Reference no: EM132830429

1. Decide whether each of the following statements is True, False, or Uncertain, and give a brief but clear explanation of your answer. (Most of the credit will be given for the explanation.)

1a) When an aluminum company made 100,000 cans, the last unit cost $0.02. The next year it made 500,000 cans and the last unit cost $0.04. This company does not benefit from economies of scale.

1b) A demand equation for gasoline is estimated to be: Ln Q = -0.54 - 0.40 Ln P + 0.25 Ln Income where Q is in millions of gallons per week and the price is per gallon. A refinery fire leads to a price increase from $1.00 per gallon to $1.50 per gallon. Since the above equation implies that gasoline demand is inelastic, the quantity demanded will drop by less than 1%.

2. A railroad which runs between two cities 'produces' two products: passenger and freight service. The marginal cost of carrying an extra ton of freight is $0, and the marginal cost of carrying an extra passenger is $0.

There are joint, fixed costs of $19,000 per day. There is no other competitor in this market. The daily demand for passenger service is

Pp = 8 - 0.005Qp with Qp the number of passengers and Pp the price of a two-way ticket.

The daily demand for freight service is Pf = 10 - 0.001Qf with Qf in tons and Pf the price per ton. Currently, Pp=$5 and Pf=$8, so that Qp= 600 and Qf=2000. The revenues from passenger service are $3000 and from freight $16,000.

The firm currently assigns overhead to products on the basis of their dollar share of revenues.

Thus, the costs allocated to the passenger business are $3,000, while those allocated to freight are $16,000. The firm's accountants argue that prices should be raised on both products, since the firm barely breaks even.

What pricing would you recommend? Evaluate the accountants' argument. Would your conclusions differ if the fixed costs were $30,000 per day?