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Agency Problem Scenarios

1. An article in the Wall Street Journal reported that large hotel chains, such as Marriott, are tending to reduce the number of hotels that they franchise to outside owners and increase the number the chain owns and manages itself. Some chains are requiring private owners or franchisees to make upgrades in their hotels, but they are having a difficult time enforcing the policy. Marriott says the upgrading is important because "we've built our name on quality."
a. What type of agency problem is involved here?
b. Why would Marriott worry about the quality of hotels it doesn't own but franchises?
c. Why would a chain such as Marriott tend to own its hotels in resort areas, such as national parks, where there is little repeat business, and franchise in downtown areas, where there is a lot of repeat business? Think of the reputation effect and the incentive of franchises to maintain quality.

2. Suppose you are the manager of a California winery. How would you expect the following events to affect the price you receive for a bottle of wine? Explain your answers.
a. The price of a comparable French wine decreases.
b. One hundred new wineries open in California,
c. The unemployment rate in the United States decreases.
d. The price of cheese increases.
e. The price of a glass bottle increases significantly due to new government anti-shatter regulations.
f. Researchers discover a new wine-making technology that reduces production costs.
g. The price of wine vinegar, which is made from the leftover grape mash, increases.
h. The average age of consumers increases, and older people drink less wine.

3. After Iraq invaded Kuwait, gasoline prices rose dramatically - up 50 percent. There were many effects of the increased price of gasoline. Explain the following effects in terms of the income effect, substitution effect, or both effects:
a. People drove less and purchased less gas.
b. People ate out less often.
c. People had more tune-ups done on their cars.
d. Bike sales went up.
e. The sale of lottery tickets fell.
f. People took vacations closer to home.

4. Recently, the House of Representatives passed legislation to increase the minimum wage in the nation from $5.15 to $7.50. What are the pros and cons of this proposal? Provide an analysis based on the demand and supply of labor.

5. Assume the demand for plastic surgery is price inelastic. Are the following statements true of false? Explain.
a. When the price of plastic surgery increases, the number of operations decreases
b. The percentage change in the price of plastic surgery is less than the percentage change in quantity demanded.
c. Changes in the price of plastic surgery do not effect the number of operations.
d. Quantity demanded is quite responsive to changes in price.
e. If more plastic surgery is performed, expenditures on plastic surgery will decrease.
f. The marginal revenue of another operation is negative.

Solution Preview

See the attached file.
1. An article in the Wall Street Journal reported that large hotel chains, such as Marriott, are tending to reduce the number of hotels that they franchise to outside owners and increase the number the chain owns and manages itself. Some chains are requiring private owners or franchisees to make upgrades in their hotels, but they are having a difficult time enforcing the policy. Marriott says the upgrading is important because "we've built our name on quality."
a. What type of agency problem is involved here?
Marriott is the owner and franchisees are pseudo owners of the brand. Maintaining quality is of utmost priority to Marriott as it has a direct impact on the customer perception. However franchisees do not want to spend money on upgrading as they think their hotels do not have any issue. Marriott is at a loss in such situations as its brand image is at stake.
b. Why would Marriott worry about the quality of hotels it doesn't own but franchises?
Franchise hotels carry the Marriott tag with them. If there are quality issues with franchise hotels, customers would show their resentment with Marriott and not with private owners.
c. Why would a chain such as Marriott tend to own its hotels in resort areas, such as national parks, where there is little repeat business, and franchise in downtown areas, where there is a lot of repeat business? Think of the reputation effect and the incentive of franchises to maintain quality.
People who come to resort areas such as national parks are generally on ...

Solution Summary

The solution discusses different scenarios with problems within an agency.

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