1.

Yes, profit maximization is a short-term objective that assures the growth of the capital, but it
neglects risk and uncertainty the company can pass through in the future. On the other hand value
Maximization is a long- term objective that undertakes safe actions in order to increase the market
value of its common stock over time more complete model of a firm. In traditional/classical
theory of the firm: the firm is thought to have profit maximization as its primary goal; the firm’s
owner-manager is assumed to be working to maximize the firm’s short-run profits. But, the value
maximization model offers insight into a firm’s voluntary “socially responsible” behavior. The
traditional theory of the firm emphasizes profits and value maximization while ignoring the issue
of social responsibility.
2. Yes, firms should take actions that are in the public interest by aligning their objectives with
philosophy of corporate social responsibility to achieve their goals. As suggested by economists,
firms that take into accounts the philosophy of corporate social responsibility can earn more profit
in the long run than firms that don’t take into account social responsibility. Corporate social
responsibility can be defined as the extent to which individual firms serve social needs other than
those of the owners and managers, even if this conflicts with the maximization of profits. This
means that the firm might: internalize social goals; represent concerns of groups other than
owners and managers; undertake voluntary action beyond that required by law, recognize the
social consequences of economic activity.

But, also firms need to consider various stakeholders interest. The managerial group in some
firms will take into account the role of stakeholders in formulating their objectives, because,
individually, they might have a significant impact on whether the firm is successful or not: for
example, employees and customers are important to the success of the firm. Unhappy customers
or workers can adversely affect the sales and costs of the firm. Thus, firms should explicitly
incorporate social concerns into their objectives includes: long-run self-interest of the firm,
stockholders and regulations. For example, the major commercial banks in the UK have closed
numerous rural branches leaving many small market towns without a branch of any bank or
building society. Although such a policy may be in the private interest of the bank, it imposes
significant costs on rural communities and helps to destroy their development prospects. Such
branch closures may also harm the image of the bank in the customer’s mind and lead to a further
loss of customers at non-rural branches.

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 Since firms have various objectives both in the short run and long run and if there is no regulation
which induce firms to act in public interest, firms may take actions which are detrimental to
public and may increase the social cost of the public. Thus, regulation is always necessary and
appropriate to induce firms to act in the public interest. But firms are encouraged to undertake
voluntary action beyond that required by law incorporating corporate social responsibility with
their objectives. However, firms with bad corporate behavior may lead to the imposition of an
expensive and inflexible regulatory regime to curb antisocial behavior, while good corporate
behavior may lead to the avoidance of government regulation and be a more beneficial outcome
for the firm. In many industries, such as advertising, governments have preferred self- regulation
by the industry rather than government-imposed regulation.

3. From the given information we have that, P1=355 ETB, P2=500 ETB, Q1=15,000 jackets,
Q2=12,000 jackets and the marginal cost per jacket is, Mc=250 ETB. The demand elasticity of
price of jackets using arc elasticity becomes,
−3,000
Q2−Q1 P2−P1 12,000−15,000 500−355 −3,000 145 ∗855
Ep= ÷ = ÷ = ÷ = 27,000
Q 2+Q 1 P 2+ P 1 12,000+15,000 500+355 27,000 855
145
−2,565,000
Ep = =-0.66
3,915,000
Hence, the price elasticity of price of jacket is -0.66 and since, |Ep|=0.66<1, the demand for jacket
is inelastic and Nike shall raise the price to maximize the total revenue.
P−MC
Desired markup= , Where Mc= P2 =marginal cost=250 ETB and P=Price=500 ETB
MC
P−MC 500−250
Hence, the desired markup= ∗100 %= ∗100 %=¿ 100%
MC 250
Since the markup is 100% and the demand is inelastic raising the price was profitable and was able
to double the profit for Nike.

4. Returns to scale describe the relationship between outputs and scale of inputs in the long run
when all the inputs are increased in the same proportion. Moreover, returns to scale refer to the
relationship between changes in output and proportionate changes in all factors of productions.
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 To meet a long run change in demand, the firm increases its scale of production by using more
space, more machines and laborers in the factory. The law assumes that: all factors (inputs) are
variable but enterprise is fixed; technological changes are absent; there is perfect competition
and the product is measured in quantities. Basically, returns to scale are classified as increasing,
decreasing, and constant returns to scale.
1. Increasing returns to scale refers to as the increase in total output is more than proportional to
the increase in all inputs. The main causes of increasing returns to scale are the following:
 Indivisibility of factors - machines, management, labour, finance, etc. cannot be available in
very small size. When a business unit expands, the returns to scale increase because the
indivisible factors are employed to their maximum capacity.
 Specialization and division labour: When the scale of the firm is expanded there is wide
scope of specialization and division of labour. Specialized equipment can be installed. Thus,
efficiency increases and increasing returns to scale follow.
 Internal economics: As the firm expands, it enjoys internal economies of production. It may
be able to install better machines, sell its products more easily, borrow money cheaply,
procure the services of more efficient manager and workers, etc.
 External economies: When the industry itself expands to meet the increased long run
demand for its product, external economies appear which are shared by all the firms in
the industry. When a large number of firms are concentrated at one place, skilled labor,
credit and transport facilities are easily available.
2. Constant returns to scale refer to as the increase in total output is in exact proportion to the
increase in inputs. The main causes of increasing returns to scale are the following:
 Internal economies and diseconomies - But increasing returns to scale do not continue
indefinitely. As the firm expands further, internal economies are counterbalanced by internal
diseconomies. Returns increase in the same proportion so that there are constant returns to scale
over a large range of output.
 External economies and diseconomies- The returns to scale are constant when external
diseconomies and economies are neutralized and output increases in the same proportion.
 Divisible factors -When factors of production are perfectly divisible, substitutable, and
homogeneous with perfectly elastic supplies at given prices, returns to scale are constant.

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 3 .Decreasing returns to scale - Returns to scale diminish the increase in output is less than
proportional to the increase in inputs. The main causes of increasing returns to scale are the
following:
 Constant returns to scale is only a passing phase, for ultimately returns to scale start
diminishing indivisible factors may become inefficient and less productive.
 Business may become heavy and produce problems of supervision and coordination.
 Large management creates difficulties of control and rigidities.
 Internal diseconomies are added to external diseconomies of scale.
 Transport and marketing difficulties emerge.
 All these factors tend to raise costs and the expansion of the firms leads to
diminishing returns to scale so that doubling the scale would not lead to doubling the
output.
Since, at least one factor of production is fixed in the short run production the law of returns to
scale is not applicable in the short run production. Lastly, returns to scale is related with
economies of scale due to the fact increasing returns to scale can cause the economies of scale and
decreasing returns to scale can cause the diseconomies of scale. But, constant returns to scale
cause neither economies nor diseconomies of scale.
5. Given the demand estimation model,
DD= -5463+0.3643 PRICE-0.15439 OTHERPR+0.8892 INC+0.0831 ADVER
( 11.2225 ) ( 1.7141 )( 1.0895 ) ( 6.7752 )( 2.6327 )
a) Since the t-ratio for own price of beer is (1.7141) and 1.7141 <2 which shows that own price is
not statistically significant for beer and price elasticity for beer is positive rather than negative
though the measured elasticity of (0.3643) is not significantly different from 0 and show that beer
tends to have very low price elasticity.
Since the t-ratio for price of all other goods is (1.0895) and 1.0895 <2 which shows that price of all
other goods is not statistically significant for beer and price of all other goods elasticity is negative
though the measured elasticity of (-0.15439) is not significantly different from 0 and show that
beer tends to have very low price of all other goods elasticity.
Since t-ratio for average income is (6.7752) and 6.7752>2 which shows that the average income is
statistically significant at the 5% level for beer and average income elasticity is positive with

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measured elasticity of (0.8892). Moreover, by assuming all variables constant if the average
income increase by 1 Birr the demand for Habesha beer increase by Birr 0.8892.
Since t-ratio for advertising is (2.6327) and 2.6327>2 which shows that advertising is statistically
significant at the 5% level for beer and advertising elasticity is positive with measured elasticity of
(0.0831).Moreover, by assuming all variables constant if the advertising increase by 1 Birr the
demand for Habesha beer increase by Birr 0.0831.The R-square value is (95%) which shows that
95% of the demand for Habesha beer is explained by price of goods, price of all other goods and
advertising. Andt h e DW statisticsis ( 1.716 ) ∧¿ 1.716 >1.66 which shows that there is no problem
of autocorrelation in the estimation model.
b) The R2 is (95%) which indicates that 95% of the demand for Habesha beer is explained by price
of goods, price of all other goods and advertising. And also which shows that the model is fit
and adequate.
c) By assuming all variables constant if the community's average income is increased by 1000
Birr, the demand for Habesha beer increase by Birr 889.20 which is (1000*0.8892).