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Managerial Economics
Chapter 1
1. Managerial economics:-studies how to direct scarce resources in the way that most
efficiently achieves a managerial goal
2. Levi Strauss & Co. paid $46,532 for a 110-year-old pair of Levi’s jeans—the oldest known
pair of blue jeans—by outbidding several other bidders in an eBay Internet auction. Does this
situation best represent producer–producer rivalry, consumer–consumer rivalry, or producer–
consumer rivalry? Explain.
 Answer:-Consumer–consumer rivalry best illustrates this situation. Here, Levi
Strauss& Co. is a buyer competing against other bidders for the right to obtain the
antique blue jeans.
3. What is the maximum amount you would pay for an asset that generates an income of
$150,000 at the end of each of five years if the opportunity cost of using funds is 9 percent?
 Answer Solution:
PV = 150,000 + 150,000 + 150,000 + 150,000 + 150,000 (1+0.09)1 (1+0.09)2
(1+0.09)3 (1+0.09)4 (1+0.09)5 PV = 150,000 + 150,000 + 150,000 + 150,000 +
150,000 1.09 1.1881 1.2950 1.4115 1.5386 PV = 137,614.67 + 126,251.99 +
115,830.11 + 106,269.92 + 97,491.22 PV = $ 583,457.91
 What is the maximum value that a manager should pay for an oil
rig that generates an income of $155,000 at the end of each of 5 years, if the
opportunity cost of using funds is 8 percent?
 $618,870.06
4. Suppose that the total benefit and total cost from an activity are, respectively, given by the
following equations: B(Q) = 150 + 28Q - 5Q2 and C(Q)= 100 + 8Q. (Note: MB(Q) = 28-10Q
and MC(Q) = 8.)
a) Write out the equation for the net benefits.
b) What are the net benefits when Q 1? Q 5?
c) Write out the equation for the marginal net benefits.
d) What are the marginal net benefits when Q 1? Q 5?
e) What level of Q maximizes net benefits?
f) At the value of Q that maximizes net benefits, what is the value of marginal net
benefits?
Answer:
a) Net Benefit = Total benefit - Total cost =150 + 28Q – 5Q^2 - 100 - 8Q = 50 + 20Q - 5Q^2
b) AtQ = 1 . Net benefit = 50 + 20 - 5 = 65 At Q = 5 ,Net benefit = 50 + 100 - 125 = 25
c) Marginal Net benefit =MB(Q) -MC(Q) =28 – 10Q - 8 = 20 - 10Q
d) At Q = 1 ,Marginal Net benefit = 20 – 10Q = 10, at Q=5 Marginal Net benefit =-30

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((d) What are the marginal net benefits when Q =1? Q = 5? Marginal net benefits when Q = 1 are
MNB(1) = 20 0 = 0 and when Q = 5 they are MNB(5) = = 30. (e) What level of Q maximizes net
benefits? Setting MNB(Q) = 20 0Q = 0 and solving for Q, we see that net benefits are maximized
when Q = 2. (f) At the value of Q that maximizes net benefits, what is the value of marginal net
benefits? When net benefits are maximized at Q = 2, marginal net benefits are zero. That is,
MNB(2) = = 0.
5. A firm’s current profits are $550,000. These profits are expected to grow indefinitely at a
constant annual rate of 5 percent. If the firm’s opportunity cost of funds is 8 percent,
determine the value of the firm:
a) The instant before it pays out current profits as dividends.
b) The instant after it pays out current profits as dividends.
Solution
a) PV firm=550,000(1+0.08/0.08-0.05)=$19.8 million
b. $19,250,000
6. What is the value of a preferred stock that pays a perpetual dividend of $75 at the end of each
year when the interest rate is 4 percent?
 What is the value of a share of Coca Cola preferred stock that pays a perpetual
dividend of $80 at the end of each year when the interest rate is 4 percent?
 d. $2,000
 Maria spends $20,000 per year on painting supplies and storage space. She
recently received two job offers from a famous marketing firm. Offer A was for
$100,000 per year, and offer B was for $90,000 per year. However, she turned
both job offers down to continue a painting career. If Maria sell 20 paintings per
year at a price of $10,000 each, then
a. her economic profit is $90,000 per year.
b. her economic profit is $100,000 per year.
c. her economic profit is $180,000 per year.
d. her accounting profit is $80,000 per year.
e. her accounting profit is $180,000 per year.

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7. It is estimated that over 90,000 students will apply to the top 30 M.B.A. programs in the
United States this year.
a) Using the concept of net present value and opportunity cost, explain when it is
rational for an individual to pursue an M.B.A. degree.
b) What would you expect to happen to the number of applicants if the starting
salaries of managers with M.B.A. degrees remained constant but salaries of
managers without such degrees increased by 15 percent? Why?
Solution

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a) The net present value of student’s application of top 30 M.B.A programs in USA is the value
of benefits which these students are received from attending school minus the opportunity cost of
attending school instead of doing something else. The rational for an individual to pursue an
M.B.A degree when student’s net present value is higher than the opportunity cost or their net
present value is higher than "zero.
b) If the salaries of managers with M.B.A degrees remained constant in while none degrees
managers decreased by 20% percent& it will be increased the present value of student’s
application and decreased the opportunity! cost of getting M.B.A. Therefore& the number of
applicants would expect more students to apply.
8. Jaynet spends $20,000 per year on painting supplies and storage space. She recently received
two job offers from a famous marketing firm—one offer was for $100,000 per year, and the
other was for $90,000. However, she turned both jobs down to continue a painting career. If
Jaynet sells 20 paintings per year at a price of $10,000 each:
a. What are her accounting profits?
b. What are her economic profits?
Solution
a. Accounting profits only look at the actual revenue (in dollars) received and
the actual costs (in dollars) spent. In this scenario her revenue is 20 x $10,000
= $200,000 and her costs are $20,000 (for the supplies). Thus, accounting
profit is $180.000.
b. Economic profits include the monetary revenue and costs but also include
opportunity costs. An opportunity cost is the value of the next best alternative.
In this example she can only take one other job. The best other job would be
the higher paying one of $100,000. Thus, this is her opportunity costs. Hence,
total economic costs are $100,000 + $20,000 = $120,000 so that her economic
profit is $200,000 - $120,000 = $80,000.
9. Suppose the total benefit derived from a given decision, Q, is
B(Q) =25Q -Q2 and the corresponding total cost is C(Q) =5 + Q2, so
thatMB(Q) =25 _ 2Qand MC(Q) =2Q.
a. What is total benefit when Q = 2? Q =10?
b. What is marginal benefit when Q = 2? Q =10?
c. What level of Q maximizes total benefit?
d. What is total cost when Q =2? Q =10?
e. What is marginal cost when Q =2? Q =10?
f. What level of Q minimizes total cost?
g. What level of Q maximizes net benefits?

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Total Cost Function: C(Q)=5+Q2
Total Cost when Q = 2:
C(2)=5+(2)2C(2)=5+4C(2)=9
Total Cost when Q = 10:
C(10)=5+(10)2C(10)=5+100C(10)=105
Ans. b.
Marginal Cost Function:
MC(Q)=2Q
Marginal Cost when Q = 2:
MC(2)=2(2)MC(2)=4
Marginal Cost when Q = 10:
MC(10)=2(10)MC(10)=20
Ans. c.
The total cost is minimized at a level where the first derivative of the total cost function with
respect to quantity becomes equal to zero.
⇒ddQ(C(Q))⇒ddQ(5+Q2)⇒2Q
Equating the first-order derivative with zero:
2Q=0Q=0
The total cost of production is minimized when the total quantity produced is zero.
Ans. d.
Net Benefit Function:
NB=25Q−Q2−5−Q2NB=−2Q2+25Q−5
Net benefits will be maximized at the point where the first-order derivative of the net benefit
function becomes zero:
⇒ddQ(NB)⇒ddQ(−2Q2+25Q−5)⇒−4Q+25
Equating the first-order derivative with zero:
−4Q+25=04Q=25Q=6.25
Net benefits are maximized when the quantity is equal to 6.25 units.

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10. An owner can lease her building for $100,000 per year for three years. The explicit cost of
maintaining the building is $35,000, and the implicit cost is $50,000. All revenues are received,
and costs are borne, at the end of each year. If the interest rate is 4 percent, determine the present
value of the stream of:
a. Accounting profits.
b. Economic profits.
I'm giving you answer of a very similar question. Solve this question same way. It will be helpful
for you. Question- An owner can lease her building for $120,000 per year for three years. The
explicit cost of maintaining the building is $40,000, and the implicit cost is $55,000. All
revenues are received, and costs borne, at the end of each year. If the interest rate is 5 percent,
determine the present value of the stream of: Answer- Accounting Profit: First you need to start
with the Account Profit formula: Accounting Profit = Total Revenue - Explicit Cost Accounting
Profit = 120,000-40,000 Accounting Profit = 80,000 After you find your Accounting Profit you
need to use the Present Value of a Stream Formula which is: PV = FV1/(1+i)^1 + FV2/(1+i)^2 +
FV3/(1+i)^3 After plug in what you know.. PV = 80,000/(1+5%)^1 + 80,000/(1+5%)^2 +
80,000/(1+5%)^3 PV = 217,859.84.
11. 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 $500 and will
save you $25 at the end of each 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 $400. Assuming your opportunity cost of funds is 5 percent, which refrigerator
should you purchase?
(15) pts) You are in the market for a new refrigerator for your company’s lounge. You have
narrowed the search down to 2 models. The energy efficient model sells for $700 and will save
you $45 at the end of each of the next 5 years in electricity costs. The standard model has the
same features as the energy efficient model, but no savings in electricity costs. It is priced only at
$500.
a. Assuming that the discount rate is 6% and each refrigerator will last 5 years (and have the
same scrap value), which refrigerator should you purchase?
b. If the savings from the energy efficient model go up to $75 a year because of higher electricity
costs, will your decision change? Why?
ANSWER TO #1 a. Effectively, this is a question of whether it pays to spend an extra $200 on a
refrigerator today to save $45 over the next 5 years. You need to calculate the PV of the $45 over
5 years and see if this is less than or greater $200. PV = 45/(1+.06) + 45/(1+.06) 2 + 45/(1+.06) 3
+ 45/(1+.06) 4 + 45/(1+.06) 5 = $189.6 Since you are spending an extra $200 in today’s dollars
and only saving $189.6 in today’s dollars, you should not buy the energy efficient refrigerator.
Alternatively, you could have said that the energy efficient model net cost in today’s dollars is -
$510.5 (-$700 + 189.6) versus the standard model cost in today’s dollars of -$500. Since the cost
of the energy efficient refrigerator is greater than the cost of the standard model in today’s
dollars, you should not buy the energy efficient refrigerator

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b. With a saving of $75 each year for 5 years, the present value of those savings today is: PV =
75/(1+.06) + 75/(1+.06) 2 + 75/(1+.06) 3 + 75/(1+.06) 4 + 75/(1+.06) 5 = $315.9 Since the
savings of $75 for five years is worth $315.90 today, the net cost of the energy efficient
refrigerator today is $385.10 (or $700 - $315.90) which is less than $500 for the standard
refrigerator. You should buy the energy efficient refrigerator.
12. You are the human resources manager for a famous retailer, and you are trying to convince
the president of the company to change the structure of employee compensation. Currently, the
company’s retail sales staff is paid a flat hourly wage of $18 per hour for each eight-hour shift
worked. You propose a new pay structure whereby each salesperson in a store would be
compensated $8 per hour, plus five-tenths of 1 percent of that store’s daily profits. Assume that,
when run efficiently, each store’s maximum daily profits are $40,000. Outline the arguments that
support your proposed plan.
 The employee’s pay depends on store profit so they will work hard to achieve higher
profit.
13. Tara is considering leaving her current job, which pays $56,000 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 $20 per unit. With
annual overhead costs and operating expenses amounting to $3,160,000, Tara expects a profit
margin of 25 percent. This margin is 6 percent 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?
Solution
a) accounting cost(explicit cost)=$3,160,000 overhead and operating cost, implicit
cost=56,000 salary,opportunity cost=implicit cost + explicit
cost=3,160,000+56,000=3,216,000
b) to earn positive accounting profit the revenue per year should be greater than 3,160,000
and to earn positive economic profit the revenue per year should be greater than
3,216,000
14. You are the manager of Local Electronics Shop (LES), a small brick-and-mortar retail
camera and electronics store. One of your employees proposed a new online strategy whereby
LES lists its products at Pricesearch.com—a price comparison Web site that allows consumers to
view the prices of dozens of retailers selling the same items. Would you expect this strategy to
enable LES to achieve sustainable economic profits? Explain.
 Answer: The correct answer is No, because due to intense producer-producer rivalry.
Explanation: In economics, competition means rivalry of competition between companies
that participate in a market that apply better strategies so that they can minimize their

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costs, maximize their profits and thus remain active and innovative vis-à-vis other
companies. With this, it seeks that the economic agents strive to improve the use of
resources to produce goods and services, and to improve and innovate in the quality and
variety of these, with the purpose that results in improvements in competitiveness and
more benefit for the consumer , all this to achieve greater economic growth and social
welfare.
15. Two months ago, the owner of a car dealership (and a current football star) significantly
changed his sales manager’s compensation plan. Under the old plan, the manager was paid a
salary of $6,000 per month; under the new plan, she receives 2 percent of the sales price of each
car sold. During the past two months, the number of cars sold increased by 40 percent, but the
dealership’s margins (and profits) significantly declined. According to the sales manager,
“Consumers are driving harder bargains and I have had to authorize significantly lower prices to
remain competitive.” What advice would you give the owner of the dealership?
 Increase the percentage of the sales price the manager receives.
 Offer the manager a percentage of profits rather than sales.
 Pay the manager a fixed salary only.
CHAPTER-2
DEMAND AND SUPPLY
Q#1.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.
Solution
a. How will the demand for good X change if consumer incomes increases?
Since X is a normal good then its demand will shift out when income levels increase.
b. How will the demand for good Y if consumer incomes decreases?
Since Y is an inferior good its demand will shift in if income increases.
c. How will the demand for good X change if the price of good Y decreases?
Since the two are substitute goods a decrease in the price of Y draws away consumers from X.
Thus, the demand for X shifts in.
d. Is good Y a lower-quality product than good X? Explain.
Probably not, but this is a weird question. All we know is that it is an normal good so that people
with higher incomes consume it and it has a substitute which is an inferior good. So it seems

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likely that it is of higher quality. What is an easier argument to make is that a lower-quality good
tends to be an inferior good and a higher-quality good tends to be a normal good.
Q#2.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:
c. The price of input A increases.
d. An excise tax of $1 is imposed on good X.
e. An ad valorem tax of 5 percent is imposed on good X.
f. Atechnological change reduces the cost of producing additional units of good X.
Solution
a. The price of input A increases.
Supply would shift in.
b. An excise tax of $1 is imposed on good X.
Supply would shift in.
c. An ad valorem tax of 5 percent os imposed on good X.
Supply would shift in.
d. A technological change reduces the cost of producing additional units of good X.
Supply would shift out.
Q#3.Suppose the supply function for product X is given by Qx
s
=- 50 + 0.5Px- 5Pz.
g. How much of product X is produced when Px =$500 and Pz =$30?
h. How much of product X is produced when Px= $50 and Pz =$30?
i. Suppose Pz =$30. Determine the supply function and inverse supply function for
good X. Graph the inverse supply function.
Solution
a. How much of product X is produced when P of x = $500 and P of z = $30? 50
b. How much of product X is produced when P(Price) of x = $50 and P(Price) of z = $30?
I think there may be either a typo in this question or it is a trick question. Plug in the prices Q = -
175, which cannot happen. At these low prices no firm would supply the good. I would say the
answer is zero.
c. Suppose P(price) of z = $30. Determine the supply function and inverse supply function for
good X. Graph the inverse supply function.
The supply function is Qs = 0.5Px - 200. The inverse supply function is Px = 2Q + 400. The line
you graph should be a straight line with a positive slope. It should hit the y-axis at a price of 400.

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Q#4. The demand for good X is given by
Qxd
=1,200-1/2 Px +1/4 Py -8Pz+1/10M
Research shows that the prices of related goods are given by Py =$5,900 and Pz=$90, while the
average income of individuals consuming this product is M=$55,000.
a. Indicate whether goods 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 Px =$4,910?
d. Determine the demand function and inverse demand function for good X. Graph
the demand curve for good X.
Solution
a. Indicate whether goods Y and Z are substitutes of complements for good X.
The sign of the coefficient in front of the price of good Y is positive, +(1/4). This
means that an increase in the price of good Y increases the quantity demanded of
good X (even when the price of X stays the same). This happens when consumers of
good Y shift their demand to X when Y becomes more expensive. Thus, they are
substitutes.
The sign of the coefficient in front of the price of good Z is negative, -8. This means
that an increase in the price of good Z decreases the quantity demanded of good X
(even when the price of X stays the same). This happens when consumers of good Z
(who consume a smaller quantity of good Z) also decrease their demand for Z. Thus,
they are complements.
b. Is X an inferior or a normal good?
The sign of the coefficient in front of the income variable is positive, +(1/10). Thus,
an increase in income, M, increases the quantity demanded. Thus, X is a normal
good.
c. How many units of good X will be purchased when P(Price) of x = $4,910?
Using the earlier numbers Q = 1200 - .5(4910) +.25(5900) - 8(90) + .1(55000) = 1200
- 2455 + 1475 - 720 +5500 = 5000. Thus, 5000 units will be demanded.
d. Determine the demand function and inverse demand function for good X. Graph
the demand curve for good X.
The demand curve is given in the problem Q = 1200 - .5Px +.25Py - 8Pz +.1M. The
inverse demand curve simply solves this for Px, or rather, Px = 2400 - 2Q + .5Py -
16Pz + .2M.
I cannot graph this for you here. But I can describe it. Px should be on the vertical
axis and Q on the horizontal. The demand curve should be a straight, downward-
sloping line (the slope is -2). It should intercept the y-axis at 2400 + .5py - 16Pz +
.2M.

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5. The demand curve for product X is given by Qxd=
460 - 4Px.
a. Find the inverse demand curve.
b. How much consumer surplus do consumers receive when Px =$35?
c. How much consumer surplus do consumers receive when Px =$25?
d. In general, what happens to the level of consumer surplus as the price of a good
falls?
Solution
a. Find the inverse demand curve.
PX = - QXd
Instructions: Round your answer to the nearest penny (2 decimal places).
b. How much consumer surplus do consumers receive when Px = $35?$
c. How much consumer surplus do consumers receive when Px = $25?$
d. In general, what happens to the level of consumer surplus as the price of a good falls?
The level of consumer surplus (Click to select)doesn't change increases decreases as the price of
a good falls.
6. Suppose demand and supply are given by Qd
=50- P and Qs
=1/2P -10.
a) What are the equilibrium quantity and price in this market?
b) Determine the quantity demanded, the quantity supplied, and the magnitude of the
surplus if a price floor of $42 is imposed in this market.
c) Determine the quantity demanded, the quantity supplied, and the magnitude of the
shortage if a price ceiling of $30 is imposed in this market. Also, determine the full
economic price paid by consumers.
Solution
a. What are the equilibrium quantity and price in this market?
You need to find the price where the quantity demanded equals the quantity supplied, or rather,
the P* where 50 - P* = (1/2)P* - 10. Simplifying, 60 = (3/2)P*, or rather, P* = 120/3 = 40. Thus,
the equilibrium price is 40. You can plug it into either the demand or supply curve to find the
quantity (both allows you to double check). The equilibrium quantity is 10.
b. Determine the quantity demanded, the quantity supplied, and the magnitude of the surplus is a
price floor of $42 is imposed in this market.
A price floor is a minimum allowable price. Since equilibrium is at $40 the floor matters. At a
price of 42 the quantity demanded is Qd = 50 - 42 = 8. At a price of 42 the quantity supplied is
Qs = (1/2)(42) - 10 = 21 - 10 = 11.

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c. Determine the quantity demanded, the quantity supplied, and the magnitude of the shortage if
a price ceiling of $30 is imposed in this market. Also, determine the full price paid by
consumers.
A price ceiling is a maximum allowable price. At a price of 30 the quantity demanded is Qd = 50
- 30 = 20. The quantity supplied is Qs = (1/2)(20) - 10 = 0. The shortage is the gap between the
quantity demanded and the quantity supplied, or rather, 20 - 0 = 20. I have never heard of the
term "full price", but I expect it means the price charged for the goods, which is $30.
7. Suppose demand and supply are given byQx
s
=7-1/2px and Qx
s
=1/4px-1/2
a. Determine the equilibrium price and quantity. Show the equilibrium graphically.
b. Suppose a $6 excise tax is imposed on the good. Determine the new equilibrium
price and quantity.
c. How much tax revenue does the government earn with the $6 tax?
Solution
a. Determine the equilibrium price and quantity. SHow the equilibrium graphically.
You need to find the price where the quantity demanded equals the quantity supplied, or rather,
the P* where 7 - (1/2)P* = (1/4)P* - 1/2. Simplifying, 15/2 = (3/4)P*, or rather, P* = 30/3 = 10.
Thus, the equilibrium price is 10. You can plug it into either the demand or supply curve to find
the quantity (both allows you to double check). The equilibrium quantity is 2.
Again, I can only explain what the graph should look like. The demand curve should be a
straight, downward-sloping line. It intersects the y-axis at a price of 14 and intersects the x-axis
at a quantity of 7. The supply curve is a straight, upward-sloping line. It hits the y-axis at a price
of 2.
b. Suppose a $6 excise tax is imposed on the good. Determine the new equilibrium price and
quantity.
To model an excise tax the supply curve needs to shift up by $6. The old supply curve can be
rewritten as P = 4Q + 2. Add 6 to the intercept term to shift it up for the new tax to P = 4Q + 8,
which can be rewritten in the typical form Q = (1/4)P - 2. Setting this equal to the demand curve
you get (1/4)P - 2 = 7- (1/2)P, which simplifies to (3/4)P = 9, or rather, P = 36/3 = 12. The new
equilibrium price is 12. To find the quantity plug this into the demand curve, Q = 7 - (1/2)(12) =
7 - 6 = 1. The new equilibrium quantity is 1.
c. How much tax revenue does the government earn with the $6 tax?
One unit is sold at a $6 is charged. Thus, total tax revenue is $6.
8. The supply curve for product X is given by Qs
x
= -340 +10P x
.
a. Find the inverse supply curve.
b. How much surplus do producers receive when Qx
=350? When Qx
=1,000?
a)Inverse supply curve P=34+Q/10

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b) QX=350, PX=34+1/10(350)=34+35=69
QX=1000,px=34+1/10(1000)=134
11.You are the manager of a midsized company that assembles personal computers. You
purchase most components such as random access memory (RAM) in a competitive market.
Based on your marketing research, consumers earning over $75,000 purchase 1.3 times more
RAM than consumers with lower incomes. One morning, you pick up a copy of The Wall Street
Journal and read an article indicating that a new technological breakthrough will permit
manufacturers to produce RAM at a lower unit cost. Based on this information, what can you
expect to happen to the price you pay for random access memory? Would your answer change if,
in addition to this technological breakthrough, the article indicated that consumer incomes are
expected to grow over the next two years as the economy pulls out of recession? Explain.
 In this case, the price of the RAM can rise because cost increase, assume the news of the
Wall Street Journal, people with earning lower $80,000 they won't buy RAM because is
too expensive, and people with over these earnings will buy less RAM, in addition, the
incomes will fall, and the demand of RAM will fall too, but for the same reason the price
could fall for the poor demand.
12. 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?
 The tariff leads to decrease in supply of sugar and hence the prices of sugar shall rise
which form input products to soft drinks. Thus increasing soft drink prices will now lead
to decrease in supply of generic soft drinks.
 Now due to aggressive marketing by Coke and Pepsi the demand fir generic soft drinks
shall reduce and hence the equilibrium quantity will reduce and so will the equilibrium
prices.
13. Some have argued that higher cigarette prices do not deter smoking. While there are many
arguments both for and against this view, some find the following argument to be the most
persuasive of all: “The laws of supply and demand indicate that higher prices are ineffective in
reducing smoking. In particular, higher cigarette prices will reduce the demand for cigarettes.
This reduction in demand will push the equilibrium price back down to its original level. Since
the equilibrium price will remain unchanged, smokers will consume the same number of
cigarettes.” Do you agree or disagree with this view? Explain.
15. 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.

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16. You are an assistant to a senator who chairs an ad hoc committee on reforming taxes on
telecommunication services. Based on your research, AT&T has spent over $15 million on
related paperwork and compliance costs. Moreover, depending on the locale, telecom taxes can
amount to as much as 25 percent of a consumer’s phone bill. These high tax rates on telecom
services have become quite controversial, due to the fact that the deregulation of the telecom
industry has led to a highly competitive market. Your best estimates indicate that, based on
current tax rates, the monthly market demand for telecommunication services is given by Qd
=250-5P and the market supply (including taxes) is Qs =4P-110 (both in millions), where P is the
monthly price of telecommunication services. The senator is considering tax reform that would
dramatically cut tax rates, leading to a supply function under the new tax policy of Qs =4.171P -
110. How much money would a typical consumer save each month as a result of the proposed
legislation?

15. 15

16. 16

17. 17

18. 18

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CHAPTER 2
DEMAND ELASTICITY
1. Answer the following questions based on the accompanying diagram.
a. How much would the firm’s revenue change if it lowered price from $12 to$10? Is
demand elastic or inelastic in this range?
b. How much would the firm’s revenue change if it lowered price from $4 to$2? Is demand
elastic or inelastic in this range?
c. What price maximizes the firm’s total revenues? What is the elasticity ofdemand at this
point on the demand curve?
Answer a) When price is $12,Revenue = Demand X Price= 1 X $12= $12
When price is $10,Revenue = Demand X Price= 2 X $10= $20
The change in revenue is $8.
Price elasticity of demand= % change in quantity /% change in price
= 50% / -17%= - 2.94The value of -2.94 means that when price decrease, demand will increase
and vice versa.This shows that demand of the product is inelastic
2.The demand curve for a product is given byQxd
=1,000-2Px+0.02Pz,where Pz=$400.
a) What is the own price elasticity of demand when Px=$154? Is demand elastic or inelastic
at this price? What would happen to the firm’s revenue if it decided to charge a price
below $154?
b) What is the own price elasticity of demand when Px=$354? Is demand elastic or inelastic
at this price? What would happen to the firm’s revenue if it decided to charge a price
above $354?
c) What is the cross-price elasticity of demand between good X and good Z when Px=$154?
Are goods X and Z substitutes or complements?
Solution Preview
1. The demand curve for a product is given by Qdx =1,000 - 2Px +.02Pz where Pz = $400.
a. What is the own price elasticity of demand Px = $154? Is demanded elastic or inelastic at this
price? What would happen to the firm's revenue if it decided to charge a price below $154?
Qdx =1,000 - 2Px +.02Pz
On, differentiating with respect to Px, we get
d(Qdx)/dPx=-2
Value of Qdx at Px=$154 and Pz=$400
Qdx=1000-2*154+0.02*400=700

20. 20
Own price elasticity of demand= [d(Qdx)/dPx]*[Px/Qdx]
=-2*(154/700)=-0.44
Absolute value of own price elasticity of demand is less than 1, we can say that demand is
inelastic at Px=$154.
In case of inelastic demand, total revenue will decrease if price decreases. We can say that total
revenue will fall if firm changes a price below $154.
b. What is the own price elasticity of demand Px = $354? Is demanded elastic or inelastic at this
price? What would happen to the firm's revenue if it decided to charge a price below $354?
Qdx =1,000 - 2Px +.02Pz
On, differentiating with respect to Px, we get
d(Qdx)/dPx=-2
Value of Qdx at Px=$354 and Pz=$400
Qdx=1000-2*354+0.02*400=300
3. Suppose the demand function for a firm’s product is given by
lnQd
x=3-0.5lnPx-2.5Py+lnM+2lnA
WherePx=10, Py=4, M=20,000 ,A=250
a. Determine the own price elasticity of demand, and state whether demand iselastic,
inelastic, or unitary elastic.
b. Determine the cross-price elasticity of demand between good X and goodY, and
state whether these two goods are substitutes or complements.
c. Determine the income elasticity of demand, and state whether good X is anormal
or inferior good.
d. Determine the own advertising elasticity of demand.
Answer
a. Own price elasticity of demand = lnQx/ lnPx.
E = -1.5
Demand is elastic because the absolute value of the elasticity is greater than one.
b. Cross price elasticity Ec = Ln Qx/ Ln Py.
Ec = 2.
the two goods in question are substitutes. This is because a positive relation between
the price of one and demand of the other proves the same. As the price of one

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increases, the other automatically becomes cheaper to buy and hence the demand
increases.
c. Income elasticity Em = Ln Qx/ Ln M.
Em = -0.5.
Negative sign shows that the good X is an inferior good.
d. Advertising elasticity Ea = Ln Qx/ Ln A.
Ea = 1.
4. Suppose the own price elasticity of demand for good X is -2, its income elasticityis 3, its
advertising elasticity is 4, and the cross-price elasticity ofdemand between it and good Y is -6.
Determine how much the consumptionof 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.
5. 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 theconsumption of good X by 50 percent?
The formula for cross-price elasticity of demand (CPE) is the following:
Next, we plug in the given values of CPE and percentage change of...
See full answer below.
6. You are the manager of a firm that receives revenues of $30,000 per year fromproductXand
$70,000 per year from product Y. The own price elasticity ofdemand for product X is -2.5, and
the cross-price elasticity of demand betweenproductYandX is 1.1. How much will your firm’s
total revenues (revenuesfrom both products) change if you increase the price of good X by 1
percent?
Answer
It is given that the own price elasticity if -2.5, it implies that a 1% change rise in the price level
will decrease the demand for product X by 2.5%
Therefore, revenue loss on product X would be:

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30,000*(-2.5)/100=-750 similarily
Cross price elasticity of demand is given as 1.1, it implies that 1% increase in the price of good x
will lead to an increase in the demand for product y would be 1.1
Therefore, the revenue gain on product would be:
70,000*1.1/100=770
Using the change in revenue of both product, firms total revenue would be :-
-750+770=20 hence 1% change in the price of product x leads to increase in the total revenue of
the firm by 20.
7. Revenue at a major cellular telephone manufacturer was $1.4 billion for the ninemonths
ending March 2, up 97 percent over revenues for the same period lastyear. Management
attributes the increase in revenues to a 137 percent increase inshipments, despite a 17 percent
drop in the average blended selling price of itsline of phones. Given this information, is it
surprising that the company’s revenueincreased when it decreased the average selling price of its
phones? Explain.
8. You are the manager of a firm that sells a leading brand of alkaline batteries.A file named
Q12.xls with data on the demand for your product is availableonline at www.mhhe.com/baye7e.
Specifically, the file contains data on thenatural logarithm of your quantity sold, price, and the
average income of consumersin various regions around the world. Use this information to
perform alog-linear regression, and then determine the likely impact of a 3 percentdecline in
global income on the overall demand for your product.
9. 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 volumeof all cereal sold by Big G dropped
by 3 percent, what can you infer aboutthe own price elasticity of demand for Big G cereal? Can
you predict whetherrevenues on sales of its Lucky Charms brand increased or decreased?
Explain.
10. If Starbucks’s marketing department estimates the income elasticity of demandfor its coffee
to be 1.75, how will looming fears of a recession (expected todecrease consumers’ incomes by 4
percent over the next year) impact the quantityof coffee Starbucks expects to sell?
11. You are a division manager at Toyota. If your marketing department estimates thatthe
semiannual demand for the Highlander is Q = 100,000 -1.25P, what price should you charge in
order to maximize revenues from sales of the Highlander?
 Given the semi-annual demand for the Highlander is Q = 100,000 – 1.25P Or P =
(100,000 / 1.25) – (1// 1.25)*Q P = 80,000 - 0.8Q
Total revenue (TR) = P*Q = 80,000Q - 0.8Q^2
MR = 80,000 - 1.6Q (differentiating TR w.r.t. Q) Total revenue is maximum when
marginal revenue is zero, .
The profit maximizing quantity and price can be determined by setting marginal revenue
equal to zero, which occurs...

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12. You are a manager in charge of monitoring cash flow at a company that makesphotography
equipment. Traditional photography equipment comprises 80 percentof your revenues, which
grow about 2 percent annually. You recentlyreceived a preliminary report that suggests
consumers take three times more digitalphotographs than photos with traditional film, and that
the cross-price elasticityof demand between digital and disposable cameras is -0.2. In 2009,
yourcompany earned about $400 million from sales of digital cameras and about$600 million
from sales of disposable cameras. If the own price elasticity ofdemand for disposable cameras is
-2.5, how will a 1 percent decrease in theprice of disposable cameras affect your overall revenues
from both disposableand digital camera sales?
(a) Own-price elasticity for disposable camera = % Change in quantity of disposable camera / %
Change in its own price -2.5 = % Change in quantity of disposable camera / (-1%) % Change in
quantity of disposable camera = (-2.5) x (-1)=2.5
13. The owner of a small chain of gasoline stations in a large Midwestern town read an article in
a trade publication stating that the own-price elasticity of demand for gasoline in the United
States is -0.2. Because of this highly inelastic demand in the United States, he is thinking about
raising prices to increase revenues and profits. Do you recommend this strategy based on the
information he has obtained? Explain?
 B. Yes - since his elasticity is -0.2, a price increase will raise revenues.
CHAPTER 3
Production and Costs
A firm can manufacture a product according to the production function
Q=F(K, L)K3/4L1/4
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, MPL, 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?
Solution
1a. k=81,L=16
Q=(81)3/4
(16)1/4
=54 APL=Q/L=54/16=3.38

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1b. K=81
Q=(81)3/4
L1/4=27*L1/4
MPL=dQ/dL=27*1/4/L3/4
When L=16,MPL=6.75*/(16)3/4=0.84
When L=81,MPL=6.75*/(81)3/4=0.25
1c. L =16.
2. Afirm’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 Q F(K, L) K3/4L1/4 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.
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?
Solution
2a. Labor is the fixed input while capital is the variable input
2B. FIXED COST=20*15=300
2C) 475 UNITS CAN BE PRODUCED BY either 6 and 7 units of capital so the variable cost of
producing 475 units is 450 or 525
2d) firms must hire capital upto the point where the difference b/n the vmpk and its rental price is
minimum. This occurs at K=6
2e) total cost=300+6*75=750
Total revenue =2*475=950
Profit=TR-TC=200
2f) Till K=3, there is increasing marginal returns

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2g) Till k=4 till k=7 there are diminishing marginal returns
2h) k=8 there is negative marginal returns
3. Explain the difference between the law of diminishing marginal returns and the law of
diminishing marginal rate of technical substitution.
4. An economist estimated that the cost function of a single-product firm is
C(Q)=50+25Q+30Q2
+5Q3
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 when Q 10.
Solution
4. a. FC = $50.
5. A manager hires labor and rents capital equipment in a very competitive market. Currently the
wage rate is $6 per hour and capital is rented at $12 per hour. If the marginal product of labor is
50 units of output per hour and the marginal product of capital is 75 units of output per hour, is
the firm using the cost-minimizing combination of labor and capital? If not, should the firm
increase or decrease the amount of capital used in its production process? C(Q) 50 25Q 30Q2
5Q3
6. A firm’s fixed costs for 0 units of output and its average total cost of producing different
output levels are summarized in the table below. Complete the table to find the fixed cost,
variable cost, total cost, average fixed cost, average variable cost, and marginal cost at all
relevant levels of output.
7. A multiproduct firm’s cost function was recently estimated as
C(Q1, Q2)=75-0.25Q1Q2+0.1Q1
2
+0.2Q2
2
a. Are there economies of scope in producing 10 units of product 1 and 10 units of product 2?
b. Are there cost complementarities in producing products 1 and 2?

26. 26
c. Suppose the division selling product 2 is floundering and another company has made an offer
to buy the exclusive rights to produce product 2. How would the sale of the rights to produce
product 2 change the firm’s marginal cost of producing product 1?
Solution
7. b. Cost complementarities exist since a =0.25 < 0
8. Explain the difference between fixed costs, sunk costs, and variable costs. Provide an example
that illustrates that these costs are, in general, different.
9. A firm produces output according to a production function Q =F(K,L) =min {2K,4L}.
a. How much output is produced when K =2 and L =3?
b. If the wage rate is $30 per hour and the rental rate on capital is $10 per hour, what is the cost-
minimizing input mix for producing 4 units of output?
c. How does your answer to part b change if the wage rate decreases to $10 per hour but the
rental rate on capital remains at $10 per hour?
10. A firm produces output according to the production function Q = F(K,L) =2K+4L.
a. How much output is produced when K =2 and L= 3?
b. If the wage rate is $30 per hour and the rental rate on capital is $10 per hour, what is the cost-
minimizing input mix for producing 16 units of output?
c. How does your answer to part b change if the wage rate decreases to $10 per hour but the
rental rate on capital remains at $10 per hour? C(Q1, Q2) 75
Chapter-4
Market structure
1. Ten firms compete in a market to sell product X. The total sales of all firms selling the
product are $1 million. Ranking the firms’sales from highest to lowest, we find the top four
firms’sales to be $175,000, $150,000, $125,000, and $100,000, respectively. Calculate the
four-firm concentration ratio in the market for product X.
Solution
175,000+150,000+125,000+100,000/1000000=0.55
2. Evaluate the following statement: “Managers should specialize by acquiring only the tools
needed to operate in a particular market structure. That is, managers should specialize in
managing either a perfectly competitive, monopoly, monopolistically competitive, or
oligopoly firm.”

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 Managers should not specialize in learning to manage a particular type of
marketstructure.
 Market structure generally evolves over time, and managers must adapt tothese changes.
3. Consider a firm that operates in a market that competes aggressively in prices. Due to the
high fixed cost of obtaining the technology associated with entering this market, only a
limited number of other firms exist. Furthermore, over 70 percent of the products sold in this
market are protected by patents for the next eight years. Does this industry conform to an
economist’s definition of a perfectly competitive market?
No. The conditions for perfect competition include:
a. There are many buyers and sellers of products.
b. The products are homogenous.
c. Consumers and producers have perfect information.
d. There is free entry and exit
4. Firms like Papa John’s, Domino’s, and Pizza Hut sell pizza and other products that are
differentiated in nature. While numerous pizza chains exist in most locations, the differentiated
nature of these firms’products permits them to charge prices above marginal cost. Given these
observations, is the pizza industry most likely a monopoly, perfectly competitive,
monopolistically competitive, or an oligopoly industry? Use the causal view of structure,
conduct, and performance to explain the role of differentiation in the market for pizza. Then
apply the feedback critique to the role of differentiation in the industry.
 The pizza market belongs to the monopolistic compitetive market with a few large firms
but tens of thousands of small independent family owned outlets.
5. Del Monte has a long and rich tradition in the American food processing industry. It is perhaps
best known for packaging canned fruits and vegetables. Part of its success has involved acquiring
other brands of canned fruits and vegetables. Suppose that Del Monte is continuing its business
plan of expansion by acquisition and that the following table summarizes potential acquisition
targets. As the CEO’s horizontal merger and acquisition advisor, it is your task to guide the
decision-making process. Based only on the information contained in the table, is a horizontal
merger with one of these companies likely to pass the U.S. government’s scrutiny and enhance
Del Monte’s performance? Justify your conclusion.
Answer
 Based on the information united states government scrutiny will not allow Del monte to
acquire an other company.
6. In January 2007, XM enjoyed about 58 percent of satellite radio subscribers, and Sirius had
the remaining 42 percent. Both firms were suffering losses, despite their dominance in the
satellite radio market. In 2008, the DOJ decided not to challenge a merger, and these two firms
united to become Sirius XM. If you were an economic consultant for Sirius, what economic
arguments would you have presented to the DOJ to persuade it not to challenge the merger?
Explain.
 I woudld persuade the DOJ not to challenge the merger on the bases that the market for
satellite radio is unit elastic. A consumer have a choice.