BE Gradable Assignment 1

Prof. Ramanashetty
Marks-15
BE Assignment- 1

Answer Any 3 questions. Each question carries 5 marks

1. The Municipal Corporation of a small college town decides to regulate rents in order to reduce
student living expenses. Suppose the average annual market-clearing rent for a two bedroom
apartment had been Rs.10000 per month, and rents were expected to increase to Rs.15000 within
a year. The Municipal Corporation limits rents to their current Rs.10000-per-month level.
Explain what will happen to the rental price of an apartment after the imposition of rent controls.
Do you think this policy will benefit students? Why or why not?
Answer->
The Municipal Corporation of a small college town decides to regulate rents in order to reduce
student living expenses. Suppose the average annual market-clearing rent for a two bedroom
apartment had been Rs.10000 per month, and rents were expected to increase to Rs.15000 within a
year.
If the Municipal Corporation limits rents to their current Rs.10000 per-month level, then the rental
price of an apartment after the imposition of rent controls will be the same, but according to the
existence of price floor there will be a shortage, as the demand will exceed supply for the
apartments. I think this policy will benefit only such students, who will rent the apartment, but the
other students according to the shortage will be without a place for a living.

2. Suppose you are the manager of a chain of computer stores. For obvious reasons you have been
closely following developments in the computer industry, you have just learned that The
government has passed a two-prong program designed to further enhance the computer industry
position in the global economy. The legislation provides increased funding for computer
education in primary and secondary schools, as well as tax breaks for firms that develop
computer software. As result of this legislation, what do you predict will happen to the
equilibrium price and quantity of software?
Answer-> If the government has passed a two-prong program designed to further enhance the
computer industry position in a global economy and the legislation provides increased funding for
computer education in primary and secondary schools, as well as tax breaks for firms that develop
computer software, then as result of this legislation the demand for computer software will increase,
so the equilibrium price will rise and equilibrium quantity of software will rise too.
Answer: The equilibrium quantity certainly will increase, but the market price may
rise, remain the same, or fall, depending on the relative changes in demand and
supply. To see this, note that the increased funding for computer education at
primary and secondary schools will lead to an increase in the demand for computer
software, since it is a normal good. The reduction in taxes on software

manufacturers will lead to an increase in the supply of software. You should draw a
figure to verify that if the rightward shift in supply is small compared to the
rightward shift in demand, both the equilibrium price and quantity will increase. If
supply increases by the same amount as demand, there will be no change in the
price but the equilibrium quantity will rise. Finally, if supply increases more than the
increase in demand, the resulting equilibrium will entail a lower price and a greater
quantity. In all cases, the equilibrium quantity increases. But the effect on the
market price depends on the relative magnitudes of the increases in demand and
supply

3. For many crops, a strange situation arises a bad crop year results in a good year for farm
incomes, and a good crop year results in a bad year for farm incomes. Explain this framers
dilemma using demand and supply analysis with a relevant example.
4. Big Bird Air is legally obligated to purchase 50 jet engine from ERUS at the end of two years at
a price of $ 200000 per engine. Confident that it is protected from opportunism with this
contract, Big Bird begins making aircraft bodies designed to fit ERUSs engines. Due to
unforeseen events in the aerospace industry, in the second year of the contract ERUS is in the
brink of bankruptcy. It tells Big Bird that unless it increase the engine price to $300000, it will go
bankrupt.
a. What is the first thing should the manager of Big Bird Air do?
b. How could this problem have been avoided?
c. Did the manager of Big Bird use the wrong method of acquiring inputs?
Answer Big Bird Air is legally obligated to purchase 50 jet engine from ERUS at the end of two
years at a price of $ 200000 per engine. It tells Big Bird that unless it increase the engine price to
$300000, it will go bankrupt.
a. Firstly, the manager of Big Bird Air should take into consideration all the risks of the purchase.
b. This problem could have been avoided, if Big Bird fixed the price of the contract or predicted the
change in price of the inputs.
c. It is possible, that the manager of Big Bird used the wrong method of acquiring inputs.
Big Bird is experiencing a hold-up problem because of an incomplete contract; the
contract did not specify what would happen if ERUS went belly-up. ERUS claims it
will go bankrupt if Big Bird does not pay a price of $300,000 for the engines, in
which case Big Bird will lose its specialized investment in aircraft bodies. The
manager should verify that ERUS is indeed on the brink of bankruptcy. If not, Big
Bird can take ERUS to court if ERUS does not honor the contract price. If ERUS is on
the verge of bankruptcy, the manager should determine how much it would cost to
obtain engines from another supplier versus making them within the firm. Once the
manager knows the cost of each alternative, Big Bird may wish to bargain with
ERUS over how much more it will pay for the engines. This could be risky, however;
the lower the price negotiated, the greater the chance ERUS will go bankrupt. New
clauses must be put into the contract to protect Big Bird against ERUSs bankruptcy.

The manager should especially guard against attempts by ERUS to reduce the
quality of the engines in an attempt to save money. In any event, Big Bird should
not spend more money drawing up a new contract and paying for ERUSs engines
than it would cost to obtain them from the best alternative source.
2. This problem illustrates that when contracts are incomplete, unanticipated
events can occur that lead to costly bargaining and opportunism. The problem could
have been avoided had Big Bird written clauses into the contract that protected it
against ERUSs going bankrupt. If this was not possible, it could have vertically
integrated and produced its own engines.
3. Big Birds manager did not necessarily choose the wrong method of acquiring
engines. If it was not possible (or would have been extremely costly) to write into
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Organization of the Firm 219 initial contract protection against ERUSs going
bankrupt, and if the costs of vertically integrating would exceed the likely costs of
opportunism due to an incomplete contract, the manager made the correct decision
at the time. Sometimes bad things happen even when managers make good
decisions. If this was not the case, either a more complete contract should have
been written or Big Bird should have decided to make its own engines