Points
Question 1 /6
Question 2 /5
Question 3 /6
Question 4 /3
Total /20
Question 1 (6 points)
You are the manager of a small computer store that sells mainly PCs and printers. Your two best-selling PC models are ModelA and ModelB. You believe that it is time to reconsider the price of ModelA, which was set by your predecessor employing the cost-plus pricing methodology.
The Table below contains information about your current sales and margins:
Price Marginal cost Margin Quantity
ModelA 1000 700 300 500
ModelB 1100 800 300 400
Printers 200 150 50 600
a. Conduct a break-even analysis for a 10% decrease in the price of ModelAignoring any impact on sales of ModelB and of printers.
b. Conduct a break-even analysis for a 10% decrease in the price of ModelA taking into account sales of ModelB and of printers. Assume that 50% of any additional demand for ModelA comes from customers who would have bought ModelB otherwise, and that a typical PC purchase (of either model) leads to the purchase of 0.5 printers.
c. Suppose the estimated price elasticity of the demand for ModelA at the current price is -2. Is a (small) price reduction profitable? Is a (small) price increase profitable? (As in part b, assume that a typical PC purchase leads to the purchase of 0.5 printers. Moreover, in case of a price decrease, 50% of any additional demand for ModelA comes from ModelB, while in case of a price increase, 50% of customers who stop buying ModelA will switch to ModelB.)
Question 2(5 points)
A symphony orchestra is preparing to stage a short concert series. The first program in the series consists of music by Berlioz and Tchaikovsky, while the second program consists of music by Bartok and Stravinsky. The potential audience for the series can be thought of as divided into four, equal-sized groups. Members of the first group, whose tastes tend to be romantic, would be willing to pay $40 for a ticket to the first concert and up to $20 for a ticket to the second concert. Members of the second group, whose tastes tend to be more to the neo-classical, have the opposite preference: they would pay up to $20 for a ticket to the first concert and up to $40 for a ticket to the second concert. Members of the third group, confirmed Tchaikovsky lovers, would pay as much as $45 for a ticket to the first concert, but only $5 for a ticket to the second concert. Finally, members of the fourth group, who pride themselves on their sophisticated taste, would pay as much as $45 for a ticket to the second concert, but only $5 for a ticket to the first concert. This information is summarized in the table below.
Willingness-to-pay of Concert Patrons
Patron Type Berlioz/Tchaikovsky Bartok/Stravinsky
Romantic 40 20
Neo-Classical 20 40
Tchaikovsky 45 5
Sophisticate 5 45
Find the maximized profit for each of three situations: (a) each item is sold separately, (b) pure bundling, and (c) mixed bundling. Which of the three pricing methods yields the highest profit?
Question 3 (6 points)
Suez Computer has developed a new server called SuperServer. SuperServer is four times faster than existing servers for web applications, and twice as fast as existing servers for file sharing applications.
Suez Computer spent $2 million to develop the SuperServer. The variable cost of production is $1,000 per server. Allocated fixed costs amount to a total of $50,000.
Suez Computer’s main competitor, Ontario Computer, charges $2,000 per server, which is also the price of Suez Computer’s existing server. Because of SuperServer’s superior speed, Suez Computer considers charging more than $2,000 for it.
50% of Suez potential buyers need servers for web applications, the remaining 50% for file sharing applications. The typical web application customer needs four standard servers. The typical file-sharing application customer needs six standard servers.
Suez Computer is unable to charge different prices to different customers, i.e., it cannot practice direct price discrimination.
Ownership of a server is associated with the following annual costs per server: $250 for software licenses and $250 for electricity.
(For all questions, assume that customers are fully rational and choose whichever option gives them the highest surplus).
a. What is the profit-maximizing price of the new SuperServer? State the main assumptions you are making for your analysis.
b. Suez Computer considers adding a lower quality version of SuperServer to its product line. The lower quality version would be nothing but a SuperServerwithout Suez Computer’s proprietary “performance enhancer” software tool loaded onto it. The variable cost of production would hence remain $1,000. For web applications, the lower quality version of SuperServer would be twice as fast as a standard server. For file sharing applications, it would be 1.5 times as fast as a standard server.
i. If Suez Computer were to sell only one version of SuperServer, which one should it sell and at what price?
ii. What are the profit-maximizing prices if the firm sells both versions of SuperServer? Can the firm improve profits by selling two instead of only one version?
Question 4 (3 points)
Andretti Company produces a single product called a Dak. The company currently produces and sells 60,000 Daks each year at a selling price of $32 per unit. The company’s unit costs at this level of activity are given below:
Direct materials ………………… $10.00
Direct labor ……………………. $6.80
Fixed manufacturing overhead ……… $5.00 ($300,000 total)
Variable selling expenses ………….. $1.20
Fixed selling expenses ……………. $3.50 ($210,000 total)
Total cost per unit ……………….. $26.50
Andretti Company has sufficient capacity to produce 90,000 Daksper year without any increase in fixed manufacturing overhead costs.
Each of the following questions is independent.(1 point each, no partial credit)
a. Compute the break-even quantity change of a $3 price increase.
b. A large customer in a foreign market wants to purchase 20,000 Daks. Import duties on the Daks would be $1.70 per unit, and costs for permits and licenses would be $9,000. The only selling costs that would be associated with the order would be $3.20 per unit shipping cost. Compute the per unit break-even price on this order, i.e., the minimum price at which this deal would be profitable for Andretti.
a. The company has 1,000 Daks in stock that have some irregularities and therefore cannot be sold at the normal price. What costs are relevant for setting the price of these Daks? Explain.