Economics Problem Solving Examples

This assignment delves into economic decision-making scenarios. It presents several problem sets requiring students to calculate expected losses and profits in situations involving merchandise purchases and auctions. The focus is on understanding the impact of probability and utility on consumer choices. It also explores concepts like information symmetry and bidding strategies within an auction setting.

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Economics for Managers
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Contents
Question 1...................................................................................................................................................3
Question 2...................................................................................................................................................4
Question 3...................................................................................................................................................5
Question 4...................................................................................................................................................6
Question 5...................................................................................................................................................7
Question 6...................................................................................................................................................8
Question 7...................................................................................................................................................9
Bibliography................................................................................................................................................9

Question 1
The costs of Production line are fixed while the costs of labour can be changed. (It is assumed
the factory produces at a the lowest minimum cost currently. ) Assuming that labour is the only
variable cost here,
MC = Cl..
Cl.. = Cost of Labour per unit of cards produced
Total Cost of Production is
TC= Ck + 100,000 Cl..
CK = Total Cost per Unit of the capital Used (Capital = Production line Costs)
It is generally, assumed that , in the Short run, the capital is fixed and cannot change. It is the
labour costs that are variable. Hence, the total change in costs will be the Labour Costs. Given
that the labour has to be paid a time and half, new Marginal cost will be:
MC = 1.5 Cl..
The Total Costs will be
TC = Ck + (1.5C l X 150,000)
Total cost = Ck + 225,000 Cl
The change in costs is 125,000 CL for 50,000 units. Hence, the change in cost per unit is 2.5 Cl.
In order to maximize profits, Marginal Revenue (Price) should equal Marginal Costs. (Chauhan
2009)Hence, the price should increase by 2.5 CL.

The Short Run Cost Curve will move upward will the marginal revenue or price will move
higher too.
Figure 1 Changes in Short Run Marginal Cost Curve and Marginal Revenue

Question 2
Nora specializes in the job of printing, Nora can achieve greater economies of scale, if her total
number of units printed increases. Nora can gain cost advantages, if she sources printing
materials by the bulk from the suppliers (in addition to other reasons for achieving economies of
scale. Nora’s Nicest Knick Knacks must attempt to buy in bulk from the suppliers, in order to
gain economies of scale for any production, if she decides to increase production.
Nora gains value from diversification of product since not only does it help increase Nora
achieve more sources of revenue but also possibly insure against the increases or decreases in
demand of T-shirts.
Nora loses value from diversification at it reduces the possibility of specialization to some
extent. If the diversification of product, has caused Nora to reduce her demand for T-shirts, then
Nora may lose the advantage of bulk buying. However, there will be a “floor price” to the T-shirt
that Nora buys. If Nora’s demand for T-shirts has exceed the output that is corresponding to the
floor price, then there will be no negative impact on the diversification of the portfolio. The
Portfolio diversification is expected to have only a positive impact. However if, the demand for
Tshirts (Q) is lower than the demand corresponding the floor price, then there will be a loss of
value due to the loss of gains from bulk buying.
Figure 2 Floor Price of T-Shirt to Nora . Made by Author. Adapted from Diagram of
Marginal Costs by Samuelson and NordHaus (2004)

Question 3
In order to reduce the unprofitability, the bar must attempt to equate the Marginal Cost to
Marginal Revenue since profits are maximized at this point. Hence, the Marginal costs must be
decreased by way of increasing the number of customers (assuming capped by capacity Q*). The
Marginal Cost of the consumer on the weekend is the Total Costs to Hank’s HonkTonk (total
cost of operations on the weekend + Total Cost of the Live Music) / (Total Number of
Customers)
TCo + TCLM / Q
Let us assume that the consumer spends the “x” amount on food and drinks. Let us assume that
this is the maximum willingness to pay by the consumer. This is the Marginal Revenue when no
cover charge is introduced. Therefore, without a cover charge, the Total Revenue of the bar is
Qx. Therefore, TCo + TCLM must be equal to or greater than “x”.
There are different pricing strategies that a bar can levy (Pricing strategies do not include any
strategies to reduce the marginal cost). Below is a two part pricing strategy:
Strategy A: Set a low entry charge instead of a cover charge that covers the Marginal Cost with
no free drinks or food available. However, this may decrease the demand for the ticket but may
increase the Total Revenues, depending on the elasticity of demand for the tickets.
Strategy B: Keep the cover charge but increase the price of the cover. Such a pricing is called
two part pricing. The long line of consumers suggests that the demand for the cover ticket is high
as the number of people waiting to enter is high. Customers will be willing to pay as much cover
charge as is their consumer surplus and no more. This is the maximum consumer surplus. (Food
and Drinks + Entertainment) The cover charge can be increased to point “x” since this the
customer is already willing to pay that much.

Question 4
Let the price of the ticket be “P”. Let the profit per ticket price of the Six Flags of Texas be x.. A
discounted price of (P-5) would have to be offered to every customer who enters the Six Flags
over Texas with a promotional can.
The profits per ticket for the sale of every can , is reduced to $(x- 5). On the other hand, the
marginal cost of the tickets is higher due to promotion as the tie-up (probably) requires
additional spending.
The consumers who choose to buy Coca Cola, who may be outside of the 20 miles radius (or
outside the Dallas Fortworth Metroplex may gain negligible, zero consumer surplus due to the
promotion , if the promotion offers entry to only the Dallas Forthworth location since the cost of
traveling to Dallas Fortworth nullifies the utility gained from the promotion. These customers are
not expected to be repeat customers. Hence, the promotion may not be expected to improve the
long run total revenue of the park.
If Six Flags over Texas targets the promotion towards the residents of the Dallas- Fortworth area,
then the cans must be picked up by the residents of the Dallas Fortworth area or those people
who are currently in the area.
In summation, the short run costs may or may not increase due to promotion. However,
negligible or no short run marginal benefits would be expected from the promotion. Hence, the
promotion should be restricted to grocery stores selling the promotional cans within the 20 miles
radius.

Question 5
The given scenario is a case of infinite repeated games. Given below is matrix of the expected
gain, with or without games: The pay off without co-operation i.e the payoff when the two firms
co-operate and do not hire a consultant is $2 million for both the firm and the supplier.
If the firm hires a consultant, then it gains ¾ of the gains i.e 3 million. The net gain is $
3,000,000 - $ 500,000 i.e the net gain is 2,500,000. However, this gain is accrued only until the
supplier does not retaliate. Let us call this process as Round 1 of the game. Assuming perfect
information, the supplier may also employ a consultant to gain a greater share of the market.
However, the hiring of the consultant will lead to capturing ¾ of the market share I,e
$3,000,000. The net gain is $2,500,000. This is round 2
The process of hiring a consultant by the supplier will cause the firm to hire another consultant.
In such a scenario, the gains that the firm stands to gain are valued at $3 million but the net gain
is $2 million since the hiring of consultants will costs the firm $ 1 million. This is Round 3.
The supplier will experience the same process with the same net gains in Round 4. Thus, the
games can be repeated infinitely and the net gains and losses will decrease and increase with
every round. Thus, the firms are better off by co-operating and stabilizing the net gains at $2
million.
Net Pay off with Co-Operation Net Payoff with Non Co-
operation
Table 1 :Net Pay Off in every Round of the Game
Supplier
Firm
Supplier
Firm
Round 1 $ 2,000,000
$ 2,000,000
$ 1,000,000
$3,000,000
Round 2 $ 2,000,000
$ 2,000,000
$ 3,000,000
$1,000,000
Round 3 $ 2,000,000
$ 2,000,000
$ 1,000,000
$ 2,000,000
Round 3 $ 2,000,000
$ 2,000,000
$ 2,000,000
$ 1,000,000

Question 6
Let the possibility of choosing the wrong merchandise be “x” and the possibility of choosing the
right merchandise will be (1-x) since whenever the wrong merchandise is not selected , the right
merchandise is selected
In this case, x is less than 1 since the possibility of the buyer choosing the wrong merchandise
always is 1.
The total expected losses, if the wrong merchandise is selected is 200,000 x i.e the average
loss X probability of selection of the wrong merchandise.
The expected profits from selecting the right merchandise is (1-x) 300,00.
For the buyer to have made the right decision, the expected losses of the merchandise must be
less than or equal to the profits expected. The probability where the expected losses are equal to
the expected profits is the threshold.
Thus, the threshold is
200,000 x = (1-x) 300,000
Therefore,
200,000 x = 300,000 – 300,000 x
Therefore x = 0.6. The probability of the design’s failure that the firm should carry is 0.6.
Therefore, the probability of the design’s success that the firm must carry is 0.4 i.e the
buyer must be right 40% of the time.

Question 7
There is perfect symmetry of information available in this situation since there is oral bidding.
Let the consumers that bid $50 for the lamp be A and B; let the consumers that bid $70 be C and
D Hence, there may be a bidding war between the two consumers that are, the person bidding the
higher bid wins. This sets the minimum bid at $5. Bidders A and B will be priced out of the
auction, unless they are willing to bid higher. However, the maximum bid will go to the person
that bids the highest i.e. either consumer C or D. If the utility of the lamp derived for bidder C or
D is higher than $70, then they will bid higher. The consumer with the highest utility will win the
bid, since their willingness to pay will be higher.
Bibliography
Chauhan, SPS (2009). MICROECONOMICS: Theory and Applications, Part 1. New Delhi, PHI
Learning PVT. Ltd. ISBN8120337158.
Samuelson, Paul A and Nordhaus, William R. (2004). Economics: Seventeenth Edition. 2002 ed.,
New Delhi, Tata- McGraw Hill Publishing Company. ISBN0-07-048645-X,