Managerial economics

Question I :

Why would a firm choose to remain in an industry in which it makes an economic profit of zero? Name a Vietnamese firm that does this.

A firm will make an economic profit of zero if its sale is a normal profit. In other words, it  cover both out of pocket expense and its opportunity cost or accounting profit equals the opportunity cost. It means that economic = 0 which be called normal profit. Suppose that, accounting profit exceeds the opportunity cost is called economic profit, beside that, accounting profit less than opportunity cost is called economic loss.

In short run, a company want to maximize its profit (or minimize its loss) should produce at a certain level where additional revenue is equal to the additional cost of producing as MR = MC rule. However, the market price is not always enough high, the company get an economic profit. So it will face to out put price at the normal profit or even operating loss.

The company gets an economic profit of zero when the price equals the average cost (AC) or following the formula: MC = MR = P = AC. At this time, the its sale covers fix cost, varible cost and opportunity cost so that, the firm remains in an industry and to get economic income in future.

In Vietnam, firms sell its product with high competition market in the main farm maket. They sell its product at the the profit only enough for their opportunity cost. Because of all most this compay are belong the state company, so that, managers are requested to get profit at least equal interest rate. They must ensure their worker’salary.

Question II :

How realistic is the assumption of constant variable unit costs in volume cost profit analysis? Does it detract a great deal from the value of this analysis? What is a large volume firm in Vietnam that probably has a variable unit cost? 

Volume cost profit analysis is an economic analysis which is used in sure situation. It evaluate the affect of change in quantity of product on cost and profit. It bases on some limiting assumptions when the price, average variable cost are constant. So the firm may forcast its cost and sales. Conducting a break even analysis is a formula of simple math as:

Break even Point = Fiwed Costs / (Unit Selling Price – Variable Cost)  

As Keat and Young (2009) wrote, “if we assum the relationship between average variable cost and price for each product remains the same and the quantities of various products are produced in constant proportions, such as assumption does not appear to be unrealistic for relatively small changes in total revenue”. However, as we known, if the company produces more than a product, which each of products has a different price and a different variable cost. So we not use above formular to caculate Break even Point. But others consider it like the most way.

This analysis does not detract form its value in assumption. All most of firms in Vietnam are at small or medium size. They have variable cost and produce just one or two products. They can estimate the quantity of each at constantproportion and use average variable cost per unit to caculate the Break even Point.

Question III :

Price discrimination is often defended on the basis of equity. What is meant by this statement? Comment on its validity in terms of a USA company selling some products in Vietnam in relatively cheaper prices than in the USA.

Price discrimination is a statement which an identical product is sold in different market at different prices. There are three degrees price discrimination.

First degree of price discrimination, the firm will charge prices along demand curve all the way to the point where demand equals marginal cost.

Second degree of price discrimination happens when a company use a differential price by block of service. For example in telecommunication fields in Vietnam, the price of first block of 30s per a call is different from the next block after 30s.

Third degree of price discrimination is the most popular. The production may go up if the demand curve is not straight line. So customers willing to pay at low price to get the benefit than in condition of a single price monopoly, beside that, others will pay higher prices in lower price.

USA firms sell several products in Vietnam with cheapper prices than in the USA. For example: the Microsoft sofware is sold in Vietnam with cheapper prices than in the USA. Almost Vietnamese can get it while in America, they can not affort to buy. Because the Vietnam market is more competitive than USA’market. And finally, the demand curve in Vietnam market is more elastic than USA’market.

Question IV :

Briefly explain the structure-conduct-performance approach to the study of industrial economic. How does this approac fit in the Vietnamese economy?

The structure conduct performance (S-C-P) is used to connect elements of market structure to performance in industrial economics. On the other hand, this structure studies the way that firms and markets are organized and affected to the economy from point of view of social welfare.

The industry structure is the basic of S-C-P which include buyer and seller concentration, product differentiation, condition of entry, and the elasticity of demand for the product. Performance is the measured in terms of welfare maximization. Besides, conduct is reqired pricing strategies, promotion, advertising, product development, legal tactics, and choice of product as well as the potential for collusion among companies.

As Keat and Young (2009) pointed out that: “An in dusstry market with great concentration will fall far short of reaching such a goal. Its performance will be marked by both productive and allocative inefficiencies. Price will be above marginal cost, the choice and ultimately profits will be higher than under competitive circumstances. This high level of profitability arises from the industry’s pricing policy and not because of any cost advantages”. (p. 374).

The outcome of S-C-P method is that high industry concentration becomes a cause for the intervention of government against possible mergers.

In Vietnam, the S-C-P approach is applicable for strategy researchers. It helps to evaluate the existence of competition in the industry, moreover, it measures the performance of industry and finds out its potential.

Question V :

Suppose the Sri Lanka government awarded contracts to private companies to rebuild the country’s infrastructure damaged by the tsunami and it based its contracts on a percentage of the cost of the reconstruction. Would this constitute a moral hazard? If so, what would the government need to do to prevent such a problem? Are these kinds of “cost plus” contracts used in Vietnam? By whom?

The term of Mral hazard is appeared when a loan is made the private companies may choose to change transaction. Then, this company receive the loan, it is easier to get the money to use other purposes.

Sri lanka government awarded contracts to private companies to rebuild the country’s infrastructure damage by the tsunami and it based its contracts on a percentage of the cost of reconstruction. This situation it a cost-plus price practive. In other words, the private firm will caculate the varible cost, add to it an allocation for fixed cost, after that add a profit percentage to reach a total cost of the contract. May be lead to the prolem of moral hazard so that, private firms will try go down its cost due to increase their earning. Consequently, the project is the lower quality.

The government have to control closely and enforce a quality level after the contract is signed. There are many contruction in Vietnam which Vietnamese government awards contracts to build such as: buildings, bridges and highways. They also used the cost-plus pricing in contracts. However, to avoid the problem of moral hazard, the government may choose prestigious companies and apply o procedure to control better quality of projects.

Question VI :

How is the company’s optimal capital budget determined? Does the decision-making process in this case resemble the procedure used in determined the price and quantity of output? How?

The key of optimal capital bubget determined is the evaluating worth of investment projects. It means that capital project must be used correctly the cash flow and the time value of money. There are two methods which are considered as: the payback method and the accounting rate of return method.

The payback method calculate the period of time essentially to get back the original investment.

The accounting rate of return method is outcome (percentage) from average annual profits. These methods discount cash flows to the net present value (NPV), internal rate of return (IRR) and profitability index (PI).

There is a capital budgeting model which companies should use to optimize capital budgeting plan. Every project will be used internal rate of return (IRR) due to compare with marginal cost of capital (MCC) to search the optimal point on the graph.(with the vertical axis is IRR and MCC, the horizontal axis is the investment capital) where the capital budgeting of the firm is optimixed.

When IRR = MCC, at that time, that is the point of the optimal investment budget.

In addition, it also similar the procedure used in determing the price and quatity of out put, the company should operate a capacity where the marginal revenue (MR) equas the maginal cost (MC), MR = MC.

More importantly, firms should do the amount of the investments at the point where the internal rate of return (IRR) equals the marginal cost of capital (MCC), IRR = MCC.

Question VII :

Explain the difference between the Moving Averrage approach and Exponential smoothing approach to forecasting. Which do you think would be better for your company? Why?

The moving average approach and exponential smoothing approach is also called smoothing method. This method use an averrage of past observation to forecast future if we consider that the future is the reflection of several of past result.

Acctually, the past observation to forecast one period ahead . the equation is following:

E t+1 = ( Xt + Xt-1 +…+ Xt-N+1 ) / N

Where: E t+1 = Next (t+1) forecast period

Xt , Xt-1 = Actual valual at their respective times

N = Number of observation included in average

Exponential smoothing method is different the moving average method. We can see its treat all the past observation as the same degree of important. However, the forecaster would belive the older past result the lesser suitable to future trend. So that, the exponential smoothing method the smaller weighing factor for older past results in the following:

E t+1 = wXt + (1-w)Et

Where: w is the weight assigned to an actual observation at period t.

Making forecast, the fore caster no need collecting previous result as many as moving average method needs. More importantly, the w value is determined.

In summary, both these forecasting methods have several advantages and disadvantages. The advantage is the simplicity of method. So two methods should be used just for short term estimates.

Question VIII :

A firm is making a long-run planning decision. It wants to decide on the optimal size of plant and labor force. It is considering building a medium-sized plant and hiring 100 workers. Engineering estimates suggest that at those levels, the marginal product of capital will be 100 and the marginal product of labor will be 75. If the wage rate is $5 and the rental rate on capital is $10, is the firmmaking right decision? Support your aswer.

We have: MPL = 75, MPK = 100 with (L = labor: variable input; K = Capital: varible input)

To maximize its profit, the firm must use two inputs (labor and capital) to meet the denmand of marginal revenue of K and L input.

Wage rate of labor: w = $5

Rental rate on capital: r = $10

Leading to:  MPL  / w = 75/5 = 15 (1)

MPK  / r = 100/10 = 10 (2)

From (1) & (2), we can see that the firm is not making the right decision or they should hire more labor and reduce capital rental value.