ME - Tutorial 1

1. Raj operates a small shop specializing in Bakery

items. He owns the building and supplies all his
own labor and money capital. Thus, Raj incurs no
explicit rental or wage costs. Before starting his
own business Raj earned $1,000 per month by
renting out the store and earned $2,500 per
month as a manager for a large department store
chain. Because Raj uses his own money capital,
he also sacrificed $1,000 per month in interest
earned on NSE. Rajs monthly revenues from
operating his shop are $10,000 and his total
monthly expenses for labor and supplies
amounted to $6,000. Calculate Rajs monthly
accounting and economic profits.
2. Hema is a full time homemaker and also takes
tuitions and knits sweaters in spare time. While in
Dubai in the summer holidays, she bought some
dress material for which she paid Rs 50 per
meter. This material could be sold back to the
local fabric shop in Cochin at Rs 150 per meter.
Hema is considering using that material to make
dresses, which she would sell to her friends and
neighbors. She estimates that each dress would
require 4 meters of material and 4 hours of her
time, which she values at Rs. 100 per hour. If the
dresses could be sold at Rs 900 each, could
Hema earn a positive economic profit by making
and selling the dresses?
3. Luna Biotech has accumulated cash of Rs 10
lakh. It commenced a Rs 10 lakh R&D project to
develop a new drug to treat a rare disease. The
new drug is expected to generate revenue of Rs
20 lakh. So far, Luna Biotech has already spent
Rs 6 lakh on R&D. Meanwhile, a scientist has
already developed a drug to treat the same
disease. The scientist has offered to sell here
invention to Luna biotech for Rs 2 lakh. Her drug
would be just as effective and also yield revenue
of Rs 20 lakh. Luna has only Rs 4 million cash on
hand and cant borrow, so it must choose
between continuing its own R&D or buying the
scientists invention.
a. What is the maximum that Luna should pay to
the scientist for her invention?
b. Suppose that the scientist demands Rs 3 lakh
for her invention, i) what is Lunas accounting
profit from continuing with R&D? ii) What is
Lunas economic profit from continuing with
R&D? iii) Should continue its own R&D or buy
scientists invention?
4. In the following examples, state how you would
use the principle of marginal analysis to make a
decision.
a. Deciding how many days to wait before doing
your laundry
b. Deciding how much library research to do
before writing your term paper
c. Deciding how many bags of chips to eat
d. Deciding how many lectures of a class to skip
5. International Widget is producing fifty widgets at a
total cost of Rs50,000 and is selling them for
Rs1,200 each for total revenue of Rs 60,000. If it
produces a fifty-first widget, its total revenue will
be Rs 61,200 and its total cost will be Rs 51,500.
Should the firm produce the fifty-first widget?

ME - Tutorial 1
1. Raj operates a small shop specializing in Bakery
items. He owns the building and supplies all his
own labor and money capital. Thus, Raj incurs no
explicit rental or wage costs. Before starting his
own business Raj earned $1,000 per month by
renting out the store and earned $2,500 per
month as a manager for a large department store
chain. Because Raj uses his own money capital,
he also sacrificed $1,000 per month in interest
earned on NSE. Rajs monthly revenues from
operating his shop are $10,000 and his total
monthly expenses for labor and supplies
amounted to $6,000. Calculate Rajs monthly
accounting and economic profits.
2. Hema is a full time homemaker and also takes
tuitions and knits sweaters in spare time. While in
Dubai in the summer holidays, she bought some
dress material for which she paid Rs 50 per
meter. This material could be sold back to the
local fabric shop in Cochin at Rs 150 per meter.
Hema is considering using that material to make
dresses, which she would sell to her friends and
neighbors. She estimates that each dress would
require 4 meters of material and 4 hours of her
time, which she values at Rs. 100 per hour. If the
dresses could be sold at Rs 900 each, could
Hema earn a positive economic profit by making
and selling the dresses?
3. Luna Biotech has accumulated cash of Rs 10
lakh. It commenced a Rs 10 lakh R&D project to
develop a new drug to treat a rare disease. The
new drug is expected to generate revenue of Rs
20 lakh. So far, Luna Biotech has already spent
Rs 6 lakh on R&D. Meanwhile, a scientist has
already developed a drug to treat the same
disease. The scientist has offered to sell here
invention to Luna biotech for Rs 2 lakh. Her drug
would be just as effective and also yield revenue
of Rs 20 lakh. Luna has only Rs 4 million cash on
hand and cant borrow, so it must choose
between continuing its own R&D or buying the
scientists invention.
c. What is the maximum that Luna should pay to
the scientist for her invention?
d. Suppose that the scientist demands Rs 3 lakh
for her invention, i) what is Lunas accounting
profit from continuing with R&D? ii) What is
Lunas economic profit from continuing with
R&D? iii) Should continue its own R&D or buy
scientists invention?
4. In the following examples, state how you would
use the principle of marginal analysis to make a
decision.
e. Deciding how many days to wait before doing
your laundry
f. Deciding how much library research to do
before writing your term paper
g. Deciding how many bags of chips to eat
h. Deciding how many lectures of a class to skip
5. International Widget is producing fifty widgets at a
total cost of Rs50,000 and is selling them for
Rs1,200 each for total revenue of Rs 60,000. If it
produces a fifty-first widget, its total revenue will

be Rs 61,200 and its total cost will be Rs 51,500.

Should the firm produce the fifty-first widget?

Solution1

Solution 2
Accounting Profit = 900 (4*50) = 700
Opportunity Cost = 4*100 + 4*(150-50) = 800
Economic Profit = 700 800 = -100
Solution 3
a) Maximum $4million as till then the economic profit will be zero.
b) (i) Accounting Profit = 20 10 = 10 million
(ii) Opportunity cost = 20 6 3 = 11 million
Economic Profit = 10 11 = -1 mn
(iii) Buy Scientists invention.
Solution 4
a. Each day that you wait to do your laundry imposes a cost: you have fewer clean clothes to choose from.
But each day that you wait also confers a benefit: you can spend your time doing other things. You will wait
another day to do your laundry if the benefit of waiting to do the laundry that day is greater than the cost.
b. The more research you do, the better your paper will be. But there is also an opportunity cost: every
additional hour you spend doing research means you cannot do other things. You will weigh the opportunity
cost of doing one more hour of research against the benefit gained (in terms of an improved paper) from
doing research. You will do one more hour of research if the benefit of that hour outweighs the cost.
c. Each bag of chips you eat gives you a benefit: it satisfies your hunger. But it also has a cost: the money
spent for each bag (and, if you are weight-conscious, the additional calories). You will weigh the cost
against the benefit of eating one more bag. If the cost is less than the benefit, you will eat that one more bag
of chips.
d. Each lecture that you skip implies a cost: getting further behind with the material and having to teach it
to yourself just before the exam. But each skipped lecture also means you can spend the time doing other
things. You will continue to skip lectures if the cost of skipping is lower than the benefit of spending that
time doing other things.
Solution 5
Incremental Reveue for 51st Unit = 61200 60000 = 1200
Incremental Cost for 51st Unit = 51500 50000 = 1500
Incremental Profit for 51st Unit = -300
Need NOT to produce 51st unit.