Question 1. (2 points) For the firms with sales revenue maximization objectives and nonlinear total revenue and total cost functions, what will happen as: a. firms carry out an advertising campaign? b. labor cost for producing goods decreases? (Using graphs and arguments for your explanations) Answer: For the firms with sales revenue maximization objectives, assumes they have to meet a constraint profit called π a. Firms carry out an advertising campaign: - Advertising is used for the purpose of informing or persuading customers. - To analyse effect of advertising on sales revenue-maximizing firms, assumes: + Advertising cost is shown as cost per unit, TC increasing linearly + Total revenue keeps increasing (TR) + Market price of the goods remains unchanged - Vertical: total money - Horizontal: advertising expenditure - OAp: the level of advertising expenditure maximizing profits OAs: the level of advertising expenditure maximizing sales revenue subject to a profit constraint - The sales revenue maximizing firm spend more on advertising than a profit maximizer. The price sales maximizer charged is lower than that of the profit maximizer. - Advertising increases sales but with decreasing effectiveness. For sales maximizing firms, spending on advertising and price reduction would be good for them to grow market share (because advertising shift the consumer demand out rather than just move the demand along the curve as price reduction does), even though they have to pay attention to meet the profit constraint. b. labor cost for producing goods decreases: - Labor cost for producing goods is variable cost. - When the labor cost for producing goods decreases, the profit curve moves from profit 1 -> profit 2 - The quantity produced changed from Q1 to Q2 (larger sales) Question 2. (2 points) According to Williamson’s Managerial utility model, in cases that firms are facing a decrease in profit, what should they do without hindering their operations? (Using graphs and arguments for your explanations) Answer: According to Williamson’s Managerial utility model, firm behavior can be explained by the assumption that senior managers seek to maximize their own utility function. The managers received benefits equal to monetary benefits (salary) + non pecuniary benefits. The non pecuniary benefits to the managers are counted as discretioanry expenditure or managerial slack to the firm. These expenditures can only be pursued providing actual profit ( π1) is greater than the minimum profit that is necessary to keep shareholders happy and willing to hold their stock (πM). Discretionary profits (πD) which is the difference between π1 and πM enable managers to increase their benefits. πD=π1-πM To the form of Williamson type, the reported profits equal to: π1-Ed (Ed: discretionary spending) (actual profit minus discretionary spending) In cases that firms are facing a decrease in profit, the firm faces 2 threats: dissatifying the shareholders (if they report lower profit) and hindering the operation (if they cut operation cost to maintain reported profit). In response to these threats, the managers should lower discretionary spending to stablize reported profits. Discretionary spending equals to expenditures on staff (S), fringe benefits (M) and discretionary investments (Id). Facing such threats above, the managers better lower their discretionary spending in the short run. Because obviously, the survival of the firm is much more important than those spendings. Question 3. (2 points) The estimated regression (Px) is the price of the product, Po is that of another product and Y is real income) is as follows: LogQx= 300 - 1.2 LogPx+ 0.8 LogPo+2.3 LogY (R2=0.81 and all coefficients are statistically significant) Answer the below questions and explain clearly the reasons: 3.1. The initial values of variables are: Px= $100, Po=$120 and Y= $1000. What is the value of the quantity demanded? 3.2. As price of the product increases by 1%, how will the quantity demanded change? Does this result follow the Law of Demand? 3.3. Is this good normal or inferior? 3.4. Is the another product complementary or substitute? Answer: 3.1. Qx=300-1.2Px+0.8Po+2.3Y Substitute Px= $100, Po=$120 and Y= $1000: => Qx=300-1.2*100+0.8*120+2.3*1000=2576 3.2. The price elasticity of demand for good X coefficient: -1.2 -> If the price increases by 1%, the quantity demanded decreases by 1.2% This change follows the Law of Demand. 3.3. The income elasticity of demand is positive (2.3>0) -> When the income increases, the demand increases -> Normal good 3.4. The cross price elasticity of demand is positive (0.8>0) -> When price good X increases, demand for another good increases -> Substitues Question 4: Read the following article from Brain Misamore (2018), explain your understanding about the principal – agent problems of Google and Apple? In your opinion, how could this problem affect the performance of these two firms and other firms in real life? (explain with evidence from real cases) Answer: 1. Explain understanding about the principal-agent problems of Goodle and Apple: Apple: - Outside investors hold a large power - From 2012 to 2017, Apple paid out 72% of their operting cash flow to their shareholders due to them using powers to push the firm to adapt the short-term solution to the agent-principal problem. - Due to a large cash amount flowing out of the business, Apple managers are not able to invest on innovation as they were before and have to face up to the threats of losing their edge in technology. Google: - Founders retain large power in their hands. - They pay 6% of their operting cash flow to their shareholders. - Due to a large amount of money to invest back into the business, Google invested in many different projects but the effectiveness of those projects remained questioned. 2. Opinions of effect of the problems on performance: The principal-agent problem put me under thinking of the problem as a dilemma. There are 2 sides in the dilemma and falling too deep into one of these two is not good for the firm. Both managers and shareholders are needed for firms to survive and grow and they are 2 factors affecting the presence and future of the firms. Thus, to stablize the firm’s operation, the firm should balance their power, a very large power holder should not exist in the firm. It may be good for the firm if someone cares about their future to hold such power but in the long run, there are large risks for innovation if one person holds a large power. The firm should prioritize the long term benefits and try to balance interest of different groups. If there is an issue happens, they have to fix it. To stablize the performance, there are solution: - - Align the interest of 2 groups and create a contract framework: between the principal and the agent to address issues of information asymmetry, stimulate the agent’s incentives to act in the best interests of the principal, and to determine procedures for monitoring agents. Performance evaluation and compensation: In order to address the principal-agent problem, the compensation must be linked to the performance of the agent. Tying the agent’s compensation closely to the benefits obtained for the principal helps to eliminate conflicts of interest.
