Managerial Economics: A Problem Solving Approach
5th Edition
ISBN: 9781337106665
Author: Luke M. Froeb, Brian T. McCann, Michael R. Ward, Mike Shor
Publisher: Cengage Learning
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Chapter 18, Problem 7MC
To determine
Winner’s curse.
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A risk-averse manager is considering two projects. The first project involves expanding the market for bologna; the second involves expanding the market for caviar. There is a 10 percent chance of a recession and a 90 percent chance of an economic boom. During a boom, the bologna project will lose $10,000, whereas the caviar project will earn $20,000. During a recession, the bologna project will earn $12,000 and the caviar project will lose $8,000. If the alternative is earning $3,000 on a safe asset (say, a Treasury bill), what should the manager do? Why?
For each of the following scenarios, determine whether the decision maker is risk neutral, risk averse, or risk loving.a) A manager prefers a 10 percent chance of receiving $1,000 and a 90 percent chance of receiving $100 to receiving $190 for sure.b) A shareholder prefers receiving $775 with certainty to a 75 percent chance of receiving $1,000 and a 25 percent chance of receiving $100.c) A consumer is indifferent between receiving $550 for sure and a lottery that pays $1,000 half of the time and $100 half of the time.
Use the expected value information to illustrate how having more bidders in an oral auction will likely result in a higher winning bid.
Chapter 18 Solutions
Managerial Economics: A Problem Solving Approach
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- A risk-averse manager is considering a project that will cost £100. There is a 10 percent chance the project will generate revenues of £100, an 80 percent chance it will yield revenues of £50, and a 10 percent chance it will yield revenues of £500. Should the manager adopt the project? Explain. What will a risk-neutral and risk-loving manager do in the same situation?arrow_forwardBPO Services is in the business of digitizing information from forms that are filled out by hand. In 2006, a big client gave BPO a distribution of the forms that it digitized in house last year, and BPO estimated how much it would cost to digitize each form. Form Type Mix of Forms Form Cost A 0.5 $3.00 B 0.5 $1.00 The expected cost of digitizing a form is . Suppose the client and BPO agree to a deal, whereby the client pays BPO to digitize forms. The price of each form processed is equal to the expected cost of the form that you calculated in the previous part of the problem. Suppose that after the agreement, the client sends only forms of type A. The expected digitization cost per form of the forms sent by the client is . This leads to an expected loss of per form for BPO. (Hint: Do not round your answers. Enter the loss as a positive number.)arrow_forwardFor each of the following scenarios, determine whether the decision maker is risk neutral, risk averse, or risk loving. a. A manager prefers a 20 percent chance of receiving $1,400 and an 80 percent chance of receiving $500 to receiving $680 for sure. b. A shareholder prefers receiving $920 with certainty to an 80 percent chance of receiving $1,100 and a 20 percent chance of receiving $200. c. A consumer is indifferent between receiving $1,360 for sure and a lottery that pays $2,000 with a 60 percent probability and $400 with a 40 percent probability.arrow_forward
- Consider a first-price, sealed-bid auction, and suppose there are only three feasible bids: A bidder can bid 1, 2, or 3. The payoff to a losing bidder is zero. The payoff to a winning bidder equals his valuation minus the price paid (which, by the rules of the auction, is his bid). What is private information to a bidder is how much the item is worth to him; hence, a bidder’s type is his valuation. Assume that there are only two valuations, which we’ll denote L and H, where H > 3 > L > 2. Assume also that each bidder has probability .75 of having a high valuation, H. The Bayesian game is then structured as follows: First, Nature chooses the two bidders’ valuations. Second, each bidder learns his valuation, but does not learn the valuation of the other bidder. Third, the two bidders simultaneously submit bids. A strategy for a bidder is a pair of actions: what to bid when he has a high valuation and what to bid when he has a low valuation. a. Derive the conditions on H and L…arrow_forwardIf some auction participants for crude-oil field leases have estimates that the oil in the ground is worth $1.2 million, $1.3 million, or $1.5 million with certainty; other auction participants have estimates that the same oil field lease is worth $1.1 million, $1.3 million, or $1.5 million with certainty; and a third group of auction participants have estimates that the same oil field lease is worth $1.1 million, $1.2 million, or $1.3 million, and all three forecasts contain the true common value, what is that value? How would you as auctioneer-seller design an auction to reduce strategic underbidding and realize this true value?arrow_forward1. One time your company needs cash and plans to auction off subsidiaries to the highest bidder. Mention the type of auction that will maximize your company's revenue from the sale if:a. Bidder is neutral on risk and has independent personal judgment?b. Bidder is risk-neutral and has an affiliated valuation estimate? 2. A manager will use a business strategy so that in the long run the company's profits will increase. The entry of competitors has an impact on the unfavorable profitability of the company. To deal with the entry of new competitors, a manager can consider the limit pricing strategy.a. Explain what is meant by limit pricing!b. How can the limit pricing strategy be effective? 3. It is known that the demand function of "I like" brand dry food companies in the monopolistic competition market is P = 100 - 2Q, while the cost function is TC = 5 + 2Q. in this case P = price level, Q = output level, and TC = total cost.a. Determine the combination of prices and production levels…arrow_forward
- How to solve this question? Consider an antique auction where bidders have independent private values. There are two bidders, each of whom perceives that valuations are uniformly distributed between $100 and $1,000. One of the bidders is Sue, who knows her own valuation is $200. What is Sue's optimal bidding strategy in a Dutch auction?arrow_forwardConsider a game where there is a $2,520 prize if a player correctly guesses the outcome of a fair 7-sided die roll.Cindy will only play this game if there is a nonnegative expected value, even with the risk of losing the payment amount.What is the most Cindy would be willing to pay?arrow_forwardSuppose Xavier has tickets to the Super Bowl, but is terribly ill with a noncontagious infection. How would a decision maker perform his economic calculation on whether to attend the game, based on the traditional model of risk behavior?arrow_forward
- A strategy is a decision rule that describes the actions a player will take at each decision point. The normal-form game indicates the players in the game, the possible strategies of the players, and the payoffs to the players that will result from alternative strategies. In the game presented in Table Normal-Form Game, does player B have a dominant strategy? What is the secure strategy for player B in the game presented in Table Normal-Form Game?arrow_forwardTwo parties, Juan and Ben, have been negotiating the purchase by Ben of Juan's car. Juan receives a new and higher bid for his car from Adriana. How might Adriana's bid change Juan and Ben's threat values? The threat values are unchanged. Juan now values the car at the price of Adriana's bid, her bid is his opportunity cost of selling the car to Ben, and that opportunity cost is Juan's new threat value. Juan's new threat value is the product of the difference between Ben and Adriana's offers and the probability the car will be sold to Adriana. Juan's threat value is unchanged, but Ben has to consider his new opportunity costarrow_forwardIn a principal-agent problem, if the contract implies that the more risk-averse agent will bear less risk, we can say that this contract exhibits A.risk sharing is not optimal because the less risk-averse (or risk-neutral) agent should bear none of the risk. B.efficiency in risk-bearing. C.risk sharing is not optimal because risk-neutral agents should face no risk. D.risk sharing is not optimal because all risk should be transferred to the most risk-averse agent.arrow_forward
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