ECN520M Business Economics 9 July 2013

M & T 1800-2115 Mid-term Questions

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Answer all questions. No emailed answers will be accepted. Discussion is encouraged but
in case of detected "carbon copy" answers for a given question, both papers will receive a
"0" rating for that problem. Be thorough but concise. Good luck!

1. (15 pts.) Consider the problem below on elasticities. Suppose demand for Royale
(high end) bags worldwide is denoted by Ql, while its world price is Pl.

(a) What is the price elasticity for this luxury item if a price rise from P20,000 to P
40,000 results in a fall in demand from 100,000 to 90,000 units around the
original quantity of 100,000 units. How would a high end bag manufacturer set
about making the own-price elasticity of demand for one of its brands fall
(towards zero)?
(b) How does the own price elasticity of demand relate to total revenues? If we
measured the price elasticity of demand for high end bags as elastic at the
current price, what would it imply? What if we found that demand were
inelastic?
(c) What would be the formula for the cross-price elasticity of demand for high end
bag, Ql, with respect to a change in price of unbranded bags, Pe? Suppose
that the cross-price elasticity of (c) is close to zero. What does that imply about
how separate these market segments are? What is the implication of this for
pricing decisions for high end bag suppliers? Are there other business
implications of this value for bag manufacturers?

2. (10 pts.) In each of the following situations, what is the government’s role? Does
the government’s intervention improve the outcome? Thoroughly discuss the trade
offs.

(a) amending the 1987 Philippine Constitution to suit to “current economic”

conditions
(b) finally implementing the birth control law and promoting use of condoms and
sex education in classrooms
(c) dismantling all shanty houses along the Pasig river as a solution to the
worsening floods in Metro Manila
(d) implementation of the Kasambahay law

3. Consider the following scenario. Sally and Jenny are preparing for an exam the
following day. However, their best friend, Adora who is from another block, is
celebrating her birthday that night. Each student decides whether to study or
party. We model this as a game, where each student has two actions: Study and
Party.
 Construct a payoff matrix with the following features:
(i). Each player gets a higher payoff when the other player study.
(ii) Sally has a dominant strategy to study.
(iii) Jenny prefers to study if and only if Sally parties.

In answering this question, you should

(a) (5 pts.) Write down the payoff matrix of the simultaneous-move game.
(b) (5 pts.) Will this game have a Nash equilibrium? If yes, indicate the equilibrium.

4. You manage a catering company called Yummy operating from an office in

Ortigas. While you have a regular core crew, for very important clients you hire the
services of top chefs as an added attraction. You have signed a contract with one
top chef for a VIP client for her golden wedding anniversary. The contract specifies
that the chef receives P60,000 plus P12 per person that will show up at each party.
Assume that you have additional marginal costs of P8 per person served. Also
assume you have constant marginal cost; and that you are not capacity
constrained. The demand curve for the catering is Q = 8,000 − 100P.

(a) (5 pts.) What price should you charge?

(b) (5 pts.) Suppose that a Celebrity chef is joining your top chef. Invitees of your
VIP client would not want to miss a party where this Celebrity chef will be
featured. His influence will cause demand at any price to double. The Celebrity
chef agrees to a fixed payment that does not depend on the number of people
served. What is the maximum amount you would be willing to pay him?

5. (10 pts.) Adrian is a rising entrepreneur and a young IT specialist. He opened his
own IT services company. To do so,

(a) he quit his job, which was paying P42,000 per year;
(b) he cashed in a P30,000 certificate of deposit that was yielding 5%;
(c) he took over a building his father owned, previously rented for P15,000/year;
(d) he furnished the office with a forged Malang that he once bought by mistake
and is still paying P4,000 a year for.

In the first year, he sold P180,000 worth of IT services and incurred expenses of
P72,000 for IT equipment, P60,000 for extra help, and P6,000 for utilities. He
anticipates future sales and costs to be the same (assume zero inflation).

Was this IT company a good idea (monetarily)? Justify and discuss your answer
thoroughly.

6. (10 pts.) Suppose your company is into Premium Sports Club playing rights selling.
You have analyzed the market carefully, and you know that at a price of P120,000,
you will get 800 new clients per year. In addition, you know that at any price above
P120,000 no one will buy because potential clients would rather put their P120,000
elsewhere. You know that for every P20,000 you lower your price, you will be able
to attract an additional of 200 clients. For example, at a price of P100,000, you
can get 1000 new clients, at a price of P80,000, you attract 1,200 clients, and so
on.

(a) Draw the demand curve facing your company.

(b) Draw the effective marginal revenue curve facing your firm.
(c) If the marginal cost of each sports club playing right is P100,000, how many
new clients will you be able to get, and what “price” will you charge?
(d) What if the marginal cost is P85,000, how many new clients will you be able
to serve, and what “price” will you charge?