Professor Leonardo Bursztyn Management 405

Fall 2013 Managerial Economics

Problem Set 1 (100 points: 20 points each) 1. Business expansion Suppose that you operate a nurse-managed clinic and are considering extending the hours of operation into the evenings to enable you to see more patients. If you do so, it will add to expense but also to revenue, since the patients seen are eligible for third-party reimbursement. The income statement of the organization appears below. In the right hand column are projected income and expenses if the expansion is implemented. Note that the expansion involves a drop in revenue per visit because it entails seeing patients with lower reimbursement. The average reimbursement falls from $50 ($287,500/5,750) to $48 ($414,000/8,625) as a result of the expansion. Questions: Show your work! a. What is the marginal cost per visit of catering to the additional visits? b. What is the marginal revenue per visit of catering to the additional visits? c. On a purely economic basis, does it make sense to expand the clinic? Why or why not?

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Professor Leonardo Bursztyn Management 405

Fall 2013 Managerial Economics

2. Career choice Joe quits his computer programming job, where he was earning a salary of $50,000 per year, to start a computer software business in a building that he owns and was previously renting out for $24,000 per year. In his first year of business he has the following expenses: salary paid to himself, $40,000; rent, $0; other expenses, $25,000. Find the accounting cost and the economic cost associated with Joes computer software business. 3. Total and average costs A firm has a fixed production cost of $5,000 and a constant marginal cost of production of $500 per unit produced. a. What is the firms total cost function? Average cost? b. If the firm wanted to minimize the average total cost, would it choose to be very large or very small? Explain, 4. Selling cars at a loss A recent issue of Business Week reported the following: During the recent auto sales slump, GM, Ford, and Chrysler decided it was cheaper to sell cars to rental companies at a loss than to lay off workers. Thats because closing and reopening plants are expensive, partly because the automakers current union contracts obligate them to pay many workers even if theyre not working. When the article discusses selling cars at a loss, is it referring to accounting profit or economic profit? How will the two differ in this case? Explain. 5. Sulfur dioxide emissions Assume that scientific studies provide you with the following information concerning the benefits and costs of sulfur dioxide emissions: Marginal social benefits of abating (reducing) emissions: MSB = 500 20A Marginal private benefits of abating emissions: MPB = 400 35A Marginal costs of abating emissions: MC = 200 + 5A Where A is the quantity abated in millions of tons and the benefits and costs are given in dollars per ton. Private benefits were estimated for an average firm that releases sulfur dioxide in its industrial processes. a. Why do the private benefits differ from the social benefits?
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Professor Leonardo Bursztyn Management 405

Fall 2013 Managerial Economics

b. What is the socially efficient level of emissions abatement? What is the privately efficient level? c. Calculate the marginal social benefits, the marginal private benefits, and the marginal costs at the socially efficient level. What are these quantities at the privately efficient level? d. Suppose that emissions abatement is at the privately efficient level. What would you suggest be done to achieve the socially efficient level?

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