Managerial Economics - Case Project
(150 pts.)
Read this page carefully before starting.
The case has been posted on my web site so you can download it and type as many answers as possible. The graphs do not have to be typed. Presentation is very important though – you are turning this in to your CEO in an attempt to get a promotion and a raise.
DO NOT CHANGE the page numbers. In other words, your case should have the same number of pages as is presented here. If you need to insert a page for the ad that you do, that’s fine. SEE DIRECTIONS BELOW.
Never copy and paste!! If you use the Koch chapter, the internet or any other notes for reference – do NOT copy information verbatim. Use the concepts, but not the specific examples.
On Friday, you must turn in your completed case at the beginning of class. I will not accept late cases.
Hard Copy: PLEASE – your hard copy turned into me should be easy to read and professionally completed.
DIRECTIONS – READ carefully:
1. Leave the spacing the same as is given in the report – as stated above, your pages should stay the same as presented. So you might have some blank pages if you don't use the blank space I left for graphs, etc. Make this page zero (this page – your cover page). So delete these directions and put in your cover page information.
2. Do not print out front and back – one-sided only please.
3. Bold the questions, then your answers should not be in bold and there should be a space (at least one or two) between the question and your answers. Use Arial 10 point font. SHOW ALL WORK. No work, no points.
4. Circle all FINAL number answers and make it clear what they are: for example if you are finding a market clearing price for O.J. –
Price for O.J. = $XXX (and circle this)
5. Prices should be presented in dollars and cents (for example, $10.25), so round accordingly. Quantity numbers should be rounded to the nearest .5 (for example, 10.20 should be rounded to 10, 10.55 should be rounded to 10.5). Round up if there is a question (for example 10.25 would be 10.5).
6. Answers should always reflect some concept or theory that we discussed in this class.
Page One
You have just been chosen to head up a new profit center (PC) for your company.
Your PC is responsible for producing and selling three products:
Soybeans
Cocoa
Orange Juice (O.J.)
Before you go any further, your CEO has asked you to come up with and write down a very precise vision statement for your PC. What is your PC’s vision? Hint: I am getting tired of visions like: “We will be the most environmentally friendly profit center on earth.” If being envionmentally friendly is in your core mission, then please be specific and creative regarding that. Also: your CEO is a big fan of Charles Koch. So you want to impress her by showing you are familiar with Koch’s ideas. (3 pts.)
Before your PC proceeds any further, you decide you need to establish some principles as to how your PC will create value for the company and for society. Explain at least two principles your PC will follow in creating value. (4 pts.)
Page Two
Your PC has been given a “fact sheet” (attached) that was prepared by the financial department of your company. These data reflect what the company knows about your products. However, your PC has been assigned the task of hiring all new workers and acquiring all new inputs for your PC. Basically speaking, explain two criteria your PC will use in acquiring inputs and your reason behind each criteria. Remember, you can either make or buy inputs. Oh, and your CEO is also a fan of Ronald Coase and you want to show her that you know about his theories. (6 pts.)
The CEO of your company has just called and asked your PC’s advice on the following issue:
Your PC has been producing boxes to ship your soybeans in. The machine used to make the boxes is defunct. The cost to remove and dispose of the old machine is $2,500 (and must be done weather you buy the new machine or not). A new machine would cost $35,000. To install it, the cost would be $2,500. Variable costs for the new machine to produce boxes is $2.00 per box for materials and $1.00 per box for labor. Although the boxes are used internally, they could be sold or bought externally for $5.00.
You will need 20,000 boxes.
Should you make (stay vertically integrated) or buy the boxes? Provide a detailed explanation for your CEO with numbers and words. (4 pts.)
Page Three
Given your response to the question above, you are attempting to determine a transfer price for your boxes (since another PC in your company wants to use boxes as well). What transfer price would you charge and why? (3 pts.)
At this point your PC decides to learn about your markets. Given the information on your fact sheet regarding the demand for your products:
a. Determine the demand equations (short version) for each product. (3 pts.)
b. Graph the demand functions for each product – showing vertical and horizontal intercepts with numbers. (6 pts.)
Page Four
Page Five
While you were having a “power lunch” with a politician (you were lobbying for a tariff),
the price of coffee increased by $1.50 (so it is now $5.50 for example),
the price of sugar decreased by $1,
the price of pinto beans decreased by $2,
the price of grapefruit juice decreased by $1,
the price of champagne increased by $2,
and the income in all of your markets increased by 5 (from 40 to 45).
Since your CEO has asked for a presentation, your PC now needs to know how these changes will affect demand. Determine your new demand functions (short versions) and graphically show how they have changed (show the changes on your graphs with arrows). Include both intercepts on all graphs. (12 pts.)
Page Six
Page Seven
Your CEO has also asked your PC to calculate your market clearing prices and quantities for all three of your products (given the new changes that took place while you were having a power lunch). Provide this information for your CEO (including both numbers and graphs). (9 pts.)
Tell your CEO if you think you should keep producing all three of your products given the information you calculate. (2 pts.)
Page Eight
Page Nine
OH NO!! Your CEO has found out about your lobbying activity and has called a meeting. She explains that she does not believe in protective tariffs – “they are not good business because they harm incentives in my company!” What argument do you think your CEO provided to your PC to make her point? Make sure you use economic theory in your answer (hint: key word here is “incentives.”). (3 pts.)
After giving your presentation to the CEO and apologizing for the lobbying, the index of your materials costs in all of your markets increased by 2 (due to the FED’s “easy money” policies). Show how that will change your supply functions and graph the changes (with arrows). Just determine and graph your supply functions – without demand. If you have decided to drop a product from your operations at this point, you don’t have to determine its new supply function. (6 pts.)
Page Ten
Page Eleven
Given all of these changes to your supply data, you realize your prices are not providing you with satisfactory inventory levels. Explain why using words, numbers and graphs. (6 pts.)
What inventory costs are too high? Why? (4 pts.)
What prices do you want to charge now? (2 pts.)
Page Twelve
Page Thirteen
Your PC notes that the advertising campaigns for O.J. used by the previous profit center managers were not very effective (see your fact sheet). Come up with a new ad campaign for your O.J. given the vision you wrote earlier for your PC. Be creative and professional!! Artwork, a tv ad, etc. are all possibilities. Present your ad to your CEO. (Insert a page here if necessary). (6 pts.) Points will not be given if it is clear there was no effort put into your advertisement. You will have to present your ad (with a Power point presentation) to your CEO – so keep this in mind. Some of your presentation grade will be based on your advertisement.
Page Fourteen
Good job! Your new ad campaign managed to change your advertising elasticity for O.J. from .2 to 2. You are given this information just in time. Your PC has just been advised that a major competitor (Oppie’s Grapefruit Juice) has just decreased their price by 10%. How much more advertising will you have to do to offset this price decrease? Explain this to your CEO using elasticity information. (4 pts.)
Your CEO has now informed you that average income in your marketing area for OJ has decreased by 10%. She wants to know how this will change the demand for your OJ (%)? Explain this to her by using elasticity information. (4 pts.)
Page Fifteen
Given your answer to the last question, you decide to ask the Champagne producers to decrease their prices in order to help out with your OJ demand (won’t hurt to ask!). How much (%) would the champagne price have to decrease to make up for the income change of 10%? Explain to your CEO using elasticity information. (2 pts.)
Do you think the Champagne producers will agree to your suggestion? Why or why not? (2 pts.)
Page Sixteen
While you were busy with your OJ issues things changed in the Soybean market. Income went down by 10% AND the price of pinto beans decreased by 5%. You advise your CEO that you could combat these two changes in one of two ways:
Explain to your CEO what you would have to do (specifically) in each of the above cases using elasticity information (given that you do each separately). (8 pts.)
Page Seventeen
You now have to deal with some input decisions. Given the information on your fact sheet regarding the marginal productivity of your workers – how many workers would you hire for each of your products you are still producing? Explain. (Be sure to use the prices your PC is now charging for your products. These are the latest market clearing prices you determined above. Ignore any changes that might have been made due to the elasticity problems you just completed). (6 pts.)
Page Eighteen
Your PC produces an inferior O.J. on the side to sell as a generic product. You realize that when you produce this inferior O.J. you also automatically produce pulp – which has an external market (used by Bob’s Business). Your PC determines that the marginal cost of producing both products is
MC = 2 + 1Q. The marginal revenue and price equations are as follows:
Price of inferior O.J. = 14 – 3Q
MR of inferior O.J. = 14 – 6Q
Price of Pulp = 10 – 2Q
MR of Pulp = 10 – 4Q
Given this information, what is the profit maximizing level of output for inferior O.J. and pulp? Explain with numbers. (2 pts.)
What prices would your PC charge for the inferior O.J. and pulp? Explain with numbers. (2 pts.)
Are both MR’s positive at your output level? Explain with numbers. (2 pts.)
Page Nineteen
Your CEO has asked you to provide a visual (graphical) interpretation of your answers above. Graph your demand, MR and MC curves for inferior OJ and put your price, MC and Q level numbers on your graph for your CEO. (4 pts.)
Your CEO decided that price discrimination might help sell more OJ (your superior brand). She has asked you to come up with a way your company could use price discrimination to sell OJ. Be specific (what is your means? Don’t simply say first degree, etc., give me a specific pricing scheme) and tell your CEO how you will meet your requirements for successful price discrimination and what “degree” of price discrimination you are using and why? (4 pts.)
Page Twenty
You are now considering a tie-in pricing scheme for your soybeans since you notice that people buy brown sugar with soybeans. You have the following information regarding your two market segments:
Segment One Reservation Prices
Soybeans = $18.00/lb, Brown Sugar = $5/lb
Segment Two Reservation Prices
Soybeans = $16.00/lb, Brown Sugar = $8/lb
Segment One includes 20,000 customers and Segment Two includes 15,000 customers.
Explain to your CEO why/how a tie-in sale would increase revenue for your PC. (6 pts.)
Page Twenty One
In order to make your O.J., you have orange squeezing stations set up in your factory. You are considering adding another station. Common costs for your stations (you currently have 25) equal $200,000. The marginal cost of operating a new station is $25,000. You calculate that the new station will bring in $30,000 in additional revenue. If common costs are equally divided among all 26 stations, should you add the new station?
Is this a good decision? Why or why not? Explain in words and numbers.
Page Twenty Two
Your CEO has asked you for a graphical representation of your profit position for your superior brand of OJ. Using your latest market clearing price (ignore your price discrimination scheme you devised earlier – you sell all of the cases for the same price), graph your position by graphing P, MR, AR, ATC and MC curves. (4 pts.)
Your accountants have given you the following information:
Your profit maximizing level of output = 86.5 (in millions)
At that level of output, AVC = $5 and AFC = $6.
What is your profit exactly? (1 pt.)
Page Twenty Three
Using the total revenue you just determined, and given the following information:
Average price for your O.J. = $18.00
Average transaction made from your O.J. factory = $10,000
Regular customer buys from your factory one time per month.
Conversion ratio is 1 in 3.
Determine: a) the value of a new regular customer per year. (1 pt.)
b) if you want to increase your sales by 10%, how many new regular customers would you need to meet your desired sales target? (2 pts.)
c) given your answer to (b), how many new customers would you have to pull in to try your O.J. in order to obtain your goal? (1 pt.)
Page Twenty Four
In order to motivate your sales force you decide to have a contest. Describe your contest including why you think it will motivate your workers. But also describe a potential problem that might occur with your contest. Relate it to your specific contest scheme! (3 pts.)
Page Twenty Five
Given your profit picture, does your PC celebrate and have a party – deciding that all of your decisions have been great and you can rest a while. Or, does your PC think about the situation differently? What thoughts does your PC have at this point? By the way, your CEO is also a fan of Joseph Schumpeter and W. Edwards Deming. Show that you know about their theories. (4 pts.)
Good job! Your CEO has decided to promote you and give you a big raise!!
Managerial Economics
Case Project Fact Sheets
Demand Information
Qd Soybeans = 100 – 10P
Qd Cocoa = 50 – 3P
Qd O.J. = 36 – 6P
Note: Soybeans and Cocoa are sold in pounds, O.J. is sold in cases. All demand information is for the time period = one hour.
When including all factors that determine demand – the demand functions are:
Qd Soybeans = 100 – 10P + 2I + .5PPB
Where: I = Income, PPB = Price of Pinto Beans
Qd Cocoa = 50 – 3P – 1I + 1PC – 2PS
Where: I = Income, PC = Price of Coffee, and PS = Price of Sugar
Qd O.J. = 36 – 6P + 4I + 6PGJ – 2PCh
Where: I = Income, PGJ = Price of Grapefruit Juice, and PCh = Price of Champagne
Currently (at the start of your case), the PPB = $6, PC = $4, PS = $2, PGJ = $2, PCh = $10,
Income = $40,000 (or 40)
Supply Information
Qs Soybeans = -20 + 7P – 3W + 2T – 4M
Qs Cocoa = -10 + 4P – 3W + 3T – 3M
Qs O.J. = -12 + 6P – 3W + 5T – 1M
Where: W = average hourly wage for labor, T = technology factor, and M = index measuring materials cost
Currently, the W = $10 for Soybeans and Cocoa workers and $7 for O.J. workers, T = 3, and M = 5 for all products.
Elasticity Information (numbers are positive unless they have a negative sign in front)
Soybeans –
Price Elasticity of Demand = -25
Cross Price Elasticity with Pinto Beans = 5
Income Elasticity of Demand = 6
Advertising Elasticity = 4
Cocoa –
Price Elasticity of Demand = -13.6
Cross Price Elasticity with Coffee = .8
Cross Price Elasticity with Sugar = -4
Income Elasticity of Demand = -3
Advertising Elasticity = 2
O.J. –
Price Elasticity of Demand = -50
Cross Price Elasticity with Grapefruit Juice = 4
Cross Price Elasticity with Champagne = -.5
Income Elasticity of Demand = 6
Advertising Elasticity = .2
Worker Productivity Information
Soybeans and Cocoa Per Pound - Wage of Soybean and Cocoa workers = $10.00 per hour
|
Workers |
Total Product/Hr. |
|
20 |
100 |
|
21 |
105 |
|
22 |
112 |
|
23 |
122 |
|
24 |
124 |
|
25 |
120 |
O.J. Per Case - Wage of O.J. workers = $7.00 per hour
|
Workers |
Total Product/Hr. |
|
20 |
35 |
|
21 |
47 |
|
22 |
60 |
|
23 |
65 |
|
24 |
68 |
|
25 |
69 |