ECON HW-1

ECON 3305 Dr. Durmaz Homework – 1 Due: 2/15/2015

 

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The homework covers Ch 1~3. It has to be your individual work. Copying answer from others will violate ACADEMIC HONESTY policy to cause a failing grade. For each question, please show the necessary derivation (if applicable) and highlight the answer. Limit your answers within 5 pages. No cover sheet is required. Q1: Ch 1 (15%)

At the beginning of the year, an audio engineer quit his job and gave up a salary of $ 175,000 per year in order

to start his own business, Sound Devices, Inc. The new company builds, installs, and maintains custom audio

equipment for businesses that require high- quality audio systems. A partial income statement for Sound

Devices, is shown below:

2011:

Revenues Revenue from sales of product and services . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . $ 970,000 Operating costs and expenses

Cost of products and services sold . . . . . . . . . . . . . . . . . . . . . . . 355,000 Selling expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 155,000

Administrative expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45,000 Total operating costs and expenses . . . . . . . . . . . . . . . . . . . . . . . $ 555,000

Income from operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 415,000 Interest expense (bank loan) . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . 45,000 Legal expenses to start business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28,000 Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 165,000 Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 177,000 To get started, the owner of Sound Devices spent $ 100,000 of his personal savings to pay for some of the capital

equipment used in the business. In 2011, the owner of Sound Devices could have earned a 15 percent return by investing in stocks of other new businesses with risk levels similar to the risk level at Sound Devices.

a. What are the total explicit, total implicit, and total economic costs in 2011? b. What is accounting profit in 2011? What is economic profit in 2011? c. Given your answer in part c, evaluate the owner’s decision to leave his job to start Sound Devices. Q2: Ch 1 (10%) An article in The Wall Street Journal reported that large hotel chains, such as Marriott, are tending to reduce the number of hotels that they franchise to outside owners and increase the number the chain owns and manages itself. Some chains are requiring private owners or franchisees to make upgrades in their hotels, but they are having a difficult time enforcing the policy. Marriott says this upgrading is important because “we’ve built our name on quality.” a. What type of agency problem is involved here? b. Why would a chain such as Marriott tend to own its hotels in resort areas, such as national parks, where there is

little repeat business, and franchise hotels in down-town areas, where there is a lot of repeat business? Think of the reputation effect and the incentive of franchises to maintain quality.

 

 

 

ECON 3305 Dr. Durmaz Homework – 1 Due: 2/15/2015

 

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Q3: Ch 2 (25%)

Suppose you are the manager of a California winery. How would you expect the following events to affect the market equilibrium price you receive for a bottle of wine? Please state the shift (leftward or rightward) of demand or supply.

a. The price of comparable French wines decreases. b. One hundred new wineries open in California. c. The price of a glass bottle increases significantly due to new government anti-shatter regulations. d. Researchers discover a new wine- making technology that reduces production costs. e. The average age of consumers increases, and older people drink less wine.

Q4: Ch 2 (10%)

Evaluate the following statements using graphical analysis. Provide a brief narrative explanation of your graph to support your evaluation. Make sure the axes and curves in your graphs are properly labeled.

a. “When demand for home heating oil increases, a shortage of heating oil will occur.” b. “A decrease in the supply of random access memory (RAM) chips for personal computers causes a

shortage of RAM chips.” Q5: Ch 3 (10%)

Appalachian Coal Mining believes that it can increase labor productivity and, there-fore, net revenue by reducing air pollution in its mines. It estimates that the marginal cost function for reducing pollution by installing additional capital equipment is

MC= 40P,

where P represents a reduction of one unit of pollution in the mines. It also feels that for every unit of pollution reduction the marginal increase in revenue (MR) is

MR= 1,000 −10P.

How much pollution reduction should Appalachian Coal Mining undertake?

 

 

ECON 3305 Dr. Durmaz Homework – 1 Due: 2/15/2015

 

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Q6: Ch 3 (15%) Twentyfirst Century Electronics has discovered a theft problem at its warehouse and has decided to hire security guards. The firm wants to hire the optimal number of security guards. The following table shows how the number of security guards affects the number of radios stolen per week. # of security guards # of stolen per week

0 50 1 30 2 20 3 14 4 8 5 6

a. If each security guard is paid $200 a week and the cost of a stolen radio is $25, how many security guards should

the firm hire? b. If the cost of a stolen radio is $25, what is the most the firm would be willing to pay to hire the first security

guard? c. If each security guard is paid $200 a week and the cost of a stolen radio is $50, how many security guards should

the firm hire? Q7: Ch 3 (15%) Bavarian Crystal Works designs and produces lead crystal wine decanters for export to international markets. The production manager of Bavarian Crystal Works estimates total and marginal production costs to be

TC = 10,000 + 40Q + 0.0025Q2

and MC = 40 + 0.005Q

where costs are measured in U. S. dollars and Q is the number of wine decanters produced annually. Because Bavarian Crystal Works is only one of many crystal producers in the world market, it can sell as many of the decanters as it wishes for $50 apiece. Total and marginal revenue are

TR = 50Q and MR = 50 where revenues are measured in U. S. dollars and Q is annual decanter production. a. What is the optimal level of production of wine decanters? What is the marginal revenue from the last wine

decanter sold? b. What are the total revenue, total cost, and net benefit (profit) from selling the optimal number of wine decanters? c. Is the optimal profit in answer b good enough to keep Bavarian Crystal Works in the market? Please comment on

it.