eco204_HW_16

# eco204_HW_16 - University of Toronto Department of...

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Unformatted text preview: University of Toronto, Department of Economics, ECO 204 2008‐2009 S. Ajaz Hussain ECO 204 2008‐2009 Ajaz Hussain HW 16 Question 1 In 1996, the drug Prilosec became the best selling anti‐ulcer drug in the world. Prilosec’s marginal cost (production and packaging) was only about \$0.60 per daily dose. The manufacturer initially set the price at \$3 per daily dose. Research on demand for leading prescription drugs estimates price elasticities to be in the range ‐1.4 to ‐1.2. Does setting a price of \$3 (or more) make sense? Question 2 Check whether the commercial price of \$800/hr in the Prestige Telephone Company is in the elastic portion of the demand curve (recall from Lecture 17 that a company can only maximize profits in the elastic ‐‐ i.e. |E| > 1 ‐‐ portion of the demand curve). Hint: You should look at the solution to the case ‐‐ check your email for password. Question 3 Ajax Air (AA) is the exclusive carrier on the Toronto‐ Niagara Falls route. AA needs to determine the number of flights per week and the fare per passenger. After totaling operating and fuel costs, airport charges, sobering up pilots etc. it calculates the operating cost per flight to be \$4,000. Each aircraft carries 100 passengers and the airline expects to fly all flights filled to capacity (i.e. there is ample demand for travel to ensure that all seats will be unsold). AA estimates weekly demand to be P = 120 – 0.1Q where Q is number of passengers and P is the fare in dollars. For this question, assume the MC is AVC 1 . 1 Technically MC ≠ AVC: to see what MC really is, consider a flight. If no seats are sold then assume the flight does not take off (in real life this is not true because a flight may have to pick up passengers from the destination and travel to another city‐‐ thus even if there are no passengers at the origin city, the flight must depart. When the first 1 University of Toronto, Department of Economics, ECO 204 2008‐2009 S. Ajaz Hussain (a) What is the MC of each passenger? (b) What is the optimal number of flights per week and the passenger fare? (c) Take your answer in part (b) as the AA’s capacity. Suppose AA has been offered \$6,000 per week to carry freight. Assume that a freight flight does not carry passengers and vice versa. How many passenger and freight flights should AA operate? Assume AA does not have fixed costs. What is the passenger fare? Use Technique 1 (“opportunity cost”) from the Hoo‐Sin/G‐in‐ dart motorcycle example in Lecture 18. (d) Repeat part (c) using Technique 2 (“multivariate” decision problem) from Lecture 18 (see from the Hoo‐Sin/G‐in‐dart motorcycle example). Don’t forget the constraint that QP + QF = 400 where the subscript “P” is for passengers and “F” is for freight. Question 4 Ajax Super‐Komputers manufactures two products: electronic control devices (ECD) and specialty microchips. The microchips are a component of ECDs and can be sold to other high tech manufacturers for \$550. The AC of microchips is \$300. The AC of ECDs is \$500 plus the cost of two microchips. ECD sells for \$1500. Currently, the microchips production facility is running at 100% capacity. Assume there are no fixed costs and that the cost function is linear. (a) Should the company produce ECDs? Isthis product profitable? (b) Now suppose production of microchips is below 100% capacity. Should the company produce ECDs? (c) Now suppose that \$200 of the ECDs AC is fixed. Also assume microchip production is at 100% capacity. Should ECDs be produced? seat is sold, the flight must take off. The MC of the first passenger is \$2,000 (the full operating cost of the flight). Given that with a single booking the flight must depart, the MC of the second, third etc. passengers are all zero. 2 ...
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## This note was uploaded on 05/02/2011 for the course ECO 204 taught by Professor Hussein during the Fall '08 term at University of Toronto.

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