BM 2012 Mid Term Examination: Managerial Economics:

Time 90 minutes
Total Marks 35

Answer all questions

1. The table below gives a profile of the marks obtained by a student in the three
subjects English, Economics and Mathematics for the number of hours studied. If
a student decides to study for 10 hours, his grade will depend on the total marks in
the best two out of three subjects, subject to passing in each subject. The pass
marks in each subject is 50? You have to justify your answer that is state how you
arrive at the solution to get full marks.
Subjects/Hours of
study 0 1 2 3 4 5 6 7 8
English 0 45 60 72 83 87 90 92 93
Economics 0 40 60 70 75 79 82 84 85
Mathematics 0 50 75 85 90 94 97 99 100

4 marks.

2. An economy is endowed with 100 units of labor and 100 units of electricity, and
150 units of storage space to store the two final produce namely water and cloth.
Both labor and electricity are used for producing two goods water and cloth,
which may be used to produce saris and dhotis. Either 1 unit of labor can be used
with the use of a manual hand pump to pump 1 gallon of ground water or one
can use 1 unit of electricity with the help of an electric pump to pump 1 gallon of
ground water. Manufacture of cloth requires both labor and electricity; 1 meter of
cloth will require 2 units of electricity and 1 unit of labor. Both water and cloth
needs to be stored in a common storage space, 1 gallon of water requires 1 unit of
storage space and 1 meter of cloth requires 1 unit of storage space. Draw the
Production Possibility Frontier for this economy, label points on the frontier
where resources such as labor, electricity and storage space are fully utilized and
places where they are not. Can we comment that all places on the frontier where
resources are not fully utilized are technically inefficient from the Pareto point of
view?
5 marks

3. Suppose that in a year an American worker can produce up to 200 pillows or 30

televisions, while a Pakistani worker can produce 200 pillows or 18 televisions. In
the following year an American worker can produce up to 200 pillows or 30
televisions, while a Pakistani worker can produce 200 pillows or 25 televisions.
Therefore this does not necessarily imply that Pakistani workers will be better off
the following year. Comment whether the statement is true or false giving reasons
if Pakistan and America engage in trade with each other in both the years.
4 Marks
 4 There are three goods consumed by a person. In situation A, when the prices
are (1, 1, 2), the consumer chooses the bundle (5, 19, 9). In situation B, when
the prices are (1, 1, 1), the consumer chooses the bundle (12, 12, 12). In
situation C, when the prices are (1, 2, 1) the consumer chooses the bundle (27,
11, 1). Examine whether his choices satisfy the weak axiom of revealed
preference, and whether one can come up with a ranking of the bundles (5, 19,
9), (12, 12, 12) and (27, 11, 1).
4 marks
5. The Laspeyres Index and the Paasche’s Index gives the proportionate increase in
expenditure if one were to consume the same bundle that one did in the base and
the current period respectively. In an economy let citizens consume only vanilla
ice-cream and strawberry ice-cream, and they consider both of them perfect
substitutes and are willing to give up one strawberry ice-cream for every one
vanilla ice-cream. In the base period vanilla ice-cream costs Rs. 2 a cup, and
strawberry ice-cream Rs. 4 a cup. In the current period vanilla ice-cream costs Rs.
8 a cup and strawberry ice-cream Rs. 6 a cup. (a) Calculate and comment on the
extent the Laspeyres Index over-estimates the proportionate increase in
expenditure and the extent to which the Paasche’s Index under-estimates the same
in its own context. (b) The goal of a consumer price index is to measure changes
in the cost of living, mention three problems with the index that are widely
acknowledged but difficult to solve.
7 marks
5 Citizens of India consume two goods, domestic travel and foreign travel
packages, which cost pd and pf per package. The Government of India (GOI)
wants to promote domestic tourism that is encouraging people to travel by
Indian Railways, Indian Airlines and stay in ITDC hotels. It therefore offers
its employees a cash salary X which is taxed at the rate t per unit of cash
earned and a Leave Travel Allowance (LTA) of an amount Y, which will not
be taxed if spent on domestic holiday packages. Citizens have the option to
spend an amount Z which is less than Y on domestic holiday packages, and
can avail cash of the amount Y-Z, but have to pay taxes on the same. (a) Draw
the budget line of a common citizen of India who is a GOI employee. (b)
Indicate on a diagram the income and the substitution effect if GOI reduces
the tax rate to zero, when initial expenditure on domestic holiday packages
was more than Y. (c) Indicate on a diagram the income and the substitution
effect if GOI reduces the tax rate to zero, when initial expenditure on domestic
holiday packages was less than Y.
6 marks

7 A person can work for a maximum of T hours and earn a wage of w per hour.
If his income exceeds I < wT, he will be taxed at a rate of 10% for the extra
income earned above I. Discuss the individuals change in labor supply with
the help of a diagram when there is an increase in the minimum limit I, if his
initial income was less than I. Illustrate the answer with the help of a diagram
with leisure on x axis and income on y axis.
4 marks