Practice Calculations
P. 421, Chapter 10.
Question 2a) 1) the first part of this question is straightforward to answer. Put the chart into an Excel sheet and calculate the profit at each price point. The sheet will reveal the point of maximum profit:
P
Profit
mc
For the second part, two different price points are assumed. This requires finding the point of maximum profit for each customer group and then adding the two together. So in this case the point of maximum profit for adults is $12, and the point of maximum profit for children is $11. The profit for adults at this point is $56 and the profit for children at this point is $54, for a combined maximum profit of $56+$56 = $110.
P
Qa
Qc
Profit
Pa
Pc
5
15
20
0
0
0
6
14
18
32
14
18
7
13
16
58
26
32
8
12
14
78
36
42
9
11
12
92
44
48
10
10
10
50
50
11
9
9
54
54
12
8
6
98
56
42
13
7
4
88
56
32
14
6
2
72
54
18
mc
5
3) the difference between the profits for each approach is that while the first approach is in the assumption of a single price in the first scenario and two price points in the second scenario. By assuming that two different price points can be used, the company has the ability to optimize each one individually, which allows it to find a slightly higher total maximum profit. Under the first scenario, the ideal price point is only the maximum profit point for children, but it not for adults.
Chapter 11, p. 449, Q2.
An adverse selection problem is defined in the textbook as "a situation resulting from asymmetric information in which parties may not come to an agreement on a transaction because of distrust on the part of the party with incomplete market information…" in the scenario presented, the credit card company would normally set credit rates based on the creditworthiness of the customer. Because the credit card company cannot do this, it must find a price point that will allow it to generate a profit commensurate with the risk it undertakes. The problem is that consumers with good credit may find these rates unpalatable if they know their own worth in the credit markets. Good consumers may therefore avoid the credit card companies, leaving only the bad consumers. The rate decision made by the card company is adverse because it is not pricing according to market conditions, a function of its asymmetrical information. This costs it customers it would otherwise want to have.
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