BECO505: Advance Managerial

Economics
 CHAPTER 1

Q2. Discuss the importance of the command process and the traditional
process in the making of management decisions. Illustrate specific ways
in which managers must consider these two processes.
Answer: The Command process is influenced by the government or central authority to
find the answer that best fit to the three basic questions (What, how, for whom). The
government owns most of the resources of production like land and other natural
resources and take decisions about the allocation of resources to controls all the factors of
production.
On the other side, The Traditional process uses the culture and trends of the population.
In this kind of system, the customs and traditions are used to decide what to produce, how
to produce, and for whom to produce.
The managers should take into account both command process that related to
government’s laws and regulations that govern and control the action of both consumers
and products and the traditional process that related to religions, customs and traditions
during answer the three questions What, how, and for whom.

Q3. Discuss the implications of profit for managers as entrepreneurs

versus owners as entrepreneurs?

Answer: Entrepreneurship is the willingness to take certain risks in the pursuit of

goals, so the profit may become huge. An entrepreneurship comes with new ideas lead to
new products or services, and take place in the economic success of a business.
Management, in contract, is the ability to organize resources and administer tasks to
achieve objectives and makes every effort to accomplish the job effectively. The
managers take less risk than the entrepreneurship and get less profit accordingly. The
managers contribute to the success of a business.

Q8. Following are examples of typical economic decisions made by the

managers of a firm. Determine whether each is an example of what,
how, or for whom.
a. Should the company make its own spare parts or buy them from an
outside vendor?

Answer: the best question here is “How to produce the spare parts. What and
for whom are known. Therefore, the managers of a firm should know the best way
to make spare parts available weather through make or buy.
 b. Should the company continue to service the equipment that it sells or
ask customers to use independent repair companies?

Answer: the best question here is “What to do, continue to service or stop it
and ask the customer to do it through another repair companies.

c. Should a company expand its business to international markets or

concentrate on the domestic market?

Answer: the best question here is “for whom to expand or concentrate on a

certain market niche.

d. Should the company replace its own communications network with a

"virtual private network" that is owned and operated by another
company?

Answer: the best question here is “How to replace the available network with
another one.

e. Should the company buy or lease the fleet of trucks that it uses to
transport its products to market?

Answer: the best question here is “How to buy or lease the fleet of trucks.

Q9. (Optional) have you been personally involved in the making of a

decision for a business concerning what, how, or for whom? If so,
explain your rationale for making such decision. Were these decisions
guided by the market process, the command process, or the traditional
process? Explain.

Answer: I used to make these decisions on almost a daily business. As I have a small
service center in Sana’a. There were many important decisions to make, what type of
services, how the services will be done and for whom to provide.
Yes, many decisions were guided by a market process such as third parties choice to
support once the services providing to the customers. The command process also guided
many decision, as the laws and regulations of Yemen should allow all services.
Regarding tradition process, we always considered religion and customs when provided
the services where we did not provide prohibited services or the services not accepted by
society.
 CHAPTER 2

Q2. What are transaction costs? How does opportunistic behavior tend
to increase transaction costs?
Answer: Transaction cost is incurred when a company enters into a contract with other
entities. This cost including the original investigation to find outside firm, cost of
negotiation a contract, enforcing the contract and coordinating transaction.
Opportunistic behavior occurs where one party takes advantage of the other because of e
changing the market conditions to maximize self-interest. The concept has an important
role in increasing the transaction cost. When transaction costs are high, a company may
choose to provide the service or product itself. However, carrying out operations tend to
increase transaction costs.

Q4. A company has 2 million shares outstanding. It paid a dividend of

$2 during the past year and expects that dividend will grow at 6 percent
annually in the future. Stockholders require a rate of return of 13
percent. What would you expect the price of each share to be today, and
what is the value of company’s common stock?
Answer: Outstanding shares= $2 million, Dividend paid last year= $2
What is the price of each share (p)?

D0= dividend paid last year=$2 D1= dividend paid coming year=?
g= annual constant growth rate= 0.06 r= rate of return=0.13

D1= D0 (1+g) = 2(1+0.06) = $2.12

p = D1/(r-g) Where p = the price of each share at the beginning time.

p = 2.12/ (0.13-0.06) =$30.286

The value of company’s common stock= outstanding shares x price per share
= 2,000,000* 30.286 = $60, 572000
Q5. You have a choice to open your own business or being employed by
someone else in a similar type of business. What are some of the
consideration in return for opportunity costs that would you have to
include in arriving at your decision making?
Answer: the opportunity cost is the benefit, profit, or value of something that must be
given up to acquire or achieve something else. If you have two choices - either an apple or
an orange - and you choose the apple, then your opportunity cost is the orange you could
have chosen but did not. You gave up the opportunity to take the orange in order to choose
the apple. In this way, the opportunity cost is the value of the opportunity lost. If we apply
this concept in a given situation. We have two choices, open our own business or be
employed by someone else. If we chose to start our own business as the best choice, we
would leave off the opportunity of being employed by someone else. The benefits of getting
employee no risk will be taken and we keep getting the payment. Therefore, the opportunity
cost would be losing our own business and all benefits come from it.
On the other side, choosing to start working with other as an employee, we would leave off
the opportunity of starting our own business. The benefit of starting our own business is
receiving all benefit as owner. Therefore, the opportunity cost would be losing be employed
and all benefits related to it.

Q8. Various depreciation method can be used to arrive at accounting

benefit number. From the viewpoint of an economist, how should
annual depreciation be determined?
Answer: various depreciation methods have used for computing depreciation expense
include straight-line, unit of production or activity and others. This kind of depreciation
defined as the reduction in the value of a product arising from the passage of time due to
use or abuse, wear and tear. The decline in value of a physical asset used each year to
generate revenue. Depreciation from an accounting point of view is a cost on a historical
basis.
From the economist side, Economic depreciation is a measure of the decrease in the
market value of an asset over time which including replacement cost beside historical
cost. This depreciation includes intangible costs from the accounting point of view.

Q11. Discuss the relationship between corporate organizational

structure and agency problem. What is the implication of the structure
on management compensation plan to minimize the agency problem?
Answer: the organizational structure is the typically hierarchical arrangement of lines
of authority, communications, rights and duties of an organization. Whereas agency
problem is a conflict of interest inherent in any relationship where one party is expected to
act in another's best interests. The relationship that management of a company work to gain
more benefits at the expense of others. The good way to way to minimize the agency
problem is to connect performance to the financial benefits such as payment.

Q15. Why must management consider risk as well as return while

evaluating alternative or choosing a course of action?
Answer: due to risk always affects the amount of return management should consider
them. A manager has to check the percentage of risk and return and choose the task or
project that has the highest return with a minimum level of risk.

Q19. How does implicit cost lead to a difference between accounting and
economist profits?
Answer: Accounting profit is the difference between the total revenue and the total cost,
excluding the implicit cost, which is the cost of the opportunity. On the other hand, the
economic cost is the difference between the total revenue and the total cost, including the
implicit cost.
Therefore, accounting profit can be defined as the revenue deducted from the explicit
costs, and economic profits, as the revenue deducted from explicit and implicit costs.
 CHAPTER 3

Q7.Why do you think it is important for managers to understand the

mechanics of supply and demand both in the short run and in the long
run. Give examples of companies whose business was either helped or
hurt by changes in supply or demand in the markets in which they were
competing.
Answer: For managers, it is important to understand the mechanic's supply and demand
in order to help them plan during the short run and long run to ensure there is no shortage
or surplus in production. The knowledge of the mechanics also helps in general in order
to take care of the market in terms of demand and supply.
For example, the solar market before the war in Yemen, not a big industry. After the
war, the demand for solar systems increased. In the short run, the prices moved upward
the supply curve than the demand decreased so new equilibrium price appeared. In the
long run, many companies enter the market, which made the market to saturate with a
different brand of solar system and the price has fallen.

Q 9. Overheard at the water cooler in the corporate headquarters of a

large manufacturing company: “The competition is really threatening
us with their new product line. I think we should consider offering
discounts on our current line in order to stimulate demand." In this
statement, is the term demand being used in a manner consistent with
economic theory? Explain. Illustrate your answer using a line drawn to
represent the demand for this firm's product line.
Answer: Yes, the term demand is used inconsistently with the economic theory because it
refers to the manufacturing company (the supply of the product). The company is facing high
competition so they offer discounts on their current line in order to stimulate demand and
keep their market position.

It is obvious that the relationship between the demand for the product offered by the firm
and its price is negative. Therefore, the draw showing the negative relationship between
quantities demanded and price.
The demand curve is sloping downward, because of the law of demand: as price falls,
quantity demanded rises and vice versa.

Q 12. Define the rationing function of price. Why is it necessary for the
price to serve this function in the market economy?
Answer: Rationing function of price is the increase or decrease in price to clear the market of
any shortage or surplus. The price higher so that less of the consumable will be purchased and
more will be conserved or rationed. Rationing is necessary because of the scarcity problem. When
needs are unlimited, but resources are limited, available commodities must be rationed out to
competing uses so those buyers willing and able to pay the price only purchase.

Problems:

P2. The following relations describe the supply and demand for posters.
QD = 65,000 – 10,000P
QS = - 35,000 + 15,000P
Where Q is the quantity and P is the price of a poster, in dollars.
Answer:
a. Complete the following table.

Price QS QD Surplus or shortage

$ 6.00 55000 5000 surplus
5.00 40000 15000 surplus
4.00 25000 25000 Equilibrium
3.00 10000 35000 shortage
2.00 -5000 45000 shortage
1.00 -20000 55000 shortage

b. What is the equilibrium price?

-The equilibrium price is 4 $.

-The equilibrium quantity is 25000

P4. Consider the following supply and demand curves for a certain
product.
QS = 25,000P
QD = 50,000 - 10,000P
a. Plot the demand and supply curves.
b. What are the equilibrium price and equilibrium quantity for the
industry? Determine the answer both algebraically and graphically.
(Round to the nearest cent.)

Answer:
a. To draw demand curve we assume it is ideal so we need two points.
Assume that QD = 0 ----------- P= 50000/10000= $5
Assume that P=0 ------------ Qd= 50,000
To plot the demand curve connect the two points.

For supply curve

Assume that QS = 0 ----------- P= $0

Assume that P=0 ------------ Qs = 0

Assume that P=5 ------------ Qs = 25000*5= 125,000

 b. the equilibrium price and equilibrium quantity

At the equilibrium, the quantity of demand is equal to quantity of supply

QS = QD
25000P=50000-10000P ------ P=50000/35000
P=$1.43 the equilibrium price.
At the equilibrium price ------- QS = 25000(1.43) = 35750

& QD = 50000-10000(1.43) = 35750

The equilibrium price= 1.43 USD as it shown in the chart.

5. Following are three simple equations. Plot them on a graph in which

Q is on the vertical axis and P is on the horizontal axis. Then transform
these equations so P is expressed in terms of Q and plot these
transformed equations on a graph in which P is on the vertical axis and
Q is on the horizontal axis.
a. Q = 250 – 10P
b. Q = 1,300 – 140P
c. Q = 45 – 0.5P
Answer:
a. Assume that Q = 0 ----------- P= 25 - 0.1Q = 25 – 0.1(0)= $25
Assume that P =0 ------------ Q = 250 – 10(0) = 250

b. Assume that Q = 0 ----------- P= 9.29 - .007Q = $9.29

Assume that P =0 ------------ Q = 1300 – 140(0) =1300
c. Assume that Q = 0 ----------- P= 90 - 2Q = $90
Assume that P =0 ------------ Q = 45 – 0.5P =45