DEVELOPMENT MANAGEMENT INSTITUTE (DMI)

PDM 2016-18 TERM I - MID-TERM EXAMINATION

MANAGERIAL ECONOMICS (ME)
Total Marks: 40

Duration: 3.00 Hrs.

17-Aug-2016

Instructions to Examinees:
a. All questions are compulsory except 8 or 9. You can choose either 8 or 9.
b. The marks are indicated along with questions.
c. You can refer to Managerial Economics by Salvatore and Rastogi during exam.

1. (Marks-5) The local DVD-on-rent shopkeeper offers a plan to rent out a DVD.

Plan A: Pay 3 per video, with no additional fees.

Plan B: Join the Frequent Viewer Club. Here you pay a yearly membership fee of 50, with
an additional charge of 2 for each video rented.
Plan C: Join the Very Frequent Viewer (VFV) Club. In this club you pay a yearly membership
fee of 150, with an additional charge of 10 for each video rented.

a. Which plan would you select if you intended to rent 75 movies a year at the lowest possible
cost?
b. Which plan would you select if you intended to rent 125 movies a year at the lowest possible
cost?
c. In this exercise, is the number of DVDs rented endogenous or exogenous? Explain.
d. Is the choice of plan (A, B, or C) endogenous or exogenous? Explain.
e. Are total expenditures on videos endogenous or exogenous? Explain.
Ans: Formulate each plan as a function of dvd, the number of DVDs to rent.
TCA=3dvd; TCB=50+2dvd; TCC=150+10dvd
Then we have, dvd =75
TCA (75)=225; TCB (75)=200; TCC (75)=900
Plan B provides the lowest possible cost of 200 if you will purchase 75 DVDs.
b) Similarly for dvd=125, again Plan B provides the lowest possible cost.
c) In this case, the number of DVDs rented is exogenous because we are choosing a plan
given a fixed level of DVDs.
d) Because you may choose the plan, the plans are endogenous. Note, though, that the
details of the individual plans are exogenous.
e) Because you may choose the plan and the plans imply a total cost given a fixed level of
videos, you are implicitly choosing the level of total expenditure. Total expenditures are
therefore endogenous.

2. (Marks-6)The Municipal Corporation of Patna decides to regulate rents in order to reduce

student living expenses. Suppose the average annual market-clearing rent for a one bedroom
studio apartment had been 7000 per month, and rents were expected to increase to 9000
within a year. The city corporation limits rents to their current 7000-per-month level.
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a. Draw a supply and demand graph to illustrate what will happen to the rental price of an
apartment after the imposition of rent controls.
b. Do you think this policy will benefit all students? Why or why not?
Ans: No. It will benefit those students who get an apartment, although these students may
find that the cost of searching for an apartment is higher given the shortage of apartments.
Those students who do not get an apartment may face higher costs as a result of having to
live outside the college town. Their rent may be higher and their transportation costs will
be higher, so they will be worse off as a result of the policy.
3. (Marks-4) In 2015, the total demand for Indian wheat was QD = 3244 283P and the
domestic supply was QS = 1944 + 207P. At the end of 2015, both Brazil and Indonesia opened
their wheat markets to Indian farmers. Suppose that these new markets add 200 million
bushels to Indian wheat demand.
What will be the free market price of wheat and what quantity will be produced and sold by
Indian farmers?
Ans: If Brazil and Indonesia add 200 million bushels of wheat to Indian wheat demand, the
new demand curve will be Q + 200, or
QD = (3244 283P) + 200 = 3444 283P.
Equate supply and the new demand to find the new equilibrium price.
1944 + 207P = 3444 283P, or
490P = 1500, and thus P = 3.06 per bushel.
To find the equilibrium quantity, substitute the price into either the supply or demand
equation. Using demand
QD = 3444 283(3.06) = 2578 million bushels.
4. (Marks-5) In 2015, Biharis tanked 25 million bottle of beers. The average retail price was 50
per bottle. Statistical studies have shown that the price elasticity of demand is 0.4, and the
price elasticity of supply is 0.5. Using this information, derive linear demand and supply curves
for the beer market in Bihar.
Ans: We know the demand elasticity is 0.4, P = 2, and Q = 23.5, which means we can solve
for the slope, b, by 0.4 = (2/23.5)*(Q/P), Q/P=-4.7=-b
To find the constant a, substitute for Q, P, and b in the demand function to get 23.5 = a
4.7(2) and a = 32.9.
The equation for demand is therefore QD = 32.9 4.7P.
Similarly, QS = 11.75 + 5.875P.
5. (Marks-2)A manager makes the statement that output should be expanded as long as average
revenue exceeds average cost. Does this strategy make sense? Explain.
Ans: This statement confuses the use of average values and marginal values.
The proper statement is that output should be expanded as long as marginal revenue exceeds
marginal cost. Clearly, average revenue is not the same as marginal revenue, nor is average cost
identical to marginal cost. Indeed, if management followed the average-revenue/average-cost
rule, it would expand output to the point where AR=AC, in which case it is making zero profit
per unit and, therefore, zero total profit!
6. (Marks-3)Fill the gaps
2

Quantity of Variable Input

Total Output

0
1
2
3
4
5
6

0
225

Marginal Product of
Variable Input

Average Product of
Variable Input
300

300
1140
225
225

7. (Marks-5)Fill in the blanks in the table. Also show what happens to the firms output choice
and profit if the price of the product falls from 60 to 50.

Q(uantity)

C(ost)

R(evenue)

0
1
2
3
4
5
6
7
8
9
10
11

100
150
178
198
212
230
250
272
310
355
410
475

0
60
120
180
240
300
360
420
480
540
600
660

P=60
MC
(Profit)
(Marginal
Cost)
-100
-90
50
-58
28
-18
20
28
14
70
18
110
20
148
22
170
38
185
45
190
55
185
65

P=50
MR (Marginal
Revenue)
60
60
60
60
60
60
60
60
60
60
60

R(evenue)

MR

(Profit)

0
50
100
150
200
250
300
350
400
450
500
550

50
50
50
50
50
50
50
50
50
50
50

-100
-100
-78
-48
-12
20
50
78
90
95
90
75

Ans: At a price of 60, the firm should produce 10 units of output to maximize profit, which is 190
when q = 10. This is also the point closest to where price equals marginal cost without having marginal
cost exceed price. At a price of 50, the firm should produce nine units to maximize profit, which will
be 95. Thus, when price falls from 60 to 50, the firms output drops from 10 to 9 units and profit
falls from 190 to 95.
8.

(Marks-10)The demand equation for a popular brand of local cola drink, Neera is given by
the equation
Qx=100-5Px+0.001M+10Py
where Qx = monthly consumption per person in Litre
Px = price per Litre of the Neera drink = 80
M = Individual income = 20,000
Py = price per litre of a competing brand of local cola drink, ThumsUp = 85
a. Interpret the parameter estimates of Px, M and Py in the equation.
Answer: The demand equation in Qx, a 1 increase in the price of the drink will result in a
5-Litre decline in monthly consumption of drink per person. A 1,000 increase in individual
income will result in a 1-Litre increase in monthly consumption of Neera per person. Finally,
a 1 increase in the price of the competing brand ThumsUp will result in a 10-Litre increase
in monthly consumption of the Neera per person. In other words, the two brands of cola
drink are substitutes.
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b. At the stated values of the explanatory variables, calculate the monthly consumption (in
Litre) of the local cola drink, Neera.
Answer: Substituting the stated values into the demand equation yields
c. What is the relationship between Neera and ThumsUP?
Answer: As in a, the two brands are substitutes.
d. Is Neera a normal or inferior good?
Answer: It is normal good, as an increase in monthly income will increase the demand for
Taadi.
e. Rewrite the demand equation in the form of income M only.
Answer: M=-100,000-1000Qx
f. Suppose that mean Individuals income increased to 30,000. How does this change your
answer to part b?
Answer: Substituting the stated values into the demand equation yields
Qx = 100 - 5(80) + 0.001(20, 000) + 10(85) = __ Litre
9. (Marks-10)Consider the monopolist that faces the following market demand and total cost
functions:
Q=22-0.2P
TC=100-10Q+Q2
a. Find the profit-maximizing price (Pm) and output (Qm) for this firm. At this pricequantity
combination, how much is consumer surplus?
Answer: P=110-5Q, TR=PQ, Profit=TR-TC, foc, Qm=10, Pm=60, Consumer Surplus= 0.5
(110-Pm)Qm=250
b. How much economic profit is this monopoly earning?
Answer: Profit=-100+120Q+-6Q2=500
c. Suppose that government regulators required the monopolist to set the selling price at the
long-run, perfectly competitive rate. At this price, what is consumer surplus?
Answer: The perfectly competitive long-run equilibrium price is defined as P = MC = ATC,
foc, ATC, Q*=10, or MC=ATC, Q*=10; Ppc=10, Qpc=20; CS=0.5(110-Ppc)Qpc=1000
d. Relative to the perfectly competitive long-run equilibrium price, what is the deadweight loss
to society at Pm?
Answer: Deadweight loss=0.5(Pm-Ppc)(Qpc-Qm)=250