Problem Set 1 Suggested Solutions

# Problem Set 1 Suggested Solutions - ECON 106 Economics of...

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ECON 106 – Economics of Entrepreneurship Prof. Ackerberg Problem Set #1 Suggested Answers 1) a) False, market power of the suppliers of your inputs is a very important consideration. If you buy your materials from a supplier with very little competition (i.e. there are few or no other suppliers of the input) and there are no substitute materials you can use to produce your product, this supplier will have a lot of bargaining power over you. If you find yourself making big profits, you can expect the supplier to raise the price it charges you, extracting much of these profits. b) False, with a bundle price of \$10, you earn only \$30 in profits. Alternatives include 1) selling the bundle at a price of \$18 and earning \$36 in profits, 2) selling the goods individually at \$5 apiece (\$30 profits), 3) selling the goods individually at \$8 apiece (\$32 profits) and 4) selling the goods individually at \$10 apiece (\$20 profits). There are also alternatives where one sets different individual prices (e.g. sell A at \$8, sell B at \$10), but all of these make less than \$32 in profits. Clearly, one makes the most profits selling the bundle at a price of \$18. c) False, with learning by doing you should generally set initial prices lower (and initial quantities higher) than you would otherwise. This is because by setting lower initial prices, one produces and sells more initially. This moves you down the learning curve and results in lower costs in the future, increasing profitability. d) True, from our notes we have the result that A/(PQ) = -E A /E P , i.e. the profit-maximizing proportion of revenue to be spent on advertising should be equal to the ratio of the advertising elasticity of demand to the price elasticity of demand. E A is the same for both markets, E P is less negative in the men’s market than the women’s market (demand is more inelastic). Since E P is less negative for men, E A /E P is more negative for men, and A/(PQ) = -E A /E P is more positive for men. e) Uncertain. As argued in class, this type of advertising can convince consumers of your product’s quality if there is the potential for repeat purchases. 2)

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## This note was uploaded on 09/03/2009 for the course ECON 106E taught by Professor Ackerberg during the Spring '08 term at UCLA.

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Problem Set 1 Suggested Solutions - ECON 106 Economics of...

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