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Econ analysis for managers

Econ analysis for managers

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You are on page 1of 10

MBA 614: Economic Analysis for Managers

Instructor: Dr. Ke Yang

Exam #1

Total: 100 points

Summer 2014

Instruction:

Read question carefully and be sure you answer all parts of the question you choose. Please make sure

you show all the reasoning and steps that lead to your final conclusion. Partial credit will be given if

your answer is on the right track but not complete.

Make sure all the notations and marks in your calculation and graphs are legible.

**************************************************************************************

1. (20 points) If demand is represented by Qd = 50 -.5P +.005I where I is income and I=$50,000 and supply

is represented by Qs = 100 +.4P - 2W where W is wages and W=$15.00.

a) Compute the equilibrium price and quantity where wages=W=$15.00.

b) Compute the equilibrium price and quantity if income falls to I=$40,000?

c) Plot the demand and supply for the two income level. In the graph, mark all values that fully

identify the curve.

a) At equilibrium

Qs = Q

d

100 +.4P - 2W = 50 -.5P +.005I

100 + .4P -2(15) = 50 -.5P +.005(50,000)

.9P=230

P *= 255.55

Plugging this in supply equation we get Q* = 172.22 or 172

b) At equilibrium

Qs = Q

s

Or Qs = 100 +.4P - 2W = 50 -.5P +.005I

100 + .4P -2(15) = 50 -.5P +.005(40,000)

.9P = 180

P* = 200

Plugging this in supply equation we get Q* = 150

c) Supply intercept

Qs = 100 +.4P - 2W

Qs = 100 + .4P -2(15)

1/.4 Qs = 100/.4 + P -30/.4

=2.5Qs = 250+P-75

P= -175 +2.5 Q

Demand intercept

Old demand with income @50,000

Q

d

= 50 -.5P +.005(50,000)

Q

d

= 50 -.5P +250

1/.5 Q

d

= 50/.5 P + 250/.5

2 Q

d

= 100-P+500

P = 600 2 Q

d

New demand with income @ 40,000

Q

d

= 50 -.5P +.005(40,000)

Q

d

= 50 -.5P +200

1/.5 Q

d

= 50/.5 P + 200/.5

2 Q

d

= 100-P+400

P = 500 2 Q

d

P

Q

$175

$600

$500

D1

D2

$255.55

172 150

$200

Income @50,000

Income @40,000

University of Hartford

Barney School of Business and Public Administration

MBA 614: Economic Analysis for Managers

Instructor: Dr. Ke Yang

Exam #1

Total: 100 points

Summer 2014

2. (20 points) Suppose an investment can yield three possible cash flows with their probabilities given in

the parentheses: $600(p=0.5); $-100 (p=0.2) and $800 (p=0.3).

a) Compute the expected value and the standard deviation of this investment. Is this investment risky?

Why?

E(x) = .5 x 600 + (-100 x.2) + 800 x .3

= 520

Variance = .5(600 -520)

2

+ .2(-100-520)

2

+ .3 (800 -520)

2

= 103,600

SD = (103,600)

1/2

= 321.86

Higher SD reflects more risk. Here the difference between E(x) and SD is higher by a lot, we can

therefore classify this investment as risky.

b) The equation E(x)=359 + 0.5SD describes the indifference curve of this investor. Is this investor risk

averse, risk neutral, or risk loving? Explain your answer and draw the curve.

E(x)=359 + 0.5SD

520 = 359 + .5(321.86) or E(x) is 520 and SD is 160.93

Yes, person is risk averse. She is willing to take on more risk and stay equally happy only if there is an increase

in expected return. In other words- if you are compensated for additional risk you are risk averse. Since the

risk is bad the IC is positively sloped. The person gains utility from an increase in expected value but he

experiences a reduction in utility from increase in the Sd.

$ 520

$359

160.93 Sd(x)

E(x)

Risk Premium $161

c) How much would this person pay for the investment opportunity (certainty equivalent of the current

investment)? How much is risk premium for the current investment?

The certainty equivalent (i.e. risk free investment) is $359. She would be willing to accept a certain return of

$359 (the vertical intercept of her indifference curve) at zero risk

The risk premium $161.

RP= E(x) RFI (Risk free investment).

3. (20 points) Patrick consumes only two goods: Celtic Music concerts and Celtic Springs Water. Patrick

earns $100 per month at his part-time job in the library. The price of Celtic concerts is $10. The price of

Celtic Springs Water is $2. Patrick currently goes to 5 Celtic concerts and consumes 25 bottles of Celtic

Spring Water in a month.

(a) Draw Patrick's budget constraint and optimal consumption bundle. Please put Celtic concerts on the x-

axis.

Budget constraint

Celtic Music Concert ( good x) and Celtic Spring Water (good y)

P

x

= $10 and Income (I) = $100 -> I/P

x

= 100/10

P

y

=$2 and I = $100 -> I/P

y

= 100/2 = 50

Optimal Consumption Bundle has two assumptions

1) the optimal bundle lies on the budget line and 2) Indifference curve (IC) is tangent to the BL at the

optimal bundle.

Equation for BL = I = (P

x

) x + (P

y

) y (here P

x

= price of x or price of Celtic Music concert and x is the

quantity we have to buy of music concert. Similarly, P

y

is the price of the spring water and y is the quantity

of the water and I = income)

= 100 = 10x + 2y

We also know that if the indifference curve and budget line are tangent, they have the same slope at that

point

Slope of IC = -MRS

x.y

= - MU

x

/ MU

y

and given that U = x*y slope of IC is y/x

Slope of BL = -P

x

/ P

y

= -10/2

University of Hartford

Barney School of Business and Public Administration

MBA 614: Economic Analysis for Managers

Instructor: Dr. Ke Yang

Exam #1

Total: 100 points

Summer 2014

We mentioned that Slope of IC = Slope of BL

-y/x = -10/2 or y = 5x

No we have two equations and two unknowns, Using them to solve optimal bundle of x and y

100 = 10x + 2y and y = 5x

100 = 10x +2(5x) -> 100 =10x+10x -> x= 5. Plugging this in y = 5x we get y=25, which means that the

optimal bundle is Celtic Music concert = 5 and Celtic spring water is 25. As plotted in the graph his existing

income of 100 is allowing to gain maximum utility and currently consumes optimal bundle.

(b) In April Patrick receives a 5% pay increase. Meanwhile the inflation raises the price of concerts to

$10.50 and the price of Celtic Springs Water to $2.10. Draw Patrick's new budget constraint and optimal

consumption bundle. Please put Celtic concerts on the x-axis. How many Celtic concerts does he attend in

April? How many bottles of water does he drink in April?

Using the same principle as above the answer is going to remain the same since there is a proportionate increase

of 5% in Patricks income, Price of music concert and spring water. So the optimal bundle will remain as 5

music concerts and 25 spring water. The curve is going to remain same as above. He will attend 5 concerts and

will drink 25 bottles.

Spring Water (y)

Music Concert (x)

I/Px =10

25

I/Py = 50

5

BL

IC

Optimal Point

4. (20 points) The demand equation for crossing the G.W.Bridge in New York City is P = 50-0.0001Q

where P is the toll at the bridge and Q is the number of vehicles that cross the bridge every day.

a. Compute the toll that would maximize revenue for the state of New York. At this toll, how many cars

would cross the bridge?

If P = 50-0.0001Q then D = 50,000-10,000P

TR = PxQ

TR= 50-0.0001Q x Q

TR = 50-0.0001Q

2

MR = Change in TR/ change in Q

TR is max when MR is 0 therefore

0 = 50 0.0002Q - > Q = 25000 and pugging this in the price equation we get P= 25

Total maximum revenue is 250000 x 25 = $6,250,000

b. What is the price elasticity at this toll? Explain your answer. Also illustrate this price/quantity

combination in a graph with demand curve and marginal revenue curve.

Point PEoD = P/Q * change in Q / change in P

Using the original demand equation we can find out that when price changes by1 there is a change in Q of -

10,000.

25/250000 * -10,000/1 = 1 = Point price elasticity

This means that the price is unit elastic which means with move higher in prices for toll will cause a

proportional decrease in the number of cars crossing the toll.

University of Hartford

Barney School of Business and Public Administration

MBA 614: Economic Analysis for Managers

Instructor: Dr. Ke Yang

Exam #1

Total: 100 points

Summer 2014

Total Revenue

0

50,000

$50

D

Price per unit

$25

# of cars MR

Quantity

$6250000

Quantity 25000o

N= 1

c. Suppose the company in charge of the maintenance of the bridge successfully negotiates a 20%

increase in its annual fee. The State of New York hires you to advise them how to cover this cost. Would

you advise them to raise the toll you computed in part a)? (Yes, or No, explain your answer). Would you

advise them to raise revenue some other way? Explain your answer.

Since we know that the PEoD is unit elastic. We know that increasing prices will decrease the total

revenue. For example if we were to increase the price to cover additional 20% and raise the price to $30.

Plugging this in the demand equation from above D = 50,000-10,000P. We get total number of cars as

200,000. This will reduce the TR to $6,000,000. Therefore I will not advise to change the price of the

toll.

Additional cost of increase in annual fee can be covered through non toll revenue such as billboard

advertisements on toll booth, revenue from service plazas, leveraging surplus property, expanding tag

usage and cost cutting by employing automated toll booths.

University of Hartford

Barney School of Business and Public Administration

MBA 614: Economic Analysis for Managers

Instructor: Dr. Ke Yang

Exam #1

Total: 100 points

Summer 2014

5. (20 points) England and Scotland both produce scones and sweaters. Suppose that an English worker

can produce 50 scones per hour or 1 sweater per hour. Suppose that a Scottish worker can produce 40 scones

per hour or 2 sweaters per hour.

Panel A (time to produce the product) Scones Sweaters

England for 1 unit of each .0200 hrs 1 hrs

Scotland for 1 unit of each .0250 hrs .50 hrs

Panel B (production in 1 hour)

England 50 1

Scotland 40 2

Total Units 90 OR 3

a. Which country has the absolute advantage in the production of each good? Which country has the

comparative advantage?

England to make 1 sweater will have to give up 50 scones and Scotland to make 1 sweater will have to give up

20 scones. Therefore, Scotland has comparative advantage in producing sweaters since it is giving up less

scones to make 1 sweater (20 scones instead of 50 scones in case of England) Conversely, England has absolute

advantage over Scotland in making scones since its giving up .020 of a sweater vs Scotland, which is giving up

.050 of the sweater to produce 1 cone.

b. If England and Scotland decide to trade, which commodity will Scotland trade to England? Explain.

Since Scotland has a comparative advantage in making sweaters they will make more of sweaters and specialize

in that product

c. If a Scottish worker could produce only 1 sweater per hour, would Scotland still gain from trade? Would

England still gain from trade?

Even if it only produces 1 sweater per hour, Scotlands opportunity cost will remain lower than England in

making scones since the rate of output is lower in Scotland. Therefore Scotland will gain from trading with

England. Scotland can trade 1 sweater it makes for 50 scones (assuming Englands total demand for sweater is

1) However, England will not gain much from this trade because before they were getting 2 sweaters for 50

scones and now they will get only 1 sweater. And if England decides to move to sweater production and decides

to trade with Scotland on scones- it will only get 40 scones.

Bonus Question (5 points): Comment on how you like the course so far and what we can do to improve your

learning experience of economic theory class, particularly when you take it online. (50-100words)

The course is really interesting. It allows me to grasp how markets function. But I am a little disappointed with

the way it had been taught. I was expecting lectures to go through details about nuances of several equations

and theories, which are hard to understand from just the book and PPTs. It feels very plain and less interactive.

Additionally- I think this course needs to link and discuss various real life instances to the course since this is a

graduate level course (I mean theories is all good, but I am looking for something for more than just formulas

and something like real life application) What will improve this course is recorded lectures where the instructor

explains the theories, applies to real life situations and discusses managerial applications, rather than relying on

books and text cases. I feel like I have been left to my devices. So far it feels like its more focus on theory than

practice. I honestly dont think the current level of instructions on presentations even makes a small dent.

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