Managerial Economics Assignment Questions

Submission is on the 15th May 2024

Question 1.
Suppose that two soft-drinks companies, Coca-Cola (denoted by Coke) and Pepsi, are
competing in a small duopoly market. We know that their products are cola drinks. Suppose
that their research departments found a positive relationship between advertisement and sales
(and the resulting profits). They need to decide whether they have to undertake
advertisements. Coke expects immediate response decisions, for any of its decisions, from
Pepsi, and vice versa. The strategies and the payoff (in millions of Ghana cedis) matrix of this
advertisement game are presented in the Table below.
a. Examine the type of game Coca Cola and Pepsi are involved in in this scenario and
justify why.
b. What is a dominated strategy?
c. Determine logically whether there is a strictly dominated strategy for each company.
d. Determine the equilibrium of the game, if any, through the process of iterated
elimination of strictly dominated strategies.

Pepsi’s strategies
Advertise Don’t advertise
Coke’s strategies Advertise 30, 20 40, 0
Don’t advertise 10, 15 30, 5
Question 2.
Suppose that two of the important computer chip manufacturers in the world, Intel
Corporation and AMD Corporation, both based in the USA, need to set the prices of their
newly introduced processors. Any price set by Intel is expected to affect the sales and the
profits of AMD, and vice versa. Moreover, any price decision by Intel is expected to bring an
immediate response from AMD, and vice versa. Suppose that their strategies and the
associated payoffs (in millions of dollars) of the two companies are as represented by the
Table below.

a. Examine the type of game Intel and AMD are involved in in this scenario and justify
why.
b. What is a dominated strategy?
c. Determine logically whether there is a strictly dominated strategy for each company.
d. Determine the equilibrium of the game, if any, through the process of iterated
elimination of strictly dominated strategies.

AMD’s strategies
Low price Medium price High price
Low price 40, 40 50, 40 60, 30
Intel’s strategies Medium price 40, 50 50, 50 50, 30
High price 30, 60 30, 50 30, 30

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Question 3.
Assume that two of the world’s leading passenger aircraft manufacturers, Boeing based in the
USA and Airbus based in France, want to frame sales strategies for the coming financial year.
Assume also that their strategies will be successful only if one of them concentrates on the
emerging markets (of Asia, Eastern Europe, Africa, and South America) and the other
concentrates on the existing markets (of Western Europe, Oceania and North America). A
single market cannot accommodate the aircrafts of both manufacturers and each manufacturer
can concentrate only on one market. Their strategies and associated payoffs (in billions of
dollars) are presented in the Table below. Determine the strictly dominant or dominated
strategies, if any, in this game. What will be the equilibrium of the game?

Airbus’s strategies
Existing Markets Emerging Markets
Boeing’s strategies Existing Markets -2, -2 5, 5
Emerging Markets 5, 5 -2, -2

Question 4.
Players MTN (A) and Telecel (B) are playing a simultaneous move game and both can
choose either strategy S1 or strategy S2. If both choose S1 both receive 0. If both choose S2
both receive -2. If their chosen strategies differ they both receive -4.
(a) Write out a table representing each player’s strategies and payoffs (payoff matrix).
(b) State the set of strategy profiles.
(c) Suppose player A plays S1. What is B’s best response and why?
(d) Suppose player B plays S2. What is A’s best response and why?
(e) Does A have a dominant strategy? Justify your response.
(f) Is there a unique outcome by elimination of dominated strategies? Justify your response.
(g) What is (or are) the pure strategy NE to this game?
(h) Explain precisely why it is the NE (if more NE just pick one of them). Pick one strategy
profile that is NOT a NE and explain precisely why.
(i) Which of the NE do you find most likely to prevail in the real world. Why? What about if
the game was played repeatedly?

Question 5.
Discuss the implications of profit for managers as entrepreneurs versus owners as
entrepreneurs.

Question 6.
Explain the implications of resources, scarcity, opportunity cost, production, and market for
the managerial decision-making process.

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Question 7.
Discuss the relationship between corporate organizational structure and agency problems.
What are the implications of structure on management compensation plans to minimize the
agency problems?

Question 8.
Do you agree with the following statement: “All corporate projects have equal risk levels”? If
you do not agree, how does a company’s investment appraisal decision affect the degree of
risk associated with its stock? Explain.

Question 9.
Why may corporate managers not specifically aim at profit (or wealth) maximization for their
companies?

Question 10.
Discuss the major actions taken by the market to minimize or prevent agency problems.

Question 11.
Why must management consider risk as well as return while evaluating alternatives or
choosing a course of action?

Question 12.
Why do you think it is important for managers to understand the mechanics of supply and
demand both in the short run and in the long run? Give examples of companies whose
business was either helped or hurt by changes in supply or demand in the markets in which
they were competing.

Question 13.
“If the Government of Ghana levies an additional tax on luxury items, the prices of these
items will rise. However, this will cause demand to decrease, and as a result the prices will
fall back down, perhaps even to their original levels.” Do you agree with this statement?
Explain.

Question 13.
Overheard at the water cooler in the corporate headquarters of a large manufacturing
company: “The competition is really threatening us with their new product line. I think we
should consider offering discounts on our current line in order to stimulate demand.” In this
statement, is the term demand being used in a manner consistent with economic theory?
Explain. Illustrate your answer using a line drawn to represent the demand for this firm’s
product line.

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Question 14.
In the short run, firms that seek to maximize their market share will tend to charge a lower
price for their products than firms that seek to maximize their profit. Do you agree with this
statement? Explain.

Question 15.
In 2002, Philip Morris sold its Miller Brewing Division to South African Breweries.
a. What impact do you think this transaction had on the market structure of the beer
industry in the United States? In world markets? Explain.
b. Using the economic concepts presented in production theory, cost theory, perfect
competition, monopoly and monopolistic competition, discuss possible reasons why
both parties agreed to this transaction.

Question 16.
Explain the structure-conduct-performance approach to the study of industrial economics.

Question 17.
A group of five students has decided to form a company to publish a guide to eating
establishments located in the vicinity of all major college and university campuses in the
state. In planning for an initial publication of 6,000 copies, they estimated the cost of
producing this book to be as follows:

Paper $12,000
Research 2,000
Graphics 5,000
Reproduction services 8,000
Miscellaneous 5,000
Personal computer 2,000
Desktop publishing software 500
Overhead 5,500
Binding 3,000
Shipping 2,000

By engaging in this business, the students realized that they would have to give up their
summer jobs. Each student made an average of $4,000 per summer. However, they believed
they could keep expenses down by doing much of the research for the book by themselves
with no immediate compensation.
They decided to set the retail price of the book at $12.50 per copy. Allowing for the 20
percent
discount that retail stores in their state generally required, the students anticipated a per-unit
revenue of about $10.00. The director of the campus bookstore advised them that their retail
price was far too high, and that a price of about $8.75 would be more reasonable for a
publication of this kind.

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One of the students, who was a math and statistics major, asked the bookstore manager to
provide her with historical data on sales and prices of similar books. From these data, she
estimated the demand for books of this kind to be
Q=18,500−1,000 P
where Q = Number of books sold per year
P = Retail price of the books

a. Construct a numerical table for the retail demand curve and plot the numbers on a
graph. Calculate the elasticity of demand for the interval between $12.50 and $8.00.
b. Do you think the students should follow the store manager’s advice and price their
book at $8.75? Explain. If you do not agree with this price, what would be the optimal
price of the book? Explain.
c. Assuming the students decide to charge the optimal price, do you think they should
proceed with this venture? Explain.
d. Assuming the student’s demand equation is accurate, offer some possible reasons why
the bookstore manager would want to sell the book at the lower price of $8.75.

Question 18.
The owners of a small manufacturing concern have hired a manager to run the company with
the expectation that he will buy the company after five years. Compensation of the new vice
president is a flat salary plus 75% of first $150,000 of profit, and then 10% of profit over
$150,000. Purchase price for the company is set as 4½ times earnings (profit), computed as
average annual profitability over the next five years. Does this contract align the incentives of
the new vice president with the goals of the owners?

Question 19.
Designing a Managerial Incentives Contract
Specific Electric Co. asks you to implement a pay-for-performance incentive contract for its
new CEO and four EVPs on the Executive Committee. The five managers can either work
really hard with 70-hour weeks at a personal opportunity cost of $200,000 in reduced
personal entrepreneurship and increased stress-related health care costs or they can reduce
effort, thereby avoiding the personal costs. The CEO and EVPs face three possible random
outcomes: the probability of the company experiencing good luck is 30 percent, medium luck
is 40 percent, and bad luck is 30 percent. Although the senior management team can
distinguish the three “states” of luck as the quarter unfolds, the Compensation Committee of
the Board of Directors (and the shareholders) cannot do so. Once the board designs an
incentive contract, soon thereafter the good, medium, or bad luck occurs, and thereafter the
senior managers decide to expend high or reduced work effort. One of the observable
shareholder values listed below then results.

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Assume the company has 10 million shares outstanding offered at a $65 initial share price,
implying a $650,000,000 initial shareholder value. Since the EVPs and CEOs effort and the
company’s luck are unobservable to the owners and company directors, it is not possible
when the company’s share price falls to $50 and the company’s value to $500,000,000 to
distinguish whether the company experienced reduced effort and medium luck or high effort
and bad luck. Similarly, it is not possible to distinguish reduced effort and good luck from
high effort and medium luck. Answer the following questions from the perspective of a
member of the Compensation Committee of the board of directors who is aligned with
shareholders’ interests and is deciding on a performance-based pay plan (an “incentive
contract”) for the CEO and EVPs.

Required:
a. What is the maximum amount it would be worth to shareholders to elicit high
effort all of the time rather than reduced effort all of the time?
b. If you decide to pay 1 percent of this amount (in Question a) as a cash bonus,
what performance level (what share price or shareholder value) in the table
should trigger the bonus? Suppose you decide to elicit high effort by paying a
bonus should the company’s value rise to $800,000,000. What two criticisms
can you see of this incentive contract plan?
c. Suppose you decide to elicit high effort by paying a bonus only for an increase
in the company’s value to $1,000,000,000. When, and if, good luck occurs,
what two criticisms can you see of this incentive contract plan?
d. Suppose you decide to elicit high effort by paying the bonus when the
company’s value falls to $500,000,000. When, and if, bad luck occurs, what
two criticisms can you see of this incentive contract plan?
e. If the bonus compensation scheme must be announced in advance, and if you
must pick one of the three choices in questions b, c and d, which one would
you pick and why? In other words, under incomplete information, what is the
optimal decision by the Board’s Compensation Committee dedicated to act in
the shareholders’ interest?
f. Audits are basically sampling procedures to verify with a predetermined
accuracy the sources and uses of the company receipts and expenditures, the
larger the sample, the higher the accuracy. In an effort to identify the share
price that should trigger a bonus, how much would you, the Compensation
Committee, be willing to pay an auditing consultant who could sample the
expense and revenue flows in real time and deliver perfect forecasting
information about the “luck” the firm’s sales force is experiencing? Compare
shareholder value with this perfect forecast information relative to the best
choice among the bonus plans you selected in Question e. Define the
difference as the Potential Value of Perfect Forecast Information.

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 g. Design a stock option-based incentive plan to elicit high effort. Show that one
million stock options at a $70 exercise price improve shareholder value
relative to the best of the cash bonus plans chosen in Question e.
h. Design an incentive plan that seeks to elicit high effort by granting restricted
stock. Show that one-half million shares granted at $70 improves shareholder
value relative to all prior alternatives.

Question 20.
In the face of stable (or declining) enrollments and increasing costs, many colleges and
universities, both public and private, find themselves in progressively tighter financial
dilemmas that require basic re-examination of the pricing schemes used by institutions of
higher learning. One proposal advocated by the Committee for Economic Development
(CED) and others has been the use of more nearly full-cost pricing of higher education,
combined with the government provision of sufficient loan funds to students who would not
otherwise have access to reasonable loan terms in private markets.
Advocates of such proposals argue that the private rate of return to student investors is
sufficiently high to stimulate socially optimal levels of demand for education, even with the
higher tuition rates. Others argue against the existence of significant external benefits to
undergraduate education to warrant the current high levels of public support. As with current
university pricing schemes, proponents of full-cost pricing generally argue for a standard fee
(albeit higher than at present) for all students. Standard-fee proposals ignore relative cost and
demand differences among activities in the university.
a. Discuss several possible rationales for charging different prices for different courses
of study.
b. What are the income-distribution effects of a pricing scheme that charges the same fee
to all students?
c. If universities adopted a system of full-cost (or marginal cost) pricing for various
courses, what would you expect the impact on the efficiency of resource allocations
within the university to be?
d. Would you complain less about large lecture sections taught by graduate students if
these were priced significantly lower than small seminars taught by outstanding
scholars?
e. What problems could you see arising from a university that adopted such a pricing
scheme?

Question 21.
The Pear Computer Company just developed a totally revolutionary new personal computer.
It estimates that it will take competitors at least two years to produce equivalent products.
The demand function for the computer is estimated to be
Q=5,000,000−2000 P
The marginal (and average variable) cost of producing the computer is $900.
a. Compute the profit-maximizing price and output levels assuming Pear acts as a
monopolist for its product.
b. Determine the total contribution to profits and fixed costs from the solution generated

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 in Part (a).
Pear Computer is considering an alternative pricing strategy of price skimming. It
plans to set the following schedule of prices over the coming two years:

c. Calculate the contribution to profit and overhead for each of the 10 time periods and
prices.
d. Compare your results in Part (c) with your answers in Part (b).
e. Explain the major advantages and disadvantages of price skimming as a pricing
strategy.

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