UNIVERSITY OF MELBOURNE

DEPARTMENT OF ECONOMICS
ECON90015 Managerial Economics
Semester 2, 2016
Tutorial Exercise 1: Introduction to key concepts
KEY CONCEPTS:
Opportunity cost
Marginal analysis
Cost-benefit principle
Sunk cost
Marginal benefit
Marginal cost
Task 1
a)

Suppose Linda is considering setting up her own consulting business. In her present job at
McKinseys she earns $100,000 a year job. Working for McKinseys is Lindas best use of her
time apart for operating her own business. To set up the business Linda must also buy an office
for $50,000. Should she choose to cease operating her own business at some future date she
knows she will be able to sell the office for the same price as she bought it. If she did not buy the
office she would invest the money. The annual rate of interest is 10 per cent. What is the
opportunity cost to Linda of operating her own consulting firm for a year? Suppose Linda is
considering hiring a research assistant What would she need to take into account to calculate the
opportunity cost of that decision?

b)

Rent-a-Plane Inc. has agreed to charter one of its planes to take a group of tourists from
Melbourne to Cairns. The tourists will return to Melbourne by car, and hence they do not require
the plane for the return trip. Rent-a-Plane Inc. needs to return its plane to Melbourne within one
day after its arrival in Cairns. Rent-a-Plane Inc. is approached by a group who are interested in
flying one way on its plane from Cairns to Melbourne. The manager of Rent-a-Plane wants to
charge a price to that group that will cover the opportunity cost. The cost of fuel (that does not
vary with number of passengers) is $5,000 each way. The cost of wages to pilots is $1,000 each
way. The cost of wages to other flight crew is $1000 each way if there are passengers and $500
each way if there are no passengers. Where passengers have traveled the cost of cleaning the
plane is $100. What is the minimum amount the manager should be willing to accept to rent the
plane to travel from Cairns to Melbourne? Explain your reasoning.
c)
The publisher Murdoch Packer is thinking of publishing a book on The Life and Times of John
Howard. Murdoch will incur three types of costs in publishing such a book. An up-front royalty
payment of $100 would need to be made to Mr. Howard prior to his writing the book. The cost of
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typesetting and printing the book would be $1000. And the cost of advertising would be $250.
Murdoch decides that each copy of the book should be sold for $25. Suppose that after Howard
has written the book, but before it has been sent to typesetting, Murdoch has to decide whether to
proceed with publication. To proceed with publication Murdoch must think that revenue from
book sales will be at least as great as the opportunity cost of production. What is the minimum
number of copies he would need to expect to sell in order to want to publish?
Task 2
Consider the following three scenarios:
a)

You have already spent $10M on a project. You need another $5M to complete the project.
Once completed there is a probability of one-half that the project will earn revenue minus
operating cost equal to $2M, and a probability of one-half that the project will earn revenue minus
operating cost equal to $10M. Should you complete the project?

b)

You are running a newspaper stall outside a railway station. You make 10cents for every
newspaper you sell. With distribution of advertising brochures to nearby neighbourhoods you
believe that you can increase your sales as shown in the table below. For each 100 advertising
brochures you must pay $10. How many brochures should you distribute?
Number of
brochures
distributed
0
100
200
300
400
500

Total sales of
newspapers to
neighbourhoods
0
200
350
475
550
600

Task 3
Bill and Leng are discussing about using monetary rewards to provide incentives for behaviour.
Bill says: I would always use monetary payments to get people to act as I wanted. CEOs pay
should be tied exclusively to their companies share prices, school teachers should have their pay
linked to the exam performance of their students, and any sportsperson should be paid only
according to his or her individual performance. But Leng disagrees: Monetary payments may
be one useful mechanism for providing incentives. But there are also other ways of providing
incentives that can be important. And you always have to be careful that monetary incentives are
not having perverse effects.
Who do you agree with?
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