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MANAEGERIAL ECONOMICS

ASSIGNMENT # 3
CHAPTER 6 & 7

PREPARED BY
SAAD KARIMI (4123541)
DATED: 5TH FEB

CHAPTER 6
TECHNICAL PROBLEMS:
QUESTION 2:Fill in the blanks:
a. The price elasticity of demand for a firms product is equal to 21.5 over the range of prices being considered by the firms
manager. If the manager decreases the price of the product by 6 percent, the manager predicts the quantity demanded
will _____ (increase, decrease) by ______ percent.
b. The price elasticity of demand for an industrys demand curve is equal to 21.5 for the range of prices over which supply
increases. If total industry output is expected to increase by 30 percent as a result of the supply increase, managers in this
industry should expect the market price of the good to______ (increase, decrease) by _____ percent.
ANSWER:
a) increase, 1.29 or 129%
b) increase, 0.012 or 1.2%
QUESTION 7: Use the graph on the next page to answer the following questions:
a. The interval elasticity of demand over the price range $3 to $5 is .
b. The interval elasticity of demand over the price range $10 to $11 is .
c. The interval elasticity of demand over the price range $5 to $7 is .
ANSWER:
E = Change in Q x Average P
Change in P Average Q
a) 0.5
b) 7.0
c) 1.0
Question 11: Suppose the demand for good X is Q = 20P.
a. When P = $1, total revenue is _____ .
b. When P = $2, total revenue is _____.
c. When P = $4, total revenue is _____ .
d. The price elasticity of demand is equal to _____ at every price. Why?
ANSWER:
a)
b)
c)
d)

Q = 20 , P = 1, TR = 20
Q = 10 , P = 2, TR = 20
Q = 5 , P = 4 , TR = 20
Elasticity = 1 at every point because percentage change in both the variables is equal.

QUESTION 16: The general linear demand for good X is estimated to be


Q = 250,000 - 500P - 1.50M - 240PR
where P is the price of good X, M is average income of consumers who buy good X, and PR is the price of related good R.
The values of P, M, and PR are expected to be $200, $60,000, and $100, respectively. Use these values at this point on
demand to make the following computations.
a. Compute the quantity of good X demanded for the given values of P, M, and PR.
b. Calculate the price elasticity of demand E. At this point on the demand for X, is demand elastic, inelastic, or unitary
elastic? How would increasing the price of X affect total revenue? Explain.
c. Calculate the income elasticity of demand EM. Is good X normal or inferior? Explain how a 4 percent increase in income
would affect demand for X, all other factors affecting the demand for X remaining the same.

d. Calculate the cross-price elasticity EXR. Are the goods X and R substitutes or complements? Explain how a 5 percent
decrease in the price of related good R would affect demand for X, all other factors affecting the demand for X remaining the
same.
ANSWER:
a) Q = 250,000 - 500P - 1.50M - 240PR
Q = 250,000 500(200) 1.50(60,000) 240(100)
Q = 57,600 units
b) E = Bp/Q
E = -500(200)/57600
Ep = -1.73 (as it is less than zero, therefore it is inelastic)
c) Ei = -1.5(60000)/57600
Ei = -1.56 (it is an inferior good as elasticity is less than zero)
Q = 250,000 500(200) 1.50(84,000) 240(100)
Q = 0 (increase if 4% in income will result in zero demand for good X)
d) Er = -240(100)/57600
Er = -0.41 (negative sign indicates that the goods are complement goods)
Q = 250,000 500(200) 1.50(60,000) 240(95)
Q = 37200 (the demand of good X will decrease by 20,400 units)

APPLIED PROBLEMS:
QUESTION 4: Aztec Enterprises depends heavily on advertising to sell its products. Management at Aztec is allowed to
spend $2 million monthly on advertising, but no more than this amount. Each month, Aztec spends exactly $2 million on
advertising. What is Aztecs elasticity of demand for advertising? Can you write the equation for Aztecs demand for
advertising?
ANSWER: Elasticity = 1, because changes in the price of advertising have no effect on total advertising expenditures.
Quantity of ads demanded = $2,000,000/Pad or Q = 2,000,000 P .
Question 7: As manager of Citywide Racquet Club, you must determine the best price to charge for locker rentals. Assume
that the (marginal) cost of providing lockers is 0. The monthly demand for lockers is estimated to be Q = 100 - 2P.
where P is the monthly rental price and Q is the number of lockers rented per month.
a. What price would you charge?
b. How many lockers are rented monthly at this price?
c. Explain why you chose this price.
ANSWER:
a) P = $25 per month.
b) Q = 50 lockers per month.
c) Since costs are irrelevant in this problem, the manager sets a price that maximizes TR. TR is maximized at the unit
elastic point on demand which occurs at P = 25, Q = 50.

CHAPTER 7
TECHNICAL PROBLEMS:
Question 4: Linear industry demand function of the form Q = a + bP + cM + dPR was estimated using regression analysis.
The results of this estimation are as follows:
a) Is the sign of b as would be predicted theoretically? Why?
b) What does the sign c of imply about the good?
c) What does the sign of d imply about the relation between the commodity and the related good R?

d) Are the parameter estimates a , b , c , and d statistically significant at the 5 percent level of significance?
e) Using the values P = 225, M = 24,000, and PR = 60, calculate estimates of
(1) The price elasticity of demand ( E ).
(2) The income elasticity of demand ( E M).
(3) The cross-price elasticity ( E XR).
ANSWER:
a) It can be predicted theoritically because in a demand function relationship between quantity demand and price is
always negative, whereas sign is also negative as shown in the table.
b) Positive sign of c implys that as income increases the demand also increases of good X. Therefore it is an normal
good.
c) Positive sign of Pr shows that as price of related good increases the demand of good X aslo increases, therefore
they are perfect substitutes.
d) All the parameters are significant at 5% significance level.
e) Q = 68.38 + (-6.5)(225) + (0.139)(24000) + (-10.77)(60)
Q = 1296
E = -6.5(225)/1296
Ep = -1.128
Em = 0.139(24000)/1296
Em = 2.57
Er = -10.77(60)/1296
Er = -0.49