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Fall Quarter, 2009 – 2010 / SL 351, Managerial Economics; EMGT 531, Economics for Technical Managers
Textbook Problems:
Extra Problems:
1. Diversified Products. You are the manager of a diversified products firm that received revenues
of $30,000 per year from product X and $70,000 per year from product Y. The own-price
elasticity of demand for product X is – 2.5, and the cross-price elasticity of demand between
product X and product Y is 1.1. How much will your firm‟s total revenues (combined revenues
from both products) change if you increase the price of good X by 1%?
2. Kodak. You are a manager in charge of monitoring cash flow at Kodak (in 2002). Traditional
photography equipment comprises 80% of Kodak‟s revenues, which grow about 2% annually.
You recently received a preliminary report that suggest consumers take three time more digital
photographs than photos with traditional film, and that the cross-price elasticity of demand
between digital and disposable cameras is – 0.2. Over the last several years, Kodak has invested
over $5 billion to develop and begin producing digital cameras. If the own price elasticity of
demand for disposable cameras is -2.5, how will a 1% decrease in the price of disposable
cameras affect Kodak‟s overall revenues from both disposable and digital camera sales?
3. Use data set „rhit pizza‟. This data set contains hypothetical demand data for an unidentified
pizza supplier to the Rose-Hulman campus over the 2001-2002 academic year.
a. Regress Q1 on P1 and P2.
b. Regress lnQ1 on lnP1 and lnP2. Interpret your regression results in light of this data
transformation.
c. Plot Q1 against the date variable and see if you can determine what other factors might
usefully be included as explanatory variables in a demand model.
d. Modify the regression specification from part (b) to include the following additional right
hand side variables: FINALS, INSESSION, MON, TUE, WED, THU, FRI, SAT (not
SUN!). Compare your results with those you obtained in part (b).
4. Use data set „export good‟. This data set contains hypothetical historical sales data (variable
q1) for an unspecified producer that sells in both domestic and foreign markets.
a. Generate a chart showing the month/year on the horizontal axis and q1 on the vertical
axis.
b. Regress q1 on the trend variable.
c. Regress lnq1 on lnp1, lnp3, lnip, and lntwex.
d. Regress lnq1 on lnp1, lnp3, lnip, lntwex, and trend.
e. Comment on your regression results.
5. Use the following data to generate the forecast MAPE, RMSE, and FA:
A. The demand faced by CPC in a typical market in which P = $10, Pop = 1,000,000
persons, I = $60,000, and A = $10,000 is:
Q = 5,000 - 4,000P + 0.02Pop + 0.25I + 1.5A
= 5,000 - 4,000(10) + 0.02(1,000,000) + 0.25(60,000) + 1.5(10,000)
=15,000
A. With quantity expressed as a function of price, the industry supply curve is:
= -25,000,000 + 500,000P
With price expressed as a function of quantity, the industry supply curve is:
Q = -25,000,000 + 500,000P
500,000P = 25,000,000 + Q
P = $50 + $0.000002Q
A. Each company will supply output to the point where MR = MC. Because P = MR in
this market, the supply curve for each firm can be written with price as a function of
quantity as:
Olympia
MRO = MCO
P = $350 + $0.00005QO
Yakima
MRY = MCY
P = $150 + $0.0002QY
Olympia
P = $350 + $0.00005QO
0.00005QO = -350 + P
QO = -7,000,000 + 20,000P
Yakima
P = $150 + $0.0002QY
0.0002QY = -150 + P
QY = -750,000 + 5,000P
Olympia
P = $325: QO = -7,000,000 + 20,000($325) = -500,000 0
(because Q < 0 is impossible)
P = $350: QO = -7,000,000 + 20,000($350) = 0
P = $375: QO = -7,000,000 + 20,000($375) = 500,000
Yakima
P = $325: QY = -750,000 + 5,000($325) = 875,000
P = $350: QY = -750,000 + 5,000($350) = 1,000,000
P = $375: QY = -750,000 + 5,000($375) = 1,125,000
For Olympia, MC = $350 when Q0 = 0. Because marginal cost rises with output,
Olympia will never supply output unless a price in excess of $350 per unit can be
obtained. Because negative output is not feasible, Olympia will simply fail to supply
output when P < $350. Similarly, MCY = $150 when QY = 0. Thus, Yakima will
never supply output unless a price in excess of $150 per unit can be obtained.
C. When P < $350, only Yakima can profitably supply output. The Yakima supply
curve will be the industry curve when P < $350:
P = $150 + $0.0002Q
or
Q = -750,000 + 5,000P
D. When P > $350, both Olympia and Yakima can profitably supply output. To derive
the industry supply curve in this circumstance, simply sum the quantities supplied by
each firm:
Q = QO + QY
= -7,000,000 + 20,000P + (-750,000 + 5,000P)
= -7,750,000 + 25,000P
To check, at P = $375:
Q = -7,750,000 + 25,000($375)
= 1,625,000
(Note: Some students mistakenly add prices rather than quantities in an attempt to derive the
industry supply curve. To avoid this problem, it is important to emphasize that industry supply
curves are found through adding up output (horizontal summation), not by adding up prices
(vertical summation).)
P3.10
A. When quantity is expressed as a function of price, the demand curve for Eye-de-ho
Potatoes is:
C. The equilibrium price is found by setting the quantity demanded equal to the quantity
supplied and solving for P:
QD = QS
100 - 25P = -100 + 75P
100P = 200
P = $2
= 10%/-1%
= -10 (Highly elastic)
The profit-maximizing price can be found using the optimal price formula:
P* = MC/(1 + 1/εP)
= ($23,500 + $350)/[1 + 1/(-10)]
= $26,500
P4.7
A.
Q P2 + P1 (150 - 90) ($10 + $12)
EP = = = - 2.75
P Q2 + Q1 ($10 - $12) (150 + 90)
B.
Q PX 2 + PX 1 (600 - 300) ($10 + $12)
EPX = = = - 3.67
PX Q2 + Q1 ($10 - $12) (600 + 300)
C. Yes, the |EP| = 2.75 > 1 calculated in part A implies an elastic demand for appetizers
and that an additional price reduction will increase appetizer revenues. EPX = -3.67 <
0 indicates that beverages and appetizers are complements. Therefore, a further
decrease in appetizer prices will cause a continued growth in beverage unit sales and
revenues. Alternatively, If P = a + bQ, then $12 = a + b(90) and $10 = a +
b(150). Solving for the demand curve gives P = $15 - $0.033Q. At P = $12, total
revenue is $1,080 (= $12 × 90). If P = $10, total revenue is $1,500 (= $10 × 150). At
P = $8, total revenue is $1,680 (= $8 × 210). In any case, to determine the profit
effects of appetizer price changes it is necessary to consider revenue and cost
implications of both appetizer and beverage sales.
P4.8
A.
Q I2 + I1
EI =
I Q 2 + Q1
50 - 30 $58,500 + $55,500
=
$58,500 - $55,500 50 + 30
= 9.5
B. Without a price increase, sales this year would total 50 million units. Therefore, it is
appropriate to estimate the arc price elasticity from a before-price-increase base of 50
million units:
Q P 2 + P1
EP =
P Q 2 + Q1
30 - 50 $16.50 + $15.50
=
$16.50 - $15.50 30 + 50
= - 8 (Elastic)
C. Lower. Since carpet demand is in the elastic range, EP = -8, an increase (decrease) in
price will result in lower (higher) total revenues.
P4.9
QY 2-QY1 P X 2+P X1
A. EPX =
P X 2-P X1 QY 2+QY1
= 1.5 (Substitutes)
Q 2 -Q1 P 2 + P1
B. EP =
P 2-P1 Q 2 + Q1
= -3 (Elastic)
Q 2 -Q1 P 2 + P1
C. EP =
P 2-P1 Q 2 + Q1
-3 = P 2 + $130
4(P 2 - $130)
13P2 = $1,430
P2 = $110
B. The effective price reduction is $2 since 40% of sales are accompanied by a coupon:
ΔP = -$5(0.4) or P2 = $12 - $5(0.4)
= -$2 = $10
ΔP = $10 - $12
= -$2
C. To calculate the arc advertising elasticity, the effect of the $2 price cut implicit in the
coupon promotion must first be reflected. With just a price cut, the quantity
demanded would rise to 13,000, because:
Q* - Q 1 P 2 + P 1
EP =
P 2 - P 1 Q* + Q 1
D. It is important to recognize that a coupon promotion can involve more than just the
independent effects of a price cut plus an increase in advertising as is implied in Part
C. Synergistic or interactive effects may increase advertising effectiveness when the
promotion is accompanied by a price cut. Similarly, price reductions can have a
much larger impact when advertised. In addition, a coupon is a price cut for only the
most price sensitive (coupon-using) customers, and may spur sales by much more
than a dollar equivalent across-the-board price cut.
Synergy between advertising and the implicit price reduction that accompanies
a coupon promotion can cause the estimate in Part C to overstate the true advertising
elasticity. Similarly, this advertising elasticity will be overstated to the extent that
targeted price cuts have a bigger influence on the quantity demanded than similar
across-the-board price reductions, as seems likely.
P5.3
A. To find the revenue-maximizing price-output rental rate, set MR = 0, and solve for Q.
TR = P×Q
= ($1,200 - $0.04Q)Q
= $1,200Q - $0.04Q2
MR = ∂TR/∂Q
MR = $1,200 - $0.08Q = 0
0.08Q = 1,200
Q = 15,000
MR = MC
$1,200 - $0.08Q = $800
0.08Q = 400
Q = 5,000 At Q = 5,000, P = $1,200 - $0.04(5,000) = $1,000
= $1,000 × 5,000
= $5 million per week
π = TR - TC
= $1,200Q - $0.04Q2 - $800Q
= $1,200(5,000) - $0.04(5,0002) - $800(5,000)
= $1 million per week
(Note: ∂2π/∂Q2 < 0. This is a profit maximum because total profit is falling for
Q > 5,000.)
P5.8
A. Demand
QD = 4,000 - 200P + 2,000T
200P = 4,000 - QD + 2,000T
P = $20 - $0.005QD + $10T
Supply
QS = -2,000 + 200P
200P = 2,000 + QS
P = $10 + $0.005QS
$100
$90
$80 Supply Curve
$70
Hourly Rate
$60
$50
$40
$30
D6
$20 D5
D4
$10 D3
D1 D2
$0
0 1 2 3 4 5 6 7 8 9 10 11 12
B.,C.
D. This problem illustrates the identification problem. If either the demand or supply
function is shifting while the other is stable, then the price/output data can be used to
trace out the stable curve. Here the supply curve is stable while demand is growing
rapidly (shifting to the right). Therefore, the price/output data given in the problem
can be used to trace out the relevant supply curve.
P5.9
B. To determine whether quantity demanded depends upon “own” price, the question
must be asked: is bP ≠ 0? If bP ≠ 0, then evidence exists that sales do indeed depend
upon price. For testing purposes, the null hypothesis one seeks to reject is the
converse of the above question:
H0: bP = 0 (Two-tail test)
bP 5
where |t| = | |= = 2.78 > t 28, =0.01 = 2.763
bP 1.8
Therefore, it is possible to reject H0: bP = 0 with 99% confidence and conclude that
demand is sensitive to price.
| bPY | - 1 1.10 - 1 *
t= = = 2.5 > 1.812 = t10, = 0.05
| b PY | 0.04
This means it is possible to reject H0 with 95% confidence and conclude that tour
demand is elastic with respect to price.
where
bI1.85 *
t= == 4.11 > 2.764 = t10, =.01
bI 0.45
This means it is reasonable to reject H0 with 99% confidence and conclude tours are
a normal good.
b PX 0.50 *
t= = = 1.43 > 1.372 = t10, = 0.10
PX 0.35
This means it is reasonable to reject H0 with 90% confidence and conclude tours and
X are substitutes.
D. Both “own” and competitor advertising appear to increase sales. Although relatively
uncommon, this is not a rare occurrence. Advertising of substitutes can sometimes
raise sales for competitor products due to beneficial spillover effects following
increased customer awareness.
P6.3
A. St = S0(1 + g)t
$65,000,000 = $25,000,000(1 + g)10
2.6 = (1 + g)10
ln(2.6) = 10 × ln(1 + g)
0.956/10 = ln(1 + g)
(0.0956)
e -1 = g
g = 0.100 or 10.0%
= $168,610,00
P6.4
A. Ct = C0egt
$100 = $80e3g
1.25 = e3g
ln(1.25) = 3g
g = 0.223/3
= 0.074 or 7.4%
A. At = At-1 + ΔAt-1
= 80.
P6.6
A.
St+1 = St + 2 Y t - 1 St + 2 A t - 1 St
Y t-1 A t-1
CA t
- 0.5 - 1 St
CA t-1
= St + 2 St Y t - 2 St + 2 St A t - 2 St
Y t-1 A t-1
CA t 1
- 0.5St + St
CA t-1 2
1 CA t
= 2 St Y t + 2 St A t - St
Y t-1 A t-1 2 CA t-1
- 2.5St
B.
St+1 = 2($500,000)(1.02) + 2($500,000)(0.80)
- 0.5 ($500,000)(1.10) - 2.5 ($500,000)
= $1,020,000 + $800,000 - $275,000 - $1,250,000
= $295,000
P6.8
A. St+1 = St + ΔS
= St - ΔSP + ΔST
= St - 2(Pt+1/Pt - 1)St + 3(Tt+1/Tt - 1)St
= -2(Pt+1/Pt)St + 3(Tt+1/Tt)St
1. Diversified Products.
Use :
2. Kodak.
Use :
P2 P1 Constant
1.788 -2.850 17.276
1.091 1.164 7.813
0.020 6.657 #N/A
3.064 301.000 #N/A
271.532 13,338.205 #N/A
SAT FRI THU WED TUE MON INSESS FINALS ln(P2) ln(P1) Constant
-0.310 0.207 -0.188 -0.676 -0.204 -0.706 1.407 0.956 1.022 -1.270 1.420
0.100 0.100 0.099 0.099 0.100 0.100 0.061 0.116 0.748 0.804 1.269
0.726 0.463 #N/A #N/A #N/A #N/A #N/A #N/A #N/A #N/A #N/A
77.711 293 #N/A #N/A #N/A #N/A #N/A #N/A #N/A #N/A #N/A
167.155 63.02 #N/A #N/A #N/A #N/A #N/A #N/A #N/A #N/A #N/A
MAPE 0.0355
RMSE 205.5103
FA 0.965
BIAS 0