Applied Problems-5 1

Applied Problems-5-Week 5

Rahul Parikh

BUS640: Managerial Economics (MAF1148A)

Dr Brian Shaw

January 8, 2012

Applied Problems-5 2

Applied Problems-5

Chapter 11: Applied Problem 8:

Suppose you own a home remodeling company. You are currently earning short-run profits.

The home remodeling industry is an increasing-cost industry. In the long run, what do you

expect will happen to:

a. Your firm’s costs of production? Explain.

Answer: The firm's cost of production will increase,

Explanation: The firm's cost of production will increase, because the industry is an

increasing-cost industry. As the company is earning short-run profits, new companies will

enter into the market, being encouraged by economic profits, and will bid up input prices for

all the firms in the remodeling industry. Thus demand for input factors will increase.

According to Thomas and Maurice (2011) “When a market is characterized by a large

number of small producers, the demand curve facing the manager of each individual firm is

horizontal at the price determined by the intersection of the market demand and supply

curves”. So, inputs will become costlier for increasing-cost industry. Input prices would not

be bid up if the industry is a constant cost industry. Hence we can say that costs of production

of the firm will increase.

b. The price you can charge for your remodeling services? Why?

Answer: The price you can charge for your remodeling services will decrease (or fall).

Explanation: Price will fall, because as the company is earning short-run profits, more

companies will enter the market to compete, being encouraged by the profit. The extra

competition will decrease the prices, which will shift the supply to rightward, causing fall in

equilibrium price.

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c. Profits in home remodeling? Why?

Answer: Profits (Economic Profit) in home remodeling will fall to zero.

Explanation: As discussed above, new companies will enter in the market, because of

current short run profits. This will increase competition, and will eliminate economic profit in

long run, so economic profit will fall to zero in home remodeling, which means that the long

run equilibrium will be established when economic profits will fall to zero, as new company

will enter the market in the long run.

Chapter 12: Applied Problem 5:

Antitrust authorities at the Federal Trade Commission are reviewing your company’s recent

merger with a rival firm. The FTC is concerned that the merger of two rival firms in the same

market will increase market power. A hearing is scheduled for your company to present

arguments that your firm has not increased its market power through this merger. Can you do

this? How? What evidence might you bring to the hearing?

Answer: Yes, I can do this by producing certain evidences before the antitrust authorities at

the Federal Trade Commission, at the time of scheduled hearing.

To present the arguments before the Antitrust authorities at the Federal Trade Commission

that my firm did not increased its market power through this merger, one of the evidence that

I will bring to the hearing, to support my firm’s controversy would be showing that my firm's

elasticity of demand was either unchanged by the merger, or even got larger by the merger.

Thus I will be able to convince FTC, by measuring my own-price elasticity before, and after,

the merger, that consumers still have ample substitutes for my product after merger.

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I may also show that after merger, there are enough other products that are close substitutes

to my product, to ensure that it is a competitive market, by presenting FTC with the evidence

of large, positive cross-price elasticities.

Chapter 13: Applied Problem 1:

When McDonald’s Corp. reduced the price of its Big Mac by 75 percent if customers also

purchased French fries and a soft drink, The Wall Street Journal reported that the company

was hoping the novel promotion would revive its U.S. sales growth. It didn’t. Within two

weeks sales had fallen. Using your knowledge of game theory, what do you think disrupted

McDonald’s plans?

Answer: I think McDonald’s had several issues with its utilization of game theory to predict

profits when they decreased the price of their most famous burger, the Big Mac. McDonald’s

plan got disrupted due to following issues, based on game theory:

McDonald’s have several major competitors / rivals in the market, so simply lowering the

price of an already cheap product would not do much in the way of profit maximization.  The

competitors will respond by selling their product at par or even cheaper than McDonald. For

example: Burger King can sell its flagship Whopper for 99 cents, which would be $1 less

than its regular price. Similarly Wendy’s, Sonic, etc, would come up with their own

promotions. Thus the competitors are too large, to benefit more from an improvement in

general industry conditions than by improving their position at the expense of others (Thomas

& Maurice, 2011). With so many attractive deals in the fast food industry, it is easy for

customers to go elsewhere, if one does not feel like having a Big Mac.

Secondly, although McDonald corp. lessened the cost of the Big Mac, they didn't lessen the

cost of the soft drink and fries. Hence the consumer may have been saving 75% on the Big

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Mac, but they were paying full price for the soft drink, and the French fries, which made up

for the 75% reduction in price of its Big Mac.

Third aspect is that most of all buyers of fast foods are more health conscience, and healthier

choices could have an impact on McDonald’s plan. Fast food buyers are aiming healthier

selections, such as salads, grilled chicken sandwiches and yogurt, rather than the Big Mac

giving 34g of fat and 590 calories (nutritiondata.self.com), while a 6 inch turkey sub giving

only 3.5 g of fat and 210 calories, (www.livestrong.com), so healthier choices could have an

impact on its plan.

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References:

Anonymous (n.d.), Self Nutrition Data; McDonald’s sandwich: Big Mac; Retrieved

December 30, 2011 from

http://nutritiondata.self.com/facts/foods-from-mcdonalds/6220/2

Anonymous (May 2, 2007), Turkey Sandwich Subway; Retrieved December 30, 2011 from

http://www.livestrong.com/thedailyplate/nutrition-calories/food/subway/turkey-

sandwich/

Thomas, C. & Maurice, S. (2011). Managerial economics: Foundations of business analysis

and strategy (10th International ed.). New York: McGraw-Hill ISBN: 978-0-07-

122120-4.