ECONOMICS QUESTION BANK ASSIGNMENT

1) You are a manager in charge of monitoring cash flow at a company that makes
photography equipment. Traditional photography equipment comprises 80 percent
of your revenues, which grow about 2 percent annually. You recently
received a preliminary report that suggests consumers take three times more digital
photographs than photos with traditional film, and that the cross-price elasticity
of demand between digital and disposable cameras is _0.2. In 2009, your
company earned about $400 million from sales of digital cameras and about
$600 million from sales of disposable cameras. If the own price elasticity of
demand for disposable cameras is _2.5, how will a 1 percent decrease in the
price of disposable cameras affect your overall revenues from both disposable
and digital camera sales?

Answer:
Your overall revenues will change by $23.2 ± 0.1
Explanation:
Applying the change in revenue formula for two products we get,
ΔR = [$400(1-2) + ($600(-0.3)] * (-0.04) = $23.2 million,
Thus revenues will rise by $23.2 million

2) A consumer must divide $600 between the consumption of product X and

product Y. The relevant market prices are Px=$10 and Py=$40.
a. Write the equation for the consumer's budget line. Y=.......... + ............
b. In the graph below, illustrate the consumer's opportunity set,
c. In the same graph, illustrate the consumer's opportunity set when the price of
good X increases to $20.
How does this change alter the market rate of substitution between goods X and Y?

Answer:
Write the equation for the consumer's budget line.
The budget constraint is stated as:
  M=xPx+yPyM=xPx+yPy, where M is the consumer's income.
With good y on the y axis and good x on the x-axis, the budget line is equal to:

 y=MPy−PxPyxy=MPy−PxPyx
Given that M = $600, Px = $10 and Py = $40, the consumer's budget constraint will
be equal to:

 y=60040−1040xy=60040−1040x

 y=15−0.25xy=15−0.25x

Question b:

In the graph below, illustrate the consumer's opportunity set.

The figure below shows the consumer's opportunity set (the possible
combinations that are affordable to the consumer). The opportunity set is
represented by all the points below the budget line.

The shaded area below the budget line is the opportunity set.
Question c:

In the same graph, illustrate the consumer's opportunity set when the price of
good X increases to $20. How does this change alter the market rate of
substitution between goods X and Y?
When Px increases to $20 while the income and Py remain constant, the budget
line will tilt to:

 y=60040−2040xy=60040−2040x

 y=15−0.5xy=15−0.5x
The opportunity set with the new budget line is represented in the figure below:

The market rate of substitution is the slope of the demand curve. The change in
the price of good X has changed the market rate of substitution from:

−0.25−0.25 to −0.5

3) The Polish General’s Pizza Parlor is a small restaurant catering to patrons with a
taste of European pizza. One of its specialties is Polish Prize Pizza. Tammy
Dough, manager of Polish General, must forecast weekly demand for these special
pizzas so that she can order the correct amount of pizza shells weekly. Recently,
the demand has been as follows:
Week Number of Polish Prize Pizzas sold.

September 1 50

September 8 65

September 15 52

September 22 60

September 29 70

October 6 60
a) Forecast the demand for Polish Prize Pizza for September 22 – October 6,
using the 3 period moving average method. Note: Round up all the forecast.
b) Forecast the demand for September 22 – October 6, using weights of 0.5,
0.3, 0.2 for the most recent, next recent, and most distant data, respectively.
c) Assume that the forecast for September 1 to be 55. Forecast the demand for
September 8-October 6 using the exponential smoothing method with =
0.3.
d) Now, forecast the demand for September 8-October 6 using the exponential
smoothing method with = 0.6. How do they compare to that in part (c)?

4) A firm manufactured a product according to the production function Q =

F(K,L) = K^3/4L^1/4

a. Calculate the average product of labor, APL, when the level of capital is fixed at
16 units and the firm uses 16 units of labor. How does the average product of labor
change when the form uses 81 units of labor?

Output is 16 units. Dividing by the 16 units of labor you get an APL of 1.

When labor is increased to 81 output increases to 24. Dividing by 81 gives you

an APL of 0.30.

b. Find a expression for the marginal product of labor, MPL, when the amount of
capital is fixed at 16 units. Then, illustrate that the marginal product of labor
depends on the amount of labor hired by calculating the marginal product of labor
for 16 and 81 units of labor.
The MPL is 2L^(-3/4). Thus, at 16 units of labor MPL is 0.25. At 81 units it is
0.074.

c. Suppose capital is fixed at 16 units. If the firm can sell its output at a price of
$100 per unit and can hire labor at $25 per unit, how many units of labor should
the firm hire to maximize profits?

Revenue is P*Q = 100(16^(3/4)*L^(1/4)) = 800L^(1/4). Cost is 25L. Thus,

profit is 800L^(1/4) - 25L. Taking the derivative of this and setting it equal to
zero you get 200L^(-3/4) = 25, which simplifies to 8 = L^(3/4). Solving you get
L=16. Thus, 16 units of labor should be hired.

5) An economist estimated that the cost function of a single-product firm is C(Q) =

50 + 25Q +30Q^2 + 5Q^3
Based on this information, determine:

a. The fixed cost of producing 10 units of output.

50 (the constant amount)

b. The variable cost of producing 10 units of output.

25(10) + 30(10)^2 +5(10)^3 = 8250.

c. The total cost of producing 10 units of output.

8250+50 = 8300

d. The average fixed cost of producing 110 units of output.

50/110 = 0.454545

e. The average variable cost of producing 10 units of output.

8250/10 = 825

f. The average total cost of producing 10 units of output.

8300/10 = 830
g. The marginal cost when Q = 10.

MC = 25 + 60Q +10Q^2 = 25 + 600 + 1000 = 1625

6) A manager hires labor and rents capital equipment in a very competitive

market. Currently the wage is $6 per hour and capital is rented at $12 per hour. If
the marginal product of labor is 50 units of output per hour and the marginal
product of capital is 75 units of output per hour, is the firm using the cost-
minimizing combination of labor and capital? If not, should the firm increase or
decrease the amount of capital used in its production process?

No. It is not minimizing cost. MPL/wage = 8.33 and MPK/rent = 6.25. That
means that the last dollar spent on capital generated very little additional
output compared to the next dollar spent on labor. This firm should use less
capital and hire more workers. This process should continue until the two
measurements are equal.

7) A multiproduct firm's cost function was recently estimated as C(Q1, Q2) = 75 -

0.25Q1Q2 + 0.1Q1^2 + 0.2Q^2

a. Are there economies of scope in producing 10 units of product 1 and 10 units of

product 2?

Economies of scope occurs when the average cost of producing a good

decreases when more of another good increases. Yes, this is true here because
of the negative, -.25 on the -.25Q1Q2 part of the cost function.

b. Are there cost complementaritites in producing products 1 and 2?

Yes, there are complementarities. An increase in the output of one good

decreases the marginal cost of the other. Mathematically, this arises because
of the -.25Q1Q2 term. Increasing one of the variables affects the marginal cost
of the other.
c. Suppose the division selling product 2 is floundering and another company has
made an offer to buy the exclusive rights to produce product 2. How would the sale
of the rights to produce product 2 change the firm's marginal cost of producing
product 1?
As stated above, increasing the output of Q2 decreases the marginal cost of
producing Q1. Therefore, dropping Q2 to zero increases the MC of good 1.

8)
P = f(Q),
TR(Q) = QP = Qf(Q)
MR = R’(Q) = f(Q) + Qf ’(Q).
Suppose we now both divide and multiply the right-hand-side of MR by P = f(Q):

MR = P( ) = P(1 + ).
At this point we make use of the facts that demand is monotonically decreasing
and f ’(Q) = dP/dQ to assert that

so that Ed = = .

Inverting both sides, we see that = -1/Ed.

Substituting this into our equation for MR we obtain the following:

MR =P(1 - 1/Ed).

We now have an expression that relates MR to the elasticity of demand:

MR = P(1 - 1/Ed).

If demand is inelastic, Ed < 1 and MR < 0. As profit maximization requires

that MR = MC and MC is always positive, we see that a monopolist must always
price in the elastic portion of the demand curve. MR > 0 if and only if Ed > 1.
9) A firm has kept track of the quantity demanded of its output during four time
periods. Product price, consumer income, and advertising expenditures were also
recorded for each time period. The information is provided in the table that follows.
Use it to calculate the arc elasticity of demand with respect to price, income, and
advertising.

Time Period 1 2 3 4

Quantity 120 80 100 80

Price 20 30 30 30

Income 150 150 250 250

Advertising 50 50 50 30

Solution:

The price elasticity of demand (using time periods 1 and 2) is

[(120 − 80)/(20 − 30)][(20 + 30)/(120 + 80)] = −1

The income elasticity of demand (using time periods 2 and 3) is

[(80 − 100)/(150 − 250)][(150 + 250)/(80 + 100)] = 0.44

The advertising elasticity of demand (using time periods 3 and 4) is

[(100 − 80)/(50 − 30)][(50 + 30)/(100 + 80)] = 0.44

10) A firm has estimated the following demand function for its product:

Q = 8 − 2P + 0.10I + A

where Q is quantity demanded per month in thousands, P is product price, I is an index

of consumer income, and A is advertising expenditures per month in thousands.
Assume that P = $10, I = 120, and A = 10. Use the point formulas to complete the
elasticity calculations indicated below.
(i) Calculate quantity demanded.

(ii) Calculate the price elasticity of demand. Is demand elastic, inelastic, or unit

elastic?

(iii) Calculate the income elasticity of demand. Is the good normal or inferior? Is it a
necessity or a luxury?

(iv) Calculate the advertising elasticity of demand.

Solution:

(i) Q = 8 − (2)(10) + (0.10)(120) + (1)(10) = 10

(ii) (−2)(10/10) = −2.0 so demand is elastic

(iii) (0.10)(120/10) = 1.2 so the good is normal and a luxury

(iv) (1)(10/10) = 1.0