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ECO204_2009_Test_3_solutions

ECO204_2009_Test_3_solutions - ECO 204 2009 2010 Test 3...

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ECO 204, 2009 - 2010, Test 3 This test is copyright material and may not be used for commercial purposes without prior permission University of Toronto, Department of Economics , ECO 204 2009 2010 . Ajaz Hussain Test 3 Solutions F ILL O UT I NFORMATION AS IT APPEARS IN ROSI LAST NAME: FIRST NAME: MIDDLE NAME: U T ORONTO ID #: SIGNATURE: SCORES Question Points Score 1 40 2 30 3 30 TOTAL SCORE OUT OF 100 Y OU CANNOT L EAVE THE ROOM IN THE FIRST HOUR OF THIS TEST Y OU MUST STAY SEATED DURING THE LAST 10 MINUTES OF THE TEST PLEASE WAIT UNTIL ALL TESTS ARE COLLECTED D O NOT UN STAPLE THIS TEST . IF YOU DO , IT IS YOUR RESPONSIBILITY TO STAPLE THE TEST . G RADERS ARE NOT RESPONSIBLE FOR LOOSE PAGES ONLY A ID ALLOWED : A C ALCULATOR . F OR YOUR CONVENIENCE , THERE IS A WORKSHEET AT THE END OF THIS TEST K EEP ANSWERS BRIEF . T O EARN CREDIT , SHOW CALCULATIONS AND GIVE ARGUMENTS TO SUPPORT YOUR ANSWERS Good luck! Page 1 of 32 S . Ajaz Hussain, Dept. of Economics, University of Toronto
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ECO 204, 2009 - 2010, Test 3 This test is copyright material and may not be used for commercial purposes without prior permission Question 1 [40 Points] Ajax Micro Books (AMB) produces and sells the microeconomics textbook “ The Collected Works of Lord e CON man”. AMB has signed a long term contract with Rhigherson University. Under the terms of this contract, AMB sells 100 textbooks a month at a price of $50 per textbook. AMB also sells textbooks as a price maker in the general (“commercial”) market. Exhibit 1 below contains information on units, price, revenues and gross margin to revenue ratio for the first 3 months of 2010: Exhibit 1: Ajax Micro Books January 2010 February 2010 March 2010 Units (Books) Commercial 10 30 50 RHigherson University 100 100 100 Total 110 130 150 Price (per book) Commercial 95 85 75 RHigherson University 50 50 50 Revenues ($) Commercial 950 2,550 3,750 RHigherson University 5,000 5,000 5,000 Gross Margin : Revenue Commercial 0.7894 0.7647 0.7333 RHigherson University 0.6 0.6 0.6 AMB has a total capacity of 200 books a month and has a constant returns technology. AMB’s monthly total fixed cost is $1,000. Page 2 of 32 S . Ajaz Hussain, Dept. of Economics, University of Toronto
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ECO 204, 2009 - 2010, Test 3 This test is copyright material and may not be used for commercial purposes without prior permission (a) [5 points] Without using any calculus show that in March 2010 AMB is not charging the optimal commercial price. Will you recommend that AMB raise or lower the commercial price? Show all calculations and clearly state assumptions. Answer We know that if a business charges the optimal (profit maximizing) price then either the optimal price rule balances: ܲ ൌ ൬ ܧ 1 ൅ ܧ ൰ ܯܥ Or, the optimal markup rule balances: ܲ െ ܯܥ ܲ ൌ െ 1 ܧ In this question we can check whether the optimal markup rule balances since this company has constant returns (and therefore ܯܥ ൌ ܣܸܥ ) so that: ܲ െ ܣܸܥ ܲ ൌ െ 1 ܧ Or: ሺܲ െ ܣܸܥሻܳ ܲܳ ܲܳ െ ܣܸܥ ܳ ܲܳ ܴ െ ܸܶܥ ܴ ൌ Gross Margin: Revenue Ratio ൌ െ 1 ܧ In March 2010, the commercial gross margin : revenue ratio is 0.7333. Does this equal െ1/ܧ ? We can
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