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Economics Essay

5568 words - 23 pages

omECO 204, 2010-2011, Test 3 Solutions  This test is copyright material and may not be used for commercial purposes without prior permission 

University of Toronto, Department of Economics, ECO 204 2010 ‐ 2011 Ajaz Hussain  TEST 3 SOLUTIONS 1   These solutions are purposely detailed for your convenience 


t a

Other Services

Prestige Data Services


PC = $800/hr

Commercial  Customers

  The Prestige Data Services’ cost function was estimated to be (here  is “hours of data services”):  223,436 28  

The Prestige Data Services’ commercial inverse demand function in March 2003 was estimated to be:  1,466 4.83   Page 2 of 37   
S. Ajaz Hussain, Dept. of Economics, University of Toronto 

ECO 204, 2010-2011, Test 3 Solutions  This test is copyright material and may not be used for commercial purposes without prior permission 

(a) Under the terms of a regulation ruling PDS’s intercompany billing are capped at an average of  $82,000/month. What does this imply for the average intercompany hours that can be billed per  month? Is Prestige Data Services abiding by or violating the terms of the ruling? Give a brief explanation.   Answer:  If intercompany revenues are capped at $82,000/month and prices are $400/hr then:    400 82,000  205  This implies that intercompany hours should be 205 hours/month on average. Is PDS billing 205 hours  on average each month? Look at:  Exhibit 1: Prestige Telephone Company     January 2003    February 2003   Intercompany Hours   206  181  Commercial Hours   123  135  Total Revenue Hours   329  316          Service  Hours   32  32  Available Hours   223  164  Total Hours   584  512    Notice that average intercompany hours from Jan – Mar 2003 were:  206 181 3 223 610 3 203.33 

March 2003    223  138  361     40  143  544 

Thus, PDS is abiding by the terms of the agreement.   (b) What kind of returns does PDS have for its “variable” inputs? Give a brief explanation based on the  figures above (not below).  Answer:  The Prestige Data Services’ cost function was estimated to be (here  is “hours of data services”):  223,436 28  

Since this is a linear cost function PDS must have constant returns. In particular, notice that:  28 28  Page 3 of 37   
S. Ajaz Hussain, Dept. of Economics, University of Toronto 

ECO 204, 2010-2011, Test 3 Solutions  This test is copyright material and may not be used for commercial purposes without prior permission 


is constant, PDS has constant returns.  

(c) Recall that PDS has never earned profits. Calculate the breakeven number of commercial hours and  the equation of the demand curve in the month when PDS breaks even. Show all calculations.  Answer  PDS sells data services to intercompany and commercial customers. Now profits are:  Π Π Π Π Breakeven commercial output is when:  Π – – Breakeven Breakeven Breakeven Assuming  28 and  Breakeven 205 we have:  400 28 205 800 28 191    –





We can now compute the demand curve in the month when PDS breaks even. Assuming the “other  factors” besides price are pushing the demand curve right we see that in the breakeven month, the  demand curve has the same slope as the March 2003 demand curve: 

Page 4 of 37   

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