Problem Set #1

 

  1. The owners of a company, Econ Air have hired a new vice president to run the company with the assumption that he/she will buy Econ Air after a period of five years. The compensation package for the new vice president is a fixed salary plus seventy-five percent commission of first $150,000 of profit, and then ten percent of profit over $150,000.  The purchase price for Econ Air is set as 4.5 times earnings (profit), calculated as average annual profitability over the next five years.  Does the contract align the incentives of the new vice president with the goals of the owners of Econ Air?

 

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  1. Sarah is considering leaving her current job, which pays $60,000 per year, to start a new company that produces a line of inkless pens. Market research suggests she can sell about 150,000 units during the first year at a price of $25 per pen.  With annual overhead costs and operating expenses amounting to $3,500,000, Sarah expects a profit margin of 7 percent.  This margin is 2 percent larger than that of her largest competitor, Pens, Inc.

 

  1. If Sarah decides to embark on her new venture, what will her accounting costs be during the first year of operation?  Her implicit costs?  Her total opportunity costs?
  2. How much revenue would she need to earn positive accounting profits?  Positive economic profits?
  3. Based on your analysis, what should Sarah do (what is her highest valued use)?

 

  1. Please complete the tutorial available at http://sambaker.com/econ/, titled Total Cost, Variable Cost, and Average Cost.

 

  1. Supporters of communist/command economic systems argue consumers pay lower prices for some goods and services because the government impose limits on what producers may charge. List at least two ways that consumers may not benefit (or how consumers pay in other ways for the lower priced goods).

 

 

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