Practical Asset Pricing ECM 152

Class 8
Fabio Calonaci
Semester C, 2023

1. Solution a:

The solution is the following:

Reference value = $85,000
Positive differentiation value = (0.185-0.01)*$100,000 = $18,500 (costs saved from
using StableServer)
Negative differentiation value = (15-10)*1,500 = $7,500 (added costs from using
StableServer)
EVC = $85,000 + $18,500 - $7,500 = $96,000

Solution b:

1 End-Benefit effect: When your product is an essential part of a known end-use

2 Shared-Cost effect: When the cost is shared

3 Advantageous mental account: Customers have different mental accounts which

they evaluate separately when they make purchase decisions

2. Solution:

• Theres long-standing tension between economics and marketing despite the fact
that marketing is an offshoot of economic

• Marketing is really the blending of economics and psychology (with a little

sociology thrown in)

• The major difference between economics and marketing is that economists be-
lieve consumers are rational and seek products providing the greatest utility

• Marketers accept that consumers (including business consumers) are sometimes

(often) irrational else why would middle-aged men like red corvettes

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 – Utility includes social status, ego stroking, group affinity and lots more
borrowed from psychology and sociology
3. Assume that an apartment rents for $650 per month and, at that price, 10,000 units
are rentedyou can see these number represented graphically below. When the price
increases to $700 per month, 13,000 units are supplied into the market. By what
percentage does apartment supply increase? What is the price sensitivity?
• We know that
percent change in quantity
Price Elasticity of Supply =
percent change in price

• From the midpoint method we know that

Q2 − Q1
percent change in quantity = × 100
(Q2 + Q1 ) ÷ 2
P2 − P 1
percent change in price = × 100
(P2 + P1 ) ÷ 2

• We can use the values provided in the figure in each equation

13, 000 − 10, 000 3, 000
percent change in quantity = × 100 = × 100 =
(13, 000 + 10, 000) ÷ 2 11, 500
26.1
700 − 650 50
percent change in price = × 100 = × 100 = 7.4
(700 + 650) ÷ 2 675

• Then, those values can be used to determine the price elasticity of demand
26.1 percent
Price Elasticity of Supply = = 3.53
7.4 percent

• Again, as with the elasticity of demand, the elasticity of supply is not followed
by any units. Elasticity is a ratio of one percentage change to another percentage
changenothing moreand is read as an absolute value

• In this case, a 1% rise in price causes an increase in quantity supplied of 3.5%.

Since 3.5 is greater than 1, this means that the percentage change in quantity
supplied will be greater than a 1% price change

• If youre starting to wonder if the concept of slope fits into this calculation, read
on for clarification
4. Solution:
Price elasticities.

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 • The calculation is % change in income = [($60,000 - $50,000)/($60,000+$50,000)/2]=($10,000/$
=18.18% item % change in quantity demanded = [(5-3)/(5+3)/2]= (2/4)x100

= 50

• Hence the income elasticity of demand is 50/18.18 = 2.75

• The income elasticity of demand is positive and therefore it is a normal good

5. Solution:
Cross-price elasticities.

• Complement goods have negative cross price elasticities

• If good A is a complement for good B, like coffee and sugar, then a higher price
fo B will mean a lower quantuty of A consumed
•

6. Solution:
Cross-price elasticities.

• The calculation is % change in price = [($450 - $400)/($450+$400)/2]=($50)/($450)x100

=11.76% item % change in quantity demanded = [(20-15)/(20+15)/2]= (5/17.5)x100

= 28.57

• Hence the income elasticity of demand is 28.57/11.76 = 2.43

• The cross price elasticity of demand is positive and therefore they are substitutes
goods

7. Solution:

• The income elasticity of demand for doughnuts is equal to the percentage change
in the quantity demanded of doughnuts divided by the percentage change in
income

• Since a recession is a slowdown in total production in the economy and therefore

is typically accompanied by higher rates of unemployment, we should anticipate
that income will fall.

• Since the income elasticity of demand is positive, doughnuts are a normal good.

• Thus, the demand for doughnuts at every price will also fall: the demand curve
for doughnuts will shift to the left holding everything else constant.

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