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# ELASTICITY & DEMAND

1. Assume that the demand for plastic surgery is price inelastic. Are

the following statements true or false? Explain. a. When the price of plastic surgery increase, the number o operations decrease. The percentage change in the price of plastic surgery is less than the percentage change in quantity demanded.
b. c. Changes in the price of plastic surgery do not affect the number of

operations.
d. Quantity demanded is quite responsive to changes in price.

## e. If more plastic surgery is performed, expenditures on plastic surgery will decrease.

f. The marginal revenue of another operation us negative 2. The price elasticity of demand for imported whiskey is estimated to

be -0.20 over a wide interval of price. The federal government decides to raise the import tariff on foreign whiskey, causing its price to rise by 20 percent. Will sales of whiskey rise or fall, and by what percentage amount?

## MANAGERIAL DECISION IN COMPETITIVE MARKET

3. Consider a price-taking firm that has total fixed cost of \$50 and

faces a market- determined price of \$2 per unit for its output. The wage rate is \$10 per unit of labor, the only variable input. Using the following table, answer the questions below. (1) Units of labor (2) Output (3) Marginal product (4) Marginal revenue product (5) Marginal cost (6) profit

1 2 3 4 5 6 7 8 9 10

5 15 30 50 65 77 86 94 98 96

a. Fill in the blanks in column 3 of the table by computing the marginal product of labor for each level of labor usage. Fill in the blanks in column 4 of the table by computing the marginal revenue product for each level of labor usage.
b.

c. How much labor should the manager hire in order to maximize profit? Why? d. Fill in the blanks in column 5 of the table by computing marginal cost. e. How many units of output should the manager order to produce in order to maximize profit? Why? f. Fill in blacks in column 6 with the profit earned at each level of labor usage. Do your answers to parts c and e maximize profit? Does it matter whether the manager chooses labor usage or chooses output in order to maximize profit? Why?
g.

How much labor should the manager hire when the wage rate is \$20? How much profit is earned? Is marginal product greater of less than average product at this level of labor usage? Why does it matter?
h. 4. The manager of all city Realtors wants to hire some real estate agents to specialize in selling housing units acquired by the resolution trust corporation(RTO) in its attempt to bail out the savings and loan industry. The commission paid by the RTC to the company to sell these homes is a flat rate of \$2000 per unit sold, rather than the customary commission

that is based on the sale price of a home. The manager estimates the following marginal product schedule for real estate agents dealing in government owned housing: Marginal product Marginal Number of (number of additional revenue real units sold per year) product estate agent 1 20 ________ 2 17 ________ 3 15 ________ 4 12 ________ 5 8 ________ 6 4 ________ a. Construct the marginal revenue product schedule by filling in the blanks in the table. b. If the manager of All city realtors must pay a wage rate of \$32000 per year to get agents who will specialize in selling RTC housing , how many agents should the manager hire? Why? c. If the wage rate falls to \$18000 per should the manager hire? year, how many agents

d. Suppose the RTC raises its commission to \$3000 per unit sold, Now what is the marginal revenue product for each real estate agent employed? e. Now that the RTC is paying \$3000 per unit sold, how many agents should the manager hire if the wage rate is \$30000?

5. Grocery stores and gasoline stations in a large city would appear to be examples of competitive markers: There are numerous relatively small sellers, ach seller is a price-taker, and the products are quite similar. a. How could we argue that these markets are not competitive? b. Could each firm face a demand curve that is not perfectly elastic? c. How profitable do you expect grocery stores and gasoline stations to be in the long run?

## MANAGERIAL DECISION FOR FIRMS WITH MARKET POWER

6. Assume a monopoly has the following demand schedule: Price 20 15 10 5 Calculate total revenue at Quantity 200 300 500 700 each P and Q combination.

a. b.

## Calculate marginal revenue per unit for each decrease in price.

c. For the change in price for \$20 to \$15, is demand elastic or inelastic? How much revenue does the firm lose from reducing the price on the 200 units it could have sold for \$20? How much revenue does the firm gain from selling 100 more units at \$15? Compare the two changes with MR. d. Answer part c for the price change from \$15 to \$10.

7. In the following table, columns 1 & 2 make up the portion of the production function of a monopolist using a single variable input, labour. Columns 2 & 3 make up the demand function facing the monopolist over this range of output. (1) Labor 9 10 11 12 13 14 15 (2) Quanti ty 50 100 140 170 190 205 215 (3) Price \$21 20 19 18 17 16 15

a. Derive MP, MR, and MRP over this range. b. If the wage rate is \$60, how much labor would the manager hire? Why? What if the wage falls to \$40?

8. The following curve shows the long run average and marginal cost curves for a monopolistically competitive firm.

a. Assume the firm is in the short run and making profits. Draw in the demand and marginal revenue curves. Show output and price. b. Now let the firm reach long-run equilibrium. Draw in precisely the new demand and marginal revenue curves. Show output and price. c. Why must MR = LMC at exactly the same output at which LAC is tangent to demand? d. Construct the firms output and price in long run equilibrium with the price and output if this firm was a perfect competitor.

## STRATEGIC DECISION MAKING IN OLIGOPOLY MARKETS

9. Find the solution for the following advertising decision game between Coke and Pepsi by using the method of successive elimination of dominated strategies.

Pepsis budget Low High A \$400,\$400 Low D \$500,\$300 G \$375,\$420 High H \$300,\$378 E \$450,\$525 I \$525,\$750 B \$320,\$720 F \$540,\$500 Medium C \$560,\$600

Cokes budget

Medium

a. Does coke have a dominated strategy in the original payoff table? If so, what is it and why is it dominated? If not, why not? b. Does Pepsi have a dominated strategy in the original payoff table? If so, what is it and why is it dominated? If not, why not? c. After the first round of eliminating any dominated strategies that can be found in the original payoff table, describe the strategy situation facing Coke and Pepsi in the reduced payoff table.

d. What is the likely outcome of this advertising decision problem? e. Pepsis payoff occurs when Coke and Pepsi both choose high ad budgets. Explain why Pepsi will not choose a high ad budget?