Manegerial Economics

* Chapter 12. If you decide to pay 1 percent of this amount (in Question 1) as a cash bonus, what performance level (what share price or shareholder value) in the table should trigger the bonus? Suppose you decide to elicit high CEO effort when, and if, medium luck occurs by paying a bonus should the company’s value rise to $800,000,000. What criticism can you see of this incentive contract plan?

Solutions:We find both contracts elicit lower-thanpredicted levels of effort. Effort choices elicited by the option contract do not differ significantly from effort choices elicited by the stock contract except for male subjects whose choices suggest a strategy of exploration. The option contract elicits a higher effort level for these subjects than a stock contract. This is evidence that, for a definable subset of the population, employee effort choices will differ across stock-based and option-based compensation contracts that are similarly costly to the employer.

3. Suppose you decide to elicit high CEO effort when, and if, good luck occurs by paying a bonus only for an increase in the company’s value to $1,000,000,000. What criticism can you see of this incentive contract plan?

Solutions:Of course, the shareholders would also like to elicit High Effort with Medium and Bad Luck since those behaviors would also increase company profit. But Good Luck and Low Effort cannot be distinguished from Moderate Effort and Bad Luck, and furthermore, there is no incentive for High Effort.

6. In an effort to identify the share price that should trigger a bonus, the payment for the CEO, and maximize shareholder value, how much would you, the Compensation Committee, be willing to pay an auditor to examine the expenseand revenue flows in real time and deliver perfect forecasting information about the “luck” the firm is experiencing? Compare shareholder value with this perfect information relative to the best choice among the cash bonus plans in Questions 2, 3, and 4. Solutions:

Chapter 21. For each of the determinants of demand in Equation 2.1, identify an example illustrating the effect on the demand for hybrid gasoline-electric vehicles such as the Toyota Prius. Then do the same for each of the determinants of supply in Equation 2.2. In each instance, would equilibrium market price increase or decrease? Consider substitutes such as plug-in hybrids, the Nissan Leaf and Chevy Volt, and complements such as gasoline and lithium ion laptop computer batteries. Solution for # 1

According to the equation:QD = f(P, PS, PC, Y, A, AC, N, CP, PE, TA, T=S …)where QD = quantity demanded of (e.g., Toyota Prius/ Chevy Malibu)P = price of the good or service (the auto)PS = price of substitute goods or services (e.g., the popular gasoline-poweredHonda Accord or Chevy Malibu)PC = price of complementary goods or services (replacement batteries)Y = income of consumersA = advertising and promotion expenditures by Toyota, Honda, and GeneralMotors (GM)AC = competitors’ advertising and promotion expendituresN = size of the potential target market (demographic factors)CP = consumer tastes and preferences for a “greener” form of transportationPE = expected future price appreciation or depreciation of hybrid autosTA = purchase adjustment time periodT/S = taxes or subsidies on hybrid autos

If the quantity demanded is the Toyota Prius, the P is the price of the car and as the price rises we would expect a decrease in the quantity sold; PS is the price of substitutes and as the price of the Chevy Malibu rises we would expect the quantity of the Toyota Priuses to rise;

PC is the price of complements and we would expect that as the price of things like replacement batteries rises we would see a decline in the quantity of Priuses sold; Y is income and we’d expect as income rises to sell more Priuses as they are normal goods; A is advertising and we’d also expect more Priuses sold as advertising and promotional expenditures rises; AC is competitors’ advertising and we’d expect a negative impact on the quantity of the Prius sold as AC rises;

N is the size of the target market or population and we’d expect that larger markets will sell more Priuses; CP is consumer preferences for greener transportation which should help the Prius seen as being greener; PE is the expected future price of hybrid cars and we’d expect that the greater the resale price of the car that more will wish to buy it;

TA is the purchase adjustment time period that tends to show that more Priuses are sold if the time period permitted for analysis is longer; and T/S involves taxes on or subsidies for hybrid cars that we say in periods when there are tax subsidies to buy hybrids that car sales of hybrids rises. Equation [2.2] is the supply function: QS = f(P, PI, PUI, T, EE, F, RC, PE, T/S, …).

P is price, PI is inputs like metal, PUI is the price of unused inputs like fiberglass, T is technological improvement like robots; EE is exit or entry of other automakers, RC is the regulatory cost of compliance, PE is the expected future price of the Prius, TA and T/S are already mentioned. In general, we should not include variables other than price in both the supply function and the demand function because they then become endogenously determined. It is more common to include these only in the supply function.

6. The manager of the aerospace division of General Aeronautics has estimated the price it can charge for providing satellite launch services to commercial firms. Her most optimistic estimate (a price not expected to be exceeded more than 10 per- cent of the time) is $2 million. Her most pessimistic estimate (a lower price than this one is not expected more than 10 percent of the time) is $1 million. The expected value estimate is $1.5 million. The price distribution is believed to be approximately normal. Solutions:

General Aeronautics question involving distributions.

A. Because price distribution is normal, the expected price is halfway between the most optimistic price and the most pessimistic price, which is $1.5 million. B. Using the Table 1, the z value corresponding to leaving 10 percent in the lower tail of a normal distribution is approximately 1.28. Therefore, 1.28 standard deviations correspond to a distance of $500,000 below the mean ($1 million minus $1.5 million). Hence one standard deviation is equal to:

1.28ϭ = -$500,000, or = $390,625.C. z = ($1.2 million $1.5 million) / $390,625 = 0.77, so from Table 1, we can find the p(z < 0.77) = 22.06%