Exercise 1. A consumer has a choice of spending $20,000 on a Honda or $14,000 on a Kia. She was observed buying a Kia during the weekend. Does this mean
... [Show More] the consumer prefers the Kia to the Honda? Explain your answer.
Exercise 2. In order to encourage energy conservation, many public utility companies charge consumers a higher rate on units of electricity consumed in excess of some threshold amount. In contrast, a common practice by other firms is to offer “quantity discounts” to consumers who purchase large quantities of a good. Suppose income is $100, PX = $2 if the consumer buys less than 40 units of X, and PY = $5.
A. For the energy case, assume PX = $3 if the consumer buys more than 40 units of X
Draw the budget constraints in each of the cases above. What are the implications of the opportunity sets in terms of consumer behavior to consume each of the products?
Exercise 3. A discount shoe store always runs a ’buy one, get one free (limit one free pair per customer)’ campaign. A customer asked a clerk, if he would sell her one pair for half price. The clerk answered, ”I’m sorry, I can’t do that.” but when the customer decided to leave the store, the clerk hastily offered, “However, I think I can give you a 40% discount on any pair in the store.”
Assuming the consumer has $200 to spend on shoes (X) or all other goods (Y ), and that shoes cost $100 per pair:
a. Illustrate the consumer’s opportunity set with the ”buy one, get one free” deal and with a 50 percent discount.
Exercise 4. You are a manager at a certain factory that designs small gadgets. The factory has been quite successful in the past years. Your CEO is wondering whether or not it is a good idea to expand the factory this year. The cost to expand the factory is $1.5M. Doing nothing will result in expected $3M in revenue if the economy stays good and people continue to buy plenty of gadgets, but only $1M in revenue is expected if the economy is bad. On the other hand, expanding the factory carries an expected $6M in revenue if economy is good and $2M if the economy is bad.
Assume there is a 40% chance of a good economy and a 60% chance of a bad economy. Also, assume the costs of operating the factory account to $.5M if the factory is expanded and $.3M if not.
a. Illustrate a Decision Tree showing these choices. [Show Less]