1. Explain why excise taxes are more effective at raising tax revenues when applied to products with price inelastic demand versus ones with price elastic demand. Under what conditions would it be possible for tax revenues to decline with higher excise taxes?
2. You operate a small but popular and profitable restaurant/bar in a college town. There are several other restaurants and bars nearby. You have conducted a market research study and discovered that the price elasticity of demand for local residents is lower (less elastic) than the price elasticity of demand for college students, who are usually in town only while the college is in session about 9 months out of the year. Discuss at least two pricing strategies you can use to increase your revenues and analyze them in terms of their ability to generate additional profits. Indicate any additional assumptions you are making.
3. Assume the operations manager at the company you own prefers to put in low effort rather than high effort. In order the manager to exert high effort, his expected financial gain must be at least $60,000 higher than if he puts in low effort. You are evaluating three possible compensation packages:
• A flat salary of $300,000
• A payment equal to 5% of the expected profits from the profit center
• A flat payment of $200,000 plus 5% of any profits over $10 million.
a. Discuss the effects of each of the compensation packages on company profits and the behavior of the manager. What assumptions are needed in order to compare the expected values and risks associated with each option?
b. How would a risk averse versus a risk neutral manager view the different compensation packages?
4. Explain how natural monopolies cause market failure? How is the deadweight loss associated with this form of market failure measured? What is a typical form of government intervention to correct it? How effective is this type of intervention? Use the material from this course to support your answer.