econ questions 11

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Answer the following questions:

Divisional Profit Measure

Discuss the advantages and disadvantages of using divisional profit as the basis of incentive compensation for division managers compared to using company profit as the basis.

Local Phone Companies

State utility commissions typically regulate local phone companies, but local phone companies also offer long-distance service to their customers. Rival long-distance carriers also connect to local phone lines to provide long-distance service to customers. Recently, the rival long-distance carriers have complained that the local phone company repair persons have put peanut butter on rival long-distance carrier’s phone lines to encourage rats to eat through the lines. If true, why is this a profitable strategy?

Wedding Dresses

Stores that sell wedding dresses do not typically permit photos, and do not have tags in the dresses that would identify the manufacturer and style type. What is the purpose of these rules? Suggest one other way of accomplishing the same objective.

Barbie Dolls and Accessories

Why might Mattel set a much lower contribution margin on its Barbie dolls than on the accessories for the dolls?

Selling Salsa

Your family business produces a secret recipe salsa and distributes it through both smaller specialty stores and chain supermarkets. The chains have been demanding sizable discounts but you do not want to drop your prices to the specialty stores. How can you legally accommodate the chains without losing profits from the specialty stores?

Real Estate Agents

When real estate agents sell their own, rather than clients’, houses, they leave the houses on the market for a longer time (10 days longer on average) and wind up with better prices (2% higher on average). Why?

Incentive Conflicts

Which of the following are characteristic of principal-agent conflicts that often exist in a firm? (Note: The entire statement must be true in order to be a correct answer.)

  • Managers do not always operate in the best interest of owners because owners are generally more risk averse than managers.
  • Managers generally have a shorter time horizon than owners; thus, managers do not fully take into account the future long-run profitability of the firm.
  • Managers do not always operate in the best interest of owners because managers care about the non-cash benefits of their jobs.
  • Firms can usually find solutions that reduce agency costs without increasing monitoring or incentive costs.

Public School Principals

Each year, public schools are rewarded with bigger budgets for achieving a rating of “excellent” or “recommended” and are punished for rating “needs improvement.” These ratings are based on meeting thresholds on a broad set of measures such as attendance rates, graduation rates, standardized test scores, SAT scores, etc. Discuss the incentives for principals under this scheme and how you might improve them.

Transfer Pricing

Suppose that a paper mill “feeds” a downstream box mill. For the downstream mill, the marginal profitability of producing boxes declines with volume. For example, the first unit of boxes increases earnings by $10, the second $9, the third $8, and so on, until the tenth unit increases profit by just $1. The cost the upstream mill incurs for producing enough paper to make one unit of boxes is $3.50.

  • If the two companies are separate profit centers, and the upstream paper mill sets a single transfer price (the price the box company pays the paper mill), what price will it set, and how much money will the company make?
  • If the paper mill were forced to transfer at marginal cost, how much money would the company make?
 
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