Managerial Finance
Autor: tweetlively • April 14, 2016 • Course Note • 888 Words (4 Pages) • 882 Views
Review Test Submission: PROBLEM SET #3
Question 1
20 out of 20 points
Peter Higgins is a sales agent for XZY Company. He has an effort cost function of C = e2 and a reservation wage of $1,500. His wage package is W = 1,500 + 0.2Q where the CEO sets the incentive at 0.2 and Q = 200e. Q is the output. If the CEO increases the incentive from 0.2 to 0.25, what happens to the Peter's effort? Will profits rise or fall?
Selected Answer:
Compensation = W0 + BQ
Solving under lower incentive Solving under the higher incentive
1,500 + 0.2Q 1,500 + 0.25Q
1,500 + .2(200e + u) 1,500 + .25(200e + u)
1,500 + .2(200) 1,500 + .25(200)
1,500 + 40 1,500 + 50
Compensation function: $1,500 + 40e Compensation function:1,500 + 50e
Employee’s cost function: e2 Employee’s cost function: e2
Expected compensation is $2,300 Expected compensation is $2,750
Expected output Q = 200(20)= $4,000 Expected output Q = 200(25) =5,000
Expected profit = $1,700 Expected profit = $2,250
Peter’s effort will increase based on incentive and increase in his utility.
Expected profit will raise in this case to $2,250
Question 2
20 out of 20 points
Great Cars, Inc. faces the following demand function for its automobiles:
P = 55,000 – 200 Q
Its marginal cost (MC) is $9,000. What will its price be if it decides to sell the automobiles by itself and what will the price be if it sells though DistriCorp, an independent distributor. Note that when Great Cars, Inc. contracts with DistriCorp, it has to take into account that DistriCorp faces the same demand curve. What is the consequence of this exclusive dealing on prices?
Selected Answer:
MR = MC
P = 55,000 – 200 Q
55,000 – 400 Q = 9,000
55,000 – 9,000 = 400 Q
Q = 46,000/400
Q = 115 automobiles
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