ASSIGNMENT # 1

SONG LI 210191716 MAHWASH TANWIR 210120293 ECON5100 JUNE 11TH 2009

I. CASE STUDY: PERSONAL VIDEO RECORDER 1. With the cable companies offering a combined cable box and PVR with a small additional monthly charge that also simplifies the setup and the operation, there will likely be an increase in demand of these cable company provided PVRs. With users then being able to snip commercials, the demand of airtime from advertisers will decrease or shift to the left. In essence, there will be a decrease in demand of airtime from advertisers as a result of increase in consumer demand of the PVRs. Advertisers will look for alternate means to advertise their product, such as through billboards, radio or through popular websites and search engines on the internet. Demand for these alternate means of advertising may go up. 2. a) Qd = 30 - .0002P + 26V (Equation 1) Substituted V = 1 and isolated for P P = 280 000 5000Q (Equation 2) Price per minute charged for advertising Marginal Revenue Demand for advertising

MR = 280 000 10 000Q (Equation 3) Total revenue is maximized when MR = 0 Solving for Q with MR = 0: 0 = 280 000 10 000Q Q = 280 000 / 10 000 = 28 minutes Substituting Q into Equation 2: P = 280 000 5000 (28) = $140 000 /minute Total Revenue (TR) = Q x P = 28 X 140 000 = $ 3 920 000

Therefore, the price charged should be $140 000/minute. 28 minutes of advertising should be sold. The total revenue is $3 920 000.

b) Price = $140 000/minute = constant With V = 0.5; Q = 30 - .0002 (140 000) + 26 (0.5) = 15 minutes When the number of expected viewers falls to 0.5 million, the quantity demanded for advertising on the show decreases to 15 minutes.
EQ d
,V d

= (Q\Q)/ (V/V) = ((15-28)/21.5) / ((0.5-1)/.75) = 0.60465/0.6666 = 0.91

Viewer elasticity between the two points is < 1 which means that we are in the inelastic region of demand. The percentage decrease in quantity demanded for advertisement is less than the percentage decrease in the number of expected viewers. To maximize revenue, price will need to be increased until elasticity becomes 1. 2. As more viewers begin using PVRs, the revenues of the major networks will decline. With 1 million viewers, the total revenue is $3 920 000. With 0.5 million viewers, the total revenue decreases to $2 100 000 (when the price per minute remains constant). 3. In the long run as the number of viewers expected to watch the advertisements goes down, the demand from advertisers will shift to the left i.e. it will go down. Advertisers will look for alternate means to advertise. This will significantly impact the revenues of major television networks. If the television companies would want to advertise for 30 minutes during a time slot of 60 minutes for popular shows, they will have to significantly reduce the price per minute charged for advertising. The marginal revenue will be less than zero and the demand curve would be in the inelastic region. There will be a significant amount of lost revenue. To achieve maximum revenue, as demand for advertising goes down, networks will have to look for alternate means of generating revenues. 4. As quantity of demand goes down, major networks should continue to assess periodically the number of viewers expected to watch commercials and adjust the prices accordingly to maximize revenues by keeping marginal revenue at zero and elasticity at one. In addition, producers of TV programs should start promoting brands more frequently during popular TV shows through product placement where the main characters can be seen using products such as pop drinks, cars etc with specific brand. Major networks can also charge premiums on PVRs and generate

revenues that way. Another option is to generate revenues through advertising on the network websites. Networks can earn huge revenues through all these alternative options.

II. ECONOMICS OF THE SCALE (PLANT SIZE) (a) PLANT 1

Q 30 52 80 110 130 145 155 162 FC 20000 20000 20000 20000 20000 20000 20000 20000 VC 10000 20000 30000 40000 50000 60000 70000 80000 TC 30000 40000 50000 60000 70000 80000 90000 100000 AFC 666.67 384.62 250.00 181.82 153.85 137.93 129.03 123.46 AVC 333.33 384.62 375.00 363.64 384.62 413.79 451.61 493.83 AC 1000.00 769.23 625.00 545.45 538.46 551.72 580.65 617.28

PLANT 2
Q 50 80 120 164 200 220 235 248 FC 40000 40000 40000 40000 40000 40000 40000 40000 VC 10000 20000 30000 40000 50000 60000 70000 80000 TC 50000 60000 70000 80000 90000 100000 110000 120000 AFC 800.00 500.00 333.33 243.90 200.00 181.82 170.21 161.29 AVC 200.00 250.00 250.00 243.90 250.00 272.73 297.87 322.58 AC 1000.00 750.00 583.33 487.80 450.00 454.55 468.09 483.87

PLANT 3
Q 80 124 175 226 260 274 282 287 FC 60000 60000 60000 60000 60000 60000 60000 60000 VC 10000 20000 30000 40000 50000 60000 70000 80000 TC 70000 80000 90000 100000 110000 120000 130000 140000 AFC 750.00 483.87 342.86 265.49 230.77 218.98 212.77 209.06 AVC 125.00 161.29 171.43 176.99 192.31 218.98 248.23 278.75 AC 875.00 645.16 514.29 442.48 423.08 437.96 460.99 487.80

PLANT 4
Q 100 160 218 272 302 320 335 345 FC 80000 80000 80000 80000 80000 80000 80000 80000 VC 10000 20000 30000 40000 50000 60000 70000 80000 TC 90000 100000 110000 120000 130000 140000 150000 160000 AFC 800.00 500.00 366.97 294.12 264.90 250.00 238.81 231.88 AVC 100.00 125.00 137.61 147.06 165.56 187.50 208.96 231.88 AC 900.00 625.00 504.59 441.18 430.46 437.50 447.76 463.77

The AC curves for each of the four plant sizes are shown in Figure 1 below.

1200.00 $

Figure 1 AC curves of the four plant sizes b) The return to increasing plant size in this example is to define the long run average cost curve. The long run average cost curve tells the firm the plant size and the quantity of labour to use at each output to minimize cost. In the long run, the firm should choose the plant size that minimizes average total cost and produce a given output at the least possible cost. The plant size1 to 3 are economies of scale. The plant size 4 belongs to diseconomies of scale. In this case the firm should produce the output at 260 units by selecting the plant size 3.

1000.00

c) For Q = 125 units, plant 1 should be selected. It has the lowest cost (~$530) and is within the economies of scale albeit very close to MES. For Q = 250 units, plant 3 should be selected. It has the lowest actual short term cost (~ $430) and is within economies of scale. For Q within 200 to 300 units, without detailed information, it is difficult to make the judgement. Generally speaking, plant size 3 is preferred. However if the owner expects to grow the business in the future, he should choose the bigger plant size in order to benefit from larger scale in long run. III. a) TRANSPORTATION ELASTICITIES Q = demand for fuel P = price for fuel H = other factors including fuel efficiency, driving frequency and vehicle ownership QUK = - aUK x PUK + HUK QUS = - aUS X PUS + HUS aUK = 3 x aUS ( already given ) HUK = 0.2 x 0.8 x 0.8 x HUS HUK = 0.32 X HUS We can compare the price elasticity of fuel at a fixed price P as following: EUK = aUK x P/QUK EUS = aUS x P/QUS EUK / EUS = 3 x QUS / QUK Based on the above calculation, QUS is greater than QUK. Therefore, we can conclude that price elasticity of demand for fuel in UK is more than three times greater than that in US. i) The information provided tells us that demand for fuel in UK is less than demand for fuel in US, which enables us to compare the elasticity of demand for fuel in two countries with a given price level. Although we still lack further information to define an accurate ratio, it is fair to say that price elasticity of demand for fuel in UK is more than three times greater than that in US.

ii)

The price elasticity of automobiles in the UK is higher than the price elasticity of automobiles in the US. According to the information provided, automobiles are driven 20% less in the UK compared to the US and average per person ownership of automobiles is lower by almost 20%. This suggests two possibilities: 1) distances in the UK are less and 2) people have a choice to use alternate means of transportation such as public transit e.g. buses, subway, trains etc. Hence price elasticity of automobiles in the UK is greater compared to that in the US.

b) The relatively low elasticity of driving with respect to fuel prices hides a much higher overall elasticity of driving. Overall price elasticity means price elasticity of demand for driving with respect to the overall cost. Fuel price elasticity means price elasticity of demand for driving with respect to fuel price. Overall cost of driving can include fixed costs, finance charges, fuel and oil expenses, maintenance and parts, and parking and tolls. Fuel cost is only a small portion of the overall cost of driving. Also, fuel prices are a poor indicator of the elasticity of driving, because over the long term consumers will purchase more fuel-efficient vehicles. Hence the overall price elasticity of driving is more elastic compared to the fuel price elasticity.

IV.

CASE STUDY: THE US DOJ CLAIMS ALCOAS BAUXITE ACQUISITIONS ANTICOMPETITIVE.

(a) Aluminum manufacturers elect to control all three stages of aluminum fabrication to reduce inventory, transportation and processing costs by setting up the processing plant near the bauxite mine in order to keep assets for different stages of production in the same proximity. No, they would not be better off by purchasing bauxite from independent mining operations or refined stuff-alumina from independent refineries for the following reasons: 1. Increased price of bauxite and refined stuff alumina (mining operators and refineries will have a profit margin). 2. Inventory costs 3. Shipping/transportation costs 4. Quality of bauxite and alumina 5. Bauxite and Alumina lead times and minimum buy requirements. (b) Integrating vertically gives firms the choice of site specificity which allows them to perform well by generating all levels of product at minimal costs (by controlling product costs), maintain high product quality and maximize profit on the final product. It gives them the competitive advantage and

bigger market share. It ensures that the sources of supply are reliable because they are their own subsidies from raw bauxite to the finished ingots. With integration, profitability of the firm increases.

V.

APPLICATION OF DEMAND AND SUPPLY MECHANISM

a) Q= quantity of oil (billions of barrel per year) At Q > 3.4 foreign oil was cheaper to produce. At Q < 3.4 foreign oil was more expensive to produce. b) If there had been no import quota, the US price of petroleum would have been $1.75. The US would have produced 3.4 billions of barrels of oil per year and would have imported 2.1 billions of barrels of oil per year. c) With an oil import quota of 1 billion, US price was $3.00 d) The loss to US consumers due to the oil import quota is $6.5 Billion 1.25 x 4.9 + 0.5 x 1.25 x 0.6 = 6.5 Billion e) Holding constant the price of crude oil, OPEC reduced the quantity of crude oil it supplied by 3 billion barrels per year. Calculating Equilibrium price by holding Qs constant: 17+ 0.25P = 19- 0.25P P= $4 / barrel Before curtailment: Qs = 17 + 0.25 (4) Qs = 18 billion barrels / year After curtailment: Qs = 14 + 0.25 (4) Qs = 15 billion barrels/year The percent change in total quantity supplied is: ((15-18)/18) x 100 = -16.66% f) The equilibrium price of crude oil before OPEC curtailed its output was $4 per barrel as shown in e) above. Calculating Equilibrium price after curtailment by keeping Qs = Qd = constant.

14+ 0.25P = 19 0.25P P= $10 / barrel The equilibrium price of crude oil after OPEC curtailed its output was $10 per barrel. g) Before curtailment: Qs= 17 + 0.25(4) = 18 billion barrels / year Qd = 19 0.25(4) = 18 billions barrels / year After curtailment: Qs = 14 + 0.25(10) = 16.5 billion barrels / year Qd = 19 0.25(10) = 16.5 billion barrels / year The equilibrium quantity of crude oil demanded and supplied before OPEC curtailed its output was 18 billion barrels per year. The equilibrium quantity of crude oil demanded and supplied after OPEC curtailed its output was 16.5 billion barrels / year. h) Calculating price elasticity of demand for crude oil in the short run at price = $10. P=4 P=10 Qd=19-0.25x4= 18 Qd=19-0.25x10=16.5

Ep= (1.5/16.5) / (6/10)= 0.15 In the short run the price elasticity of demand for crude oil would be 0.1 which is less than 0.4. Demand tends to be more inelastic in the short term than in the long term as time is a factor in elasticity. In the long run environmental factors such as war and other externalities can increase elasticity. Consumers have more choice in the long run and can elect to buy electric cars etc to reduce dependence on oil and hence increase the elasticity of demand for oil.

i) OPECs objective is to keep crude oil prices stable. In the short run OPECs curtailment of prices will have a bigger impact. In the long run the prices will fluctuate based on other factors such as the number of oil suppliers, wars and other externalities. As prices will fluctuate, OPEC will try to stabilize oil prices not increase them.