Questions and Answers of Managerial Economics And Strategy

2.4 Using the figure in the Mini-Case, “Natural Gas Regulation,” show how much consumer surplus increases if regulators require the producer to change from average cost pricing to marginal cost
2.3 A retailer buys cakes from a wholesaler at $2 per unit and sells it to its customers in a retail market where the market demand is given by p = 10 - Q.Show that if the wholesale price falls by
*2.2 A monopoly drug company produces a lifesaving medicine at a constant cost of $5 per dose. The demand for this medicine is perfectly elastic at prices less than or equal to the $200 (per day)
2.1 Illustrate and describe the effects on output and welfare if the government regulates a monopoly so that it may not charge a price above p, which lies between the unregulated monopoly price and
1.4 Describe the market failures analyzed in Chapter 9 (monopoly) and Chapter 15 (asymmetric information).
1.3 A town council is considering building a new bridge over a small river that runs through the town to reduce congestion on the existing bridge and decrease commuting times. Each of 1,000 commuters
1.2 Does a Pareto improvement necessarily pass the cost-benefit test? Is the converse true? Explain.
*1.1 If a policy change causes a Pareto improvement, is the outcome necessarily Pareto efficient? If a situation is Pareto efficient, are Pareto improvements possible? If a change occurs that causes
6. Discuss why granting intellectual property rights promotes innovation.
5. Show why open-access, club, and public goods cause market failures and how government responses help.
4. Explain the market failure effects of externalities and government responses to them.
3. Describe how antitrust laws and competition policies promote competition and reduce market failures.
2. Show the effects of direct government intervention in imperfectly competitive markets.
1. Explain why inefficiency in some markets provides a rationale for government intervention.
7.3 As in Question 7.3 of Chapter 14, Samantha’s utility function is U(Y) = Y0.5. She tries to maximize her expected utility. She owns a car for business that she will have to replace if it is
7.2 Anika is hired by the owner of a kitchen supply store to manage the store. Anika and the owner are both risk neutral. The probability of weak demand is 0.2 and the probability of strong demand is
7.1 In a used car market, all potential buyers and sellers are risk neutral. The buyers value the good-quality used cars at $10,000 and the lemons at $4,000, while the reservation price of the lemon
6.3 In 2012, Hewlett-Packard Co. announced that its new chief executive, Meg Whitman, would receive a salary of $1 and about $16.1 million in stock options, which are valuable if the stock does
6.2 Curtis manages an electronics store in Wichita, Kansas. He considers carrying either cameras from Nikon Americas that come with a U.S. warranty or gray market Nikon cameras from a European
6.1 In the Managerial Solution, show that shareholders’expected earnings are higher with the new compensation scheme than with the original one.
5.5 Rental cars sold on the used car market receive lower prices than cars of the same model and year that were owned by individual owners. Does this price difference reflect adverse selection or
5.4 A mobile phone manufacturer provides a warranty under which it covers all manufacturing defects up to five years after the purchase of a mobile phone.During that period, the company repairs or
*5.3 Explain why full employment may be inconsistent with no shirking based on the efficiency wage model.
5.2 Many substandard condo developments have been built by small corporations that declare bankruptcy or go out of business when legal actions are started against them by condo buyers. What legal
5.1 Many law firms consist of partners who share profits.On being made a partner, a lawyer must post a bond, a large payment to the firm that will be forfeited on bad behavior. How would such an
4.9 Louisa is an avid cyclist who is currently working on her business degree. She normally rides an$800 bike to class. If Louisa locks her bike carefully—locks both wheels—the chance of theft
4.8 A health insurance company tries to prevent the moral hazard of “excessive” dentist visits by limiting the visits per person per year to a specific number.How does such a restriction affect
4.7 Suppose now that the publisher in Question 4.6 faces a downward-sloping demand curve. The revenue is R(Q), and the publisher’s cost of printing and distributing the book is C(Q). Compare the
4.6 Suppose that an author of popular science fiction novels is paid a royalty of share of the revenue from sales, where the revenue is R = pq, p is the competitive market price for such novels,
4.5 In the situation described in Question 4.4, how do your answers to parts (a) and (c) change if Andy’s first contract changes so that he receives a basic fixed wage of 10 and, in addition, a
*4.4 Pat hires Andy to manage her store. Andy’s effort is given in the left column of the table. Each cell shows the store’s net income (ignoring Andy’s cost of effort).Low Demand High Demand
*4.3 Zhihua and Pu are partners in a store in which they do all the work. They split the store’s business profit equally (ignoring the opportunity cost of their own time in calculating this
4.2 Why are used-car salesmen usually paid on a commission basis rather than given a fixed salary?Explain.
4.1 Traditionally, doctors were paid on a fee-for-service basis. Now, increasingly, doctors are paid on a capitated basis (they get paid for treating a patient for a year, regardless of how much
3.8 A study found that urologists in group practices that profit from tests for prostate cancer order more of them than doctors who send samples to independent laboratories. Doctors’ groups that
3.7 A bank can make one of two types of loans. It can loan money to local firms, and have a 75% probability of earning $100 million and a 25% probability of earning $80 million. Alternatively, it can
3.6 Customers of a large auto repair center complained that its mechanics were repeatedly pressurizing them to undertake unnecessary, expensive repairs.This escalated to the point that the auto
*3.5 A promoter arranges for many different restaurants to set up booths to sell Cajun-Creole food at a fair.The promoter provides appropriate music and other entertainment. Restaurants agree to pay
3.4 In Question 3.3, will Amy choose the surplus-maximizing level of effort if she pays the owner a fixed fee and keeps the residual profit from the shop? Alternatively, what happens if Amy earns a
3.3 Suppose that the expected value (see Chapter 14) of daily profits for an ice cream shop, before paying the manager, Amy, is E = 500 + 8e, where e is Amy’s daily overtime hours. Amy is
3.2 Organic food products are often believed to be more nutritious than their standard counterparts.However, they are also more expensive. If they are labeled properly, will consumers still buy the
3.1 Sometimes a group of hungry students will go to a restaurant and agree to share the bill at the end regardless of who orders what. What is the implication of this fee-sharing arrangement on the
2.6 Before purchasing major appliances, consumers often read reviews about appliances that are available for sale on different Web sites. Now, suppose some Web sites offer to provide “reliable
2.5 How does John Hancock Life Insurance use modern communications technology to reduce adverse selection? (Hint: See the Mini-Case, “Discounts for Data.”)
2.4 Some sellers offer to buy back a good later at some prespecified price. Why would a firm make such a commitment?
*2.3 Employers often have a hard time predicting the quality of job applicants. Can workers use education as a signal to indicate that they have high ability?
2.2 Certain universities give written evaluations of student performance rather than letter grades. One rationale is that eliminating the letter-grade system reduces the pressure on students, thus
2.1 In the world of French high cuisine, a threestar rating from the Michelin Red Guide is a widely accepted indicator of gastronomic excellence.French consumers consider Gault Milleau, another
1.10 Suppose that half the population is healthy and the other half is unhealthy. If an insured healthy person gets sick, the full cost to the insurance company is$1,000. If an insured unhealthy
1.9 It costs $20 to produce a low-quality electric shaver and $30 to produce a high-quality shaver. Consumers cannot distinguish good shavers from poor shavers when they purchase one. They value
*1.8 Many buyers value high-quality used cars at the full-information market price of p1 and lemons at p2. A limited number of potential sellers value high-quality cars at v1 … p1 and lemons at v2
1.7 Suppose that everyone in the used car example in the text is risk neutral, potential car buyers value lemons at $4,000 and good used cars at $8,000, the reservation price of lemon owners is
1.6 Use Akerlof’s lemons model to explain why restaurants that cater to tourists are likely to serve lowquality meals. Tourists will not return to this area, and they have no information about the
1.5 Akerlof (1970) observed that if you buy a new car and try to sell it in the first year—indeed, in the first few weeks after you buy it—the price that you get is substantially less than the
1.4 You want to determine whether the market for single-engine airplanes has a lemons problem. Can you use any of the following information to help answer this question? If so, how?a. Repair rates
*1.3 A firm spends a great deal of money on advertising to inform consumers of the brand name of its mushrooms. Should consumers conclude that its mushrooms are likely to be of higher quality than
*1.2 A sign at the back of an older model of a BMW vehicle reads, “Owner relocating abroad. Must sell—great condition.” Is this sign trying to mitigate adverse selection or moral hazard?
1.1 In 2008, during the global financial crisis, the American Insurance Group (AIG) incurred heavy losses, having undertaken very risky behavior in the past. When it was on the verge of collapse, the
5. Explain how monitoring can reduce moral hazard problems.
4. Construct contracts that reduce or eliminate moral hazard.
3. Show how moral hazard decreases gains and distorts risk sharing in economic transactions.
2. Describe the methods used to reduce adverse selection.
1. Explain why adverse selection prevents desirable transactions.
7.3 Samantha’s utility function over this year’s net income, Y, is U(Y) = Y0.5. She owns a car for business that she will have to replace if it is stolen. If her car is not stolen her net income
7.2. An investor is considering five possible investment strategies. The investor cares only about the expected payoff and possibly the variance of each strategy. The following table shows the
7.1 Aman, Bo, and Celia are considering an investment opportunity such that each person’s final wealth(the return net of the investment) will be W1 = +25 thousand with probability 0.6 or W2 = +100
6.1 Global Gas International offers to subcontract the Halidurton Heavy Construction Corporation to build an oil pipeline from Canada to New Orleans for $500 million. The probability that the oil
*5.3 Joe lost a substantial amount gambling at a racetrack today. On the last race of the day, he decides to make a large enough bet on a longshot so that, if he wins, he will make up for his earlier
5.2 Evan is risk preferring with respect to gains and risk averse with respect to losses. Louisa is risk preferring with respect to losses and risk averse with respect to gains. Illustrate both
5.1 First, answer the following two questions about your preferences:a. You receive $5,000 and are offered a choice between receiving an extra $2,500 with certainty or flipping a coin and getting
4.7 During the Great Recession, many homeowners around the world owed more on their houses than they were worth. Often, U.S. borrowers who cannot meet their mortgage payments can give their houses to
4.6 In Q&A 14.4, advertising increases the probability of high demand to 80%. If all the other information in the Q&A stays the same, what is the minimum probability of high demand resulting from
4.5 Robert Green repeatedly and painstakingly applied herbicides to kill weeds that would harm his sugar beet crops in 2007. However, in 2008, he planted beets genetically engineered to withstand
4.4 Use a decision tree to illustrate how a risk-averse kidney patient would make a decision about whether to have a transplant operation. The patient currently uses a dialysis machine, which lowers
4.3 DVD retailers choose how many copies of a movie to purchase from a studio and to stock. The retailers have the right to return all unsold copies to the studio for a full refund, but the retailer
4.2 Use a decision tree to illustrate how a risk-neutral plaintiff in a lawsuit decides whether to settle a claim or go to trial. The defendants offer $50,000 to settle now. If the plaintiff does not
4.1 Andy and Kim live together. Andy may invest$10,000 (possibly by taking on an extra job to earn the additional money) in Kim’s MBA education this year. This investment will raise the current
3.8 In order to avoid losses from last-minute cancellation, private vacation rentals at a popular tourist destination have started to insist on full payment from prospective renters 45 days in
3.7 In 2015, Lloyd’s of London, a major global insurer, concluded that a chain reaction of floods, drought, and related diseases could cripple the world’s food supply. What actions can firms and
3.6 After a severe earthquake hit a small town, the government offered subsidies to people whose houses were destroyed. How does the expectation that subsidies will be offered again for major
3.5 An insurance agent (interviewed in Jonathan Clements,“Dare to Live Dangerously: Passing on Some Insurance Can Pay Off,” Wall Street Journal, July 23, 2005, D1) states, “On paper, it never
*3.4 Consider a household with a current disposable income of $250,000. This household faces a 10%chance that their house will burn down, and it will cost them $240,000 to rebuild the house. Suppose
3.3 Lucy, the manager of the medical test firm, Dubrow Labs, worries about the firm being sued for botched results from blood tests. If it isn’t sued, the firm expects to earn a profit of 100, but
3.2 Why do many investment advisors recommend that managers invest only a small share of their savings in the stock of companies they work for? (Hint: See the Managerial Implication “Diversify Your
3.1 Malee, who is risk averse, has two pieces of jewelry, each worth $1,000. She plans to send them to her sister’s firm in Thailand to be sold there. She is concerned about the safety of shipping
2.12 Based on the information in the Mini-Case,“Gambling,” provide at least three reasons why many risk averse people gamble in casinos.
2.11 Isabella just inherited a small hotel in a seaside town from her aunt. In good years (those without rain and with plenty of sunshine), she earns $200,000 from the hotel. If the weather is poor,
2.10 Joanna is considering three possible jobs. The following table shows the possible incomes she might get in each job.Outcome A Outcome B Probability Earnings Probability Earnings Job 1 0.5 20 0.5
2.9 Based on the information in the Mini-Case, “Stocks’Risk Premium,” are the comparative returns to 10-year U.S. treasury bonds and the S&P 500 stock index consistent with risk aversion on the
2.8 Suppose that an individual is risk averse and has to choose between $100 with certainty and a risky option with two equally likely outcomes: +100 - x and +100 + x. Use a graph (or math) to show
2.7 Given the information in Q&A 14.2, Irma prefers to buy the stock. Show graphically how high her certain wealth would have to be for her to choose not to buy the stock.
*2.6 Max has a concave utility function of U(W) = W0.5.His only asset is shares in an Internet start-up company.He will learn the stock’s value tomorrow. He believes that it is worth $625 with a
2.5 Suppose that Sharmila has a utility function of U(W) = W0.5 and an initial wealth of W = +650.How much of a risk premium would she want to participate in a gamble that has a 50% probability of
2.4 Use calculus to determine whether the following utility functions imply risk aversion, risk neutrality, or risk preference:a. U(W) = ln (W).b. U(W) = W0.4.c. U(W) = W2.d. U(W) = 2W.(Hint: See
2.3 Maoyong’s utility function with respect to wealth is U(W) = ln W (where “ln W” means the natural logarithm of W). Plot his utility function and use your figure to determine whether Maoyong
2.2 Would risk-neutral people ever buy insurance that was not fair (that was biased against them)? Explain.
2.1 Reza offers to bet Fatima that if a six-sided die comes up with five or six dots showing, he will pay her $15, but if it comes up with any other number of dots, she will owe him $10. Is that a
1.6 To discourage people from breaking laws against speeding, society can increase the probability that someone exceeding the speed limit will be caught and punished, or it can increase the size of
1.5 What is the difference—if any—between an individual gambling at a casino and gambling by buying a stock? What is the difference for society?
*1.4 By next year, a stock you own has a 20% chance of being worth $2,000 and a 90% probability of being worth $500. What are the expected value and the variance?

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