MANAGERIAL ECONOMICS1. Describe the effects of each of the following managerial ecisions or economic infl!ences on the"al!e of the firm#A. $he firm is re%!ire to install new e%!i&ment to re!ce air &oll!tion.Answer#The most direct effect of a requirement to install new pollution control equipmentwouldbe anincrease inthe operatingcost component of the valuationmodel.Secondaryeffects might beexpectedinthediscount rateduetoanincreaseinregulatoryrisk, andintherevenuefunctionif consumers react positivelytotheinstallation of the pollution control equipment in production facilities.B. $hro!gh hea"' e(&enit!res on a"ertising) the firm*s mar+eting e&artmentincreases sales s!bstantiall'.Answer#All three major components of the valuation modelthe revenue function, costfunction, and the discount rateare likely to be affected by an increase in advertising.!evenues and cost will both increase as output is expanded.The discount rate maybeaffectedifthefirm"sprofit outlookchangessignificantlybecauseofincreaseddemand #growth$ or if borrowing is necessary to fund a rapid expansion of plant andequipment to meet increased demand.C. $he&ro!ctione&artment &!rchases newe%!i&ment that lowers man!fact!ringcosts.Answer#The primary effect of newer and more efficient production equipment is a reductioninthetotal cost component of thevaluationmodel. Secondaryeffects onfirmrevenues could also be important if lower costs make price reductions possible andresult in an increase in the quantity demanded of the firm"s products.%ikewise, thecapitali&ation rate or discount factor can be affected by the firm"s changing prospects.D. $he firm raises &rices.,!antit' emane in the short r!n is !naffecte) b!t in thelonger r!n) !nit sales are e(&ecte to ecline.Answer#The time pattern of revenues is affected by such a pricing decision to raise prices inthenear term. Thiswill alter productionrelationshipsandinvestment plans, andaffect the valuation model through the cost component and capitali&ation factor.E. $he -eeral Reser"e S'stem ta+es actions that lower interest rates ramaticall'.Answer#A general loweringofinterest ratesleadstoareductioninthecost ofcapital ordiscount rate in the valuation model... /ow is the &o&!lar notion of b!siness &rofit ifferent from the economic &rofit conce&t0 1hatrole oes the iea of normal &rofits &la' in this ifference0Answer#Thekeydistinctionisthat businessoraccountingprofit providesameasureofthetotalreturnoncapital investment, whereaseconomicprofit referstothereturnoncapital inexcess of that required #expected$ by investors.'ormal profit refers to the riskadjusted rateof profit required by investors to attract and retain funds for capital investment.(any of theprofit theories described in the chapter actually confound the business and economic profitconcepts.21hich conce&t33the b!siness &rofit conce&t or the economic &rofit conce&t33&ro"ies the morea&&ro&riate basis for e"al!ating b!siness o&erations01h'0ANSWER) The economic profit concept provides the most appropriate basis for evaluating the operationsof abusinesssinceit allowsfor ariskadjustednormal rateof returnonall capital devotedtotheenterprise.*ven when business profits are substantial, economic profits can sometimes be negative giventhe effects of risk, inflation, and other factors.Substantial business profits are no guarantee to the growth,or even maintenance, of capital investment.+n actual practice, investors adjust reported accounting datato account for additional factors that must be considered.$4. Characteri5e each of the following statements as tr!e or false) an e(&lain 'o!r answer.A. +f marginal revenue is greater than average revenue, the demand curve is downward sloping.Answer# ,alse. Since average revenue is falling along a downward sloping demand curve, marginal revenue must be less than average revenue for the demand curve to slope downward.B. -rofit is minimi&ed when total revenue equals total cost.Answer#,alse. -rofits are maximi&ed when marginal revenue equals marginal cost. -rofits equal &ero at the breakeven point where total revenue equals total cost. -rofits are minimi&ed when the difference between total revenue and total cost is at a maximum.C. .iven a downwardsloping demand curve and positive marginal costs, profitmaximi&ing firms always sell more output at lower prices than revenuemaximi&ing firms.Answer#,alse. -rofit maximi&ation involves setting marginal revenue equal to marginal cost. !evenue maximi&ation involves setting marginal revenue equal to &ero. .iven a downward sloping demand curve and positive marginal costs, revenue maximi&ing firms charge lower prices and offer greater quantities of output than profit maximi&ers.D. (arginal cost must be less than average cost for average cost to decline as output expands. Answer#True. Average cost falls as output expands so long as marginal cost is less than average cost. +f this condition is met, average costs decline whether marginal costs are falling, rising or constant.E. (arginal profit is the difference between marginal revenue and marginal cost, and always exceeds &ero at the profitmaximi&ing activity level.Answer#,alse. (arginal profit equals marginal revenue minus marginal cost, and equals &ero at the profit maximi&ing activity level.6. 1hat is the ifference between ris+ an !ncertaint'0Answer# httMwww.'o!rarticlelibrar'.com7managerial3economics7!ncertaint'3ris+3an3&robabilit'3anal'sis3in3economic3acti"it'3managerial3economics7.849.7http)//www.econlib.org/library/0night/kn!1-2.html1ncertainty is a situation regarding a variable in which neither its probability distribution nor its mode of occurrence is known. ,or instance, an oligopolist may be uncertain with respect to the marketing strategies of his competitors. 1ncertainty as defined in this way is extremely common in economic activity.The concept 3risk4 is a situation in which the probability distribution of a variable is known but itsactual value is not. !isk is an actuarial concept. !isk may be defined as an uncertainty of financial loss on the occurrence of an unfortunate event. A risk is an uncertainty of loss. !isk is an objectified uncertainty or a measurable misfortune. *very business involves some risk and most people do not like being involved in any risky enterprise. The greater the risk, the higher must be the expected gain in order to induce them to start the business.To preserve the distinction which has been drawn in the last chapter between the measurable uncertainty and an unmeasurable one we may use the term 5risk5 to designate the former and the term 5uncertainty5 for the latter. The word 5risk5 is ordinarily used in a loose way to refer to any sort of uncertainty viewed from the standpoint of the unfavorable contingency, and the term 5uncertainty5 similarly with reference to the favorable outcome6 we speak of the 5risk5 of a loss, the 5uncertainty5 of a gain. 7ut if our reasoning so far is at all correct, there is a fatal ambiguity inthese terms, which must be gotten rid of, and the use of the term 5risk5 in connection with the measurable uncertainties or probabilities of insurance gives some justification for speciali&ing theterms as just indicated. 8e can also employ the terms 5objective5 and 5subjective5 probability to designate the risk and uncertainty respectively, as these expressions are already in general use with a signification akin to that proposed.The practical difference between the two categories, risk and uncertainty, is that in the former the distribution of the outcome in a group of instances is known #either through calculation a &riori or from statistics of past experience$, while in the case of uncertainty this is not true, the reason being in general that it is impossible to form a group of instances, because the situation dealt with is in a high degree unique. The best example of uncertainty is in connection with the exercise of judgment or the formation of those opinions as to the future course of events, which opinions #and not scientific knowledge$ actually guide most of our conduct. 'ow if the distribution of the different possible outcomes in a group of instances is known, it is possible to get rid of any real uncertainty by the expedient of grouping or 5consolidating5 instances. 7ut that it is &ossible does not necessarily mean that it will be one) and we must observe at the outset thatwhen an individual instance only is at issue, there is no difference for conduct between a measurable risk and an unmeasurable uncertainty. The individual, as already observed, throws hisestimate of the value of an opinion into the probability form of :a successes in b trials5 2a7b beinga proper fraction$ and 5feels5 toward it as toward any other probability situation.;. Confrontewithachoicebetween