Econ and Financial Analysis
# 5 The figure below shows a portion of a consumer’s indifference map, and a budget line. The consumer’s income is $1,200 and the price of Y is $6.
a. Draw the budget constraint facing this consumer. Label the optimal consumption bundle “r.”
b. Which is the highest indifference curve the consumer can reach?
c. For this budget constraint, how many units of X will the consumer purchase?
d. How many units of Y?
e. Point r is a ____________________.
Now let the price of Y fall to $8 while the price of X remains $12.
f. Draw the new budget constraint. Label the new optimal consumption bundle “s.”
g. On this new budget constraint, how many units of X will the consumer purchase?
h. How many units of Y?
1. In 2013 Terry Brady, the legendary athlete from Indiana, decided to leave his job as
head football coach at Mattoon High School to open Brady Advantage, his own
sporting goods store, in Terre Haute. By locating Brady Advantage halfway between
St. Louis and Indianapolis, Brady hoped to attract customers from both large
metropolitan markets. A partial income statement for Brady Advantage follows:
2013
Revenues
Revenue from sales of goods and services………………. $210,000
Operating costs and expenses:
Cost of products and services sold………………………… $82,000
Selling expenses………………………………………………. $6,000
Administrative expenses…………………………………….. $12,000
Total operating costs and expenses ……………………. $100,000
Income from operations ………………………………………… $110,000
Interest expense (bank loan)………………………………….. $14,000
Non-recurring expenses to start business…………………… $8,000
Income taxes……………………………………………………… $16,000
Net income………………………………………………………… $72,000
Terry Brady’s coaching job at Mattoon High paid $45,000 of annual salary and
benefits. To get the sporting goods store opened, Brady used $50,000 of his
personal savings, which was earning a guaranteed 12 percent annual rate of return.
Brady opened his store in a building that he owned in Terre Haute. Prior to opening
his store, the building was rented for $24,000 per year.
a. In 2013, Brady Advantage incurs $_______________ of total explicit costs
for using market-supplied resources.
b. In 2013, the opportunity cost of Brady’s equity capital is $______________.
c. The total implicit cost of using owner-supplied resources in 2013 is
$____________.
d. The total opportunity cost of resources used by Brady Advantage in 2013 is
$_______________. The total economic cost in 2013 is $_______________.
e. The accounting profit for Brady Advantage in 2013 is $_______________.
f. Based on his profit in 2013, did Terry Brady increase his wealth by quitting his
job at Mattoon High and opening Brady Advantage? Explain your answer
carefully. [Hint: Compute economic profit in 2013].
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2. Suppose the quantity demanded of good (Qd) depends only on the price of the
good (P), monthly income (M), and the price of a related good R (PR):
Qd
=180 -10P- 0.2M +10PR
a. On the axes below, construct the (direct) demand curve for the good when M
= $1,000 and PR = $5. The equation for demand is
Qd = ________________________.
b. Interpret the intercept and slope parameters for the demand equation in part
a.
c. Let income decrease to $950. Construct the new demand curve. This good is
_________________ (normal, inferior). Explain using your graph.
d. For the demand curve in part c, find the inverse demand function:
P = _____________________.
e. Let the price of good R increase to $6 (income remaining at $950). Construct
the new demand curve. Good R is a _______________________ (substitute,
complement) good. Explain using your graph.
f. For the demand curve in part e, the demand price for 20 units is $________.
At a price of $4, the maximum amount consumers are willing and able to
purchase is __________ units.
g. For the demand curve in part e, find the equilibrium price and quantity when
supply is
Qs
= -10+10P.
PE = ____________ and QE = ____________
Construct the supply curve and verify your answer.
h. For the equilibrium in part g, the consumer surplus is $____________.
Producer surplus is $____________. Social surplus is $____________. The
net gain to society created by the market for this good is $____________.
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3. Use the figure below to answer the following questions
a. At 15 units of the activity, marginal benefit is $______ and marginal cost is
$______.
b. Adding the 15th unit of activity causes net benefit to __________ (increase,
decrease) by $______.
c. At 35 units of the activity, marginal benefit is $______ and marginal cost is
$______.
d. Subtracting the 35th unit of activity causes net benefit to __________ (increase,
decrease) by $______.
e. The optimal level of activity is ______ units, MB = $______ and MC = $______.
f. Can you compute total benefit, total cost, and net benefit for the optimal level of
activity? If so, how? If not, why not?
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4. The following figure shows a portion of a consumer’s indifference map. The
consumer faces the budget line ZL, and the price of Y is $20.
a. The consumer’s income = $__________. The price of X is $_____________.
b. The equation for the budget line ZL is Y = ______________________.
c. What combination of X and Y would the consumer choose? Why?
d. The marginal rate of substitution at the combination in part c is __________.
e. Explain in terms of the MRS why the consumer would not choose either
combination A or B.
f. If the budget line pivots to ZM, the consumer chooses _______ units of good
X and _________ units of good Y.
g. Along budget line ZM, the price of X is $_________ and the price of Y is
$________.
h. The new MRS is equal to __________.
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5. The figure below shows a portion of a consumer’s indifference map, and a budget
line. The consumer’s income is $1,200 and the price of Y is $6.
a. Using the given budget line, what is one point on the consumer’s demand for
X?
b. Pivot the budget line and derive two other points on the consumer’s demand
for X.
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6. The figure below shows a portion of a consumer’s indifference map. The price of X is
$12 and the price of Y is $30. The consumer’s income is $300.
a. Draw the budget constraint facing this consumer. Label the optimal
consumption bundle “r.”
b. Which is the highest indifference curve the consumer can reach?
c. For this budget constraint, how many units of X will the consumer purchase?
d. How many units of Y?
e. Point r is a ____________________.
Now let the price of Y fall to $8 while the price of X remains $12.
f. Draw the new budget constraint. Label the new optimal consumption bundle
“s.”
g. On this new budget constraint, how many units of X will the consumer
purchase?
h. How many units of Y?
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7. Using the following demand schedule, calculate the following:
? Total revenue and Marginal revenue
? Price elasticities (over a range).
? Draw a chart and use it to explain IN DETAIL the relation among marginal revenue,
price, and elasticity of demand.
Price
Quantity
demanded
Total
revenue
Marginal
revenue
Elasticity of
demand
$50 20 _______ xx xx
45 25 _______ _______ _______
40 30 _______ _______ _______
35 35 _______ _______ _______
30 40 _______ _______ _______
25 45 _______ _______ _______
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8. For the past 12 months you have been the night manager of Dixie Fried Chicken. In
order to evaluate your performance as a manager, your boss estimates the following
linear trend equation for nighttime sales (Qt) over the last 12 months (t = 1,..,12):
Qt
= a + bt
where Qt is the number of pieces of chicken sold nightly.
The results of the regression are as follows:
DEPENDENT VARIABLE: QT R-SQUARE F-RATIO P-VALUE ON F
OBSERVATIONS: 12 0.8991 89.108 0.0001
VARIABLE
PARAMETER
ESTIMATE
STANDARD
ERROR T-RATIO P-VALUE
INTERCEPT 175.0 38.88 4.50 0.0011
T 16.0 6.4 2.50 0.0314
a. Evaluate the statistical significance of the estimated coefficients. Does this
estimation indicate a significant trend, either upward or downward, in sales
during your tenure as night manager?
b. Perform t-tests for significance of the trend equation at the 5 percent level of
significance.
c. If your boss uses the estimated linear trend to forecast your sales for months
14 and 16, how many units does he expect you to sell in these months?
Q
ˆ
t=14
= _______________ and
Q
ˆ
t=16
= _______________
d. Comment on the precision of these two forecasts.
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9. The following figure shows a firm’s isoquant for producing 2,000 units of output and
four isocost curves. Labor and capital each cost $50 per unit.
a. At point A, the MRTS is _____________ (less than, greater than, equal to) the
input price ratio, w/r. The total cost of producing 2,000 units of output with
input combination A is $_____________.
b. By moving from A to B, the firm __________________ (increases, decreases)
labor usage and _________________ (increases, decreases) capital usage. At
point B the MRTS is ________________ (greater than, less than, equal to) the
input price ratio, w/r. The movement from A to B __________________
(increased, decreased) total cost by $____________.
c. At Point D the firm __________________ (minimizes, maximizes) the cost of
producing 2,000 units of output. The MRTS is _______________ (greater than,
less than, equal to) the input price ratio, w/r.
d. The optimal input combination is __________ units of labor and __________
units of capital. At this combination, the total cost of producing 2,000 units is
$ ___________________.
e. At point E, the MP per dollar spent on ____________ is less than the MP per
dollar spent on ____________. The total cost of producing 2,000 units of
output with input combination E is $_____________.
f. The movement from E to F reduces the MP per dollar spent on ____________
and increases the MP per dollar spent on ____________. This movement
__________________ (increased, decreased) total cost by
$______________.
g. At input combination D, the MP per dollar spent on labor is _____________
(greater than, less than, equal to) the MP per dollar spent on capital.
h. Input combination C costs $____________. The firm would not use this
combination to produce 2,000 units of output because __________________.
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10. A manager of a monopolistic competitor faces the following demand and cost
schedules:
Quantity Price Total Cost
0 $25 $1,000
100 20 1,800
200 16 2,800
300 10 4,000
400 5 5,400
500 1 7,000
a. The manager should produce __________ units.
b. The manager should charge a price of __________ units.
c. The maximum amount of profit that can be earned is $ __________.
d. If total fixed cost doubles, the firm should produce __________ units. The
maximum amount of profit that can be earned is $__________.
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11. For the following 5 questions, consider the expansion path illustrated below. The price
of capital is $2.
? What is the price of labor?
? The efficient amount of capital for producing 100 units of output is
? The marginal rate of technical substitution at point B is __________.
? The average cost of producing 400 units is
? The efficient amount of labor for producing 400 units of output is
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12. Matching Definitions of Key Terms
a) average profit
b) average revenue product
(ARP)
c) break-even points
d) constant-cost industry
e) economic rent
f) increasing-cost industry
g) long-run competitive
equilibrium
h) marginal revenue product
(MRP)
i) perfect competition
j) perfectly elastic demand
k) profit margin
l) shut down
m) shutdown price
? ___________________ A market structure in which a large number of firms sell a
homogenous product or service with no restrictions on entry or exit and each firm is a
price-taker.
? ___________________ The demand facing a price-taking firm.
? ___________________ A firm produces zero output but must still pay its fixed costs.
? ___________________ Price minus average total cost.
? ___________________ Output levels where P = ATC.
? ___________________ Price below which a firm shuts down in the short run.
? ___________________ All firms produce where price equals long-run marginal cost, and
economic profits are zero.
? ___________________ Industry in which input prices rise as all firms in the industry
expand output.
? ___________________ Industry in which input prices remain constant as all firms in the
industry expand output.
? ___________________ Payment in excess of a resource’s opportunity cost.
? ___________________ The additional revenue earned by hiring one more unit of a
variable input.
? ___________________ The average revenue per worker.
? ___________________ Total profit divided by quantity.
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13. A monopolist is producing a level of output, 80 units, at which price is $12, marginal
revenue is $8, average total cost is $14, average variable cost is $5, and marginal cost is $2.
a. What is the Lerner Index? Explain in detail what you answer means.
b. Look at the graph of the demand and cost conditions facing the firm
(above). Is the firm making the profit-maximizing decision? Why or why
not? If not, what should the manager do? Why?
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14.Corsicana is a very small town with two fast-food restaurants, BK and Mac, situated
on opposite corners of the only busy intersection in town. BK and Mac compete on
the basis of the prices they set for their burger, fry, and soda combination meals.
The Corsicana Gazette, the local newspaper in which they advertise their prices, is
published once a month. On the last day of the month, BK and Mac simultaneously
choose their combo meal prices, which will remain in effect for all of the next
month.
The managers at BK and Mac only consider two possible prices: a low price of
$3 or a high price of $4. The monthly profits from each of the four possible
combinations of decisions are given in the following table:
BK’s combo price
Low ($3) High ($4)
Mac’s combo price
Low ($3) A
$3,000, $5,500
B
$6,500, $5,000
High ($4) C
$2,000, $9,000
D
$5,000, $8,000
Payoffs in dollars of monthly profit.
a. Is the pricing decision facing Mac and BK a prisoners’ dilemma? Why or why
not?
b. What is the cooperative outcome? What is the noncooperative outcome?
c. Which cell(s) represent cheating in the pricing decision? Explain.
d. If Mac and BK make their pricing decision just one time, what are their pricing
decisions likely to be? Explain.
FINAL TEST / August 4, 2015
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15. The following figure shows the demand and cost curves facing a firm with
market power in the short run.
? The profit-maximizing level of output is
? The firm will sell its output at a price of
? What is the total revenue?
? What is the total cost?
? The firm earns profits of
FINAL TEST / August 4, 2015
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16. Use the following payoff table for Hardaway Corporation and Paxton Industries.
These two firms must make simultaneous pricing decisions. They can choose low,
medium, or high prices. The payoffs given are in thousands of dollars of profit per
month.
Paxton Industries
Low Medium High
Hardaway Corp.
Low
A
$30, $30
B
$45, $20
C
$32, $20
Medium
D
$20, $45
E
$40, $40
F
$45, $35
High
G
$15, $48
H
$38, $52
I
$50, $50
Payoffs in thousands of dollars of monthly profits.
? Following the procedure of successive elimination of dominated strategies, the
manager of Hardaway Corporation will eliminate in the first round the strategy
of setting
? Following the procedure of successive elimination of dominated strategies, the
manager of Paxton Industries will eliminate in the first round the strategy of
setting
? After the first round of eliminating dominated strategies for both firms, are
there dominant/dominated strategies?
? For the simultaneous pricing decision facing Hardaway Corporation and Paxton
Industries, what is the likely outcome?
? Is it a strategically stable pricing decision?
? Is it a Nash equilibria? Explain.
