University of Rochester/The Simon Business School
Managerial Economics and Organizational Architecture
Publisher: McGraw Hill
By James A. Brickey/Clifford W. Smith/Jerold L. Zimmerman
Chapter 2 Economist’s View of Behavior
1. (BSZ question 2-3) The Solace Company has an inventory of steel that it originally purchased for $20,000. It currently has an offer to sell the steel for $30,000. Should Solace’s management agree to sell? Explain.
We do not have enough information to make an informed decision on whether Solace management should buy or sell. First, we are unclear on the current market value for steel relative to the amount of inventory they hold. If the market value is higher than the offered amount of $30,000, it is disadvantageous to sell. Additionally, we do not know the market trend in the value of steel. If the value of steel was appreciating over time, it would not be advantageous to sell at the current time because the opportunity cost of holding provides more value (greater marginal benefit).
Taking a different angle, we also don’t have details about the Solace company’s products. If they are able to use the inventory of steel to produce a product with higher value (ex. steel pipes, property, bridge, etc), it also may be less advantageous to sell. For a simple example — if the cost of turning the pre-existing steel inventory into steel pipes was $5,000 and the new value of the steel pipes was $50,000 it would be more advantageous to not sell the steel at value of $30,000.
2. (BSZ question 2-13) A company recently raised the pay of employees by 20 percent. Employee productivity remained the same. The CEO of the company was quoted as saying, “it just goes to show that money does not motivate people.” Provide a critical evaluation of this statement. (5 points)
3. In the article “The Rational Choices of Crack Addicts,” Dr. Carl Hart states that “when [addicts in his experiments] were given an alternative to crack, they made rational economic decisions.” Please use information from the accompanying article and concepts from this course to explain his statement.
4. On a recent trip passing through the Cattaraugus Indian reservation an observer noted several gas stations selling gasoline 30¢ per gallon cheaper than in Buffalo, NY and its suburbs (the reservation is approximately 30 miles south of Buffalo, NY; 16 miles from the nearest suburbs of Buffalo). The observer also noticed a surprising number of RVs and trucks pulling boats at these gas stations. Please use concepts discussed in class to explain why the Indian-owned gas stations would price 30¢ lower than competitors (rather than a smaller price differential) and why a larger proportion of customers would be driving RVs or towing boats. Note: The gasoline sold on the reservation is indistinguishable from gasoline sold elsewhere (i.e., there is no quality difference).
5. Tom lives a simple life. He works to earn income and spends his income on two goods: medical care and food.
a. How much of each good would we expect Tom to consume? Draw a diagram to support your answer.
b. Tom has been in a car accident that will leave him unable to work for three months. How would we expect his consumption of medical care and food to change? Draw a diagram to support your answer.