Assignment 1, ECON 6921. The assignment is due 2/3 at the start of class. 102 points. Late assignments will be penalized.
1. (20) Amazon recently had a very public dispute with the book publisher Hachette regarding its prices for e-books.Amazon was trying convince Hachette to lower its price for e-books, arguing that doing so would benefit both consumers and the publisher; Hachette was refusing to cut their prices, countering that lower prices would hurt both the publisher and its authors.
Amazon explained their objectives in terms of price elasticity on the following discussion board:
Read the full post then answer the following questions.
a.) Amazon states that "For every copy an e-book would sellat $14.99, it would sell 1.74 copies if priced at $9.99." Use this information to calculate the price elasticity of demand for e-books between these two prices (you may use either the simple or the midpoint formula). Show your work.
b.) Suppose Amazon was selling 1,000,000 Hachette e-books when the price was $14.99. If their above calculations are correct, how many would they sell after the price is cut to $9.99? What would the total revenue from Hachette e-books equal before and after the price cut?
c.) Amazon claims that “e-books are highly price elastic.”If this is the case, why wouldn't Amazon want to cut prices even further? For example, why not cut the price of e-books to $0.99 instead of $9.99?
d.) Given that Amazonis arguing that cutting e-book prices to $9.99 would benefit both Amazon and Hachette, why do you think Hachette was against this price cut?It is obvious that Hachette did not agree that this move would have benefitedthem; otherwise they would have voluntarily cut prices. Briefly explain what might be wrong with Amazon’s reasoning from Hachette’s perspective.
2. A study of 130 stock purchase plans found that on average, these plans offered about 8 percent of the corporation’s stock to its managers at a discount of 12 to 15 percent off the market price.
- (5) Briefly explain the purpose of these stock purchase plans.
- (5) Do you think the stock market would view these plans favorably or negatively (ie. Do you think the value of the stock would rise or fall after the announcement of these plans)? Briefly explain why.
3. a.) (3) Suppose a new firm has start-up costs equal to $2,000,000. Their marginal costs are constant at $20/unit. Calculate their average total costs at the following quantities:
Q=10,000
Q=50,000
Q=100,000
b.) (4) On a clearly labeled set of axes graph out their MC and ATC curve for the quantities listed above. Be sure that the amounts are clearly indicated on both axes.
c.) (5) Suppose this product is sold at a price of $25/unit. How many units does this firm have to sell before it becomes profitable?
d.) (5) Suppose a competitor is considering entering this market and they would also incur start-up costs equal to $2,000,000. They expect to sell 200,000 units/year. Will this firm enter the market? Briefly explain what this decision would depend on.
4. Read the following article from The Economist: use it to answer the following questions. If you have any issues getting to the story it is titled “The future of work, There’s an app for that”.
- (5) How is the rise of the “on-demand” economy likely to influence the “make-or-buy” decision of most firms? Briefly explain why.
- (5) What groups will benefit from the rise of the on-demand economy? What groups will likely be hurt by it?
- (5) Given all the pros and cons of the on-demand economy discussed in the article, do you believe the rise of the on-demand economy a net positive or net negative for society as a whole? Briefly explain why.
5. Most pharmaceutical companies have sizeable R&D budgets for the development of new drugs. For example, Roche spends about $10 billion/year on R&D; Pfizer spends about $8 billion/year on R&D.
a.) (5)Suppose Pfizer estimates that if they develop a new drug at a cost of $1 billion, they can expect to earn $500 million in additional profit as a result (so their stream of future revenue wouldbe $500 million higher than all of their costs, including the R&D costs). Just based on this information, do you think Pfizer should develop this drug? What does the decision of whether to invest in this new drug (or another) depend on (be specific)?
b.) (5) Some have criticized pharmaceutical companies for not investing enough in drugs that could treat debilitating illnesses like Tourette syndrome or muscular dystrophy. Why do pharmaceutical companies invest more heavily in drugs that treat say, diabetes or erectile dysfunction, than these highly debilitating illnesses? What could the government do to address this potential issue?
6. Suppose that the economists at Hallmark Cards determine that the price elasticity of demand for greeting cards is -2.
a. (5) If Hallmark’s marginal cost of producing cards is constant and equal to $1.00, use the Lerner index to determine what price Hallmark should charge to maximize profit.
b. (5) Suppose that Hallmark Cards wishes to know the price elasticity of demand faced by its arch nemesis, American Greetings. Hallmark tells you that the marginal cost of a greeting card to American Greetings is $1.22, and their price is equal to $3.25. Assuming they are maximizing profit, what is their price elasticity of demand?
7. (8)Fill in the blanks in the following production table. Use it to answer the following questions:
QPTR MRTCMCATC
0 100
1 100______140______
2 90______180______
3 80______220______
4 70______260______
5 60______300______
6 50______340______
7 40______380______
8 30______420______
- (2) If this represents a monopolist, what is the profit maximizing quantity and price?
- (2) What do their profits equal?
c. (2) If their fixed costs were $10 lower but everything else were the same, what would the profit maximizing quantity and price equal?
d. (4) Use the Lerner Index to calculate the price elasticity of demand at the profit maximizing quantity.
e. (2) If this represents a competitive industry, what would the equilibrium price and quantity equal?