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 17 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. Question 1 Suppose the Ontario government levies a fine on tobacco companies for misleading smokers about the dangers of smoking (a similar measure was passed in the US a few years ago). If the fine is collected as a lump sum tax, should tobacco companies raise the price of cigarettes to compensate for the fine? Hint: what is the rule for profit maximization? Question 2 Ajax Cable Company (ACC) provides internet access to subscribers in downtown Toronto. ACC leases network capacity from Rogers by paying Rogers $2m a month plus $10 per subscriber per month. ACC's other expenses are $2m a month. ACC's marketing department estimates demand for its internet services to be: Q = 4 P/5 where Q is number of subscribers in millions and P is the monthly price in dollars. (a) Calculate ACCs revenue maximizing price and subscribers? Show all steps clearly. (b) What is the price elasticity for your answer in part (a)? (c) What is ACC's cost equation? What is the fixed cost? What is the MC? Show all steps clearly. (d) Calculate ACC's profit maximizing price and subscribers. Show all steps clearly. 1 University of Toronto, Department of Economics, ECO 204. Summer 2009. S. Ajaz Hussain (e) ACC introduces "popup" advertising on its website, which is raises MR by $10. Calculate ACC's profit maximizing price and subscribers. (f) Rogers and ACC renegotiate their contract. Under the terms of the new contract, Rogers will provide network capacity for 1.5m subscribers a month and charge ACC $3m a month. Calculate ACCs optimal price and subscribers. Show all steps clearly. Question 3 (Summer 2008 Test 3 Question) In this question, the decision variable is "time". After graduating from UT's Commerce program, you fulfill your lifelong dream to produce a movie. You've just finished work on "The Dark Monopolist" based on the life of a nefarious criminal SadDamn Hussain. The movie cost $50m to produce. Assume the MC of "printing" movies on films is negligible. If the movie is released into theaters the revenues as a function of the number of weeks in theaters is: R(w) = 10w 0.25w2, where R is millions of dollars and w is the number of weeks the movie is shown in theaters. What is the optimal number of weeks the movie should be shown in theaters? Show all steps clearly. Question 4 In this question you will use the concept of opportunity cost to solve a 3rd degree price discrimination problem and "yield management". Yield management is a technique used by airlines to price seats. In some airlines, such as PIA, aircrafts have a first, business and economy classes but the fares within each class are uniform. In other airlines, there is price heterogeneity within classes. That is, even within the economy class seats can be sold at different prices (here's a very funny article on airline pricing). You may have experienced this yourself when booking a flight: the fare changes over time as the airline tweaks prices on current demand conditions. Let's see how yield management works. Suppose an airline operates a 180 seat aircraft between Toronto and Boston. The aircraft has a single "class". However as is typical in airlines there are different types of travelers: say "early bookers" (E) and "late bookers" (L). Their demand equations are: QE = 250 PE QL = 330 PL 2 University of Toronto, Department of Economics, ECO 204. Summer 2009. S. Ajaz Hussain Let's suppose the MC of all passengers is 0 (think of it this way: the flight always operates and passengers are not served any drinks or meals). (a) Suppose this airline was like PIA and charged the same price for all passengers. What is the common price for early and late bookers? Hint: The airline is not segmenting the market and is aggregating across segments. You may want to derive the aggregate demand curve. (b) Suppose you are in charge of pricing "early bookers" seats. If your salary is a percentage of revenues from early bookers what price will you choose? (c) Suppose you are in charge of pricing "early bookers" seats. If your salary is a percentage of total revenues what price will you choose? Use the concept of opportunity cost. 3 ...
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 Fall '08
 HUSSEIN
 Economics, Microeconomics, Pricing, Supply And Demand, Ajaz Hussain

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