Managerial Economics

Amjad Toukan
Spring 2020
PROBLEM SET #1 Answers

(1) Two drivers – Tom and Jerry – each drive up to a gas station. Before looking at
the price, each places an order. Tom says, “I’d like 10 gallons of gas.” Jerry says, “I’d
like $10 worth of gas.” What is each driver’s price elasticity of demand? Explain.

Tom's price elasticity of demand is zero, because he wants the same quantity
regardless of the price. Jerry's price elasticity of demand is one, because he spends the
same amount on gas, no matter what the price, which means his percentage change in
quantity is equal to the percentage change in price.

2.
John has decided to spend one-third of his income on clothing.

a) What is his income elasticity of clothing demand? Explain.

b) What is his price elasticity of clothing demand? Explain.
c) If John’s tastes change and he decides to spend only one-
fourth of his income on clothing, how does his demand curve
change? What is his income elasticity and price elasticity
now?

a. If John always spends one-third of her income on clothing, then her income
elasticity of demand is one, because maintaining her clothing expenditures as a
constant fraction of her income means the percentage change in her quantity of
clothing must equal her percentage change in income.

b. John's price elasticity of clothing demand is also one, because every percentage
point increase in the price of clothing would lead her to reduce her quantity purchased
by the same percentage.

c. Because John spends a smaller proportion of her income on clothing, then for any
given price, her quantity demanded will be lower. Thus, her demand curve has shifted
to the left. Because she will again spend a constant fraction of her income on
clothing, her income and price elasticities of demand remain one.

(3) Studies indicate that the price elasticity of demand for cigarettes is about 0.4. If a
pack of cigarettes costs $2 and the government wants to reduce smoking by 20
percent, by how much should it increase the price? Show work.

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b) (2.5) If the government permanently increases the price of cigarettes, will the
policy have a larger effect 1 year from now or 5 years from now? Explain.
c) (2.5) Studies also find that teenagers have higher price elasticity than do adults.
Why might this be true?

a) The price has to increase by $3.333.

b) The policy will have a larger effect 5 years from now, more time for
adjustment.
c) Teenagers have a higher price elasticity because of their limited income and
because of their young age which makes them less addicted to cigarettes than
adults (they have smoked for a shorter period of time).

PROBLEM 1:

Consider the following information regarding the quantity of corn demanded and
supplied per month, at different alternative prices.

Price per bushel (cents) Quantity demanded Quantity supplied

40 39000 83000
35 48000 78000
30 58000 74000
25 67000 67000
20 75000 62000
15 81000 59000

1. Determine the equilibrium price and quantity?

Equilibrium Price = 25 cents, Equilibrium Quantity = 67,000 bushels.

2. Describe the situation when the price is 40 cents per bushel, and predict what will
happen.

When the price is 40 cents per bushel, we have a surplus of 44,000 bushels. Suppliers
will reduce their price per bushel and the market price and quantity will approach the
equilibrium price and quantity.

3. Describe the situation when the price is 15 cents per bushel, and predict what will
happen.

When the price is 15 cents per bushel, we have a shortage of 22,000 bushels.
Suppliers will increase their price per bushel and the market price and quantity will
approach the equilibrium price and quantity.

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4. Explain what would happen if a serious transportation strike reduced corn output
(at each price) by 30000 bushels. Determine the new equilibrium price and
quantity.

The market supply of corn will decrease (supply curve will shift to the left) and the
new equilibrium price and quantity will change. The new equilibrium price is 35
cents and the new equilibrium quantity is 48,000 bushels.

PROBLEM 2:

Consider the following information regarding the quantity of pizza demanded and
supplied per month at different alternative prices.

Price ($ per pizza) Quantity demanded Quantity supplied

10 0 40
8 10 30
6 20 20
4 30 10
2 40 0
0 125 0

1. Determine the equilibrium price and the equilibrium quantity.

Equilibrium price = $6, Equilibrium quantity = 20 pizzas per month.

2. What would occur if the price were set at $4 per pizza?

When the price is $4 per pizza, we have a shortage of 20 pizzas. Suppliers will
increase their price per pizza and the market price and quantity will approach the
equilibrium price and quantity.

3. What would occur if the price were set at $8 per pizza?

When the price is $8 per pizza, we have a surplus of 20 pizzas. Suppliers will reduce
their price per pizza and the market price and quantity will approach the equilibrium
price and quantity.

4. What would happen if the demand for pizzas tripled at each price? Determine the
new equilibrium price and quantity.

The market demand of pizza will increase (demand curve will shift to the right) and
the new equilibrium price and quantity will change. The new equilibrium price is $8
and the new equilibrium quantity is 30 pizzas.

PROBLEM 3:

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Dough Crust Bread is a normal good produced by Dough Crust Bakery. Explain what
would happen to the supply or demand curve, and to equilibrium price and
quantity of Dough Crust Bread in each of the following situations:

1. Due to a recession, households, which buy Dough Crust Bread, experience a

decrease in income.

Decrease in demand (demand curve shifts to the left). Decrease in equilibrium price
and quantity.

2. The cost of wheat used in Dough Crust Bread increases significantly.

Decrease in supply (supply curve shifts to the left). Increase in equilibrium price and
decrease in equilibrium quantity.

3. Dough Crust buys improved ovens that reduce the costs of Dough Crust Bread.

Increase in supply (supply curve shifts to the right). Decrease in equilibrium price and
increase in equilibrium quantity.

4. Lovely Loaf, a rival, cuts the price of its bread.

Decrease in demand (demand curve shifts to the left). Decrease in equilibrium price
and quantity.

5. Consumers become health conscious and switch to low-calorie bread.

Decrease in demand (demand curve shifts to the left). Decrease in equilibrium price
and quantity.

6. A widespread advertising campaign promoting the health benefit of Dough Crust

consumption.

Increase in demand (demand curve shifts to the right). Increase in equilibrium price
and quantity.

PROBLEM 4:

Explain what would happen to the demand or the supply curve for oil in each of the
following situations:

1. A fall in the price of oil.

Nothing will happen to the demand or the supply curve for oil in this situation. A
change in price changes the quantity demanded or supplied and does not shift the
demand or supply curves.

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2. A change in consumer preferences to natural gas consumption.

Demand for oil will decrease (demand curve will shift to the left).

3. A strike by oil refiners' workers.

Supply of oil will decrease (supply curve will shift to the left).

4. An improved technology of oil production.

Supply of oil will increase (supply curve will shift to the right).

5. A discovery of new oil fields in Texas.

Supply of oil will increase (supply curve will shift to the right).

6. An increase in national income.

Demand for oil will increase (demand curve will shift to the right).

7. The introduction of cars running on solar energy.

Demand for oil will decrease (demand curve will shift to the left).

8. An OPEC oil embargo.

Supply of oil will decrease (supply curve will shift to the left).

9. A record breaking cold winter, raising the consumption of heating oil.

Demand for oil will increase (demand curve will shift to the right).

10. An improvement in transportation, lowering the cost of imported oil.

Supply of oil will increase (supply curve will shift to the right).

PROBLEM 5:
What effect will each of the following have on the demand for small automobiles
such as the Mini Cooper and Smart car?

1. Small automobiles become more fashionable.

Demand for small automobiles will increase (demand curve will shift to the right).

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2. The price of large automobiles rises (with the price of small autos remaining the
same).

Demand for small automobiles will increase (demand curve will shift to the right).

3. Income declines and small autos are an inferior good.

Demand for small automobiles will increase (demand curve will shift to the right).

4. Consumers anticipate the price of small autos will greatly come down in the near
future.

Demand for small automobiles will decrease (demand curve will shift to the left).

5. The price of gasoline substantially drops.

Demand for small automobiles will decrease (demand curve will shift to the left).

PROBLEM 6:

What effect will each of the following have on the supply of automobile tires?

1. A technological advance in the methods of producing tires.

Supply of automobile tires will increase (supply curve will shift to the right).

2. A decline in the number of firms in the tire industry.

Supply of automobile tires will decrease (supply curve will shift to the left).

3. An increase in the price of rubber used in the production of tires.

Supply of automobile tires will decrease (supply curve will shift to the left).

4. The expectation that the equilibrium price of auto tires will be lower in the future
than it is currently.

Supply of automobile tires will increase (supply curve will shift to the right).

5. The levying of a per-unit tax in each auto tire sold.

Supply of automobile tires will decrease (supply curve will shift to the left).

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6. The granting of a 50-cent-per-unit subsidy for each auto tire produced.

Supply of automobile tires will increase (supply curve will shift to the right).

PROBLEM 7:

In each problem below, you are to illustrate the market for textile with the
appropriately shaped standard demand and supply curves. In each case, draw the
shift in the demand and supply which result from the actions taken in the market or
changes in related variables. Indicate in the space provided whether each variable and
demand and supply will increase (+), decrease (-), remain unchanged (0), or have
ambiguous sign (?). Please, number the curves so that the direction of each shift will
be clear. Mark the original equilibrium by E1 and the final equilibrium by E2.
Textile is assumed to be a normal good.

The economy is in recession and income is decreasing.

P
| Demand :..(-)....
| Supply : ..(0)....
| Equilibrium Quantity :..(-)....
| Equilibrium Price : ..(-)....
|
|
|____________________________ Q

2. The government levies new sales taxes on textile and collects it from the
producers.

P
| Demand :.(0).....
| Supply : .(-).....
| Equilibrium Quantity :.(-).....
| Equilibrium Price : .(+).....

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 |
|
|____________________________ Q

3. Price of cotton (input in production of textile) is decreasing.

P
| Demand :..(0)....
| Supply : ..(+)....
| Equilibrium Quantity :.(+).....
| Equilibrium Price : ..(-)....
|
|
|____________________________ Q

4. Income is rising and the price of cotton in declining.

P
| Demand :..(+)....
| Supply : ..(+)....
| Equilibrium Quantity :.(+).....
| Equilibrium Price : ..(?)....
|
|
|____________________________ Q

5. Income is rising and price of cotton is rising.

P
| Demand :.(+).....
| Supply : ..(-)....
| Equilibrium Quantity :.(?).....
| Equilibrium Price : ..(+)....
|
|____________________________ Q

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6. There is expectations of higher future prices for textile products.

P
| Demand :..(+)....
| Supply : ..(-)....
| Equilibrium Quantity :.(?).....
| Equilibrium Price : ..(+)....
|
|
|____________________________ Q

PROBLEM 8:

Demand and supply for a good are given as Qd = 100 - 2P and Qs = -8 + P,

respectively (Q is in 1000 units). Suppose the market above is a perfectly competitive
market.

A. Find the market price that producers will sell their product.

We set Qd = Qs and we solve for the equilibrium price. The market price is equal to
$36.

B. Find the total quantity sold in this market.

We plug the equilibrium in either the Qd or Qs equations. We get the total quantity
sold in the market to be equal to 28,000 units.

C. Suppose the producers in this market decide to set the price at $40.00. What
market condition will exist? _____“Surplus” or “Excess Supply”_________

What will be the quantity demanded _________20,000 units_______and quantity

supplied_______32,000 units___________?

D. Suppose the producers in this market decide to set the price at $30.00. What
market condition will exist? ___”Shortage” or “Excess Demand”______

What will be the quantity demanded _____40,000 units____________and quantity

supplied____22,000 units________?

PROBLEM 9:

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Suppose a technological advance reduces the cost of making computers.

a) Draw a supply-and-demand diagram to show what happens to price and

quantity in the market for computers.

Supply of computers will increase (supply curve shifts to the right). The price of
computers will decline and the quantity of computers sold will increase.

b) Computers and adding machines are substitutes. Use supply-and-demand

diagram to show what happened to price and quantity in the market for adding
machines.

Demand for adding machines will decrease (demand curve will shift to the left). The
price of adding machines will decline and the quantity of adding machines sold will
also decrease.

c) Computers and software are complements. Draw a supply-and-demand

diagram to show what happens to the price and quantity in the market for
software.

Demand for adding machines will increase (demand curve will shift to the right). The
price of adding machines will increase and the quantity of adding machines sold will
also increase.

PROBLEM 10:

The market for pizza has the following demand and supply schedules:

Price Quantity Demanded Quantity Supplied

$4 135 pizzas 26 pizzas
5 104 53
6 81 81
7 68 98
8 53 110
9 39 121

Graph the demand and supply curves. What is the equilibrium price and quantity in
this market? If the actual price in this market where above the equilibrium price, what
would drive the market toward the equilibrium? If the actual price in this market were
below the equilibrium price, what would drive the market toward the equilibrium?

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The equilibrium price is $6. The equilibrium quantity is 81 pizzas. If the actual price
in this market where above the equilibrium price, the surplus of pizzas will drive the
market price towards the equilibrium price. If the actual price in this market were
below the equilibrium price, the shortage of pizzas will drive the market price
towards the equilibrium price.

PROBLEM 11:

Suppose that the price of basketball tickets at your college is determined by market
forces. Currently, the demand and supply schedules are as follows:

Price Quantity Demanded Quantity Supplied

$4 10,000 tickets 8,000 tickets
8 8,000 8,000
12 6,000 8,000
16 4,000 8,000
20 2,000 8,000

a. Draw the demand and supply curves. What is unusual about this supply
curve? Why might this be true?

The stadium has a fixed number of seats, that is why the supply curve is
vertical.

b. What are the equilibrium price and quantity of tickets?

The equilibrium price is $8 and the equilibrium quantity is 8,000 tickets.

c. Your college plans to increase total enrollment next year by 5,000 students.
The additional students will have the following demand schedule:

Price Quantity Demanded

$4 4,000 tickets
8 3,000
12 2,000
16 1,000
20 0

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Now add the old demand schedule and the demand schedule for the new students to
calculate the new demand schedule for the entire college. What will be the new
equilibrium price and quantity?

The new equilibrium price is $12 and the new equilibrium quantity is 8,000 tickets.

PROBLEM 12:

Market research has revealed the following information about the market for
chocolate bars:

The demand schedule can be represented by the equation Qd = 1,600 – 300P, where
Qd is the quantity demanded and P is the price. The supply schedule can be
represented by the equation Qs = 1,400 + 700P, where Qs is the quantity supplied.
Calculate the equilibrium price and quantity in the market for chocolate bars.

To calculate the equilibrium price and quantity in the market for chocolate bars, we
set Qd = Qs and we solve for the equilibrium price. Equilibrium price = 20 cents. We
plug the equilibrium price in either the demand or supply equations and we get the
equilibrium quantity to equal 1,540.

Problem 1:
The Zinger Company manufactures and sells a line of sewing
machines. Demand per period (Q) for a particular model is given by the
following relationship:

Q = 400 - .5P

where P is price. Total costs (including a "normal" return to the owners) of

producing Q units per period are:
TC = 20,000 + 50Q + 3Q2

(a) Express total profits (π) in terms of Q.

(b) At what level of output are total profits maximized? What price will be charged?
What are total profits at this output level?

Solutions:

a. Q= 400- .5P

P= 800- 2Q

=> TR= 800Q- 2Q2

Π= TR- TC
= 800Q- 2Q2 - 20,000 - 50Q - 3Q2

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 => Π = -5Q2 +750Q-20,000

b. total Profit is maximized when dΠ/ dQ= 0

=> dΠ/ dQ = -10Q+ 750 = 0
=> Q=75 units
P= 800 -2 (750)= 650
Π = -5(75)2 +750(75)-20,000
Π = $ 8,125

Problem 4:

Suppose the demand curve for a product is given by Q = 10  2P + PS, where P is the
price of the product and PS is the price of a substitute good. The price of the substitute
good is $2.00.

a. Suppose P = $1.00. What is the price elasticity of demand? What is the cross-
price elasticity of demand?

b. Suppose the price of the good, P, goes to $2.00. Now what is the price
elasticity of demand? What is the cross-price elasticity of demand?
Answers:

Suppose P = $1.00. What is the price elasticity of demand? What

is the cross-price elasticity of demand?

Find quantity demanded when P = $1.00 and PS = $2.00. Q = 10 

2(1) + 2 = 10. Price elasticity of demand =
P Q 1 2
 (2)    0.2 .
Q P 10 10

PS Q 2
Cross-price elasticity of demand =  (1)  0.2 .
Q PS 10
Suppose the price of the good, P, goes to $2.00. Now what is the
price elasticity of demand? What is the cross-price elasticity of
demand?

When P = $2.00. Q = 10  2(2) + 2 = 8.

P Q 2 4
Price elasticity of demand =  (2)    0.5 .
Q P 8 8

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 PS Q 2
Cross-price elasticity of demand =  (1)  0.25 .
Q PS 8

Problem 5:

If the marginal revenue from a product is $15 and the price elasticity of demand is
-1.2, what is the price of the product?

1
MR  P (1  )
ED

P=$90

Problem 6:

The demand for haddock has been estimated as

Log Q = a + b log P + c log I + d log Pm

Where Q = quantity of haddock sold in New England

P = price per pound of haddock
I = a measure of personal income in the New England region
Pm = an index of the price of meat and poultry

If b = -2.174, c = 0.461, and d = 1.909,

a. Determine the price elasticity of demand.

b. Determine the income elasticity of demand
c. Determine the cross price elasticity of demand
d. How would you characterize the demand for haddock
e. Suppose disposable income is expected to increase by 5 percent next year.
Assuming all other factors remains constant, forecast the percentage change in
the quantity of haddock demanded next year.

Solutions:
a. -2.174
b. 0.461
c. 1.909
d.
 The demand is elastic,
 It is necessity, and normal product.
 Meat and poultry are close substitutes to the haddock.
e. %ΔQ = %ΔI x EI
= 0.05 x 0.461

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 = 0.0231

If the disposable income increases by 5%, the quantity of haddock demanded
will increase by 2.351%.

Problem 7:

In a study of the demand for life insurance, Executive Insurers, Inc., is examining the
factors that affect the amount of life insurance held by executives. The following data
on the amount of insurance and annual incomes of a random sample of 12 executives
were collected.

Amount of life
Observation Insurance (x $1000) Annual Income (x $1000)
1 90 50
2 180 84
3 225 74
4 210 115
5 150 104
6 150 96
7 60 56
8 135 102
9 150 104
10 150 108
11 60 65
12 90 58

a. Give the nature of the problem, which would be the dependent variable and
which would be the independent variable?
b. Plot the data.
c. Determine the estimated regression line. Give an economic interpretation of
the slope (b) coefficient.
d. Test the hypothesis that there is no relationship (β = 0) between the variables.
e. Calculate the coefficient of determination
f. Determine the best estimate, based on the regression model, of the amount of
life insurance held by an executive whose annual income is $80,000.
Construct an approximate 95 percent prediction interval.

Solutions:

a. Dependent variable (Y)Amount of Life Insurance

Independent variable XAnnual Income

b.

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c. Y = 11.148 + 1.492X

The estimated slope coefficient (b = 1.492) indicates that the amount of life insurance
held by executives increases by 1.492 x $1000 = $1,492 for each $1000 increase in
annual income.

d. se = 43.34
sb = 0.565
t = (1.492 - 0)/.565 = 2.641

Since the calculated t-value is greater than the t-value from the table (t .025,10 = 2.228
or +2.228), one rejects the hypothesis at the .05 significance level that there is no
relationship between the amount of life insurance held and annual income.

e. R2 = .41

f. Source of Sum of Degrees of Mean

Variation Squares Freedom Squares
Regression 13,088 1 13,088
Residual 18,787 10 1,879
Total 31,875 11

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 F.05,1,10 = 4.96
F = MSR/MSE = 13,087/1879 = 6.966

Since the calculated F-value is greater than the F-value from the table, one rejects at
the .05 significance level the hypothesis that there is no relationship between the
amount of life insurance held and annual income.

g. y' = 11.148 + 1.492(80) = 130.508 or $130,508

Approximate 95% prediction interval:
y' ± 2(43.344) = 130.508 ± 86,688 = 43.82 to 217.196, or
$43,820 to $217,196.

#4 Regression
Variables Entered/Removedb

Variables
Model Variables Entered Removed Method

1 Annual Income
. Enter
(x1000)a

a. All requested variables entered.

b. Dependent Variable: amount of life insurance (x1000)

Model Summary

Std. Error of the

Model R R Square Adjusted R Square Estimate

1 .641a .411 .352 43.344

a. Predictors: (Constant), Annual Income (x1000)

ANOVAb

Model Sum of Squares df Mean Square F Sig.

1 Regression 13087.845 1 13087.845 6.966 .025a

Residual 18787.155 10 1878.716

Total 31875.000 11

a. Predictors: (Constant), Annual Income (x1000)

b. Dependent Variable: amount of life insurance (x1000)

Coefficientsa

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 Variables Entered/Removedb

Variables
Model Variables Entered Removed Method

1 Annual Income
. Enter
(x1000)a

Standardized
Unstandardized Coefficients Coefficients

Model B Std. Error Beta t Sig.

1 (Constant) 11.148 49.480 .225 .826

Annual Income (x1000) 1.492 .565 .641 2.639 .025

a. Dependent Variable: amount of life insurance (x1000)

Problem 8:

The country assessor feels that the use of more independent variables in the
regression equation might improve the overall explanatory power of the model.

In addition to size, the assessor feels that the total number of rooms, age, and
whether the house has an attached garage might be important variables affecting
selling price. These date for the 15 randomly selected dwellings are shown in the
following table.

Selling Price Total No. of Attached Garage

Observation (x $1000) Size (x 100 ft2) Rooms Age (No= 0, Yes= 1)
I Y X1 X2 X3 X4
1 265.2 12.0 6 17 0
2 279.6 20.2 7 18 0
3 311.2 27.0 7 17 1
4 328.0 30.0 8 18 1
5 352.0 30.0 8 15 1
6 281.2 21.4 8 20 1
7 288.4 21.6 7 8 0
8 292.8 25.2 7 15 1
9 356.0 37.2 9 31 1
10 263.2 14.4 7 8 0
11 272.4 15.0 7 17 0
12 291.2 22.4 6 9 0
13 299.6 23.9 7 20 1
14 307.6 26.6 6 23 1
15 320.4 30.7 7 23 1

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a. Using a computer regression program, determine the estimated regression
equation with the four explanatory variables shown in the tables.
b. Give an economic interpretation of each of the estimated regression
coefficients
c. Which of the independent variables (if any) are statistically significant (at the .
05 level) in explaining selling price?
d. What proportion of the total variation in selling price is explained by the
regression model
e. Construct an approximate 95 percent prediction interval for the selling price
of a 15-year old house having 1,800 square, 7 rooms, and an attached garage.

Solutions:

. a. Dependent variable : Price

Source DF Sum of Squares Mean Square F Value

Prob > F
Model 4 10339.040 2584.760 20.848 0.0001
Error 10 1239.798 123.980
C Total 14 11578.837

Root MSE 11.134621 R-Square 0.8929

Dep Mean 100.587 ADJ R-Sq 0.8501
C.V. 11.06968

Variable DF Parameter Est. Std. Error t-ratio

Prob > |t|
Intercep 1 185.6324 27.483494 0.536 0.6036
Size 1 3.921432 0.755262 5.192 .0004
Rooms 1 3.585118 4.470708 0.802 0.4412
Age 1 0.118145 0.640698 0.184 0.8574
Garage 1 2.831695 9.716504 0.291 0.7767

Y' = 14.7351 + 3.9214X1 + 3.5851X2  0.1181X3  2.8317X4

b. a = 14.7351
No significant economic meaning.

b1 = 3.9214
An increase of 100 sq. ft. in size increases the expected selling price by $3921, all other
things remaining constant.

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b2 = 3.5851
An increase of 1 room increases the expected selling price by $3,585, all other things
remaining constant.

b3 = .1181
An increase of 1 year in age decreases the expected selling price by $118, all other things
remaining constant.

b4 = 2.8317
An attached garage decreases the expected selling price by $2,832, all other things
remaining constant.

c. From the computer output, only X1(size) is significant in explaining the selling price at
the 5% significance level or better.

d. R-Square = 0.8929. The regression model explains about 89% of the variation in
selling price.

e. From the computer output, F is significant at the .0001 level.

f. y' = 14.7351 + 3.9214(18) + 3.5851(7)  .1181(15) 2.8317(1)

= 76.3426

se = 11.1346 (Root MSE from computer output)

y' ± 2 se = 76.3426 ± 2(11.1346) = 54.0734 to 98.6118, or $54,073 to $98,612

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