201 ECON 401 Managerial Economics
Due date: Friday, October 9, 2020 at 12.00 pm sharp.
No late submissions will be accepted. All assignments must be returned by 12.00 pm. You are allowed to use course materials to answer all questions. In your submission, please confirm that you completed all work without any help and list all materials you used in taking the test.
1. Faisal states that he does not care whether he drinks Coke or Pepsi “as long as it is soda.” Assume that Faisal can spend $100 per month on soft drinks.
A) Does Faisal’s statement violate any of the properties we require for preferences?
B) How many cans of Coke and Pepsi does Faisal consume, respectively, if the price of Coke is $4 per can and the price of Pepsi is $2.50 per can?
C) How does your answer change, if the price of Pepsi increases to $3? What if it increases to $5?
D) Assume the original prices, but now assume that Faisal’s income doubles. Is he better off? How does his consumption of Coke and Pepsi change?
E) Illustrate your answers A) through C) graphically.
2. The government of the city of Dayton, Ohio in the U.S.A. wants to fight crime related to illegal drug use. Users often turn to crime to finance their drug habit. The city government asks you as an economic consultant to compare two policy interventions. Interdiction, which is aimed at disrupting delivery of drugs, and education, which aims at informing users about the danger of illicit drug use. Assume that the total value of drug related crime equals the total expenditure on drugs. Which policy do you recommend to Dayton’s policymakers, if you assume that demand for illegal drugs is inelastic due to addiction? Justify your answer rigorously. Illustrate your answer graphically.
3. When the professional economists in the Trump administration calculated the benefits to household incomes based on increased wages associated with the reduction in the corporate income tax rate proposed by the administration, they were ridiculed because the total benefits to household incomes exceeded the amount of the tax cuts. Was this justified? Illustrate your reasoning graphically.
Hint: The corporate income tax is a tax on corporate profits and can be seen as a tax on the return on capital. This is known as the rental rate of capital and is the compensation the owners of capital used in the production process obtain.
4. A large crude oil producer in the Middle East asks you to help the company find the revenue-maximizing output of crude oil. The firm provides you with five years of monthly data of price and customer nominations (customer nominations refer to customers’ indicating how much crude oil they would like to buy at the particular price).
A) Carefully explain how you would answer this question. Be sure to explain what you are trying to measure, what data you will use, how you identify the demand function, and what empirical tests you run.
B) You notice that in some months both nominations and price are higher than in other months. Explain why this is not a violation of the law of demand.
C) The crude producer also wants to know if its crude oil competes with Australian coal. How would you answer this question?
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