6921 Assignment 3_SP24_Sample Answer Key-

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OMBA 6921 – Industrial Economics WB Spring 2024 Assignment 3 – 45 points - Due Friday, February 2, 2024 1. (11) Use the following article on Breakeven Quantity from Harvard Business Review: https://bit.ly/3eXmq2J to answer the following questions. a. (4) Suppose an automobile manufacturer has fixed costs equal to $300 million, and variable costs per unit (aka marginal costs) equal to $45,000 per vehicle. Calculate the breakeven quantities at a price of $65,000/vehicle and at a price $50,000/vehicle. Price is $65,000/vehicle; BEQ = FC/(P-MC) Q = $300,000,000/($65,000 - $45,000) Q = $300,000,000/$20,000 Q*=15,000 Price is $50,000/vehicle; BEQ = FC/(P-MC) Q = $300,000,000/($50,000 - $45,000) Q = $300,000,000/$5,000 Q*=60,000 b.) (4) Suppose the firm is considering investing $20 million in a new marketing campaign. If the price is $65,000/vehicle, they estimate they would sell an additional 2,000 vehicles; If the price is $50,000/vehicle they estimate they would sell an additional 3,000 vehicles. Calculate the company’s profits under both scenarios. IF P=$50,000 BEQ = FC/(P-MC) Q = $20,000,000/($50,000 - $45,000) Q = $20,000,000/$5,000 Q*=4000, so it would NOT be profitable to sell an additional 3000 vehicles under this scenario. Under this scenario the firm’s profit is lower by $5,000,000; Profit change= (P-MC)*Q = ($50,000-$45,000)*3000 = $5,000*3,000 = $15,000,000 - $20,000,000 = -$5,000,000 IF P=$65,000 BEQ = FC/(P-MC) Q = $20,000,000/($65,000 - $45,000) Q = $20,000,000/$20,000 Q*=1000, so it would be profitable to sell an additional 2000 vehicles under this scenario. Under this scenario, profit is higher by $20,000,000; Profit change= (P-MC)*Q = ($65,000-$45,000)*2000 = $20,000*2,000 = $60,000,000 - $20,000,000 = $20,000,000 c.) (3) Given your calculations above, should this firm invest the $20 million in the marketing campaign? If so, what price should they charge? Yes, the firm should invest the $20 million in the marketing campaign because they have the potential to increase profit by doing so.

Given the choice between charging a price of $65,000 and increasing profit by $20,000,000 or charging a price of $50,000 and decreasing profit by $5,000,000, obviously the firm should choose a price of $65,000. 2. (16) Suppose you manage a business that produces high-end dog food. The business produces 3,000 dog food cans per day, and can sell each can at $2.00/can regardless of how much is produced. Your firm currently employs 20 workers, each of whom earns $15/hour and work 8 hours per day. Inputs, like the meat for the food and the metal for the can, cost $1.00/can. Your overhead expenses, including rent, property taxes, insurance, etc., which does not vary with the number of cans produced, equals $250 per day. a. (3) Calculate your company’s current daily profit. Profit = TR – TC TR = $2.00 x 3,000 = $6,000 TC = Labor costs + material costs + fixed costs = ($15 x 8 x 20) + ($1.00 x 3,000) + $250 = $2400 + $3000 + 250 = $5,650 Daily Profit = $6,000 - $5,650= $350 You’re considering whether to hire additional workers to produce additional cans. Each worker would be paid $15/hr. and material costs remain constant at $1.00/can. You estimate the 21 st employee would produce an additional 200 cans per day, and the number of additional cans from each additional worker would be decreasing by 40 (a 22 nd employee could produce an additional 160 cans per day, a 23 rd employee could produce an additional 120 cans per day, etc.). b. (5) Calculate the marginal costs (change to total cost/change to output) associated with producing additional cans for employees 21 through 25. Note each employee works 8 hours/day. Marginal costs = (Change to TC) / (Change to Q); These values for each employee equals: Employee 21 – change to Q = 200; change to TC = $320; MC =$320/200 = $1.60 Employee 22 – change to Q = 160; change to TC = $280; MC =$280/160 = $1.75 Employee 23 – change to Q = 120; change to TC = $240; MC =$240/120 = $2.00 Employee 24 – change to Q = 80; change to TC = $200; MC =$200/80 = $2.50 Employee 25 – change to Q = 40; change to TC = $160; MC =$160/40 = $4.00 c. (3) If you could still sell each can for $2.00/can, how many employees should you hire, how many additional cans should you produce, and what is your company’s new daily profit? You should expand output until MR = MC; MR = $2.00; MC = $2.00 for the 23 rd employee, with a quantity of 3480 (3,000+200+160+120). The daily profit is now TR = 3480 * $2.00 = $6960 TC = $5,650 + $320 + $280 + $240 = $6,490 Profit = $6,960 - $6,490 = $470 d. (2) Suppose the price increases to $2.50/can. What is the new profit maximizing quantity and what is your company’s daily profit? The new point where MR=MC=$2.50 is with the 24 th employee, with a quantity equal to 3560 (3,000+200+160+120+80) The daily profit is now

TR = 3560 * $2.50 = $8900 TC = $5,650 + $320 + $280 + $240 + $200 = $6,690 Profit = $8,900- $6,690 = $2,210 e. (2) Suppose your company’s fixed costs were $400 per day instead of $250 per day (price remains $2.50/can). What is the profit maximizing quantity and what is your company’s daily profit? Fixed costs will not influence the profit maximizing quantity, so that remains the same. However, your profit will be reduced to $2,060 because your total costs are higher by $150/day. f. (1) What is the name of your high-end dog food company 😉 ? Building off the immense popularity of “Meow Mix” my company is named “Bow-Wow Mix” Tag-line: So good, some (mostly smaller) dogs ask for it by name! 😊 3. (9) Use this refresher on Economic Value to the Customer https://bit.ly/4aOcbJ4 to answer the following questions. a. (3) Suppose a company estimates the following for a product it sells:  Tangible value the product provides: $25  Intangible value the product provides: $15  Costs customer must incur to purchase the product: $30  The next best alternative’s EVC – costs to customer to purchase that product: $23 Use these figures to calculate the EVC, Absolute EVC, and Relative EVC for this product. EVC = Tangible value the product provides + Intangible value the product provides EVC = $25 + $15 = $40 Absolute EVC = Your product’s EVC – Costs customer must incur to purchase the product Absolute EVC = $40 - $30 Absolute EVC = $10 Relative EVC = Absolute EVC – (The next best alternative’s EVC – costs to customer to purchase that product) Relative EVC = $10 – $23 Relative EVC = -$13 b. (3) Which of these figures (EVC, Absolute EVC, or Relative EVC) is most closely related to the economic concept of consumer surplus? Briefly explain. Consumer surplus is given by the difference between a consumer’s maximum willingness to pay and price actually paid for a product. A consumer’s maximum willingness to pay for a product is based on it’s Economic Value, or expected benefits to the customer; the price actually paid is most closely related to the costs the customer must incur to purchase the product So if CS = Maximum willingness to pay (= Your product’s EVC) – price actually paid =( Costs customer must incur to purchase the product); CS is most closely related to Absolute EVC = Your product’s EVC – Costs customer must incur to purchase the product c. (3) Briefly summarize the common mistakes managers can make when using EVC? The article notes that there are three common mistakes managers make when using EVC: 1. Assuming customers know the full value of the product that they are purchasing. 2. Setting price equal to EVC 3. Assuming EVC is constant across different types of customers

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4. (9) Use following site on the market price of soybeans: https://bit.ly/36LTHIW to answer the following questions. a. (2) What was the average closing price of soybeans in 2020 and the average closing price of soybeans in 2023? The average closing price was $9.53 in 2020 and was $14.16 in 2023. b. (4) Suppose the breakeven price – which is the price needed to cover all economic average costs (including implicit costs) equals $12/bushel. Their explicit average costs equal $9/bushel. Use the average 2023 prices to calculate the accounting and economic profits for a soybean farmer that produced 12,000 bushels in 2023. Profit equals (P-ATC)*Q Accounting profit = ($14.16 - $9)*12,000 = $61,920 Economic profit = ($14.16 - $12)*12,000 = $25,920 c. (3) If the breakeven price of soybeans equals $12/bushel, what can we predict will happen in the long run to the market supply or demand of soybeans, the market price of soybeans, and the economic profits of soybean farmers? Briefly explain. Given that the current price is above the breakeven price, this suggests that soybean farmers are earning economic profits. Because soybean farming is a competitive industry with relatively low barriers to entry, economic profits will not persist in the long run. The market supply of soybeans will increase over time, which will cause the market price of soybeans to fall until it equals the breakeven price, and the economic profits of soybean farmers will fall until they are equal to their implicit costs, or the amount they can expect to earn from their next best alternative. Note when I wrote this question the price was above $13, so it was well above the breakeven price. Currently it’s just slightly above the breakeven price of $12 (just as we would predict would happen in the long run!), so I would also accept that the market supply and price will change in the long run in the market.

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