Homework 1 Managerial Economics MBA, NCCU

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1 Homework 1 Managerial Economics MBA, NCCU 1.In each of the following instances, discuss whether horizontal or vertical boundaries have been changed, and whether they were extended or shrunk. (A)The acquisition of Motorola Mobility, a dedicated Android partner, will enable Google to supercharge the Android ecosystem and will enhance competition in mobile computing. Motorola Mobility will remain a licensee of Android and Android will remain open. Google will run Motorola Mobility as a separate business. (B)Taiwanese hardware maker Acer, the world's second largest PC manufacturer, has just joined the ranks of the sky-high elite, purchasing Silicon Valley-based igware for $320 million. Acer's acquisition of the little-known cloud computing firm will reportedly allow it to launch a cloud product next year, and is seen as a long-term strategic move for the tech giant. (C)Hewlett-Packard said it is exploring a spinoff of its PC business and has bid $10.25 billion to acquire software maker Autonomy. (D)HTC Corporation, a global designer of mobile phones and devices, announced the acquisition of all outstanding shares of S3 Graphics Co., Ltd. ( S3 Graphics ) for an aggregate consideration of US$300 million, payable in cash. The acquisition strengthens HTC s technology leadership and extends its IP portfolio with the addition of 235 patents and the pending applications, including those related to graphics visualization technologies. (E)General Motors divested Delphi Automotive Systems, which manufactures automotive components, systems, and modules. (F)Online auction service ebay acquired Skype, a provider of internet telephone service. (A)Vertical boundary is extended. Horizontal boundary may be extended (G2 +Motorola) (B)Horizontal boundary is extended 1

2 (C)Horizontal boundary is shrunk. Vertical boundary is extended. (D)Vertical boundary is extended. (E) Vertical boundary is shrunk (F) Vertical boundary is extended (Skype as the phone service of ebay) or horizontal boundary is extended (two services) 2.Between 2001 and 2003, China Mobile s number of subscribers grew from 90.6 to million as the company added subscribers and acquired service providers in the poorer inland regions of China. However, over the same period, its average revenue per user (APRU) fell from 141 to 102 yuan per month and its proportion of subscribers using pre-paid service rose from 48% to 64%. (A)How would the entry of China Unicom affect the demand for China Mobile service? (B)How would China Mobile s provision of pre-paid service affect the demand for its post-paid (contract) service? (C)Compare the demand for pre-paid service in the inland regions with that in the wealthier coastal regions. (D)Relate your discussion in (b) and (c) to China Mobile s decline in ARPU. (A) would lower the demand. (B) Would lower the demand as some subscribers switch from post-paid to pre-paid service. (C) If pre-paid service is an inferior product, the demand in the inland regions would be higher. (D)ARPU is lower for pre-paid than contract service. ARPU is lower in poorer areas than richer areas. Both of these factors explain China's Mobile's decline in ARPU. 3.The price of Gucci perfume is around $150 per fluid ounce, while the price of bottled water is $1 per gallon. Tiffany buys 2 fluid ounces of Chanel and 10 gallons of bottled water a month. (A).Using relevant demand curves, illustrate Tiffany's choices. Illustrate how the following changes will affect Tiffany's demand for Gucci perfume: (i) price decreases to $140 per fluid ounce, and (ii) increase in price of another of Tiffany's favorite perfumes. (B).Tiffany spends more money each month on perfume than bottled water. Does this necessarily mean that water gives her less total benefit than perfume? Use 2

3 appropriate demand curves to address this question. (A)(i) This will decrease the quantity demanded of Chanel perfume -- movement down along the demand curve; (ii) This will decrease the demand for Chanel perfume -- the demand curve shifts to the left. (B) No. Total benefit is the area under the demand curve (which is not the same as expenditure). The area under the demand curve for perfume could be much smaller than that for water. Implication: Nancy is getting much more buyer surplus from her purchases of water than from her purchases of perfume. 4.PCCW provides broadband Internet access in Hong Kong under the brand name, Netvigator. Table 1 lists several of the plans offered in April Table 1: Netvigator Broadband Internet Access Plans Plan Monthly Included Charge per Bandwidth Subscription Hours additional hour Basic HK$ HK$2 Up to 1.5 Mbps 3M Single HK$ HK$2 Up to 3.0 Mbps User Plan 6M Single User Plan HK$ HK$2 Up to 6.0 Mbps (A). Ms. Wong subscribes to the 6M plan and uses 150 hours a month. Suppose that Wong's demand curve is a straight line such that if the price of access were HK$10 per hour or higher, she would buy nothing. Draw her demand curve, and calculate her buyer surplus. (B).Suppose that Wong switches to the 3M plan. Referring to her demand curve, how many hours would she use each month? Calculate her buyer surplus. (C). Suppose that Wong switches to the basic plan. Referring to her demand curve, how many hours would she use each month? Calculate her buyer surplus. (A) The demand curve is a straight line with the vertical intercept (10) and horizontal intercept (150). Using 150 hours, her total benefits are $750 (=1/2*10*150). Her actual amount paid is equal to $398. Therefore, her buyer surplus is $352 (= ). (B)Based on the demand curve, she would use 120 hours each month if the price is $2 3

4 per hour. For using 120 hours, her total benefits are equal to $720 (=1/2*[10+2]*120). Her actual amounts paid are equal to $338 (=298+20*2). Therefore, her buyer surplus is $382 (=$720-$338). (C)Based on the demand curve, she would also use 120 hours each month if the price is $2 per hour. For using 120 hours, her total benefits are equal to $720 (=1/2*[10+2]*120). Her actual amounts paid are equal to $398 (= *2). Therefore, her buyer surplus is $322(=$720-$398). 5.Suppose that a typical household's demand for long-distance call is represented by the equation D = p Y, where D is the quantity demanded in minutes a month, p is the price of calls in cents per minute, and Y is the household's income in thousands of dollars a year. Assume that Y=100. (A)Draw the household's demand curve. (B)How many minutes will the household buy at the price of 25 cents a minute? (C)What is the maximum lump sum that a long-distance carrier can charge the household for a package of 140 minutes of calls? (D)How can the long-distance carrier charge the household when it uses the two-part pricing method instead of package deal? (A) The demand curve will be downward sloping. (B) 140 minutes. (C) 1/2[ ]*140=59.5 (D)Fee=1/2*0.35*140=24.50; $0.25 per minute. 6.Among commercial users such as apartment buildings, hotels, and offices, the demand for water is estimated to have an own-price elasticity was -0.36, the elasticity with respect to the number of commercial establishments was 0.99, and the elasticity with respect to the average summer temperature was 0.02 (Williams and Suh, 1986). (A)Intuitively, would an increase in the number of commercial establishments increase or reduce the demand for water? Is the estimated elasticity consistent with your explanation? 4

5 (B)Intuitively, would a rise in the average summer temperature increase or reduce the demand for water? Is the estimated elasticity consistent with your explanation? (C)By considering the own-price elasticity of demand, explain how the water company could increase its profit. (A) It would increase the demand for water. This is consistent with a positive valued elasticity of (B) It would increase the demand for water. This is consistent with a positive elasticity of (C) The own-price elasticity of demand is inelastic, hence an increase in price will increase total revenue. 7.A study of the demand for gasoline at Boston-area service stations reported that the elasticity with respect to price (combining the pure price effect with the effect on waiting times) was -3.3, the elasticity with respect to station fueling capacity was 0.7, and the elasticity with respect to the average price at nearby stations was 1.2 (Png & Reitman, 1984). (A).Explain why the elasticity with respect to the average price at nearby stations is a positive number. (B).Amy s station is the only competitor to Al s. Al's station has 2% more fueling capacity. Originally, both stations charged the same price. Then Amy reduced her price by 1%. What will be the difference in quantity demanded between the two stations? (C).If Amy raises capacity from 5 to 6 fueling places, by how much could she increase price without affecting sales? (A)Because they are substitutes---an increase in the price at nearby stations (e.g. by 1%) will raise the quantity demanded at the service station under consideration (e.g. by 1.2 %). (B)Al's Q%=2%*0.7-1%*1.2=0.2%, Amy's Q%=(-1%)*(-3.3)=3.3%, the difference in Q%=3.1%. (C) Amy's Q%=20%*0.7+P%*(-3.3)=0, P%=4.2% 5

6 8.Drugs that are not covered by patent can be freely manufactured by anyone. By contrast, the production and sale of patented drugs is tightly controlled. The advertising elasticity of the demand for antihypertensive drugs was around 0.26 for all drugs, and 0.24 for those covered by patents. For all antihypertensive drugs, the own price elasticity was about -2.0 without advertising, and about -1.6 in the long run with advertising. (A)Consider a 5% increase in advertising expenditure. By how much would the demand for a patented drug rise? What about the demand for a drug not covered by patent? (B)Why is the demand for patented drugs less responsive to advertising than the demand for drugs not covered by patent? (C)Suppose that a drug manufacturer were to increase advertising. Explain why it should also raise the price of its drugs. (A) The demand for a patented drug would rise by 5 x 0.24 = 1.2%. The demand for a patented drug would rise by 5 x 0.26 = 1.3%. (B) There are fewer substitutes for drugs covered by patents, hence the demand for these drugs is less elastic with respect to advertising. (C) The increase in advertising would also cause the demand to become less elastic, hence the manufacturer should raise the price. 6