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Managerial Economics

In a competitive market, and in a world of economic uncertainty, CEO's in major companies struggle to reduce costs and increase productivity, so they can maintain economic profitability in the worst scenario.

1. What is the difference in term of cost structure between the long-run and the short-run?

2. Operating in the long-run, apply the relevant economic concepts, to minimize costs and enhance efficiency?

3. Are costs lower in the long-run than in the short-run, for all output levels, Why? Explain?

4. Is laying off a sizable a fraction of labors (a cross-the-board layoffs) economically efficient to reduce costs?Explain?

5. Large banks have a minor or no cost advantage to smaller banks, and therefore experience (MES) at early stage with relatively limited scale of operation, should the banking managers be based on cost savings? Explain?

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Managerial Economics

You and 3 members of your family watching a film in Vox Cinemas, decided to buy cokes and popcorns and have only 40 SAR in your pocket How many cokes and popcorns would you buy to maximize total utility of the family, if the price of popcorn is (5) SAR and the price of coke is (4) SAR. In the table below, you have a list of marginal utility,you expect to receive from various level of popcorns and cokes:

1. Fill the table above.

2. How many popcorns and cokes would you buy to maximize family utility?

3. What is the level of total utility in this case?

What is the level of Marginal Rate of substitution (MRS) and its relation to the indifference curve?

. Define the equation where utility is maximized for the two goods, subject to the budget constraint?

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Managerial Economics

Abdullah, the manager of computer shop wants to maximize the number of computers sold per month. He can hire an unskilled labor for 4,000 SAR a month, and the skilled one would cost him 6,000 SAR per month, and not to exceed his monthly budget of 32,000 SAR. The following table shows how the total number of computer sold varies with the number of employed (unskilled & Skilled labors):

MBu= marginal benefit of unskilled labor

MBs= marginal benefit of skilled labor

Su= salary of unskilled labor

Ss= salary of skilled labor

1. Fill in the blanks in the above table.

2. How many of unskilled and skilled labors would you hire to maximize computer sales?

3. What are the maximum computers would be sold per month?

4. Sate the equation where computers sale is maximized and the level of each activity is equal with the other?

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Managerial Economics

(7 pts) Consider a market where demand is described by QDthis market can supply quantity qs = P – 2 in the short run, for any price above 2.(Quantities are in thousands of units per year, prices are in US dollars per unit.)= 140 – 6P. An individual firm in

a. If only two firms exists in the market and they act competitively, find the equilibrium price and quantity, and calculate producer and consumer surplus. If you know firms earn zero profit, what must their fixed cost be? (recall that in the short run Profit PS – FC and assume as usual in the competitive model that firms have identical costs)

b. Calculate the elasticities of market supply and market demand at the equilibrium point.Which one is more elastic?

c. Now suppose demand for this good jumps to QD' = 220 – 6P. What will happen in this market immediately afterwards? (i.e. before price has the chance to adjust) Draw a graph, showing the relevant quantities and surpluses. Show whether either producer or consumer surplus increase.

d. Continuing from part c, evaluate what happens as price adjusts. By how much do the quantities supplied and demanded change? Does total surplus increase (assuming no externalities)?

e. Suppose that long-run firm-level supply in this market is the same as short-run supply,however the long run allows more firms to enter (and existing firms to potentially exit).Assuming that there are no barriers to entry (or exit) and that demand stays at the new level from part (c), find how many firms will be in the market in the long run competitive equilibrium.

f. What would have happened if a price ceiling had been introduced immediately after the jump in demand, in order to keep price from going above the original level? List and discuss the consequences in the market in the short run. What is a key issue regulators would need to address?

If the price ceiling remains in effect, can you tell how many firms will be in the market in the long run equilibrium?

g. Repeat part f, this time assuming that the price ceiling had been set to $2 above the original equilibrium. Draw a graph and describe both the short run and the long run.

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Managerial Economics

(7 pts) Consider a competitive market where daily supply and demand are QD (P) = 15 – -and QS(P) = 2P, where quantities are measured in thousands of units and prices are in dollarsper unit. Assume that this market does not create any externalities – meaning that all cost sand benefits are borne by the sellers and buyers directly involved in the market.

a. Calculate the formulas for the price elasticities of supply and demand as functions of price, then find their values at the equilibrium price. Are the signs consistent with what you were expecting?

b. Draw a graph of the market, showing the equilibrium point. Let's say demand changes in the following way: at any given price, the quantity demanded is reduced by 5 units.Could we have expressed this demand shift as a change in inverse demand? How would we have phrased that?

Show the new equilibrium in the graph and describe how the market price and quantity have changed – both nominally (in their own units) and in percentage terms.

Going back to the initial case, suppose that supply shifts, instead of demand: let's say that the quantity supplied decreased by 5 units at any given price. Could we have expressed this supply shift as a change in inverse supply? How would we have phrased that?

Draw a new graph, showing the new equilibrium, vs the one at part (a), and discuss how price and quantity changed (both in units and in percentage terms).

Once again, go back to the original case. Describe the impact on the market quantity and surpluses if a price floor of $4 above the equilibrium price is imposed. Show this outcome and the dead weight loss introduced in a new graph.

e. What about if a price ceiling of $4 below the equilibrium price is imposed? How are consumers and producers each affected, and by how much does total surplus decrease? Show the relevant areas in a new graph.

What accounts for the difference between the outcomes at (d) and (e)? Compare the quantity changes, as well as the amounts of dead weight loss created.

Go back to the original case. If I told you that a per-unit sales tax was imposed in this market, and that this led the quantity traded to drop to just 10 thousand units per day,would you be able to figure out the $ value of the tax (both per unit and total)?

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Managerial Economics

7. Rcal Options Wet for the Summer, Inc., manufactures filters for swimming pools. The company is deciding whether to implement a new technology in its pool filters. One ycar from now, the company will know whether the new technology is accepted in the market. If the demand for the new filters is high, the present value of the cash flows in one year will be $17.8 million. If the demand is low, the value of the cash flows in one year will be $9.4 million. The value of the project today under the assumptions is $14.3 million and the risk-free rate is 6 percent. Suppose that, in one year, if the demand for the new technology is low, the company can sell the technology for $11.8 million. What is the value of the option to abandon?

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Managerial Economics

5. Real Options Jet Black is an international conglomerate with a petroleum division and is currently competing in an auction to win the right lo drill for crude oil on a large piece of land in once year. The current market price of crude oil is $60 per barrel and the land is believed to contain 495,000 barrels of oil. If found, the oil would cost$70 million to extract. Treasury bills that mature in one year yield a continuously compounded interest rate of 4percent and the standard deviation of the returns on the price of crude oil is 50 percent. Use the Black-Scholesmodel to calculate the maximum bid that the company should be willing to make at the auction.

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Managerial Economics

17. Abandonment Value We are examining a new project. We expect lo sell 6,500 units per year at $43 not cash flow apiece for the next 10 years. In other words, the annual operating cash flow is projected to beS43 x 6,500 = $279,500. The relevant discount rate is 16 percent and the initial investment required is$980,000.

a. What is the base-case NPV?

h. After the first year, the project can be dismantled and sold for $810,000. If expected sales are revised based on the first year's performance, when would it make sense to abandon the investment? In other words, at what level of expected sales would it make sense to abandon the project?

c. Explain how the $810,000 abandonment value can be viewed as the opportunity cost of keeping the project in one year.

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Managerial Economics

22. Equity as an Option and NPV Suppose the firm in the previous problem is considering two mutually Page 712exclusive investments. Project A has an NPV of $1,200 and Project B has an NPV of $1,600. As a result of taking Project A, the standard deviation of the return on the firm's assets will increase to 55 percent per year. If Project B is taken, the standard deviation will fall to 34 percent per year.

a. What is the value of the firm's equity and debt if Project A is undertaken? If Project B is undertaken?

b. Which project would the stockholders prefer? Can you reconcile your answer with the NPV rule?

d. What does this problem suggest to you about stockholder incentives?

c. Suppose the stockholders and bondholders are, in fact, the same group of investors. Would this affect your answer lo (b)?

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