Critically assess the view that an understanding of the principles of ‘scientific’ decision-making is fundamental to the success of a modern economy.

1. Critically assess the view that an understanding of the principles of
‘scientific’ decision-making is fundamental to the success of a modern
economy.

2. (i) Explain the concept of opportunity loss, and show that the
minimum opportunity loss is equal to the Expected Value of
Perfect Information.
(ii) The failure rate in a particular examination is estimated to be
40%. Construct a table showing the probabilities of 0, 1, 2 . . . 5
students failing in a sample of five.
(iii) 150 graduate entrants are due to take their first professional
accounting exam at the Institute of Certifiable Accountants.
The probability distribution for the failure rate is estimated in
the following table:
Failure rate
0.1
0.2
0.3
0.4
0.5
Probability
0.1
0.2
0.3
0.3
0.1
Each failing student is entitled to a £10 refund on professional
fees. The Institute’s senior tutor is confident that she could
ensure a failure rate of 0.1 by holding an intensive revision
course, at a cost to the Institute of £300. Advise the Institute on
whether the revision course should take place.
A tutorial test of five students resulted in no failures. Use this
information to revise the failure rate probability distribution,
and hence reassess the revision course.

3. ‘Despite being a small local shopkeeper I can always beat the price
that Woolworths charge for the same product. Woolworths must pay
rent on its store while I own my shop and have no rent to pay.’
Discuss.
4. A firm keeps a record of sales and prices over the past seven months,
resulting in the following table:
Nov. 1985
Dec.
Jan. 1986
Feb.
March
April
May
Price (£/ton)
7.5
8.0
8.0
7.2
7.0
8.0
8.5
Sales (tons)
84.5
82.0
84.0
92.0
95.0
92.0
91.5
Use these observations to estimate demand as a linear function of
both price and time. Utilise this function to estimate demand for the
following month, on the assumption that:
(a) price remains unchanged,
(b) price increases to £9/ton.
336 Managerial Economics
Hence estimate the price elasticity of demand between these prices
and find the price which would maximise sales revenue.
Given the nature of the observations, comment on any difficulties in
interpreting your results for decision-making purposes.

Critically assess the methods used to generate empirical estimates of
both short- and long-run cost functions. Do the empirical difficulties
encountered rob the resulting estimates of any general operational
utility?
6. ‘About half of all advertising expenditure is wasted. The problem lies
in knowing which half.’ Discuss this statement and assess the usefulness of managerial models of advertising allocation decisions.
7. Analyse the effects of an increase in interest rates on the investment
activity of a profit maximising firm. Does it matter if inflation
increases in proportion to the increase in interest rates?
8. (a) Show that an increase in the unit value of stock will lead to a less
than proportionate fall in the optimum amount of stock held.
What assumptions underlie your answer?
(b) A firm faces a uniform annual demand of 100 000 units. The
purchase cost of stock is £10 per unit, whilst the cost of ordering
stock is £20, and the cost of holding stock is 14% of the average
stock value. Find the Economic Order Quantity and the Minimum Acquisition Cost.
How are your answers affected by:
(i) the fact it takes two weeks between placing an order and
stock arriving;
(ii) the offer of a 1% discount off the purchase cost if stock is
ordered in lorry loads of 17 000 units.
9. ‘The market allocates resources to the firms that best meet the needs
of consumers.’ Discuss.
10. ‘The force of competition, the desires of managers and the needs of
shareholders combine to ensure that firms maximise profit.’ Discuss.

Answer FOUR questions
1. ‘Statistically we expect that good decisions will lead to favourable
outcomes more often than will either poor decisions, or decisions
reached by default. In a sense, this is a statement of faith on which all
Examination questions and answer notes 337
rational approaches to human affairs are based’ (Amara and Lipinski). Discuss this statement, and assess the value of the analytical
decision approach as an operational tool of management decisionmaking.
2. Critically examine the theoretical and empirical validity of the profit
maximisation hypothesis.
3. The Hot-Bake shop sells only bread made that day. Each loaf
produced has a variable cost of 30p and sells for SOp. Any bread
unsold at the end of each day is thrown away.
At the start of each day, the manager must decide how many loaves
to produce. The table below records sales over the past month:
Daily sales Frequency
1000 6
1200 10
1400 10
1600 4
(a) Fixed costs are estimated at £X per day. Find the breakeven
number of loaves produced and sold, and the number if expected
daily profit was £50.
(b) Find the number of loaves produced to minimise expected
opportunity loss.
(c) Bread is produced by a fully automated machine which mixes the
dough, divides it into 1 lb units, fills each baking tin and passes
them through an oven. Out of each batch, some are rejected for
being underweight or burnt.
The proportion rejected has the probability distribution given
below:
Proportion rejected
0.05
0.10
0.15
Probability
0.25
0.60
0.15
(i) Find the number of loaves produced if the expected number of saleable loaves equals your answer to question (b).
(ii) The services of a maintenance engineer would set the
rejection rate equal to 0.05, but would cost £11 per day.
Advise the manager on whether to engage the engineer or
not, if the desired daily production is 1300.
(d) Comment on the assumptions underlying your answers, and
discuss the relevance of other decision criteria.
4. ‘Profit is the maximum value a company can distribute during the
year and still expect to be worth as much at the end of the year as it
was at the beginning.’ Discuss this statement, and comment on its
value in measuring profit for decision-making.
338 Managerial Economics
5. Cambrian Railways runs a daily container freight train between
Cardiff and Birmingham. Its two major customers are British Steel
and the Welsh Farming Co-operative. The demand for containers by
each customer is given by the equations:
P 1 = 500- 8Q1 for British Steel
P2 = 400-5Q2 for Welsh farming.
P; is the price charged by Cambrian per container, and Q; is the
number of containers used by each customer.
Cambrian’s total cost function is given by the equation:
TC = 10 000+20Q
where Q is the number of containers per trip.
(a) What are the necessary conditions for profitable price discrimination by Cambrian?
(b) What profit -maximising rule will Cambrian use if setting prices as
a discriminator? Determine the profit-maximising quantity of
freight service Cambrian will supply, show how this will be
divided between steel and agriculture and find the prices charged
in each market. Calculate Cambrian’s total profit.
(c) Assume that Cambrian is prevented by law from price discrimination. Determine Cambrian’s price and output combination
to maximise profit, and hence estimate the opportunity cost to
Cambrian of the Anti-Price Discrimination law.
6. Define an optimal inventory policy, and assess the impact on that
optimal inventory policy of:
(i) uncertain demand
(ii) uncertain lead times
(iii) customer reactions to product shortages
(iv) an oligopolistic product market.
7. (a) Compare and contrast the explanatory and extrapolatory
approaches to demand estimation. Illustrate your answer with
reference to the problem of estimating demand for a new luxury
food processor.
(b) The Welsh Kitchen Design Company sells its deluxe food processor for £150/unit. Company experience suggests that both price
and consumer incomes affect sales, with an estimated price
elasticity of demand of -3.0, whilst income elasticity is estimated
at 4.0. In 1986 the company sold one million units, whilst total
consumer disposable income was £600 billion. Estimated consumer disposable income for 1987 is £650 billion.
(i) Assuming price remains the same in 1987, estimate total
sales revenue.
Examination questions and answer notes 339
(ii) If 1988 consumer income is expected to remain constant at
£650 billion, whilst price is expected to fall by £25, estimate
sales revenue in 1988.
(iii) Estimate sales revenue in 1988 if consumer income rises by
10% between 1987/88, whilst price falls by 15%.
(iv) Use the information above to estimate demand as a linear
function of price and income.
8. ‘Despite the theoretical advantages of the discounting procedure,
capital investment was either justified in terms of some “need to
have” case presented by lower management or on the basis of some
elementary payback period calculations.” Discuss this conclusion
from an empirical survey of investment decision-making.
9. Explain the inability of economic theory to find satisfactory solutions
to the theoretical problem of price and output decision-making in
oligopolistic markets.
10. ‘Advertising in the modern economy has entered the state of persuasion as distinct from proclamation or iteration’ (Turner). Discuss this
view of advertising in relation to its role in the modern firm, and
explain the determination of an optimal advertising budget.
11. Analyse the effects of an increase in both wage rates and labour
productivity on the costs of the firm.