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Unformatted text preview: University of Toronto, Department of Economics, ECO 204. Summer 2009. S. Ajaz Hussain ECO 204 Summer 2009 S. Ajaz Hussain Practice Problems 1 Please help improve the course by sending me an email about typos or suggestions for improvements Note: Please don't memorize these solutions in the expectation that similar questions will appear on tests and exams. Instead, try to understand how to derive the answer as you'll be tested on techniques and applications, not on memorization. Moreover, tests and exams will cover topics and techniques that may not be in these practice problems. You are urged to go over all lectures, class notes and HWs thoroughly. As you may know from ECO 100, economics extensively uses marginal analysis (for example: "marginal revenue", "marginal cost" and "marginal utility"). This is because "thinking on the margin" is a powerful technique for solving problems, especially when there are no equations and graphs. Because we marginal analysis is used extensively in this course, you will practice "thinking on the margin" in the first three questions below. Question 1 In this question you will repeat the NPV example I gave in class. Ajax Private Equity (PAE) has unlimited funds to invest. Ajax's financial advisor, Madoff Advisors, has identified the following seven projects as investment opportunities: 1 University of Toronto, Department of Economics, ECO 204. Summer 2009. S. Ajaz Hussain Project A B C D E F G Initial Investment $1m $0.4m $0.3m $0.1m $0.2m $0.2m $0.1m NPV $2m $1.4m $1.2m $0.6m $0.5m $0.3m $0.05m (a) Given that you have unlimited funds which project should you invest in? (b) To his horror, Ajax discovers that he only has $1m. Unable to afford Madoff Advisors he instead engages an MBA from McGrill University in Montreal who tells Ajax that since he has $1m only he should invest in the feasible project (i.e. less than or equal to $1m outlay) with the highest NPV. Is he correct? Hint: look at the NPV per $ invested. Question 2 (ECO 204 20082009 Test 4 question) In this question, you will again practice marginal analysis. AccountingMan (no relation to Eco man) owns an "accounting education in a hurry" business (recent customers include AIG, Bear Stearns, and Nortel). AccountingMan has a sales force of 16 people and is trying to decide how many salespeople to allocate to servicing existing large accounts and how many salespeople to allocate procuring new small accounts. AccountingMan contacts his cousin Economicsman who conducts brilliant market research. The results of the market research are reproduced in Table 1 below and shows the Marginal profits and total profits (in `000s of $) from the number of salespersons allocated to each type of account. (a) Fill in the total profits for the shaded cells in Table 1 below. 2 University of Toronto, Department of Economics, ECO 204. Summer 2009. S. Ajaz Hussain Number of Salespersons 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 Table 1 EconomicMan's Report to AccountingMan Large Accounts Small Accounts Marginal 80 80 80 80 80 70 70 70 40 40 40 40 40 40 40 40 0 930 Marginal 150 150 100 100 100 50 50 50 30 30 30 30 30 20 20 20 200 1,160 (b) AccountingMan notes that with either 0 salespersons or 16 salespersons, the profits from large accounts are always greater than small accounts. He thinks all 16 salespersons should be allocated to large accounts. Is he right? Give a clear explanation. 3 University of Toronto, Department of Economics, ECO 204. Summer 2009. S. Ajaz Hussain Question 3 In this question you will practice marginal analysis for how to study for your exams. You have been procrastinating, watching TV, playing games and clubbing. One fine Monday, you wake up in the late afternoon of course and realize to your horror that you have an economics and an accounting test on Friday. Of course, you should spend every hour studying for these tests, but what is life without trips to Circa, Embassy, Wrong Bar and the Social? Given that you must club hop you calculate that you will have 5 hours to study for your tests. Your goal is to maximize the average grade across the two courses (which means you want to maximize the sum of the grades across the two courses). Your best guess for grades as a function of hours is given in Table 1 below: Study Hours 0 1 2 3 4 5 Economics Grade 70 78 83 88 90 92 Study Hours 0 1 2 3 4 5 Accounting Grade 75 81 85 87 89 90 How should you allocate 5 hours of studying between the two subjects? Question 4 (ECO 204 summer 2008 final exam question) In this question you will repeat and extend the elasticity example from lecture 1. Club Stereo currently charges a $10 cover charge (entrance fee). On average, customers have 1 drink. The elasticity of demand with respect to cover charge price is 0.6. The club manager is debating whether to raise the cover charge from $10 to $11. (a) If the club seeks to maximize "cover" revenues, should it raise the cover charge from $10 to $11? If you say yes, indicate the percentage change in cover revenues. (b) If the club seeks to maximize total revenues, should it raise the cover charge from $10 to $11? If you say yes, indicate the percentage change in total revenues. 4 University of Toronto, Department of Economics, ECO 204. Summer 2009. S. Ajaz Hussain (c) What must the price of a drink be for the total revenues from cover charge and 1 drink to increase if the cover charge increases from $10 to $11? Show all steps and calculations. State any assumptions. Question 5 (ECO 204 20072008 final exam question) In recent years, "vanity" license plates have become popular in many countries. Instead of pre assigned numbers, vanity plates have letterings chosen by drivers. For example, the plate could read "EcoBoy". Suppose Toronto City Hall experiments with vanity plates. It estimates demand for vanity plates to be given by the equation P = 100 10Q, where P is in dollars and Q is in `000s. The MC of manufacturing vanity plates is zero because as is the case in most countries vanity plates are made by prisoners. In the first year, vanity plates are priced at $60 each. In the second year, prices are lowered to $45. Toronto City Hall claims the lower prices was a resounding success as it led to higher revenues. In fact, City Hall managers propose lowering prices even further. Evaluate City Hall's pricing of vanity plates. In particular, would you advise Toronto to change their pricing strategy? 5 ...
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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- Toronto.

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