Question 1. C and S Metal Company produces pots and pans. C and S can pursue eit

Question

Question 1. C and S Metal Company produces pots and pans. C and S can pursue either of two distribution plans for the coming year. The firm can either produce pots and pans for sale under a discount store label or manufacture a higher quality line for specialty stores and expensive mail order catalogs. High initial setup costs along with C and S's limited capacity make it impossible for the firm to produce both lines. Profits under each plan depend upon the state of the economy. One of three conditions will prevail: growth (probability 0.3), normal (probability = 0.5), recession (probability 0.2) The outcome under each plan for each state of the economy is given below. Figures in the table are profits measured in dollars. The probabilities for each economic condition represent crude estimates. Discount Line Specialty Line Economic Condition Growth Normal Recessiorn 250,000 220,000 140,000 400,000 230,000 20,000 a. b. c. Calculate the expected value for each alternative. Which alternative is more risky? Taking into account the importance of risk, which alternative should an investor choose? Question 2. The elected officials in XYZ university town are concerned about the "exploitative" rents being charged to college students. The town council is contemplating the imposition of a $350 per month rent ceiling on apartments in the city. An economist at the university estimates the demand and supply curves as: QD-5600-8P and QS-500 + 4P, where P = monthly rent, and Q = number of apartments available for rent. For purposes of this analysis. apartments can be treated as identical. a. Calculate the equilibrium price and quantity that would prevail without the price ceiling. Calculate producer and consumer surplus at this equilibrium. b. What quantity will eventually be available if the rent ceiling is imposed? Calculate any gains or losses in consumer and/or producer surplus

Explanation / Answer

Answer 1 a Expected Value Discount Line

= 0.3(250000) + 0.5 (220000) +0.2(140000)

EV = 213000

b) Expected Value Speciality Line

0.3(140000 ) +.5(230000) +0.2(20000) = 239000

c) The speciality Store offers a higher expected return but not in proportion to the increased risk .

2 for discount line.

[ – ]           Pi

—————————————————

250,000             37,000               410,700,000

220,000               7,000                 24,500,000

140,000            -73,000            1,065,800,000

———————-

2 = 1,501,000,000

= 38,743

Expected Value Specialty Line:

[ – ]                 Pi

——————————————————

400,000           161,000             7,776,300,000

230,000              -9,000                  40,500,000

20,000          -219,000             9,592,200,000

———————–

2 = 16,809,000,000

= 129,650

The discount store opportunity is far less risky.

Answer 2)

To calculate equilibrium set QD = QS and solve for P.

                                Substitute P into QD to solve for Q

QD = 5600 - 8(425)

Q = 2200

                                C.S. = area A

C.S. = 0.5(700 - 425) x 2200

                                C.S. = 302,500

                                P.S. = area B

                                P.S. = 0.5(425 - 125) x 2200

                                P.S. = 330,000

                                Sum of producer and consumer surplus is:

                                302,500 + 330,000 = 632,500

Eventually the market will settle at the quantity supplied corresponding to $350 rent.

QS = 500 + 4(350)

QS = 1900

QD at P = 350

QD = 5600 - 8(350) = 2800

                                There will be a shortage of 900 apartments.

Gain = Consumer surplus is area A

                                Area A = (425 - 350) x 1900 = 142,500

Area B = loss in consumer surplus

                                To find area B, first find consumer reservation price corresponding to an output of 1900.

P = 700 - 0.125(1900) = 462.50

                                Difference Q = 2200 - 1900 = 300

Area B = 0.5(462.50 - 425) x (2200 - 1900)

Area B = 5625

                                Loss in consumer surplus is 5625.

                                Area C is loss in producer surplus not offset by gain in consumer surplus.

Area C = 0.5(425 - 350) x (2200 - 1900)

Area C = 11,250

                          c.

Area A is a gain in consumer surplus, but it is offset by a loss in producer surplus. The net changes are thus B (lost C.S.) and C (lost P.S.). The policy thus results in a deadweight loss. The deadweight loss = lost C.S. + lost P.S. or 5625 + 11250 = 16,875.

                                Deadweight loss = 16,875

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