Question 1: For an economist, one of the most jarring sights during the early weeks of the coronavirus crisis in the United States was the spectacle of bare shelves in sections of the supermarket

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Question 1:

For an economist, one of the most jarring sights during the early weeks of the coronavirus crisis in the United States was the spectacle of bare shelves in sections of the supermarket.

There was no toilet paper or hand sanitizer. Pasta, flour and even yeast could be hard to find in the early weeks of social distancing, as many people decided to take up baking. Of far greater concern, hospitals could not buy enough of the masks, gowns and ventilators required to safely treat Covid-19 patients.

What do you think happened to the laws of supply and demand? Why do you think prices didn’t rise enough to clear the market, as economic models predict?

Question 2:

One of the downsides for firms that utilize dynamic pricing, that is pricing schemes that respond in real-time to changes in supply and demand, is that they are agnostic to tragedy. For example, airlines faced a dilemma leading up to Hurricane Dorian. As hurricanes approach, ticket prices will often increase significantly for two reasons. First, is the stylized fact that ticket prices increase as a departure date approaches. Generally, this is due to the price elasticity of the travelers that tend to purchase last-minute tickets, i.e., business travelers. Second, there is an increase in demand from people trying to flee. One of the actions airlines have taken to avoid this criticism has been to cap airfares. If you were in charge of making this decision at Delta, for example, what other action might you take and why?

Question 3:

Companies often provide perks to their employees in the form of reduced prices on other firm’s products and services (e.g., corporate cell phone plans that provide discounts on monthly service, fleet buying discounts for the purchase of new cars, savings on rental cars, etc). For example, an employee can buy discounted movie tickets for $10.00. Suppose an employee buys 10 tickets a year at $10 rather than the full price of $15. How much does this employee gain from this particular discount offering? (Note: a graph is not required but may be helpful.)

Question 4:

In a Wall Street Journal article, the CEO of AT&T, Randall Stephenson, made the following statement about its DirecTV Now streaming service: “We moved the price up and, being a very price-sensitive market, we fully expected to see a considerable number of customers drop off,” Mr. Stephenson said in an interview. “We haven’t seen that. The consumers, it’s obvious that they’re finding value in the platform.” The graph below is copied from the original article and shows the trends of the homes with no pay service, on-line TV service and traditional pay TV. Using what we have learned in class, what might explain Mr. Stephenson’s comments?

Question 5:

In 1988 Volvo operated a car assembly plant at Uddevalla. The idea was to have a small team of highly skilled workers build an entire car. According to the proponents, this would reduce the tedium associated with the conventional assembly line and cut absenteeism and turnover among workers. In 1991 there were reports that it took 50 hours of labor to assemble a car at Uddevalla, in contrast to 25 hours at Volvo’s conventional assembly plant at Ghent, Belgium. If you were Volvo’s CEO what questions would you ask Uddevalla’s managers, and what steps would you take?

Question 6:

In metro-Atlanta we have several types of express lanes, notably the HOT lanes on the section of Interstate 85 north of the perimeter (Interstate 285). The HOT lanes are dynamically priced with the goal of keeping traffic moving at a specific rate of speed. (For purposes of this question let us assume that is 40 mph.) When traffic on the HOT lanes increases and the average speed slows below 40 mph, price will go up and vice-versa, when average speed is above 40 mph, price will fall. Shortly after the original opening of this HOT lane the Governor of Georgia capped the maximum rate at $13.95. What effect did this move have? More recently, this cap was removed, what effects will this move have? (Hint: drawing graphs may help)

Question 7:

It is common for supermarkets to carry both store-brand (private-label) and brand-name (producer-label) varieties of products. Many consumers view these products as perfect substitutes, meaning that consumers are always willing to substitute a constant proportion of the private-label (store-brand) for the brand-name (producer brand). Consider a consumer who is always willing to substitute three pounds of private-label sugar for two pounds of brand-name sugar. Do these preferences exhibit a diminishing marginal rate of substitution between private-label and brand-name sugar?

Assume that this consumer has $10 of income to spend on sugar, and the price of private-label sugar is $1 per pound and the price of brand-name sugar is $2 per pound. How much of each type of sugar will be purchased?

How would your answer change if the price of private-label sugar was $2 per pound and the price of the brand-name sugar was $1 per pound?

Question 8:

You work a Glaxosmithkline, a global pharmaceutical company, and your company’s executive vice president circulates a memo to the firm’s top management in which he argues for a reduction in the price of Lamictal (a drug used to treat epilepsy and bi-polar disorder). He says a price cut will increase the firm’s sales and profits. The firm’s president concurs with the opinion of the executive vice-president. As the head of marketing you respond with a memo pointing out that the price elasticity of demand for the firm’s product is about -0.75. Why is this fact relevant and what is your recommendation?

Question 9:

Upscale hotels in the United States recently cut their prices by 20% in an effort to bolster dwindling occupancy rates among business travelers. A survey performed by a major research organization indicated that businesses are wary of current economic conditions and are now resorting to electronic media, such as the Internet, to transact business. Assume a company’s budget permits it to spend $5,000 per month on either business travel or electronic media to transact business. The price of business travel is currently $1,000 per trip and the price of electronic media is $500 per hour. Suppose that the price of business travel drops 20% to $800. Given this new price for business travel the company indicates that its marginal rate of substitution between electronic media and business is 1. Is the company allocating resources optimally? If not, what can they do? Explain.

Question 10:

Recent times have seen several industries move away from bundled products (e.g., airlines and hotels). In lecture we considered examples (e.g., Disney) where it was more profitable to bundle versus selling the various products a la carte. A move away from bundling must suggest that ΠBundle < Πal a carte, that it is less profitable to bundle (Note: Π = profits = total revenue – total costs).

(1) Why might this be the case? That is, what does it suggest that firms do not know?

(2) Why is this missing information important?