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Section Overview: This section (chapters 1 and 2) provides an introduction to the field of Managerial Economics and to our main object of study, the firm, as well as an introduction to market supply and demand. We will discuss how the discipline of economics can be utilized in addressing specific situations that firms face in the real world (so we spend a bit of time going over fundamentals of economics). We then describe why firms exist, and what they try to accomplish. We also describe the workhorse of economic analysis: supply and demand. It is, to an extent, a macroeconomic model in the sense that it describes more than one consumer or firm. Understanding supply and demand analysis puts you on a very sound descriptive and prescriptive footing; i.e., you can use S&D analysis to describe the situation in a current market and can also make accurate predictions of the effects of future events.
Learning Goals: Upon completing this section, we will have an awareness of how economics (or managerial economics) is vital in understanding business situations, and will be able to recognize and elaborate on the various goals that firms may have, and how firms in different situations may have different objectives. We will understand the basic graphical model of supply and demand and be able to identify, for various types of goods or services, the factors that will affect supply or demand and then be able to predict how price and quantity will respond, in the short and long run, when these factors change. We will be able to translate graphical descriptions of supply and demand into algebraic descriptions, and vice versa.
1. The industry for taxi services in most cities exhibits the following characteristics:
a. The city has a limited number of taxi “medallions;” if you do not own a medallion from the city, you cannot operate your vehicle as a taxi service (i.e., you could not charge someone to drive them somewhere). You can buy a medallion from the city at an auction.
b. The medallion allows you to operate a taxi, not simply to just drive one. Medallion owners often lease their medallions to drivers in shifts and charge the drivers a leasing fee.
c. Taxi fares are usually set by a local city regulatory agency that oversees the industry.
d. Taxi companies hire drivers (whose skills are generally easily transferrable to other firms, occupations, or industries), and also have expenses that are specific to the taxi industry (gasoline for the cabs, insurance requirements that differ from private vehicle insurance, driver training costs).
For each of the four categories above (medallion purchase price, driver lease fee, taxi fare, wages for transferable drivers, price for gas/insurance/other nontransferable fees), describe how much market power an individual taxi driver would have in setting the price/fare/fee/wage.
Compare the market power of taxi companies today versus twenty years ago in terms of their ability to earn revenue/profit from customers. What developments, if any, have occurred that alter the amount of market power an individual taxi company has?
2. Many years ago I was on a committee discussing ways to recruit students to LSUS. Several proposals in the committee’s final report involved faculty taking time out of their day to, e.g., visit local high schools, call prospective students, speak at recruiting events on campus, etc. In the report, these proposals were listed as incurring $0 of cost since they required no university outlays. Explain why this assessment of costs was incorrect.
3. The following represents demand for widgets: QD = 820 – 7P +0.003M + 3PR, where P is the price of widgets, M is income, and PR is the price of a related good, the wodget. Supply of widgets is determined by QS = -20 + 4P.
a) Determine whether widgets are a normal or inferior good, and whether widgets and wodgets are substitutes or complements.
b) Assume that M = $45,000 and PR = $5.00. Solve algebraically to determine the equilibrium price and quantity of widgets.
c) Generate a supply/demand graph in Excel. Be sure that P is the vertical axis and Q the horizontal. Does the graphical equilibrium correspond to your algebraic equilibrium?
d) Now assume two events occur: income rises to $50,000 and supply conditions change such that QS = -30 + 3P. Solve algebraically for the new equilibrium price and quantity of widgets after these two changes.
(When you’re typing your answers, you can sub- or superscript by right-clicking and selecting Font. If you want to get really fancy, you can use the Equation Editor which may already be in the Insert tab, or you can hit the office button, select Word Options and find it in the Customize screen.)
4. Henry Ford famously paid his workers more than the market wage. In 1914 he told his board of directors that he wanted to pay $3 a day when the going wage was $2.20. One of the board members snidely asked why not pay $4 or $5 a day; Ford immediately agreed (much to the shock of the board) and started paying $5 a day. So, occasionally, firms find it beneficial to pay above (or even below) the equilibrium wage rate.
a) Why do you think a firm would pay its workers (office, factory, etc.) above-market wages?
b) Why do you think a firm would pay its managers above-market wages?
c) Some firms used to set up employment contracts where workers were paid below-market wages early on and then above-market wages later in a worker’s career. Why do you think these types of contracts were used? Also seen with these contracts was a pre-determined mandatory retirement date; why would this be an important part of such a contract?
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