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Professor Schuler
CEE594/ECON 494
Fall 2007
Problem Set 3 Solutions
Problem 1
a.
Q = 15000  2
.
8(7000) + 150(52) +
.
3(4000) +
.
35(15000) +
.
2(8000) = 11250
The elasticity of each variable is
dQ X
dX Q
where X is the variable. So,
own price:
η
P = (2
.
8)(7000
/
11250) = 1
.
742, very
sensitive
advertising:
η
A = (150)(52
/
11250) =
.
693, less than
proportional positive impact
PC price:
ηP
pc
=(
.
3)(4000
/
11250) =
.
107, very
insensitive
minicomputer price:
ηP
m
=(
.
35)(15000
/
11250) =
.
467,
somewhat sensitive, a substitute
competitor price:
ηP
c
=(
.
2)(8000
/
11250) =
.
142, very
insensitive
Your competitor must have a bad product. Focus on your own price and your advertising
budget in trying to maximize your pro±ts, and to a lesser extent, the prices of the mini
PCs that seem to be your closest competitors. Note that for every $1000 spent of
advertising, you sell 150 more computers at $7000. Your revenue maximizing price is
$5509, so depending on your
MC
, lowering your price might be your most pro±table
strategy.
b.
Certainly, you should consider the MIPS as a performance index, both in absolute
terms (e
f
ects demand for all computers) and relative to your closest competitor (the mini
PC
here).
Changing interest rates a
f
ect the opportunity cost of acquiring a computer, and then
again because your workstation and competitor’s workstation have similar prices, interest
rates may have a greater e
f
ect on overall demand. But since the mini is your real
competitor and it costs almost twice as much, rising interest rates should have the biggest
impact
on
you
by
raising
the
minicomputer’s
usage
cost
(rental
rate).
1
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View Full DocumentProfessor Schuler
CEE594/ECON 494
Fall 2007
c.
Eleven years is an eternity in this industry with rapid technological change. I’d re
estimate the entire model with recent data, particularly using performance measures. One
can estimate the model with last year’s data, then forecast this year’s sales and compare
with
actuals
to
get
a
sense
of
which
model
performs
best.
Problem 2
a.
Looking at the ±rst ±ve years alone, assuming all cash ﬂows and the 12% cost of capital
are real values then (in thousands),
0
NPV
=
5
5
1
1
55
1
250
55
(1.12)
1
t
t
t
t
r
β
=
=

+
=
≡
+
∑
∑
.
Let us also define
5
1
t
t
s
=
≡
=
∑
3.60478.
Therefore,
250 55
51.737.
o
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 Fall '07
 SCHULER

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