PROBLEM SET 1

BA 245
Managerial Economics
First Sem., AY 2020-2021
Topics: Supply and Demand, Market Equilibrium, Elasticity, and the Production
Process and Costs
[1] You are in the market for a new refrigerator for your company’s lounge, and you have narrowed the
search down to two models. The energy efficient model sells for P20,000 and will save you P1000 at the
end of each year of the next five years in electricity costs. The standard model has features similar to the
energy efficient model but provides no future saving in electricity costs. It is priced at only P16000.
Assuming your opportunity cost of funds is 5 percent, which refrigerator should you purchase?

[2] Tara is considering leaving her current job, which pays P2,240,000 per year to start a new company
that manufactures a line of special pens for personal digital assistants. Based on market research, she
can sell about 160,000 units during the first year at a price of P800 per unit. With annual overhead costs
and operating expenses amounting to P126,400,000, Tara expects a profit margin of 25%. This margin is
6% larger than that of her largest competitor, Pens, Inc.
[a] if Tara decides to embark on her new venture, what will her accounting costs be during the first
year of operation? Her implicit costs? Her opportunity costs?
[b] Suppose that Tara’s estimated selling price is lower than originally projected during the first year.
How much revenue would she need in order to earn positive accounting profits? Positive economic
profits?

[3] Dynamic Sales Center will supply 50 pocket calculators at P100 each. The supply is increased to 80
pieces when the unit price is increased by 20%. (a) Set up the supply function. (b) how many calculators
will be supplied if the unit price is P150? (c) Find the lowest price at which this item would be supplied.

[4] An entrepreneur engages in the production of virgin coconut oil, a food extract believed to offer cure
to various body ailments. He supplies 500 150-ml. bottles to Wilson Drugstore at P100 per bottle. At P60
pesos per bottle, he refuses to sell his product.
[a] determine the supply equation
[b] How many bottles are available when the unit price is P120

[5] Given the following two equations:

P=5−0.05 Q (5.1)

P=0.75+0.0125 Q (5.2)

[a] Identify which of the two equations (5.1) and (5.2) is the demand function and which is the supply
function.
[b] Calculate the equilibrium price and quantity.
[c] Calculate the price elasticity of demand at the equilibrium price and quantity. Is demand elastic at
this point?
[d] Suppose a tax of PhP0.25 per unit is levied on this good and that producers are required to collect
the tax. Calculate the new equilibrium price and quantity in the market. [Hint: Before the tax was
imposed, producers were willing to supply 100 units when P=PhP2. After the tax is imposed, they
will require a price of PhP2.25 to supply 100 units.]

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 [e] Calculate the per cent of the tax that is shifted to the consumer and the per cent that is borne by
the producer.
[f] Sketch the pre-tax and post-tax equilibriums on a diagram showing the demand and supply curves,
the prices paid by the consumer, the prices received by the producer, and the tax.

[6] Suppose demand and supply for a product are given:

Q=0.001Y −0.5 P
Q=0.5 P

where Y stands for the average household income.

[a] If average household income is PhP40,000, calculate the equilibrium price and quantity.
[b] Suppose a tax of 25 per cent of the purchase price is applied to the good and that producers are
required to collect the tax. (Assume income remains at PhP40,000) Determine the new price and
quantity.
[c] Graph the supply function and the demand function before and after the tax is imposed. Show on
the diagram the equilibrium prices with and without the tax.
[d] Determine the tax revenue and tax incidence on producers and consumers.

[7] The X corporation produces a good (called X) that is a normal good. Its competitor , Y-Corp., makes a
substitute good that it markets under the name “Y”. Good Y is an inferior good.
[a] How will the demand for good X change if consumer incomes increase?
[b] How will the demand for good Y change if consumer incomes decrease?
[c] How will the demand for good X change if the price of good Y decreases?
[d] Is good Y a lower quality product than good X? Explain.

[8] Good X is produced in a competitive market using input A. Explain what would happen to the supply
of good X in each of the following situations:
[a] The price of input A increases.
[b] An excise tax of P50 is imposed on good X.
[c] An ad valorem tax of 5 percent is imposed on good X.
[d] A technological change reduces the cost of producing additional units of good X.

[9] The demand for good X is given by

1 1 1
Q dx =1,200− P x + P y −8 Pz + M
2 4 10
Research shows that the price of related goods are given by P y=P5,900 and Pz=P90, while the average
income of individuals consuming this product is M=P55,000.
[a] Indicate whether good Y and Z are substitutes or complements for good X.
[b] Is X an inferior or a normal good?
[c] How many units of good X will be purchased when P x=P4,910?
[d] Determine the demand function and inverse demand function for good X.
Graph the demand curve for good X.

[10] The demand curve for product X is given by Q dx =460−4 P x

[a] Find the inverse demand curve.
[b] how much consumer surplus do consumers receive when P x=P35?
[c] How much consumer surplus do consumers receive when P x=P25?
[d] In general, what happens to the level of consumer surplus as the price of a good falls?

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of our products and services, and Uphold the University’s tenets of Truth, Excellence, and Service to produce
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[11] You are the manager of a firm that produces and markets a generic type of soft drink in a competitive
market. In addition to the large number of generic products in your market, you also compete against
major brands such as Coca-cola and Pepsi. Suppose that, due to the successful lobbying efforts of sugar
producers in the United States, Congress is going to levy a $0.50 per pound tariff on all imported raw
sugar – the primary input for your product. In addition, Coke and Pepsi plan to launch an aggressive
advertising campaign designed to persuade consumers that their branded products are superior to
generic soft drinks. How will these events impact the equilibrium price and quantity of generic soft
drinks?

[12] As a result of increased tensions in the Middle East, oil production is down by 1.21 million barrels per
day – a 5 percent reduction in the world’s supply of crude oil. Explain the likely impact of this event on
the market for gasoline and the market for small cars.

[13] The demand curve for a product is given by Q dx =1,000−2 P x + 0.02 P z, where Pz=P400.
[a] What is the own price elasticity of demand when Px=P154? Is demand elastic or inelastic at this
price? What would happen to the firm’s revenue if it decided to charge a price below P154?
[b] What is the own price elasticity of demand when Px=P354? Is demand elastic or inelastic at this
price? What would happen to the firm’s revenue if it decided to charge a price above P354?
[c] When the cross price elasticity of demand between good X and good Z when P x=P154? Are goods X
and Z substitutes or complements?

[14] Suppose the demand function for a firm’s product is given by

ln Q dx =3−0.5 ln P x −2.5 ln P y +lnM +2 lnA
Where
Px=P10,
Py=P4,
M=P20,000, and
A=P250.
[a] determine the own price elasticity of demand, and state whether demand is elastic, inelastic, or
unitary elastic.
[b] Determine the cross-price elasticity of demand between good X and good Y, and state whether
these two goods are substitutes or complements.
[c] Determine the income elasticity of demand, and state whether good X is a normal or inferior good.
[d] Determine the own advertising elasticity of demand.

[15] Suppose the own price elasticity of demand for good X is -2, its income elasticity is 3, its advertising
elasticity is 4, and the cross price elasticity of demand between it and good Y is -6. Determine how much
the consumption of this good will change if:
[a] The price of good X increases by 5 percent.
[b] The price of good Y increases by 10 percent.
[c] Advertising decreases by 2 percent.
[d] income falls by 3 percent.

[16] Suppose the cross price elasticity of demand between goods X and Y is -5. How much would the
price of good Y have to change in order to increase the consumption of good X by 50 percent?

[17] For the first time in two years, Big G (the cereal division of General Mills) raised cereal prices by 2
percent. If, as a result of this price increase, the volume of all cereal sold by Big G dropped by 3 percent,
what can you infer about the own price elasticity of demand for Big G cereal? Can you predict whether
revenues on sales of its Lucky Charms brand increased or decreased? Explain.

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[18] You are the manager of the Chevrolet division of General Motors. If your marketing department
estimates that the semiannual demand for the Chevy Tahoe is Q=100,000-1.25P, what price should you
charge in order to maximize revenues from sales of the Tahoe?

[19] You are a manager in charge of monitoring cash flow at Kodak. Traditional photography equipment
comprises 80 percent of Kodak’s 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 films, 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 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 Kodak’s overall revenues from both disposable and digital camera sales?

[20] As newly appointed “Energy Czar,” your goal is to reduce the total demand for residential heating
fuel in your state. You must choose one of three legislative proposals designed to accomplish this goal:
(a) a tax that would effectively increase the price of residential heating fuel by $2; (b) a subsidy that
would effectively reduce the price of natural gas by $1; or (c) a tax that would effectively increase the
price of electricity (produced by hydroelectric facilities) by $5. To assist you in your decision, an
economist in your office has estimated the demand for residential heating fuel using a linear demand
specification. The regression results are presented below. Based on this information, which proposal
would you favor? Explain.

SUMMARY OUTPUT

Regression Statistics
Multiple R 0.76
R-square 0.57
Standard Error 47.13
Observations 25

Coefficients SE t-Statistic P-value

Intercept 136.96 43.46 3.15 0.01
Price of Residential -91.69 29.09 -3.15 0.01
Heating Fuel
Price of Natural Gas 43.88 9.17 4.79 0.00
Price of Electricity -11.92 8.35 -1.43 0.17
Income -0.050 0.35 -0.14 0.90

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[21] Originally the consumer faces the budget line p 1x1 + p2x2 = m. Then the price of good 1 doubles, the
price of good 2 becomes 8 times larger, and income becomes 4 times larger. Write down an equation
for the new budget line in terms of the original price and income.

[22] What happens to the budget line if the price of good 2 increases, but the price of good 1 and income
remain constant? (assume that good 1 is plotted on the horizontal axis)

[23] If two goods are perfect substitutes, what is the demand function for good 2?

[24] Determine the utility-maximizing combination of products X and Y if the total utility function is
TU=10X + 24Y – 0.5X2 – 0.5Y2

And if Px = P2.00, Py = P6.00, and income (m) = P44.00. Show your solution. (Hint: solve the problem
using the Lagrange Multiplier).

[25] Suppose that the price of good X (plotted on the horizontal axis) rises and the price of good Y falls in such
a way that the consumer’s new optimal consumption bundle lies on the same indifference curve as
his old bundle. Graph this situation. Compare the quantities demanded between the old and new
bundles.

[26] The US government spends over $15.8 billion on its Food Stamp Program to provide millions of
Americans with the means to purchase food. These stamps are redeemable for food at over 160,000
store locations throughout the nation, and they cannot be sold for cash or used to purchase non-food
items. The average food stamp benefit is about $170 per month. Suppose that, in the absence of food
stamps, the average consumer must divide $500 in monthly income between food and “all other goods”
such that the following budget constraint holds: $500=$10A+$5F, where A is the quantity of “all other
goods” and F is the quantity of food purchased. Using the vertical axis for “all other goods,” draw the
consumer’s budget line in the absence of the Food Stamp Program. What is the market rate of
substitution between food and “all other goods”? On the same graph, show how the food Stamp
Program alters the average consumer’s budget line. Would this consumer benefit from illegally
exchanging food stamps for cash? Explain.

[27] A firm can manufacture a product according to the production function

Q=F ( K , L )=K 3/ 4 L1/ 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 firm uses 81 units of
labor?
[b] Find an expression for the marginal product of labor, MP L, 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?
[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 in order to maximize profits?

[28] A firm’s product sells for $2 per unit in a highly competitive market. The firm produces output using
capital (which it rents at $75 per hour) and labor (which is paid a wage of $15 per hour under a contract
for 20 hours of labor services). Complete the following table and use that information to answer the
questions that follow.

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of our products and services, and Uphold the University’s tenets of Truth, Excellence, and Service to produce
globally competitive and morally upright individuals.
 K L Q MPK APK APL MPL
0 20 0
1 20 50
2 20 150
3 20 300
4 20 400
5 20 450
6 20 475
7 20 475
8 20 450
9 20 400
10 20 300
11 20 150

[a] Identify the fixed and variable inputs?

[b] What are the firm’s fixed costs?
[c] What is the variable cost of producing 475 units of output?
[d] How many units of the variable input should be used to maximize profits?
[e] What are the maximum profits this firm can earn?
[f] Over what range of the variable input usage do increasing marginal returns exist?
[g] Over what range of the variable input usage do decreasing marginal returns exist?
[h] Over what range of input usage do negative marginal returns exist?

[29] Explain the difference between the law of diminishing marginal returns and the law of diminishing
marginal rate of technical substitution.

[30] An economist estimated that the cost function of a single product firm is
C ( Q ) =50+25 Q+ 30Q 2 +5 Q 3
Based on this information, determine:
[a] The fixed cost of producing 10 units of output.
[b] The variable cost of producing 10 units of output.
[c] the total cost of producing 10 units of output.
[d] The average fixed cost of producing 10 units of output.
[e] The average variable cost of producing 10 units of output.
[f] The average total cost of producing 10 units of output.
[g] The marginal cost of producing 10 units of output.

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of our products and services, and Uphold the University’s tenets of Truth, Excellence, and Service to produce
globally competitive and morally upright individuals.
PROBLEM SET 2
BA 245
Managerial Economics
First Sem., AY 2020-2021
Topics: Derivatives, Marginal Analysis, Optimization

[1] Find the derivative of each of the following functions:

[a] y=x13 [b] y=63 [c] y=7x6
[d] w=3u-1 [e] w=-4u1/2 [f] w=cx2
[g] f(w)=6w1/2

[2] Find the derivatives of:

(x 2 +3) (x +7) 4x (a x 2 +b)
[a] [b] [c] [d]
x x ( x +5) (cx +d )

[3] Find ∂ y /∂ x 1∧∂ y /∂ x 2 for each of the following functions:

[a] y=2 x 31−11 x 21 x 2 +3 x22 [b] y=7 x 1 +5 x1 x 22
[c] y=(2 x1 +3)(x 2−2) [d] y=(4 x1 +3)/(x 2−2)

[4] Given the production function Q=96 K 0.3 L0.7, find the MPPk and MPPL functions. Is MPPK a function
of K alone, or both K and L? What about MPPL?

[5] If the utility function of an individual takes the form

U =U ( x1 , x2 ) =( x 1 +2)2 ( x 2 +3)3
Where U is total utility, and x1 and x2 are the quantities of two commodities consumed.
[a] find the marginal utility function of each of the two commodities.
[b] Find the value of the marginal utility of the first commodity when 3 units of each commodity are
consumed.

[6] Determine the marginal product functions for labor (L) and capital (C) for each of the following
production functions.
[a] Q=18 L2 +14 C 3−L2 C [b] Q=10 L0.5 C 0.5
[c] Q=17 L+ 9C +0.6 L0.4 C 0.5

[7] A manager makes the statement that output should be expanded so long as average revenue
exceeds average cost. Does this strategy make sense?

[8] The original revenue function for the microchip producer is R=170Q-20Q 2. Derive the expression for
marginal revenue, and use it to find the output level at which revenue is maximized. Confirm that this is
greater than the firm’s profit maximizing output. Explain.

[9] Suppose a firm’s inverse demand curve is given by P=120-0.5Q and its cost equation is C=420+60Q+Q 2.
[a] Find the firm’s optimal quantity, price, and profit (1) by using the profit and marginal profit
equations and (2) by setting MR equal to MC. Also provide a graph of MR and MC.

[b] Suppose instead that the firm can sell any and all of its output at the fixed market price P=120.
Find the firm’s optimal output.

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of our products and services, and Uphold the University’s tenets of Truth, Excellence, and Service to produce
globally competitive and morally upright individuals.
[10] Suppose a firm assesses its profit function as
Π=-10-48Q+15Q2-Q3.
[a] Compute the firm’s profit for the following levels of output:
Q=2, 8, and 14.
[b] Derive an expression for marginal profit. Compute marginal profit at Q=2, 8, and 14. Confirm that
profit is maximized at Q=8. (Why is profit not maximized at Q=2?)

[11] Suppose a firm’s inverse demand and cost equations are of the general forms
P=a-bQ and C=F+cQ,
Where the parameters a and b denote the intercept and slope of the inverse demand function and the
parameters F and c are the firm’s fixed and marginal costs, respectively. Apply the MR=MC rule to
confirm that the firm’s optimal output and price are
Q=(a-c)/2b and P=(a+c)/2.
Provide explanations for the ways P and Q depend on the underlying economic parameters.

[12] Determine the optimum resource combination of labor and capital when
[a] Q=140 L+160 C−5 L2−2C 2,
PL=12
PC=24
TC=732

[b] Q=6 LC
PL=5
PC=10
TC=180

[13] A firm uses a single plant with costs C=160+16Q+0.1Q 2 and faces the price equation P=96-0.4Q.
[a] Find the firm’s profit maximizing price and quantity. What is its profit?
[b] The firm’s production manager claims that the firm’s average cost of production is minimized at an
output of 40 units. Furthermore, she claims that 40 units is the firm’s profit-maximizing level of output.
Explain whether these claims are correct.
[c] Could the firm increase its profit by using a second plant ( with costs identical to the first) to
produce the output in part a? Explain.

[14] A firm has the following total cost and demand functions:
1
C= Q 3−7 Q 2 +111Q+50
3
Q=100−P

[a] Write out the total revenue function R in terms of Q.

[b] Formulate the total profit function Π in terms of Q.
[c] What is the maximum profit?

[15] A purely competitive firm has a single variable input L (labor), with the wage rate W 0 per period. Its
fixed inputs cost the firm a total of F dollars per period. The price of the product is P 0.
[a] Write the production function, revenue function, cost function, and profit function of the firm.
[b] What is the first-order condition for profit maximization? Interpret the condition economically.
[c] What economic circumstances would ensure that profit is maximized rather than minimized?

[16] A two-product firm faces the demand and cost functions below:

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of our products and services, and Uphold the University’s tenets of Truth, Excellence, and Service to produce
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 Q1=40−2 P1−P2 Q2=35−P1−P2 C=Q 21 +2Q 22+10
[a] Find the output levels that satisfy the first order condition for maximum profit.
[b] What is the maximal profit?

[17] Use the Lagrange-multiplier method to find the stationary values of Z:

[a] Z=xy , subject ¿ x+2 y=2
[b] Z=x ( y + 4 ) , subject ¿ x + y=8
[c] Z=x−3 y−xy , subject ¿ x + y=6

[18] A firm’s total profit is given by π=20 x−x 2 +16 y−2 y 2

[a] What values of x and y will maximize the firm’s profit?
[b] Repeat part a assuming the firm faces the constraint x + y ≤ 8.
[c] Repeat part a assuming the constraint is x +0.5 y ≤ 7.5 .

[19] A 1984 study of cigarette demand resulted in the following logarithmic regression equation.
Log(Q)=-2.55-0.29log(P)-0.09 log(Y)+0.08 log(A)-0.1W.
(-2.07) (-1.05) (4.48) (-5.2)
Here, Q denotes annual cigarette consumption, P is the average price of cigarettes, Y is per capita
income, A is total spending on cigarette spending, and W is dummy variable whose value is 1 for years
after 1953 (When the American Cancer Society warned that smoking is linked to lung cancer) and 0 for
earlier years. The t-statistic for each coefficient is shown in the parentheses. The R-square value is 0.94.
[a] Which of the explanatory variables have real effects on cigarette consumption? Explain.
[b] What does the coefficient of log(P) represent? If cigarette prices increase by 20 percent, what will
be the effect on consumption?
[c] Are cigarette purchases sensitive to income? Explain.

[20] An expert has provided annual data on the water table and rainfall in a California region over the last
decade.
YEAR
1 2 3 4 5 6 7 8 9 10
Water 17.6 19.2 14.8 18.1 13.2 15.1 20 14.6 13.9 13.5
Table
Rainfal 36 52 34 44 26 48 56 45 39 42
l
[a] Using the 10 years of data, estimate the equation W=a+bt, where W is the water table and t is time
in years. Comment on the statistical validity of your equation. Can you conclude that the water table
level is dropping over time?
[b] Did the region have greater yearly rainfall in the first five years or the last five years of the decade?
Should rainfall be added as an explanatory variable in your regression equation? If it were, what would
be the effect on the estimate of b? Explain.
[c] Now, estimate the equation, W=a+bt+cR, where R denotes annual rainfall. Answer the questions
posed in part a above. Is this equation scientifically superior to the equation in part a?

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of our products and services, and Uphold the University’s tenets of Truth, Excellence, and Service to produce
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