MGMT 540: Managerial Economics

MIDTERM EXAM

All exam policies detailed in my announcement regarding the midterm are

applicable under the honor code. In particular, you have a maximum of 90
minutes to complete the exam (including formatting, uploading, etc.). You
are responsible for timing yourself. I will verify that you are within the time
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This exam is an individual effort. You may not work with anyone else during
the exam. You may use your book and any handouts, readings, or other
documents provided by the professor during the course or which you have
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while taking the exam. Failure to comply with these policies will result in a
grade of zero.

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the exam electronically via OwlSpace. Upload your exam using the following
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There are 20 points total on the exam. The exam information indicates
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Please indicate compliance with the honor code by writing your

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Managerial Economics, Fall 2014

I.

Midterm Exam

Multiple Choice (5 points total, 1 point each) Please circle the response that corresponds to
the most appropriate completion of the statement or best answers the question posed. Be sure
that your circle clearly indicates a single response among those provided.

Because I could not find a way to circle my answers in Word, I have written
the answer in red next to the prompt and pained the correct answer in red.
1. A decrease in income will not lead to: ANSWER A
a) a movement along the demand curve.
b) a leftward shift of the demand curve.
c) a rightward shift of the demand curve.
d) all of the above.
2. Which of the following is likely to be the least important determinant of the demand for
new homes: ANSWER D
a) interest rates.
b) household incomes.
c) expectations of future home prices.
d) the current price of building materials.
3. Assume a linear demand function. If the demand for WGASAs at the current price is
inelastic, then a small increase in price will __ increase __total revenue. ANSWER A
a) Increase
b) Decrease
4. Suppose market demand and supply are given by Q d = 100 - 2P and Q

= 5 + 3P. If a

price ceiling of $15 is imposed, ANSWER D

a) there will be a surplus of 40 units.
b) there will be neither a surplus or shortage.
c) there will be a shortage of 40 units.
d) there will be a shortage of 20 units.
5. Suppose the demand function for good X is Q Xd = 100 - 8PX + 6PY - M. If PX = $4, PY =
$2, and M = $8, what is the cross-price elasticity of demand between good X and good Y
(to the nearest hundredth)? ANSWER A
a)
b)
c)
d)
II.

0.17.
0.38.
0.21.
0.04.

Short Answer Problems (Three Problems)

Problem #1 (7 points total)

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Managerial Economics, Fall 2014

Midterm Exam

Suppose that the market for cases of BEER (think of this as generic beer) is described by the
following demand and supply functions:

Q d 20 0.5 P
Q S 25 3P
1. (2 points) Solve for the equilibrium price and quantity in this market. Assume that the
price is denominated in $/case and that quantity is denominated in 1000s of
cases/month.
Find Equilibrium
Price
Quantity demanded = Quantity Supplied
20-0.5P
=
25+3P
20-(-25)
=
3P-(-0.5P)
45 =
3.5 P
$
12.857
=
P
Equilibrium Quantity

Demand Function
Replace with Price

Q[d
]=

20

Q[d
]=

20

Q[d
]=
Q[
d]=

20
13.
571

0.
5 P
0.
12.85
5 * 714
6.
43

Equilibrium Price is $12.86, and equilibrium quantity is 13,571 cases/month

2. (2 points) Suppose that an excise tax of $5/case is imposed, which is paid by the
producer. Describe the impact of the excise tax on the equilibrium price and quantity.

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Managerial Economics, Fall 2014

Midterm Exam

What will happen to consumer surplus and producer surplus in this market? (No
computation here.)
Because of the excise tax the equilibrium price will increase and the new equilibrium
quantity will decrease. Both the consumer and producer surplus will be reduced. There will
be a portion of it that will become Government Revenue and a portion that will be lost
(Deadweight Loss).

3. (2 points) Compute the new equilibrium price and quantity (after the excise tax is
imposed)
Tax Amount
=
Inverse Supply Function
P=

$ 5
Q

-25
3

Incorporation on tax
P=

Q 3

P=

Q 3

P=

Q +
3

Supply function after tax

introduction
Q[s
]=

-25 +
3
8.3
3 +
13.
33

3P-40

After Tax Equilibrium

Price
Quantity demanded = Quantity Supplied
20-0.5P =
40+3P
20-(-40) =
3P-(-0.5P)
60 =
3.5
P

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Managerial Economics, Fall 2014

$

17.143

Midterm Exam
P

After Tax Equilibrium

Quantity

Demand Function
Replace with Price

Q[d
]=

0.
5

20

Q[d
]=

20

Q[d
]=
Q[d
]=

20
11.
429

0.
5
8.
57

17.14
286

Because of the excise tax the equilibrium price will increase by $4.29 and the new
equilibrium quantity will decrease by 2,143 cases/month. The new equilibrium price will be
$17.14 and the new equilibrium quantity will be 11,429 cases/month.
4. (1 point) What is the deadweight loss that is generated by the excise tax? (I am looking
for a computation here.)
Consumer Surplus Before Tax
Base=
Hight=
Consumer
Surplus =

13.5714286
12.8
57
27.1
43

40 13.5714286 *
2

Consumer
Surplus =

184.18

Producer Surplus Before

Tax
Base=
Hight=
Producer
Surplus=

13.57143
12.85714 -

8.333

13.57143 *

4.524

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Managerial Economics, Fall 2014

Midterm Exam
2

Producer
Surplus=

30.70

Total Surplus
Before Tax

214.88

After Tax Consumer Surplus

Base=
Hight=
Consumer
Surplus =

11.4285714
17.1
43
22.8
57

40 11.4285714 *

Consumer Surplus After Tax=

After Tax Producer
Surplus

2
130.
61

1
1
1
Hight=
7 Producer Surplus
1
=
1 *
2
Producer Surplus After
Tax =
Base=

Total Surplus After

Tax =
Government
Revenue
GR =
Q
*
GR =
11.4286 *
GR =
57.1
Deadweight Loss due to
Tax =
Deadweight Loss due to
Tax =

13.333
3.8095

21.77

152.
38

Tax Amount
5

Total Surplus before tax - Total Surplus after tax - Government

Revenue
214.88 -

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152.38 -

57.1

Managerial Economics, Fall 2014

Midterm Exam

Deadweight Loss due

to Tax =

5.36

The deadweight loss will be 5.36

Problem #2 (4 points total)

Estimated demand for a given word processing software program (Akins Writer) is given by:
QD = 20 - 12P + 6Px + 0.2M + 4A
Where:
QD is the quantity demanded (in 1000 units)
P is the price of the "Akins" program (in $100)
Px is the average price of competing programs (in $100)
M is the number of personal computers that can run Akins software (in millions)
A is the advertising expenditure (in $100,000)
Suppose, in addition, that P = 1, Px = 1, M = 30, A = 4. Answer the following:

1. (2 Points) What is the own price elasticity of demand at the current price?
Own Price
Elasticity
E[Qx,Px]
=

* Px
Qx

E[Qx,Px]
=

-12.0 *

E[Qx,Px
]=

-0.33

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Managerial Economics, Fall 2014

Midterm Exam

The own price elasticity at the current price is -0.33. This means that the demand is
inelastic because the absolute value of the own price elasticity is less than 1.

2. (2 Points) At what price does the firm maximize total revenue? (Hint: Can a small
price change increase revenue when demand is elastic? How about when demand is
inelastic?)
Maximize Revenue
Find P
E[Qx,Px]

Px
Qx

-1

-12.0

Px
Qx

0.083

Px
Qx
Px

0.083333 Qx
Q[d]=

48

-12.0 *

Q[d]=

48

-12.0 *
Q
-1.00 x

Q[d]=
2.00 Q[d]=
Q[d]=
P[d]=

P[d]=
P[d]=

P
0.0
8 Qx

48
48
24
24 48
12.
0
-12.0
-2 -4
2

Total revenue is maximized ate the point of the unit elastic price. Therefore by solving
the equation for P, using the elasticity formula, one can find the point where revenue
is maximized. The price at which this happens is $200,Problem #3 (4 points total)
You are the manager of a firm that produces WGASAs. Suppose that you currently produce
10,000 WGASAs/quarter using a mix of both labor and capital. (Assume that labor and capital
inputs are substitutes and that both types of inputs exhibit diminishing marginal product.)

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Managerial Economics, Fall 2014

Midterm Exam

1. (2 Points) Assume that, at your current mix of labor and capital, the marginal product
of labor is 4 units while the marginal product of capital is 2 units. Further suppose that
the wage rate is $10/hour while the rental rate of capital is $7/hour. Are you currently
employing the cost minimizing combination of labor and capital in order to produce
your output? If not, describe how you could produce this output more cheaply.
Cost Minimization implies that
MP
L
= MPk
w
r
But when we replace with the current values
4
>
2
10
7

0.4 >

0.28
6

The firm is not minimizing costs

The firm should find the appropriate combination of labor and capital to minimize costs.
2. (2 Points) Suppose that your firm contemplates an increase in WGASA production
from 10,000 to 15,000 units next quarter. Over this time period, capital used in
producing WGASAs is fixed at its current level. Furthermore, the firm cannot hire
additional laborers or extend the shifts of current employees. The additional WGASAs
must be produced by reallocating current laborers from production of WIDGETs, a
second product produced by your firm, to production of WGASAs. Describe as
precisely as you can how you would determine the incremental cost of producing the
5,000 additional WGASAs next quarter.
I would first determine what the explicit and implicit costs are. Explicit costs would include
current labor plus the labor reallocated from the other product. Implicit costs would be the
ones related to foregoing the production of widgets. By adding the implicit and explicit
costs I would come up with a marginal cost that would allow me to calculate the
incremental cost of those units.
END OF EXAM

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