ME Chapter 3 Tutorial Problems

FIN 6204 Managerial Economics
Chapter 3 Tutorial
Chapter Problems
1. For each of the following decision-making problems, determine whether the problem in
volves constrained or unconstrained optimization; what the objective function is and, for
each constrained problem, what the constraint is; and what the choice variables are.
(a) We have received a foundation grant to purchase new PCs for the staff. You
decide what PCs to buy.
(b) We aren’t earning enough profits. Your job is to redesign our advertising program
and decide how much TV, direct-mail, and magazine advertising to use. Whatever
we are doing now isn’t working very well.
(c) We have to meet a production quota but think we are going to spend too much
doing so. Your job is to reallocate the machinery, the number of workers, and the
raw materials needed to meet the quota.
2. Fill in the blanks in the following table to answer the questions below.
A TB TC NB MB MC
0 $0 $ $0
1 27 $35 $
2 65 $10
3 85 30
4 51 14
5 60 8
6 5 20
(a) What is the optimal level of activity in the table above?

(b) What is the value of net benefit at the optimal level of activity? Can net benefit be
increased by moving to any other level of A? Explain.
(c) Using the numerical values in the table, comment on the statement, “The optimal
level of activity occurs where marginal benefit is closest to marginal cost.”
3. Now suppose the decision maker in previous Problem faces a fixed cost of $24. Fill in
the blanks in the following table to answer the questions below. AC is the average cost
per unit of activity.
A TB TC NB MB MC AC
0 $0 $ -$24
1 3 $35 $ $32
2 65 $10
3 85 54
4 27 14
5 8 16.80
6 5 20
1
(a) How does adding $24 of fixed costs affect total cost? Net
benefit? (b) How does adding $24 of fixed cost affect marginal cost?
(c) Compared to A* in Technical Problem 6, does adding $24 of fixed cost change the
optimal level of activity? Why or why not?
(d) What advice can you give decision makers about the role of fixed costs in finding
A*?
(e) What level of activity minimizes average cost per unit of activity? Is this level also
the optimal level of activity? Should it be? Explain.
(f) Suppose a government agency requires payment of a one-time, nonrefundable
license fee of $100 to engage in activity A, and this license fee was paid last
month. What kind of cost is this? How does this cost affect the decision maker’s
choice of activity level now? Explain.
4. You are interviewing three people for one sales job. On the basis of your experience and
insight, you believe Jane can sell 600 units a day, Joe can sell 450 units a day, and
Joan can sell 400 units a day. The daily salary each person is asking is as follows:
Jane, $200; Joe, $150; and Joan, $100. How would you rank the three applicants?
5. A decision maker is choosing the levels of two activities, A and B, so as to maximize

total benefits under a given budget. The prices and marginal benefits of the last units of
A and B are denoted PA, PB, MBA, and MBB.
(a) If PA = $20, PB = $15, MBA = 400, and MBB = 600, what should the decision maker
do?
(b) If PA = $20, PB = $30, MBA = 200, and MBB = 300, what should the decision maker
do?
(c) If PA = $20, PB = $40, MBA = 300, and MBB = 400, how many units of A can be
obtained if B is reduced by one unit? How much will benefits increase if this
exchange is made?
(d) If the substitution in part c continues to equilibrium and MBA falls to 250, what will
MBB be?
6. Suppose a firm is considering two different activities, X and Y , which yield the total
benefits presented in the schedule below. The price of X is $2 per unit, and the price of
Y is $10 per unit.
activity X (T BX) activity Y (T BY
Level of activity Total benefit of )
Total benefit of
0 $0 $0
1 30 100
2 54 190
3 72 270
4 84 340
5 92 400
6 98 450
(a) The firm places a budget constraint of $26 on expenditures on activities X and Y .
What are the levels of X and Y that maximize total benefit subject to the budget
constraint?
(b) What is the total benefit associated with the optimal levels of X and Y in part a? 2
(c) Now let the budget constraint increase to $58. What are the optimal levels of X and
Y now? What is the total benefit when the budget constraint is $58?
7. Using optimization theory, analyze the following quotations:
(a) “The optimal number of traffic deaths in the United States is zero.”
(b) “Any pollution is too much pollution.”
(c) “We cannot pull U.S. troops out of Afghanistan. We have committed so much al
ready.”
(d) “If Congress cuts out the International Space Station (ISS), we will have wasted all
the resources that we have already spent on it. Therefore, we must continue
funding the ISS.”
(e) “Since JetGreen Airways has experienced a 25 percent increase in its insurance
pre miums, the airline should increase the number of passengers it serves next
quarter in order to spread the increase in premiums over a larger number of
tickets.”
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FIN 6204 Managerial Economics

(a) What is the optimal level of activity in the table above?

5. A decision maker is choosing the levels of two activities, A and B, so as to maximize

7. Using optimization theory, analyze the following quotations:

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