UniversityofToronto,DepartmentofEconomics,ECO20420092010.

AjazHussain
Test3
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Question Points Score
1 40
2 30
3 30
TOTALSCOREOUTOF100

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Question1[40Points]
AjaxMicroBooks(AMB)producesandsellsthemicroeconomicstextbookTheCollectedWorksofLord
eCONman.AMBhassignedalongtermcontractwithRhighersonUniversity.Underthetermsofthis
contract,AMBsells100textbooksamonthatapriceof$50pertextbook.AMBalsosellstextbooksasa
pricemakerinthegeneral(commercial)market.Exhibit1belowcontainsinformationonunits,price,
revenuesandgrossmargintorevenueratioforthefirst3monthsof2010:
Exhibit1:AjaxMicroBooks
January2010 February2010 March2010
Units(Books)
Commercial 10 30 50
RHighersonUniversity 100 100 100
Total 110 130 150

Price(perbook)
Commercial 95 85 75
RHighersonUniversity 50 50 50

Revenues($)
Commercial 950 2,550 3,750
RHighersonUniversity 5,000 5,000 5,000

GrossMargin:Revenue
Commercial 0.7894 0.7647 0.7333
RHighersonUniversity 0.6 0.6 0.6

AMBhasatotalcapacityof200booksamonthandhasaconstantreturnstechnology.AMBsmonthly
totalfixedcostis$1,000.

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(a)[5points]Withoutusingcalculus,showthatinMarch2010AMBisnotchargingtheoptimal
commercialprice.WillyourecommendthatAMBraiseorlowerthecommercialprice?Showall
calculationsandclearlystateassumptions.

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(b)[5points]DeriveAMBsmarginalcost.Showallcalculationsandclearlystateassumptions.

(c)[5points]Derivethecommercialdemandcurve.Showallcalculationsandclearlystateassumptions.

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(d)[10points]Solvefortheop antity pricein 2010bysolvingtheproblem: timalcommercialqu and April

s. t. q

= 1uu + q

2uu max
q
c
,q
r

c
+ , q
c
DonotsolvethisproblembyHR = HC,orequatingHL,orreducingthistoa1constraint
problem.Pleasesummarizeyouranswersbelow.Showallcalculationsandclearlystateassumptions.
Ifyoucouldntderivethecommercialdemandcurveand/orcostfunction,assumethat:
P
C
= Su - u.Sq
c
andC(q) = IFC + Suq.

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Variable Answer
q

q
c

P
c

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(e)[5points]ShouldAMBexpand,maintain,orreducethecurrentcapacityof200booksamonth?

(f)[5points]UnderthetermsoftheagreementwithRhighersonUniversity,AMBsupplies100booksa
monthat$50/book.WhatistheimpactonprofitsifAMBweretorenegotiatethecontractandraise
thepriceto$51/book?

(g)[5points]UnderthetermsoftheagreementwithRhighersonUniversity,AMBsupplies100booksa
monthat$50/book.WhatistheimpactonprofitsifAMBweretorenegotiatethecontractandsupply
101booksamonth?

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Question2[30Points]
YoumanagetheMcGrillUniversityBookstore.Thebookstorehasacapacityof1,000booksand
currentlybookshelvesarecompletelyfull.Lastmonth,thebookstoreearnedrevenuesof$60,000and
hadtotalvariablecostof$40,000.
Lastweek,AjaxMicroBookspublishedanewmicroeconomicstextbookTheCollectedWorksofLorde
CONman.AMBsellsthistextbookfor$60/book.Youretryingtofigureouthowmanycopiestoorder.
ThemarketingdepartmentestimatesthatinApril2010,thedemandcurvecouldbeP = 2uu - q or
P = 1uu - qwithequalprobability.
(a)[5points]Whatistheexpecteddemandcurve?Showallcalculationsandstateanyassumptions.

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(b)[5points]Supposethecostofunpackingboxesis$10/book.Assumethereisnocostofshelving(or
unshelving)books.Ifthebookstoremaximizesprofits,howmanytextbooksshouldyouorderand
shelve?Whatpricewillyouset?Showallcalculationsandstateanyassumptions

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(c)[5points]Foryouranswerinpart(b)provethattheoptimalmarkuprulebalances.Showall
calculations.

(d)[5points]Ifyouhadchosenthepriceinpart(b)bythecostplusrule,whatmarkupwouldyouhave
chosen?Showallcalculationsandstateanyassumptions.

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(e)[5points]Supposeyouhaveorderedbutnotshelvedthetextbooksfrompart(b).Ifactualdemand
nowturnsouttobeP = 1uu - qandAMBwillbuybacktextbooksfor$8/book,howmanytextbooks
willbeshelvedandreturned?Showallcalculations.

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(f)[5points]Repeatpart(b)assumingthatotherbookscanbesoldinthesecondarymarketforan
averageprofitof$10/book.Assumethedemandcurvefrompart(a).

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Question3[30Points]
Gamsi,Laffont,andVuonginEconometricAnalysisofCollusiveBehaviorinaSoftDrinkMarket,
JournalofEconomicsandManagementStrategy(Summer1992)estimatedthefollowingdemand
equationsfor a syrup Coke ndPepsi .
c

c p c p
1
= 26.17 - S.98P + 2.2SP + 2.6uA - u.62A + 9.S8S + u.99 I

p
= 17.48 + 1.4uP
c
- S.48P
p
- 4.81A
c
+ 2.8SA
p
+ 11.64S + 1.92 I
Alldatawasquarterlyfrom19681986where:
=quarterlyquantityofsyrupsold
=priceofsyrup(1986dollars) P
=squarerootofquarterlyadvertisingexpenses(1986dollars) A
=equals1ifspringorsummer,equals0ifwinterorfall S
I =realincome(1986dollars)
Averag a ev luesfromdatawere:
Su.22,
P
= 22.72 = , P
p
= 8.16 = S.89, A
p
= S.28, 2u.6S.
c
= , P
c
12.96 , A
c
I =
CokesIICwasestimatedtobeIIC
c
= S
c
andPepsisIICwasestimatedtobeIIC
p
= 4
p.

ForthisquestionworkwithPepsiNOTCoke
AssumePepsiplansSummer/SpringandFall/Winteratthebeginningoftheyear.Demote
spring/summeroutputbyq
s
andfall/winteroutputbyq
]
.Assumetotalannualcapacityis40units,i.e.
q
s
+ q
]
4u.

1
CokeandPepsi,thecorporations,producesyruporconcentratewhichissoldto(typically)independentbottlers.
Thebottlerscarbonatetheconcentrate,bottleanddistributethesoftdrinks.Thesedemandequationsareforthe
concentrate,i.e.bottlersdemand.
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(a)[10points]Treatingeachseasonasasegment,whataretheprofitmaximizingpriceandoutputif
thereisnopossibilityofarbitrage?Showallcalculationsandstateallassumptions.

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(b)[5points]Givenyouranswerinpart(a),wouldyouexpandPepsiscapacity?Ifyes,whatsthe
optimalcapacity?Ifnot,arguewhyyouwouldntexpandcapacity.

(c)[10points]Treatingeachseasonasasegment,whataretheprofitmaximizingpriceandoutputif
thereisapossibilityofarbitrage?Assumethecostofarbitrageis$0.50perunit.Showallcalculations
andstateallassumptions.

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(d)[5points]Givenyouranswerinpart(c),wouldyouexpandPepsiscapacity?Ifyes,whatsthe
optimalcapacity?Ifnot,arguewhyyouwouldntexpandcapacity.

THEEND.NICE!

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