Final Exam 16 December points. Please write answers in ink, but do graphs and figures in pencil.

Transcription

1 Eco 201 Name Final Exam 16 December points. Please write answers in ink, but do graphs and figures in pencil. 1. Define the term price discrimination. Is it as simple as charging different prices to different consumers? What conditions must hold for a firm to be able to practice price discrimination? How are consumers affected by price discrimination? 2. Two soft drink vendors are negotiating with the administration of Ivy College, trying to secure the exclusive right to sell soft drinks on campus. Ivy wants to grant the exclusive franchise to the highest bidder. But the president of the student association has asked that Ivy refuse to grant an exclusive right and instead allow both to sell soft drinks. Help the administration decide what to do, given the information in Figure 9-9. The line labeled One seller portrays the demand that would face the holder of an exclusive franchise. The line labeled Two sellers shows the demand that would face each of the vendors if both were allowed to sell soft drinks on campus. The marginal cost of selling a can is $0.25. a. Calculate the price per can that one seller would charge and the quantity of cans that it would sell per week. If there are no fixed costs, what is the weekly profit earned by one seller? Quantity = Price = Profit =

2 b. What is the weekly value of the exclusive right to sell soft drinks on campus? Predict the value of the winning bid. Value of Exclusive Franchise = Winning Bid = c. Calculate the price per can that students will pay if both vendors are allowed to sell soft drinks on campus. How many cans does each vendor sell per week? If there are no fixed costs, what is the weekly profit earned by each vendor? Quantity = Price = Profit = d. How much would each vendor pay per week for the right to sell soft drinks on campus if each must face competition from the other? Value of Non-Exclusive Franchise = Franchise Revenue Received by College = e. What policy would you recommend? 3a. The Army Corps of Engineers estimates that a canal between Twodot and White Sulfur Springs would save shippers $500,000 per year. The canal would cost $20 million to construct and $200,000 per year to maintain. i. Is it correct to say that the canal is a good investment in the long run because it will save society a net $300,000 per year and eventually that will sum to more than the $20 million construction cost? ii. About how low would the interest rate have to be to make the canal a profitable investment? (The canal would not be profitable if the interest payments plus maintenance costs ate up the savings to shippers.) iii. The advantage of having the government build the canal is that government can do things that are in the public interest whereas private enterprise is constrained by narrow considerations of profitability. Evaluate that argument. b. Part of the advantage of owning a home is that interest payments are tax deductible. That is, you may reduce your taxable income by an amount equal to your annual interest payments. For simplicity, assume all interest is paid at the end of a year. Suppose after applying a down payment to a home, you still need a $100,000 mortgage loan. The loan is payable over 30 years, in 30 equal annual installments beginning one year from now, at a 6% interest rate.

3 i. How large is each payment? ii. What is the amount of interest owed at the end of the first year? iii. How much do you still owe after making the first year s payment? c. You are considering buying a new air conditioner. You have two models to choose from: Brand A and Brand B. Brand A is less expensive, but it is more costly to operate. Both Brand A and Brand B have an expected life of 10 years. Using the numbers from the table below calculate which is the better buy if the interest rate is 6%? Air Conditioner Purchase Price ($) Annual Energy Cost ($) Brand A Brand B d. What would a maker of mousetraps be willing to pay for a patent that is expected to produce an addition to net revenue of $100,000 per year for the next 20 years? Since the prices of mousetraps can be expected to rise with inflation, it is appropriate to use a low discount rate of three percent. But one must consider risk. So let s add six percent for risk and discount at 9 percent. 4. What is the difference between government intervention that is designed to protect competitors and intervention that is designed to protect competition? A number of states have regulations that require a proposed new car dealership can open for business only if other new car dealerships selling the same brands of cars do not object to the new dealership. Is this a regulation that is designed to protect consumers? Explain. 5a. Complete the data for Total and Marginal Revenue Price ($/Q) Quantity (Q/day) Total Revenue Marginal Revenue b. Assume that your marginal cost is $9 and you want to maximize your net receipts. What quantity should you produce and what price should you charge? Explain. P =

4 Q = c. Could you charge $18 if you wanted to? Would you want to? 6. Consider the Spartanburg Golf Course and Golf Learning Center that is to be built between the new Marriott Hotel and the Vic Bailey Ford Dealership. a. Why is unusual to see golf courses in the middle of cities? Explain. b. The City of Spartanburg is spending $1 million on the project. Spartanburg officials claim that this is money well spent because with added $50,000 in taxes to the city budget every year, the course will pay for itself in 20 years. Will the course be a good deal for the citizens of Spartanburg? Explain.

5 1. Price discrimination occurs whenever a firm charges different prices for identical items. For a firm to price discriminate, it must have some monopoly power and must be able to control resale of its product. Moreover, the firm must be able to separate its customers into different groups in the case of third-degree price discrimination. Price discrimination can make consumers either better off or worse off. First-degree price discrimination drives consumers' surplus to zero and makes consumers worse off. On the other hand, second-degree price discrimination increases consumers' surplus and makes consumers better off. Third-degree price discrimination tends to benefit those consumers with more elastic demand, to the detriment of those consumers with less elastic demand. 2. a. They would pay 75 and drink 500 cans per week. Profit is $250 per week. b. Ivy could charge up to $250 for the exclusive franchise. Bid would not exceed $250. c. They would pay 45 and drink 800 cans per week: 400 from each seller. Each of the competing sellers will receive net revenue of $80 per week. d. It could charge no more than $80 apiece for the two competing franchises. $160. e. What is your objective? To provide more soft drinks for the students or more revenue for Ivy College? 3a. i The canal will have to be maintained. If maintenance costs $200,000 per year, the net savings will be only $300,000 per year. $300,000 per year eventually sums to more than $20 million only if we neglect to discount future amounts. ii. At one percent, $300,000 over the next 30 years is only $7,742,310. At one percent, $300,000 over the next 100 years is $18,908,700. It's only a 1.5 percent return on investment even when the return continues forever. $300,000 per year for 50 years, if discounted at 4 percent, has a present value of less than $6.5 million. At 2 percent, $300,000 per year for 50 years would justify an investment of only $9.5 million. We're a very long way from $20 million. iii. That argument goes through only if there are benefits to the larger society that cannot be captured through the collection of tolls. This looks like an application of the special-interest effect. If the project is undertaken, shippers benefit at the expense of taxpayers. b. i. $7, ii. $6,000 iii. $98, c. Brand A: $3, Brand B: $3,508.03

6 17 d. PV = Σ $200,000/(1 + r) t = $100,000(9.1285) = $912,850 t=1 4.