Managerial Economics 9th Edition by William F. Samuelson test bank

SECTION REFERENCE: Private and Public Decisions: An Economic View
DIFFICULTY LEVEL: Medium
 
 
 

32. Mike heads a new startup firm that decides to open a number of clinics that perform laser eye surgery to correct common vision problems. He hopes that over time his company can claim a substantial share of what is estimated to be an $18 billion per year market.

Briefly describe the most important factors influencing his venture’s revenues and costs. Describe the most important risks.
 
ANSWER: A complete answer should point out a number of obvious factors. On the demand side, the key question is the size of the total market willing and able to pay for the laser surgery (so as to dispense with glasses and contact lens). Because the procedure is not covered by insurance, demand will depend directly on the price (per eye) Mike’s company and others set for the procedure. Demand also depends upon the real and perceived risks of laser surgery. Demand issues raise a number of decision questions. How should the firm price and promote the clinics and procedures? Should it enlist elite physicians to oversee and endorse your firm’s services (as a means of differentiation)? Given current competitors and future entrants, what share of the total market can the firm reasonably expect to claim?
Costs are equally important. Medical equipment and office space represent significant capital costs. Besides other operating costs, Mike’s company will pay a significant licensing fee (royalty) for each procedure to the laser’s patent holder. Of course, the ultimate average cost per patient will depend on the number of patients the firm attracts and on the scale of operation. Finally, there are significant risks – not only uncertainties on the revenue and cost sides already mentioned – but medical risks to patients and liability and regulatory risks to the company.
SECTION REFERENCE: Private and Public Decisions: An Economic View
DIFFICULTY LEVEL: Hard
 
 
 

33. A small nation is considering upgrading its air force to incorporate new technology. It faces two main choices. The first is to acquire a fleet of the latest fighter aircraft, with the newest electronics and weapons. The cost of the acquisition (assuming that the U.S. President and Congress agree to the sale) is $45 million per plane, including a stock of spare parts that should last five years. The second choice is to buy an electronic upgrade for existing aircraft, with a complete overhaul of the airframes. The cost of such an upgrade is $8 million per plane, with about a 10% loss of fleet because of damage beyond repair and “cannibalization” to obtain the highest number of flyable planes. The upgrading of existing planes results in aircraft with about 90% of the capability of the new aircraft.

Top pilots in the small country's air force are concerned that they may not be flying the best aircraft, and could face a disadvantage in combat against newer planes flown by a potential enemy. However, they acknowledge that if a numerical superiority against the enemy can be obtained, an overall victory is still likely. Their theory is that three of the upgraded planes should be able to win against one of the newer planes flown by an enemy (although the pilots expect higher losses in combat). How would an economic consultant advise the defense ministry of the small country in deciding how best to spend its available budget for air defense? What objective(s) are important for this decision? What are the pros and cons of the available options?
 
ANSWER: In this case, the objective is not maximum profit or operating revenue, but obtaining the best possible air force within the prescribed budget. The two main alternatives are to purchase new aircraft, or upgrade existing planes. Clearly, an important consideration is the difference in cost of the two possibilities. An upgrade is far cheaper, and results in 90% of the operational capability of the new plane. For $45 million spent on a single new plane, the country can upgrade between five and six existing aircrafts. Assuming that the air force pilots are correct that three of the older, upgraded planes can defeat a single, newer plane, upgrading provides a greater effective amount of firepower in a future air conflict. However, an additional issue should be taken into account: higher pilot losses can be expected with the upgrade. The cost of lives lost can be important for a country that places a high value on human life. A sound decision should indicate at least a third possible choice, that is, to order a small number of new planes in addition to upgrading most of the old planes. The new planes could accompany the older planes on missions and stand by to combat enemy fighters. While expensive, it is cheaper than buying an entirely new fleet, and could reduce overall pilot loss.