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Exam 2 Problems

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1. Demand Curve Estimation. The Real Kool Toys Company manufactures and sells educational toys. An empirical demand function for one of the firm's products has been estimated over the last 21 quarters using regression analysis. The estimated demand function is:
 Q Y = -8,000 - 5,000P Y + 192A + 120I + 2,000P X (6,000) (1,000) (120) (80) (800)
R 2 = 91%
Standard Error of the Estimate = 1,000
Here Q Y is quantity (measured in units) of Product Y demanded in the current period, A is hundreds of dollars of advertising (\$00), I is thousands of dollars of disposable income per capita (\$000), and P X is the price (\$) of another toy manufactured by a competitor, ABC Toys. The terms in parentheses are the standard errors of the coefficients.
A. How would you characterize the ability of this empirical demand function to explain demand for product Y?
B. Currently, P Y is \$8, advertising is \$25,000, disposable income per capita is \$50,000 and P X is \$7. What are expected sales of Y in this period, and what range of sales would you specify for the current period if you wanted to establish a 99% confidence interval?
C. What is the demand curve currently facing Real Kool for Product Y? (Note: Be careful to properly account for the units in which advertising and income appear in the estimated demand function.)
D. What is the point price elasticity of demand for Y at the current price?
E. Given the current price elasticity of demand, would a price reduction increase Real Kool profits? Explain.
F. What demand curve would Real Kool face for Product Y if it raised advertising expenditures to \$37,500?
2. Incremental Costs. Infinite Audio, Inc., manufactures car speakers which it sells to other resellers, who then customize and distribute the products to retailers which sell hi-fi auto equipment. The yearly volume of output is 300,000 pairs. The selling price and cost per unit are shown below:
 Selling price \$150 Costs: Direct material \$25 Direct labor 45 Variable overhead 20 Variable selling expenses 15 Fixed selling expenses 10 115 Unit profit before tax \$ 35
Management is evaluating the alternative of performing the necessary customizing to allow Infinite Audio to sell its output directly to car stereo retailers for \$200 per unit under an in-house marquee. Although no added investment is required in productive facilities, additional processing costs are estimated as:
 Direct labor \$20 per unit Variable overhead \$15 per unit Variable selling expenses \$10 per unit Fixed selling expenses \$300,000 per year
A. Calculate the incremental profit Infinite Audio would earn by customizing its instruments and marketing directly to end users.
3. Firm Supply. The Copy Center specializes in high-volume printing and color copying for small businesses. This is a fiercely competitive market. The following relation exists between output and total production costs:
 Total Output Total Cost 0 \$ 500 10,000 3,500 20,000 7,500 30,000 12,500 40,000 18,500 50,000 25,500 60,000 33,500 70,000 45,000
A. Construct a table showing the marginal cost of production.
B. What is the minimum price necessary for the company to supply ten thousand copies?
C. How many copies would the company supply at industry prices of \$5,500 and \$7,000 per ten thousand?
4. Perfectly Competitive Equilibrium. Office building maintenance plans call for the stripping, waxing, and buffing of ceramic floor tiles. This work is often contracted out to office maintenance firms, and both technology and labor requirements are very basic. Supply and demand conditions in this perfectly competitive service market in St. Paul, Minnesota are:
 Q S = -20 + 2P (Supply) Q D = 80 - 2P (Demand)
where Q is thousands of hours of floor reconditioning per month, and P is the price per hour.
A. Algebraically determine the market equilibrium price/output combination.