Midterm Examination November 6, 2015 Name Department

Midterm Examinationnovember 6 2015name Depa

Answer the following Short Assay questions (3 points each):

1. NPV (2 points) Suppose an initial investment of $100 will return $50/year for three years (assume the $50 is received each year at the end of the year). Is this a profitable investment if the discount rate is 20%?
2. The Salmond home water supply “Will switching to a water meter save money?" (a) Suppose that the Salmond home water supply is not metered, and the family consumes 10,000 gallons a month. Illustrate the family's monthly demand curve for water assuming that the demand curve is a straight line, and, if the price is £50 per 1,000 gallons, the Salmond family would consume nothing. (b) Calculate the total benefit and marginal benefit from water when the Salmond family consumes 10,000 gallons a month. What is the family's buyer surplus? (c) Suppose that Scottish Water installs a water meter at the Salmond home and charges a price of £5 per 1,000 gallons. How much water would the family buy and how much would it spend each month? (d) What is the maximum that Scottish Water could charge the Salmond family for the consumption in (c)? (e) Suppose that, with metering, the Salmonds' neighbors spend more than the Salmond family on water each month. Does this imply that the neighbors get more benefit from water?
3. As we discussed in class, government charges the fixed tax incidence causing negative impacts on both buyers and sellers, making both worse off regardless of whether the tax is imposed on seller or buyer. Let’s suppose that the government charges a fixed tax of $10. Using the example and corresponding data, answer: (a) Why can we conclude “Who pays the tax is irrelevant”? (b) Why are both buyers and sellers worse off? (c) Calculate the change in consumer surplus and supplier’s surplus after the tax is imposed. (d) Calculate how large the dead weight loss is?
4. In August 2004, Infineon announced a deal with Taiwan's Winbond Electronics to build a new DRAM factory. The goal was to secure 25% of the global DRAM market. Wafers of 300 mm diameter potentially yield more than twice as many DRAMS as 200 mm wafers. A 300 mm wafer fabrication facility costs more to build and set up than a 200 mm facility. (a) Assuming variable costs are the same, explain why economies of scale in manufacturing DRAMs from 300mm wafers are larger than with 200 mm wafers. (b) Does the cost per DRAM depend on the total quantity produced by the entire company or each individual factory? (c) When a wafer fabrication facility is first commissioned, the yield tends to be low. What principle of cost does this illustrate?
5. 1. Business Hold-Up issue. A statistician writes a program module for a software package, which needs upgrades every two years. Initial fixed costs are $20,000, annual support costs are $4,000, and the opportunity cost rate of capital is 12%. (a) If the company pays $7,000/year to use the software, what is the annual economic profit to the statistician? Will they accept the offer? (b) What is the setup cost? Are these sunk costs? Why or why not? If the statistician continues working, what is the minimum they would ask for the second year? (c) If the statistician is retained, what is the minimum the company can pay to keep her? How much could they save? (d) Should the company offer \( \$24,000 \) for the first year based on potential post-investment hold-up?
6. (Extra Credit) Considering your own experiences or logic, what strategies would your or your company adopt to resolve the “Business Hold-Up problem”? Assume scenarios such as conservative vs. aggressive reactions from the statistician. Your arguments should be logical, reasonable, and aimed at business considerations.

Paper For Above instruction

The concept of net present value (NPV) is fundamental in financial decision-making, serving as a critical measure of an investment’s profitability. Calculating NPV involves discounting future cash flows to their present value and subtracting initial investments. An investment is deemed profitable if the NPV is positive. In the given scenario, an initial outlay of $100 is expected to yield $50 annually for three years, with a discount rate of 20%. Calculating the present value of these cash flows involves discounting each year's return: PV = Future Cash Flow / (1 + r)^n. For each year, PV of $50 becomes approximately $41.67, $34.72, and $28.93 respectively. Summing these yields approximately $106.32. Subtracting the initial investment of $100 gives an NPV of roughly $6.32, indicating that the investment is profitable because the NPV is positive.

Water demand analysis for the Salmond family's household illustrates basic principles of consumer behavior. The assumption of a linear demand curve implies demand decreases uniformly as price increases. When water costs £50 per 1,000 gallons and consumption is 10,000 gallons, the demand curve shows that at zero price, demand would be higher, but at this specific price, the family consumes 10,000 gallons, with the buyer surplus calculated as the difference between what they are willing to pay and the actual payment. The total benefit is the area under the demand curve up to 10,000 gallons. When a water meter is installed and the price drops to £5 per 1,000 gallons, the family would increase consumption significantly, potentially reaching a new equilibrium where their marginal benefit equals the new price. The maximum price Scottish Water can charge without losing all customers is capped at the marginal benefit perceived by the family. The neighbors' higher water expenditure may imply greater benefit, but this could also reflect differing preferences or income levels, emphasizing the importance of marginal analysis.

Tax incidence analysis reveals that, in an idealized market, the effect of a fixed per-unit tax is independent of who bears it - the so-called 'tax shifting' phenomenon. Whether the tax is levied on producers or consumers, the overall economic burden and deadweight losses remain unchanged, illustrating the concept that “who pays the tax is irrelevant" in perfectly competitive markets. Both buyers and sellers are worse off post-tax as consumer surplus declines, and producer surplus diminishes, with the total market efficiency reduced as shown by the deadweight loss. Specific calculations involve assessing pre- and post-tax equilibrium prices and quantities to quantify declines in surplus and the loss of potential trades that would have occurred absent the tax.

The semiconductor industry’s economies of scale highlight how technological and manufacturing efficiencies can lower costs with increased production volume, especially when utilizing larger wafers such as 300 mm compared to 200 mm. Since variable costs are unchanged, the primary advantage arises from the larger wafers which yield more DRAMs per wafer, spreading fixed costs over a greater output. This results in larger economies of scale, reducing the cost per unit. The overall cost per DRAM depends on total output across all factories, not just individual production lines, since total volume determines the average fixed cost coverage. The low initial yield in new wafer fabrication facilities exemplifies learning curve principles, where increased experience and process optimization enhance efficiency, reducing costs over time.

The hold-up problem in business transactions occurs when assets or investments made by one party become subject to opportunistic behavior by the other, especially after specific investments are sunk. For the statistician’s software development, fixed costs such as initial education amount to $20,000, with ongoing support costs totaling $4,000 annually. The opportunity cost of capital at 12% alongside yearly payments of $7,000 determine whether the statistician benefits from continuing the contract. Calculations suggest that if the annual benefit to the statistician exceeds their costs and opportunity costs, they will accept. Setup costs are sunk, meaning they are unrecoverable once incurred, which influences negotiation leverage. The minimum annual payment required in subsequent years can be calculated considering the opportunity cost and ongoing support costs to prevent post-investment hold-up. The company’s capacity to save money by avoiding hold-up depends on the negotiation of these minimum payments.

Resolving the business hold-up problem involves strategic contractual arrangements that align incentives, such as profit-sharing, staged investments, or performance-based payments. A conservative approach might involve securing long-term contracts with clauses preventing opportunistic renegotiation, while an aggressive strategy could include investing in relationship-specific assets or integrating operations to minimize dependency. The appropriate strategy depends on the specific context, the bargaining power of each party, and the ability to enforce contracts. Logical decision-making involves balancing risk, potential costs of opportunism, and benefits of cooperation to ensure mutually beneficial agreements that minimize transaction costs and maximize productivity.

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