Dennis B Lacson Jr.

BSMA-1E

Managerial Economics

Activity No. 2

1. How will commercial airlines respond to the threat of new $27,500 fines for keeping passengers
on the tarmac for more than 3 hours? What Inefficiency will this create?

 It may claim that they will actively cancel flights before and during storms in order to
avoid paying those fines—even if the inclement weather never occurs. Threats might
portend major changes in air travel, making it even less dependable for millions of
travelers and business travelers. When storms hit, it may take days for everyone to get
home if flights are canceled.

2. I recently sold my used car. If no new production occurred for this transactions, how could it
have created value?

 When the assets are put to higher-value purposes, wealth is created. A buyer only
purchases anything during a transaction if the price she/he must pay for it is equal to or
less than the value she assigns to it . Similar to this, a seller only sells a product if the
price he obtains for it is equal to or more than the lowest price he/she would be ready
to accept. This suggests that a wealth-creating transaction is feasible as long as the
seller’s value is lower than the buyer’s worth . If the deal goes through, it signifies that
the price was between the seller’s bottom line.

3. The US government subsidizes flood insurance because those who want to buy it live in the
flood plain and cannot get it at reasonable rates. What Inefficiency does this create?

* In this sense, subsidies are similar to taxes. Taxes will prevent some profitable transactions
from happening because otherwise feasible deals where the valuation gap between the buyer
and seller is favorable will no longer generate enough revenue to cover the tax obligations. The
asset can’t switch to its highest-valued usage as a result. With a subsidy, transactions where an
asset is transferred from a higher to a lower valued use may be completed as long as the
difference is below the subsidy’s value. As a result, the asset is put to a lower-value use.
Example, Homeowners would be willing to invest 120,00 to build a house that they value at just
100,000 if flood insurance were projected to be worth 20,000. Wealth is ruined
 4. When Kraft recently bid $16.7 billion for Cadbury, Cadbury’s market value rose, but Kraft’s
market value fell by more. What does this tell you about The value-creating potential of the deal?

 I think because Kraft’s offer is higher than the estimated future profits from Cadbury at their
current valuation.

5.Two similar surgeries breast reconstruction and breast augmentation, have different prices. Breast
augmentation is cosmetic surgery not covered by health insurance. Patients who want the surgery must
pay for themselves. Breast reconstruction following breast removal due to cancer is covered by
insurance. The price for one of the surgeries has increased by about 10% each year since 1995 while the
other has increased by only 2% per year. Which of the surgeries has the lower inflation rate? Why?

 Due to the stronger price elasticity of demand for breast augmentation surgery, it will have a
lower inflation rate than breast reconstruction surgery. We might assume that client demand for
the surgery is price sensitive since breast augmentation is a cosmetic procedure that is not
covered by health insurance. Customers can be deterred from having the surgery if the cost
rises quickly.