy is B. Therefore, since this is a one-shot game, each player
would have an incentive to cheat on any collusive arrangement.
Chapter 11:

1.

a. Since E = EF = EM, P= ( 1+EE ) MC=( 1−3

−3
) $ 100=$ 150.
b. P=
(
EF
1+ EF
MC=
) (
N EM
1+ N E M
$ 100=
)
2(−3)
1+ 2(−3) (
$ 100=$ 120.
)
c. P=
(
EF
1+ EF
MC=
) (
N EM
1+ N E M
$ 100=
)
20(−3)
1+ 20(−3) (
$ 100=$ 101.69.
)
2.
a. MR = MC at Q = 4. Inverse demand at Q = 4 is P = $60. Therefore, Q = 4, P = $60, and profits
= 4($60 – $20) = $160.
b. Charge the maximum price on the demand curve starting at $100 down to $20 for each
infinitesimal unit up to Q = 8 units. Profits are 8($100 – $20)(.5) = $320.
c. Charge a fixed fee of $320 and a per-unit charge equal to MC ($20 per unit). Output is 8
units and total profits are $320.
Create a package of 8 units and sell the package for $480. Total profits are

Chapter 12:

2
a. Both options have the same expected value but only the first has an uncertain outcome.
Therefore, preference for the first indicates the decision maker is risk loving.
b. Both options have the same expected value but only the second has an uncertain outcome.
Therefore, preference for the first indicates the decision maker is risk averse.
c. Both options have the same expected value but only the second has an uncertain outcome.
Therefore, indifference between both options indicates the decision maker is risk neutral.

5
d. The expected value, which is 0.5($60) + 0.5($0) = $30.
e. The maximum value, which is $60. The warranty removes the risk of having an unreliable
product.