Economics Promblems

1. Approximately 14 million Americans are addicted to drugs and alcohol. The federal government estimates that these addicts cost the U.S. economy $300 billion in medical expenses and lost productivity. Despite the enormous potential market, many biotech companies have shied away from funding research and development (R&D) initiatives to find a cure for drug and alcohol addiction. Your firm – Drug Abuse Sciences (DAS) – is a notable exception. It has spent $170 million to date working on a cure, but is now at a crossroads. It can either abandon its program or invest another $30 million today. Unfortunately, the firm’s opportunity cost of funds is 7 percent and it will take another five years before final approval from the Federal Drug Administration is achieved and the product is actually sold. Expected (year-end) profits from selling the drug are presented in the accompanying table.

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9
$0 $0 $0 $0 $15,000,000 $16,500,000 $18,150,000 $19,965,000 $21,961,500

What is the net present value of the project?

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Instruction: Round your answer to the nearest penny (2 decimal places). Use a negative sign (-) where appropriate.


If the firm prices below $140, revenue will:

b. What is the own price elasticity of demand when Px = $240? Is demand elastic or inelastic at this price? What would happen to the firm’s revenue if it decided to charge a price above $240?

Instruction: Round your response to 1 decimal place.

Own price elasticity:

If the firm prices above $240, revenue will:

c. What is the cross-price elasticity of demand between good X and good Z when Px = $140? Are goods X and Z substitutes or complements?
Instruction: Round your response to 2 decimal places.

Cross-price elasticity:


6. You are an assistant to a senator who chairs an ad hoc committee on reforming taxes on telecommunication services. Based on your research, AT&T has spent over $15 million on related paperwork and compliance costs. Moreover, depending on the locale, telecom taxes can amount to as much as 25 percent of a consumer’s phone bill. These high tax rates on telecom services have become quite controversial, due to the fact that the deregulation of the telecom industry has led to a highly competitive market. Your best estimates indicate that, based on current tax rates, the monthly market demand for telecommunication services is given by Qd = 250 – 5P and the market supply (including taxes) is QS = 3P – 110 (both in millions), where P is the monthly price of the telecommunication services.

The senator is considering tax reform that would dramatically cut tax rates, leading to a supply function under the new tax policy of QS = 3.5P – 110. How much money per unit would a typical consumer save each month as a result of the proposed legislation?

Instruction: Round your answer to the nearest penny (2 decimal places).


What price should BAA charge for runway slots between July and September?



18. A risk-neutral consumer is deciding whether to purchase a homogeneous product from one of two firms. One firm produces an unreliable product and the other a reliable product. At the time of the sale, the consumer is unable to distinguish between the two firms’ products. From the consumer’s perspective, there is an equal chance that a given firm’s product is reliable or unreliable. The maximum amount this consumer will pay for an unreliable product is $0, while she will pay $100 for a reliable product.


a. Given this uncertainty, what is the most this consumer will pay to purchase one unit of this product?


b. How much will this consumer be willing to pay for the product if the firm offering the reliable product includes a warranty that will protect the consumer?



19 As the manager of Smith Construction, you need to make a decision on the number of homes to build in a new residential area where you are the only builder. Unfortunately, you must build the homes before you learn how strong demand is for homes in this large neighborhood. There is a 60 percent chance of low demand and a 40 percent chance of high demand. The corresponding (inverse) demand functions for these two scenarios are P = 300,000 – 400Q and P = 500,000 – 275Q, respectively. Your cost function is C(Q) = 140,000 + 240,000Q.

How many new homes should you build, and what profits can you expect?

Number of homes you should build:   [removed] homes


Profits you can expect:



20. You are the manager of a firm that sells a “commodity” in a market that resembles perfect competition, and your cost function is C(Q) = 2Q + 3Q2. Unfortunately, due to production lags, you must make your output decision prior to knowing for certain the price that will prevail in the market. You believe that there is a 70 percent chance the market price will be $200 and a 30 percent chance it will be $600.


a. Calculate the expected market price.


b. What output should you produce in order to maximize expected profits?

[removed] units

c. What are your expected profits?




21. Pelican Point Financial Group’s clientele consists of two types of investors. The first type of investor makes many transactions in a given year and has a net worth of over $1.5 million. These investors seek unlimited access to investment consultants and are willing to pay up to $30,000 annually for no-fee-based transactions, or alternatively, $50 per trade. The other type of investor also has a net worth of over $1.5 million but makes few transactions each year and therefore is willing to pay $105 per trade.


As the manager of Pelican Point Financial Group, you are unable to determine whether any given individual is a high- or low-volume transaction investor. To deal with this issue, you design a self-selection mechanism that permits you to identify each type of investor.  You offer two types of plans for customers with more than $1.5 million in assets: one plan has an annual maintenance fee but offers a large number of “free” transactions (call this the “Free Trade” Account); the other plan has no annual maintenance fee but charges for each transaction (call this the “Free Service” Account).  Determine the specifics for each plan as listed below:

“Free Trade” Account:

  Annual maintenance fee $[removed]


  Number of “free” transactions   [removed]


  Price for each transaction in excess of the number of “free” transactions $[removed]

“Free Service” Account:

  Price per transaction