Hult International Business School

Managerial Economics
DEM 3 Mod B 2016

Homework Answer Key

Total points: 100
Please answer the following questions and upload them on MyCourses before 12:00 noon
(Dubai Time) on Saturday, February 13. Please provide your answer first and then
explain how you got to the solution. All text must be typed, not handwritten.
Numeric grades will be assigned on the following basis:
Correct solution: 50%
Correct explanation: 50%
Up to 3 points of the total grade will be subtracted for handwritten documents (-3) or
unprofessional appearance (up to -2 for typos, improper formatting and the like)
PART I: FUNDAMENTALS OF MANAGERIAL ECONOMICS (18 points)
Please use the following information to answer the next 4 questions 1-4 (2 points each)
Amy Muscle is trying to whether to open a new health club. She presently makes $25,000 per
year as an aerobics instructor and will have to give up this job if she opens the health club.
This club will have 2 sources of revenues: (1) revenues from club memberships and (2)
revenues from personal trainer fees charged to those members who request a personal trainer.
Revenues from these personal trainer fees are expected to be $15,000 per year. Amy wants to
manage the club and combine it with that of the personal trainer at the club. If she chooses to
open the club, it will cost her $210,000 per year in rent and other operating expenses. Please
circle the correct answer (no explanation required for the 4 questions below).
1.

What are her yearly accounting costs of running the club?

a)
b)
c)
d)
e)
f)
g)
h)

$0
$25,000
$185,000
$200,000
$210,000
$225,000
$235.000
None of the above

2.

What are her total opportunity costs of running the club?

a)
b)
c)
d)
e)
f)
g)
h)

3.

How much revenue from club memberships would she need to earn to make 12.5%
accounting profit margin (Accounting profit divided by Sales) for the club?
a)
b)
c)
d)
e)
f)
g)
h)

4.

$0
$25,000
$185,000
$200,000
$210,000
$225,000
$235,000
None of the above

$25,000
$185,000
$200,000
$210,000
$225,000
$235,000
$243.500
None of the above

How much revenue from club memberships would she minimally need to earn to make
12.5% economic profit margin (Economic profit divided by Sales) for the club?
a)
b)
c)
d)
e)
f)
g)
h)

$25,000
$185,000
$200,000
$210,000
$225,000
$235,000
$243,500
None of the above

Please use the following table to answer questions 5 questions (2 points each).
Provide brief explanation (no more than two lines).
# Units Produced

Total Benefits ($)

Total Costs ($)

10

110

50

200

110

270

190

330

280

390

370

5.

What is the marginal benefit of producing the 5th unit?

6.

What is the marginal cost of producing the 3rd unit?

7.

What is the marginal net benefit of producing the 1st unit?

8.

What are the net benefits of producing 2 units?

9.

At what level of output is MB=MC?

PART II: DEMAND AND SUPPLY (14 points)

Please answer the following 2 questions.
Remark 1: Please use graphical demand/supply analysis to illustrate your points
Remark 2: When a question refers to the market (for a particular product) it means the
equilibrium price and the equilibrium quantity
10.

Caviar and Melba toast are complements. Recently pollution has been a problem in the
Volga River, where much of the world's caviar originates. The sturgeons that live in
these waters are laying fewer eggs than before. Show graphically and explain the
effects on the market for caviar and the market for Melba toast. (9 points)

11.

Caviar and Melba toast are complements. Recently pollution has been a problem in the
Volga River, where much of the world's caviar originates. The sturgeons that live in
these waters are laying fewer eggs than before. In addition, the Surgeon General has
identified and communicated a number of health hazards related to eating caviar. Show
graphically and explain the joint effects of these two factors on the market for caviar
(5 points)

PART III: COST ANALYSIS (16 points)

The following information applies to the next 4 questions (4 points each). Please circle the
correct answer (no explanation required for the 4 questions below).
You are the manager of an electricity generating company operating in what is close to a
perfectly competitive market as there are 10 other electricity generating companies in the
market. You own 4 production facilities:
The largest plant is a heating oil facility with a daily capacity of 4m kWh and a marginal cost
of $0.12 per kWh generated
The 2nd largest plant is a natural gas facility with a daily capacity of 3m kilowatt/hour (kWh)
and a marginal cost of $0.11 per kWh generated.
The 3rd largest plant is a nuclear facility with a daily capacity of 2m kWh and a marginal cost
of $0.07 per kWh generated.
The smallest plant is a brown coal plant with a daily capacity of 1m kWh and a marginal cost
of $0.08 per kWh generated.
Fixed costs are $10k per year for the next 10 years. There is no cost associated with turning a
plant on or off.
12.

Tomorrows market demand is expected to be P = 1 (Q/100,000,000), where Q is the

total volume of kWh. How much electricity do you plan to generate?
a)
b)
c)
d)
e)
f)
g)
h)

13.

None
More than 0 but less than 2m KWh
3m kW
4m kWh
5m kWh
6m kWh
10m kWh
Impossible to tell based on the above information

Tomorrows market price is expected to be $0.115. How much electricity do you plan
to generate?
a)
b)
c)
d)
e)
f)
g)
h)

None
More than 0 but less than 2m KWh
3m kW
4m kWh
5m kWh
6m kWh
10m kWh
Impossible to tell based on the above information

14.

What is the average variable cost (rounded to 3 decimal places if need be) of producing
the amount of kWh selected in the previous question?
a)
b)
c)
d)
e)
f)
g)
h)

15.

Zero
$0.070/kWh
$0.080/kWh
$0.092/kWh
$0.095/kWh
$0.113/kWh
None of the above
Impossible to tell based on the above information

How much electricity do you expect to generate if tomorrows market price is expected
to be $0.10?
a)
b)
c)
d)
e)
f)
g)
h)

None
More than 0 but less than 2m KWh
3m kWh
4m kWh
5m kWh
6m kWh
10m kWh
Impossible to tell based on the above information

PART IV: MARKET STRUCTURE ANALYSIS (10 points)

The following information applies to the next 2 questions (Please show your calculation and
explain): A particular industry is comprised of 5 firms. Firm 1 has 30 percent market share,
firm 2 has 25 percent, firm 3 has 20 percent, firm 4 has 20 percent and firm 5 has 5 percent
market share.
16.

What is the Herfindahl-Hirschman Index (HHI) for this industry? (5 points)

17.

Assume that firms 2 and 5 intend to merge. Based on the 2010 U.S. Department of
Justice Merger Guidelines do you think the Justice Department would be likely to
scrutinize a merger between firm 2 and firm 5? (5 points)

PART V: PERFECT COMPETITION (16 points)

The following information applies to the next 4 questions (4 points each): Consider the
following information on production capacities for the market for a precious (commodity) metal
and its associated marginal costs (all other costs have been sunk). Please select the correct
answer. (No explanation is required)
Country Annual production (kgs) Marginal cost ($/kg)
Argentina
1000
25
Brazil
3000
30
Thailand
2000
40
US
2000
35
Ukraine
500
45
Indonesia
1000
20
Romania
3000
60
Congo
2000
80
World annual demand (in kgs) is given by: Q= 8000 - 50P
18.

What is the equilibrium price in this perfectly competitive market?

a)
b)
c)
d)
e)
f)
g)
h)

19.

$20/kg
$25/kg
$30/kg
$35/kg
$40/kg
$45/kg
$60/kg
$80/kg

How much of the world precious metal supply will be produced in Asia (Indonesia plus
Thailand)?
a)
b)
c)
d)
e)

Nothing
1000 kgs
More than 1000 but less than 3000 kgs
3000 kgs
More than 3000 kgs

20.

Suppose Indonesia, Brazil, Thailand and Argentina manage to improve their production
processes resulting in a 10% drop in marginal cost for each of these countries. What
will happen to the world equilibrium price?
a)
b)
c)
d)
e)

21.

Nothing
It will drop by 5%
It will drop by 7.5%
It will drop by 12.5%
None of the above

What will happen to the world equilibrium price should Brazil experience a mining
disaster, effectively limiting its mining capacity to 1000kgs (from 3000kgs initially)?
(Answer this question without reference to the information in question 20, but to the
information provided in the table)
a)
b)
c)
d)
e)
f)
g)

It will eventually reach $30/kg

It will eventually reach $35/kg
It will eventually reach $40/kg
It will eventually reach $45/kg
It will eventually reach $60/kg
It will eventually reach $80/kg
It will eventually exceed $80/kg

PART VI: MONOPOLY (10 points)

The following information applies to question 22 & 23: You are a strategy consultant to
Coca-Cola and have estimated that the daily demand for Coca-Cola is given by:
QC = 10 3PC + 2PG + PP + A, where
QC = the daily volume of Coca-Cola sold (in liters)
PC = the price per liter of Coca-Cola (in $)
PG = the price per liter of Ginger Ale (in $)
PP = the price per liter of Pepsi-Cola (in $)
A = the level of advertising of Coca-Cola (in $)
One can rewrite the above equation as
PC = ((10 + 2PG + PP + A QC)/3
to obtain a typical demand function
Suppose that the marginal cost of a liter of Coca-Cola is constant at $1.
Suppose that currently PC = 3, PP = 2 and PG = 3 and that A=3 and suppose that historically
neither Ginger Ale nor Pepsi-Cola have followed Coca-Colas price hikes or price cuts.
22.

What price would you recommend to Coca-Cola if its goal is to maximize profits,
knowing that Coca-Cola has decided to keep advertising expenditures at A=3? Please
show your work. (6 points)

23.

What price would you recommend to Coca-Cola if its goal is to maximize revenues,
knowing that Coca-Cola has decided to keep advertising expenditures at A=3? Please
show your work. (4 points)

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PART VII: OLIGOPOLY AND GAME-THEORETIC ANALYSIS (16 POINTS)

The following payoff matrix applies to the next 4 questions.
Both players have this information about payoffs, play this game only once and want to
maximize their individual payoffs. The first entry represents the payoff to player 1. The
second payoff represents the payoff to player 2.
Player 2
t1

t2

t3

S1

-1, -4

3, 10

4, 20

S2

1, 4

1, -10

5, 3

Player 1

24.

Suppose both players move simultaneously in the one-shot game. Does player 1 have a
dominant strategy? If so which one(s)? Explain (6 points)

25.

Suppose both players move simultaneously in the one-shot game. Does player 2 have a
dominant strategy? If so which one(s)? (No explanation required) (2 points)

26.

Does either player have a dominated strategy in the simultaneous move one-shot game?
If so which one(s)? What is/are these dominated strategies, if any? (6 points)

27.

Are there one or more Nash equilibrium strategies in the simultaneous move one-shot
game? If so, which one(s)? (No explanation required) (2 points)

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