Managerial Economics – 6005

Homework – chapter 5
5.1 Market Demand.
Michael Kelso, a Wisconsin-based management consultant, has been asked to
calculate and analyze market demand for a new video game that is to be marketed to
retail (R) and wholesale (W) customers over the Internet.
Kelso’s client estimates fixed costs of $750,000 year for the product, and that
licensing fees and other marginal costs will be $20 per unit. The client has also
provided Kelso with the following annual demand information:

PR = $62.50 - $0.0005QR
P w = $50 - $0.002Qw

A. Express quantity as a function of price for both retail and wholesale

customers. Add these quantities together to calculate the market demand
curve. Graph the retail, wholesale, and market demand curves for prices
ranging from $65 to $35 per unit.

Pr=$62.50-$0.0005Qr

m
Pr (dollars) 35 50 60 65

er as
Qr (units-thousands) 55 25 5 -5

co
Qw(Units-thousands) 7.5 0 -5 -7.5

eH w
Pw=$50-$0.002Qw

o.
rs e Graph of price vs units
ou urc
price in dollars

100 Qr (units-
50 thousands)
o

0 Qw(Units-
aC s

thousands)
-50 1 2 3 4
v i y re

Quantity in thousands
ed d
ar stu

For retail customers,

PR = $62.50 - $0.0005QR
0.0005QR = 62.50 – PR
sh is

QR = 125,000 - 2000 PR
Th

For wholesale customers,

P w = $50 - $0.002Qw
0.002Qw = 50 - P w
Q w = 25,000 – 500 P w

For retail plus wholesale customers, the market demand curve can be expressed with
quantity as a function of price as:

Q = QR + Qw
= 125,000 - 2000 PR + 25,000 – 500 P w
= 150,000 – 2500 P

This study source was downloaded by 100000827488442 from CourseHero.com on 07-15-2021 23:53:43 GMT -05:00

https://www.coursehero.com/file/6543478/chapter-51/
 Managerial Economics – 6005
Homework – chapter 5

The price must be expressed as a function of quantity,

Q = 150,000 – 2500 P
2500 P = 150,000 – Q
P = 60 – 0.0004 Q
To graph the retail, wholesale, and market demand curves for prices ranging from $65
to $35 per unit
TC = $750,000 + 20Q

m
er as
B. Fill in the following table:

co
eH w
Retail Wholesale Market Total Total Total
Price Demand Demand Demand Revenue Cost Profit

o.
$65 -5,000
rs e -7,500 -12,500 -812,500 500,000 -1,312,500
$60 5,000 -5,000 0 0 750,000 -750,000
ou urc
1,000,00
$55 15,000 -2,500 12,500 687,500 0 -312,500
1,250,00 1,250,00
$50 25,000 0 25,000 0 0 0
o

1,687,50 1,500,00
$45 35,000 2,500 37,500 0 0 168,750
aC s

2,000,00 1,750,00
v i y re

$40 45,000 5,000 50,000 0 0 250,000

2,000,00
$35 55,000 7,500 62,500 2,187,500 0 187,500
ed d

C. What price/output combination will maximize total profits?

ar stu

The profit-maximizing output level can be seen as 50,000 units, where 45,000 units
are sold to retail customers and 5,000 units are sold to wholesale customers. The
profit-maximizing price is $40 per unit. The following calculation proves the answer.
sh is
Th

TR = P X Q
= (60 – 0.0004 Q) Q
2
= 60Q – 0.0004 Q
MR = ∂TR / ∂Q = 60 -0.0008Q

TC = $750,000 + 20Q
MC = ∂TC / ∂Q = 20

The profit-maximizing activity level occurs where MR = MC. This is also where Mπ
=0.

MR = MC.

This study source was downloaded by 100000827488442 from CourseHero.com on 07-15-2021 23:53:43 GMT -05:00

https://www.coursehero.com/file/6543478/chapter-51/
 Managerial Economics – 6005
Homework – chapter 5
60 -0.0008Q = 20
0.0008Q = 40
Q = 50,000

At Q = 45,000

P = 60 – 0.0004 (50,000)
= 40
π = TR –TC
2
= 60Q – 0.0004 Q - ($750,000 + 20Q)
2
= - 0.0004 Q + 40Q - 750,000
2
= - 0.0004 (50,000) + 40(50,000) - 750,000

m
er as
= 250,000

co
eH w
o.
5.2 Elasticity. rs e
The demand for personal computers can be characterized by the following point
ou urc
elasticities: price elasticity = -5, cross-price elasticity with software = -4, and income
elasticity = 2.5. Indicate whether each of the following statements is true or false, and
explain your answer.
o
aC s

A. A price reduction for personal computer will increase both the number of units
v i y re

demanded and the total revenue of sellers.

True. Quantity demanded always rises following a price reduction. In the case of
elastic demand (here │ε p│ = 5 > 1), the percentage increase in quantity will be grater
ed d

than the percentage decrease in price, and the total revenue will rise.
ar stu

B. The cross-price elasticity indicates that a 5 percent reduction in the price of

personal computers will cause a 20 percent increase in software demand.
sh is

True. 5 percent reduction in the price of personal computers will cause a 20 percent
Th

increase in software demand because both goods have a inverse relation.

C. Demand for personal computers is price elastic and computers are cyclical
normal goods.

True. Demand for personal computers is price elastic and computers are cyclical
normal goods because ε1 = 2.5 > 1

D. Falling software prices will increase revenues received by sellers of both

computers and software.

This study source was downloaded by 100000827488442 from CourseHero.com on 07-15-2021 23:53:43 GMT -05:00

https://www.coursehero.com/file/6543478/chapter-51/
 Managerial Economics – 6005
Homework – chapter 5
True. Falling software prices will increase revenues received by sellers of both
computers and software because the demand is elastic and any decrease in an elastic
demand will result in increase in revenue.

E. A 2 percent price reduction would be necessary to overcome the effects of a 1

percent decline in income.

False: A 2% reduction in price will cause a 10% increase in the quantity of

personal computers demanded. A 1% decline in income will cause a 2.5% fall in
demand. These changes will not be mutually offsetting.

5.3 Demand Curve.

KRMY-TV is contemplating a T-shirt advertising promotion. Monthly sales
data from T-shirt shops marketing the ‘’Eye Watch KRMY-TV’’ design indicate that

Q = 1,500 – 200P

m
er as
Where Q is T-shirt sales and P is price

co
eH w
A. How many T-shirt could KPMT-TV sell at $4.50 each?

o.
rs e Q = 1,500 – 200(4.50)
ou urc
= 600
o
aC s

B. What price would KPMT-TV have to change to sell 900 T-shirt?

v i y re

P = 7.5 – 0.005Q
= 7.5 – 0.005(900)
=3
ed d

C. At what price would T-shirt sales equal zero?

ar stu

Q = 1,500 – 200P
0 = 1,500 – 200(7.50)
sh is

= 1,500 – 1,500
Q=0
Th

D. How many T-shirts could be given away?

Q = 1,500 - 200P
Q = 1,500 - 200(0)
Q = 1,500

E. Calculate the point price elasticity of demand at price of $5.

Q = 1,500 – 200P
= 1,500 – 200(5)

This study source was downloaded by 100000827488442 from CourseHero.com on 07-15-2021 23:53:43 GMT -05:00

https://www.coursehero.com/file/6543478/chapter-51/
 Managerial Economics – 6005
Homework – chapter 5
= 500

ε p = ∂Q/∂P x P/Q
= -200 x (5/500)
= -2

5.4 Optimal Pricing

In a effort to reduce excess end-of-the-method-year inventory, Harrison Ford
offered a 1 percent discount off the average price of 4WD Escape Limited SUVs sold
during the month of August. Customer response was wildly enthusiastic, with unit
sales rising by 50 percent over the previous month’s level.

A. Calculate the point price elasticity of demand for Harrison Ford 4WD Escape
Limited SUVs sold during the month of August.
EP = Percentage change in quantity/Percentage change in price
EP= 0.5/-0.01

m
er as
EP= -50

co
eH w
o.
rs e
ou urc
B. Calculate the profit-maximizing price per unit if Harrison Ford has an average
wholesale (invoice) cost of $27,600 and incurs marginal selling costs of $330
o

per unit.
aC s
v i y re

P= (27600+330)/ 0.98
P=28500
ed d

5.5 Cross-Price Elasticity

ar stu

The South Beach Café recently reduced appetizer prices from $10 to $6 for
afternoon early bird customers and enjoyed a resulting increase in sales from $60 to
$180 orders per day. Beverage sales also increased from 30 to 150 units per day.
sh is

A. Calculate the arc price elasticity of demand for appetizers.

Th

EP= (120/-4)*(16/240)
EP= -16/8
EP= - 2

B. Calculate the arc cross-price elasticity of demand between beverage sales and
appetizer prices.

EP= (120/-4)*(16/180)
EP= - 2.67

This study source was downloaded by 100000827488442 from CourseHero.com on 07-15-2021 23:53:43 GMT -05:00

https://www.coursehero.com/file/6543478/chapter-51/
 Managerial Economics – 6005
Homework – chapter 5
C. Holding all else equal, would you expect an additional appetizer price
decrease to $5 to cause both appetizer and beverage revenues to rise? Explain.
Yes, the |EP| = 2 > 1 calculated in part A implies an elastic demand for
appetizers and that an additional price reduction will increase appetizer
revenues. EPX =-2.67 < 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. To determine the profit
effects of appetizer price changes it is necessary to consider revenue and cost
implications of both appetizer and beverage sales.

5.6 Income Elasticity.

Ironside Industries, Inc., is a leading manufacturer of tufted carpeting under
the Ironside brand. Demand for Ironside’s products is closely tied to the overall pace
of building and remodeling activity and, therefore, is highly sensitive to changes in
national income. The carpet manufacturing industry is highly competitive, so
Ironside’s demand is also very price sensitive.

m
er as
During the past year, Ironside sold 30 million square yards (units) of carpeting
at an average wholesale price of $15.50 per unit. This year, household income is

co
eH w
expected to surge from $55,500 to $58,500 per year in a booming economic recovery.

o.
A. Without any price change, Ironside’s marketing director expects current-year
rs e
sales to soar to 50 million units because of rising income. Calculate the
ou urc
implied income arc elasticity of demand.

EI= (20/ 3,000)*(114000/80)

o

EI= 9.5
aC s
v i y re

B. Given the projected rise in income, the marketing director believes that a
volume of 30 million units could be maintained despite an increase in price of
ed d

$1 per unit. On this basis, calculate the implied arc price elasticity of demand.
ar stu

EPI= (-20/1)*(32/80)
sh is

EPI= - 8 (elastic)
Th

C. Holding all else equal, would a further increase in price result in higher or
lower total revenue?
Lower. Since carpet demand is in the elastic range, EP = -8, an increase
(decrease) in price will result in lower (higher) total revenues

This study source was downloaded by 100000827488442 from CourseHero.com on 07-15-2021 23:53:43 GMT -05:00

https://www.coursehero.com/file/6543478/chapter-51/
Powered by TCPDF (www.tcpdf.org)