HBX- Economics 3 Flashcards
Willingness to Sell (WTS)
From the standpoint of a supplier, the minimum price that the firm is willing to accept in return for the input it sells; from the standpoint of a seller, the minimum price that the seller is willing to accept to supply a given quantity of a good or service.
the opportunity cost for suppliers. The LOWEST price at which a supplier is willing to sell you their inputs.
Inputs could be- components for a machine tool, capital that investors are giving you, the effort that employees are exerting on their tasks in your organization, the time & effort it takes an author to write a book & whether they’d want to do so.
Wal-Mart is AMAZING at willingness to sell! Negotiating with suppliers and sharing their data with them gets the suppliers to lower prices!
Why you might be willing to sell your services/aka ‘work for’ facebook/google at a lower pay.
total value created
The difference between willingness to sell and willingness to pay
Value captured.
The difference between price & cost
Consumer Surplus
The value captured by consumers in a market transaction; mathematically, the difference between consumer willingness to pay and price, added up for all consumers who get to transact in the market.
A company books $100 million in revenue for fiscal year 2015, the most it has ever earned. However, the company earns a far lower profit than it did the previous year. What could explain this discrepancy?
- The company saw a decline in sales volume from the previous year.
- The company charged a higher price for its product in FY2015.
- The company saw the cost of its inputs increase substantially over the past year.
- The company created less value for its customers during the period.
- The company saw a decline in sales volume from the previous year.
- Even if sales volume did decline, the company still made $100 million in revenue, its most ever. The lower profits must be explained by higher costs.
- The company charged a higher price for its product in FY2015.
- Even if it did charge higher prices, the company still made $100 million in revenue, its most ever. The lower profits must be explained by higher costs.
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The company saw the cost of its inputs increase substantially over the past year.
- With higher revenues, lower profits can only be explained by higher costs.
- The company created less value for its customers during the period.
- This is not necessarily true. With lower profits, the company captured less value itself, but consumers could have captured the same or more value.
Which of the following developments will cause an increase in the value created by a firm? Select all that apply.
- Employees at the firm are willing to take a pay cut to work for the company.
- Consumer preferences change and average WTP for the company’s products increases.
- The company is able to increase the price of its main product without a significant decrease in sales.
- The company discovers a new production technology, allowing it to produce its products more efficiently.
- The rate at which the company is taxed is decreased by the government.
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Employees at the firm are willing to take a pay cut to work for the company.
- This would decrease suppliers’ willingness to sell a key input, creating more value overall.
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Consumer preferences change and average WTP for the company’s products increases.
- If customers’ are willing to pay more, but the company leaves prices the same, it is creating more value for its customers without decreasing the value captured by the firm or its suppliers.
- The company is able to increase the price of its main product without a significant decrease in sales.
- While this would lead to more value captured by the company, it would not create more value overall.
- The company discovers a new production technology, allowing it to produce its products more efficiently.
- While this would lead to more value captured by the company, it would not create more value overall.
- The rate at which the company is taxed is decreased by the government.
- While this would lead to more value captured by the company, it would not create more value overall.
Which of the following groups is NOT a competitor for Amazon?
- Overstock.com, another online shopping site
- The businesses that sell their products through Amazon.com
- UPS, a delivery service that Amazon uses to ship products to customers
- Amazon Prime customers that use the site to regularly shop
- All of the above are competitors for Amazon.
All of the above are competitors for Amazon.
- A business’ competitors include not only other companies in its industry, but also parties with which the business competes to capture value, such as suppliers and customers.
Fixed Cost (FC)
Costs incurred by a business in the production of a product or service that do not vary as the quantity produced rises or falls.
Variable Cost (VC)
Costs incurred by a business in the production of a product or service that vary with the level of production.
A hotel spends $1 million per year on rent and other fixed costs. The hotel rents out rooms at a rate of $100 per night, and incurs variable costs of $50 per night for each occupied room. In past years, the hotel has rented out 21,000 rooms per year. However, the city has become a less popular tourist destination, causing consumers to travel there less frequently. The hotel anticipates that it will have 10% fewer customers in coming years. What should the hotel do?
- Stay in business without making any changes.
- Decrease prices to $50 per room.
- Exit the industry.
Exit the industry.
- The hotel is now losing money each year. It is making enough money to cover its variable costs, but not enough to cover its total yearly cost. Therefore, it should stop paying rent and other fixed costs, and exit the industry.
Opportunity Cost
The value of the best alternative use of a resource.
the indirect costs that occur that you have to take care of- just like the direct costs/The value of the best alternative use of a resource.
The opportunity cost of a choice is the value of the best alternative choice you could have made. That’s the “cost you incur” from making your current choice.
The term economic cost is often used interchangeably with opportunity cost
Accounting Cost
A measure of the direct cost incurred in partaking in a specific business endeavor; costs reported in a company’s financial statements that serve to give an accurate description of where the firm’s money is being spent.
But if you’re looking to cost measures to guide you in decision-making, we need to go beyond accounting cost and look at……
opportunity cost
Difference between opportunity and account costs
One is better for accurate, objective reporting, (accounting) the other for guiding decision-making (opportunity).
Suppose you are a working parent and you currently earn $60,000 per year. You are debating whether you want to leave your job to be a stay-at-home parent. What costs should you consider as you make this decision?
- Cost of hiring a babysitter
- Income foregone while being a stay-home parent
- The foregone pleasure from being at home with your children
- Opportunities foregone of advancing your career
- All of the above
All of the above
- By choosing to go back to work, you need to consider the cost of hiring a babysitter and the foregone experience of being with your children. Alternatively, by choosing to stay home with your children, you are foregoing the income and career opportunity that you could have gained while working.
Which of the following statements is true regarding the differences between economic and accounting costs?
- Economic costs include all direct and opportunity costs.
- Accounting costs include all direct and opportunity costs.
- Economic costs include opportunity costs only.
- Accountants consider only opportunity costs when calculating costs.
Economic costs include all direct and opportunity costs.
- Economic costs include all costs of a decision, direct and opportunity costs, whereas accounting costs do not include opportunity costs.
Christine is a tax accountant in the United States. Due to the complexity of the U.S. tax code, many Americans often experience difficulties filing their taxes each year. Thus, in the past, Christine has made a large sum of money on the side offering her services during tax season. This year, however, a new computer software is being sold, designed to assist Americans with their taxes for a fraction of the cost that Christine has been charging her customers. At first glance, the software appears to be quite popular. What impact will this new software have on Christine’s profitability?
- The presence of the software will make Christine’s business less profitable.
- The presence of the software will make Christine’s business more profitable.
- The presence of the software will not affect Christine’s profitability.
- The impact on Christine’s profitability is unclear.
The impact on Christine’s profitability is unclear.
- It’s unclear how the presence of the software will affect Christine’s profitability. While the introduction of the software will almost surely force Christine to charge a lower price for her services to compete, Christine’s profitability also depends on her own costs. If Christine is able to use the service to improve her own productivity, her costs may also go down. If costs fall low enough, Christine may be able to maintain the same profitability or even improve her profitability if the software allows her to save time per customer and take on more customers.
Al’s Autos, a car rental company, spends $2.1 million per year on car purchases, routine maintenance and other fixed costs. The company rents out cars at an average rate of $100 per day, and incurs variable costs of $70 per day for each rental. In past years, the business has rented out 100,000 cars per year. However, the city in which the company is located has become a less popular tourist destination, causing consumers to travel there less frequently. The rental company anticipates that it will have 25% fewer customers in coming years. What should Al’s do?
- Definitely stay in business
- Decrease prices to $70 per day
- Exit the car rental industry
Definitely stay in business
- Despite the large drop in rentals from 100,000 to 75,000, Al’s is still able to cover both variable and fixed costs. It should remain in business for the time being, unless it continues to lose customers to the point at which it can no longer cover its total yearly costs.
A manufacturing company has seen a decline in its physical sales over the past few years, leaving a portion of its fixed infrastructure underutilized. What are some reasonable measures the company could potentially take to maintain its profitability? Select all that apply.
- Try to cut fixed costs in other areas where possible
- Produce more of the product and save the excess supply as inventory until demand picks back up
- Advertise its offerings more to drive sales back up to its original level
- Rent out the underutilized space to other companies for additional revenues
- Recognize some of its revenue from pre-orders early
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Try to cut fixed costs in other areas where possible
- Cutting other fixed costs, such as salaries, could decrease costs enough so that the company is able to capture the same amount of value (profits).
- Produce more of the product and save the excess supply as inventory until demand picks back up
- This is a risky strategy. The decline in sales seems persistent, so there is no guarantee that demand will pick back up. Producing more, even temporarily, will increase total variable costs too—so profitability will decline even further.
- Advertise its offerings more to drive sales back up to its original level
- This is a risky strategy. The decline in sales seems persistent, so there is no guarantee that consumers will want the product despite increased advertising. Advertising will increase total costs too—so profitability will decline even further, even if sales do increase somewhat.
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Rent out the underutilized space to other companies for additional revenues
- This could help improve profitability as the space is not being utilized anyway. If demand does pick back up, the company could take back the space or rent out more space itself.
- Recognize some of its revenue from pre-orders early
- While this tactic could create the illusion of sustained profitability, actual profitability would continue to decline. It may decline even further if the company is fined for accounting fraud.
The theme park from the previous question has finished building its fun house. The project cost $240,000 in total and requires two employees to operate it each day costing $50 per employee per day. The park estimates that approximately 400 guests will enter the fun house per day, each paying $1 to enter. After how many years will the theme park break even from operating the fun house?
Between 2 and 3 years
The park makes $400 in revenues each day from guests and must pay $50*2=$100 to its employees each day as costs of operation. Profits per day are thus equal to $400-$100=$300. With these profits, it will take the park 800 days to recover the total amount it spent building the fun house.
Suppose that you are the CEO of a national pizza chain. Your business has experienced increases in production costs over the past few years due to a continual increase in the price of cheese. When the price increases first started, your business was able to maintain its profitability by passing the higher costs on to consumers in the form of higher pizza prices. Now, however, your consumers are refusing to pay more for your product. One of your company’s executives suggests acquiring your supplier of cheese in order to control input costs. By doing so, she guarantees that your company will retain your customers and stop losing money. Should you take her advice?
- Yes– you should do anything to retain your customer base.
- No—in doing so, you may retain your customers, but you will still continue to lose money overall.
- No—customers will still continue to leave you even if you control price increases by buying the supplier.
No—in doing so, you may retain your customers, but you will still continue to lose money overall.
- Your colleague is forgetting to include opportunity costs in her reasoning. Even if you acquire the supplier, you will continue to lose money from an economic point of view. This is because you could have sold the cheese to others for a higher price than what you are receiving for it by putting it in your pizzas.
Using the information and the Graph below, find out the costs of the other bakery “Hirise”
- HiRise sells its product at $2.05 per loaf. At that price difference, consumers are indifferent between a loaf of HiRise and a loaf of Butterflake.
- HiRise uses more expensive ingredients than Butterflake; you estimate that their cost is 10% higher. HiRise does use the same amount of each ingredient, however, as you do.
- HiRise’s bakery is identical to your own: their total costs for rent, utilities, managers’ salaries, and depreciation are the same as yours. However, their capacity utilization is much higher. That is, they produce and sell 25% more loaves than you do. (For simplicity, assume that both bakeries sell all the bread they make).
- With respect to direct labor, HiRise’s wage rates are the same as yours. Worker productivity is also the same; each HiRise worker can produce just as many loaves per hour as each Butterflake worker can.
- HiRise’s total advertising spend is 50% greater than Butterflake’s.
- Butterflake’s transportation costs are 80% fixed (to cover the metropolitan area) and 20% variable (since more trips are needed for more volume).
One of the important things in figuring out the competitor’s (HiRise’s) costs is to distinguish between fixed versus variable costs, as before. Why is this important? Let’s look at the different cost line items for the two bakeries.
Fixed costs: bakery overhead, advertising, depreciation, and some of the transportation costs.
HiRise pays the same total bakery overhead costs as Butterflake, but this cost is spread out over more loaves. Since HiRise produces 25% more loaves, the per loaf overhead cost is $0.15/1.25 = $0.12. (That is, if fixed costs are spread across 100 loaves at Butterflake, the same fixed costs are spread across 125 loaves at HiRise.) A similar calculation gives us depreciation of $0.08 per loaf.
Similarly, total advertising spend is 50% higher at HiRise, so if the bakeries were producing the same amount of loaves, it would be $0.15 per loaf. Adjusting for the higher volume of loaves at HiRise brings advertising spend down to $0.12 per loaf.
Lastly, let’s look at transportation. HiRise should incur approximately the same variable cost per loaf on transportation. However, 80% of Butterflake’s transportation spending—$0.20 per loaf—is fixed. Adjusting for loaf volume, again, brings this number down to $0.16 at HiRise. If we add back in the $0.05 in variable costs, total transportation cost is $0.21 per loaf.