03 Jun Question ECO 304K INTRO MICRO Fall 2014 Hickenbottom
Question
ECO 304K
INTRO MICRO
Fall 2014
Hickenbottom
HOMEWORK #5
(Due November 19th at 11am)
1. Consider the following two projects
Project A: Costs $12,000 today. Increases profit by $3000 next year, $7,200 in two years, and $4000 in three years.
Project B: Costs $7500 today. Increases profit in two years by $8190
Both projects have no value beyond the given time frames. A firm faces a rate to borrow money of 9% and has the option of investing money with almost no risk at 5%.
a) If the firm has $25,000 on hand, with only these two project to choose from, will they invest in A, B, neither or both? Show the calculations that lead to your conclusions. Explain whether you answers would be different for either project if the firm had no money on hand to invest. (1 point)
b) Explain, based on your calculations in (a), why the rate of return on project A must be somewhere between 5% and 9%. Set up (but do not solve) and equation that would find the rate of interest where the firm is indifferent between investing in project A, and not investing in project A. (1 point)
d) Use the data in (a) to bound the rate of return for project B, then use an equation like the one in (b) to actually find the rate of return of project B. Verify that it is consistent with the bound you found. (2 points)
2. An economy is currently made up of a firm that produces bread, a firm that produces butter, and a consumer who consumes both bread and butter. Current production is 100 units of bread, 50 units of butter which the consumed by the consumer. If the output changed to 75 units of bread and 60 units of butter, the profit of the butter firm would go up by $42. The profit of the bread firm would go down by $76. The consumer prefers 75 bread and 60 butter to 100 bread and 50 butter. It is so much better that the consumer would pay $40 more to have 75 bread and 60 butter rather than have 100 bread and 50 butter. Explain, using the definition, why you know it is not Pareto Efficient to have the economy produce 100 bread and 50 butter. (1 point)
3. A demand curve is given by the following equation: P = -4Q + 160.
i) Calculate the Total Revenue when Q = 25 and when Q = 28.
ii) Calculate the price elasticity of demand between Q = 25 and Q = 28. Round decimal answers to two places.
Explain why the relation between the numbers in (i) and (ii) makes sense. (1 points
4. A firm is a monopolist and faces the following demand:
q P q P
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