1. Consolidated Drugs, Inc. has spent $4 million developing and testing a new anti-aging drug. Management now estimates that it will cost $2 million to produce and market this new product. The present value of total revenue from all future sales of this drug is estimated to be $5 million. On the basis of these numbers, management is recommending dropping the project since costs will exceed revenues. a.) Do you agree with this recommendation? Explain. b.) The head of the accounting department indicates that if the product is produced and marketed, $4 million of corporate overhead expenses will be assigned to the product. Does this new information change your answer to (a) Explain.
2. A local owner of a privately-held video rental store read in a newspaper that the elasticity of market demand for video rentals is -.45. She thus reasoned that if she raised the price of her rentals, her total revenue would increase. So she increased her price by 20%, and her revenues fell sharply. What is your explanation for this outcome?
3. A steel industry trade group estimates that the demand for steel in a particular market is given as
Qs = 2,000 - 160Ps + 8I + 140Pa,
where Qs is the demand for steel (in pounds) per year, Ps is the price of steel in cents per pound, I is income per capita in dollars, and Pa is the price of aluminum in cents per pound. Currently the price of steel is 160¢ per pound, income per capita is $20,000, and the price of aluminum is 300¢ per pound.
a. How much steel will be demanded at the current prices and income?
b. What is the own price elasticity of demand for steel? Interpret the elasticity in a mathematic and economic context -- what does this number tell you? Is the own price elasticity consistent with economic principles? Explain.
c. What is the income elasticity? Interpret the elasticity in a mathematic and economic context -- what does this number tell you? Is the income elasticity consistent with economic principles? Explain.
d. What is the practical interpretation of your answers to b. and c. when looked at together? What kinds of conclusions can you make about the demand for steel?
e. If management's objective is to maintain the quantity of steel demanded at current levels (as computed in a. above), what change in the price of steel would be necessary to compensate for a 10¢ decrease in the price of aluminum?
Part II. Multiple Choice - Please bold and underline the right choice and elaborate - one answer.
1. The production possibilities frontier is an economic model that illustrates maximum amount of two goods (say DVD's and Cars) that can be produced by an economy using its resources. The rate at which car production may be traded for DVD production along the frontier may best be described as:
a. The opportunity cost of producing DVD's
b. The efficiency used to produce DVD's
d. None of the above
2. Which of the following events is more likely to shift the US production possibilities frontier outward?
a. Consumers begin to demand more service goods instead of manufactured goods.
b. The value of the US dollar falls relative to other currencies.
c. The rate of unemployment among US workers increases.
d. A technological process is developed to reduce the cost of production of manufactured goods..
3. Recently cited evidence suggests that consuming a single glass of red wine each day will improve an individual's general health. If this evidence is widely publicized, the news will likely:
a. Cause the demand curve for red wine to become less steep (flatter)
b. Create a downward movement along the red wine demand curve
c. Shift the demand curve for wine to the left (inward)
d. Shift the demand curve for red wine to the right (outward)
4. Which of the following goods has a demand that is the most inelastic with respect its price?
a. cable television service
c. essential (life preserving) medical care
5. Due to drought conditions, the local government wants to reduce the quantity demand of water by 10%. If it is estimated that the price elasticity of demand for water is -0.3, by how much (in percentage terms) must the price of water be increased to reach this goal?
b. 3.0 %
The problem set are question in microeconomics.