Econ Assignment V2

MANAGERIAL ECONOMICS ASSIGNMENT

Table of Contents

Assignment Question no: 1............................................3Assignment Question no: 2............................................5

Assignment Question no: 3............................................7Assignment Question no: 4............................................9

Assignment Question no: 5...........................................11Assignment Question no: 6...........................................13

Assignment Question no: 7...........................................16Assignment Question no: 8...........................................19

Reference...........................................................22

Managerial Economics Assignment of 29

Assignment Question no: 1

a) Explain the concept behind the production possibilities frontier.

The production possibilities frontier (PPF) or "production

possibilities curve” shows a combination of two goods and services

that can be produced with the full available factors of production

and technology (Arnold, 2010). The production possibility curve is

represented in the below diagram.

Figure-1 Production Possibility Frontier

In the above diagram which indicates that at the production at

point X the output of Product A is A2 and output of Product B

is B2.

If suppose the product B is increased from B2 to B1 the

product A will decrease.

In the production possibilities frontier W indicates that the

resources are not fully utilized efficiently.

In the production possibilities frontier Z indicates that the

additional resources are required to product at a point beyond

or outside the curve.


b) Analyze what it means for the PPF to be bowed out from the origin

(curved), and what it means for the PPF to be a straight line

According to Riley (2012) Production Possibility Frontier is in a

straight line as the opportunity cost of producing either good is

constant which is seen in the below diagram.

Figure-1 Straight Line Production Possibility Frontier

In the above diagram shows a constant opportunity cost between two

products where the increasing output of good B from 60 to 90 units

implies giving up 90 units of good A and the marginal opportunity

cost for each extra unit of good B is 30 units of Good A.

c) State the Law of Increasing Opportunity Cost and explain why it

holds

This can be seen in figure 1 when the firm increases its output of

Product A from point Y to point X the output of Product A increases

from output A1 to A2, this result in the output of product B falls

from B1 to B2. If the decrease in output of Product B is more than

the increase in output of Product A, this is called as increasing

opportunity costs. As the output of good increases, the opportunity

cost of producing additional units of this good increase


Assignment Question no: 2a) “As the price of oranges rises, the demand for oranges falls,

ceteris paribus.” Explain. (3 marks)

The assumption of ceteris paribus is that all other things

remaining the same or unchanged, when the price of a product

increases the demand of that product will reduce. This is why as

per the law of demand when the price of orange rise the demand

falls (Mohayidin & Titley, 2007). This is represented in the

diagram below;

Figure-3 Demand Curve

As the price of orange increase from P1 to P2 the quantity demand

of the orange falls from Q1 to Q2. This is assuming that all

other things are remaining unchanged.

b) “The price of a bushel of wheat was $3.00 last month, and $2.50

today. The demand curve for wheat must have shifted leftward

between last month and today.”

There will not be any shift in demand curve with the decrease in

price of a bushel of wheat. Only a movement along demand curve

will be seen in case of all factors other than price are at held

constant. This is represented in the diagram below;


Figure-4 Demand Curve of Wheat

In the above diagram it shows that when the price of a bushel of

wheat decreases from $4.00 to $3.00 the demand for a bushel of

wheat will increase from 100 to 150. This in case of all the

factors is held constant other than the price.

The demand curve will shift due to the change in non price

determinants such as consumer income, price of substitute goods

and complement goods, taste, habits and fashion, population and

price expectations. This is represented in the diagram below;

Figure-05 Demand and Supply of Wheat

The above diagram represents the non price determinant of demand of

wheat in which a decrease in the price of substitute goods will

affect the demand curve to shift from D1 to D2 and the quantity


demand decreases from 150 to 100 and price will reduce from $4 to

$3.

c) Some goods are bought largely because they have ‘snob appeal.’

For example, the residents of Beverly Hills gain prestige by

buying expensive items. In fact, they would not buy some items

unless they are expensive. The law of demand, which holds that

people buy more at lower prices than at higher prices, obviously

does not hold for the residents of Beverly Hills. The following

rules apply in Beverly Hills: high prices buy; low prices, don’t

buy.”

Prestige or Veblen goods have upward-sloping demand curves where the

consumer desire the goods precisely because the price is high which

is also the “snob appeal,” where consumers desire the good because

it is rare, or situations where consumers interpret a high price as

a signal of high quality. (Miller & Jensen, 2007) Demand increases

with increase in prices. Eg. - Precious paintings and Jewellery and

diamonds. The demand curve of such goods will be upward sloping

which is represented in the diagram below;

Figure-06 Demand curve of Prestige or Veblen goodsManagerial Economics Assignment

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The price of a Veblen good increase from P1 to P2 will bring a

change in the quantity demand which will rises from Q1 to Q2. This

is why the residents of Beverly Hills buy goods which are expensive

and they will not buy if the prices are low or decreased.


Assignment Question no: 3The minimum wage in year 1 is $1 higher than the equilibrium wage. In

year 2, the minimum wage is increased so that it is $2 above the

equilibrium wage. We observe that the same number of people is working

at the minimum wage in year 2 as in year 1. Does it follow that an

increase in the minimum wage does not cause some workers to lose their

jobs?

The equilibrium price of labour (market wage rate) is determined by

the interaction of the supply and demand of labour. Employees are

hired up to the point where the extra cost of hiring an employee

(their wage) is equal to the addition to the sales revenue from hiring

them. This is represented in the diagram below;

Figure-07 Demand and supply of Labour

The Equilibrium wage rate is W1 where demand for the labour is equal

to the supply of the labour. The difference between demand and supply

is unemployment.

The demand of labour is shifted D1 to D2 due to the consumer demand

for the product and due to the increase in productivity of labourer


which will be more cost efficient than using capital equipment and

government if provide employment subsidy which allows business to

recruit more workers. But in case where the cost of producing a

product is increased due to the increase in wage the consumer will buy

less due to high selling price which will result in labourer

redundancy.


Assignment Question no: 4Widgets are provided by a competitive constant-cost industry where

each firm has fixed costs of $30. The following chart shows the

industry-wide demand curve and the marginal cost curve of a typical

firm:

a) What is the price of a widget?

In perfect competition the equilibrium price of industry and firm is

same and firm are producing goods where the average cost is equal to

marginal cost and price. In perfect competition Marginal Cost

(MC)=Marginal Revenue (MR)=Price (P)=Demand (D). Therefore the point

at which MC=P is $ 20. Therefore the price of widget is $ 20.00

b) How many firms are in the industry?

At the equilibrium price of $20 the industry produces 600 quantities

of goods and each firm produce 4 units of goods by which demand is


equal to supply. Therefore the total numbers of supplier are 600/4=

150.

For the remaining four parts of this question, assume that the

government imposes an excise tax of $15 per widget.

c) In the short run, what is the new price of widgets?

When government excise tax is imposed, the demand curve will be

shift back by the amount of tax. So that new price of widgets will

be Price-Tax. The quantity supply and quantity demand is equal at

300 units where the price-tax is $10, so this is the new price of

widget.

d) In the short run, how many firms leave the industry

In the short run firms are making losses but they will not leave the

industry. Firms will only leave on the Long run if making loses.

e) In the long run, what is the new price of widgets?

In the long run firms will get a profit when MC = D = AC = MR. The

new price of the widget in $20 in long run.

f) In the long run, how many firms leave the industry?

In Long run, firms will start leaving the industry until they

reaches to profit which is MC=AC=P. Here in the long run, the price

is $20.00, the industry produces 140 units and each firm produce 4

units. Therefore the total number of firms in the industry is

(140/4), which are 35. This means when there were 150 firms out of

which 115 firms will leave the industry (Which is 150-35=115).Managerial Economics Assignment

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Assignment Question no: 5

I. Consider public policy aimed at smoking

a) Studies indicate that the price elasticity of demand for

cigarettes is about 0.4. If a pack of cigarettes currently costs

$2 and the government wants to reduce smoking by 20 percent, by

how much should it increase the price?

Price elasticity of demand = Changes in quantity demand

Changes in price

Assume that the percentage increased in price is x

-0.4= -20/X

-0.4X=-20

X=20/0.4

X=50

The price is = 2+2* 50/100

2+1=3, this indicates that the price is

$3.00

b) Studies also find that teenagers have higher price elasticity

than do adults. Why might this be true?


The responsiveness of quantity demanded for the change in price

of a product is known as price elasticity of demand. The price

elasticity of cigarette is inelastic as the smoking is a habit it

becomes difficult to quit smoking even though the price rise. In

this case for adults the percentage income spending on cigarette

is less and if the price increases they can manage cigarette

spending. But in case of teenager they don’t have an income to

buy the cigarette, they use their pocket money, either they stop

cigarette when price rise; as they are not much addicted to it or

they smoke less or occasionally. Therefore for the cigarette the

teenagers have higher price elasticity than adults.

II. Suppose that business travellers and vacationers have the

following demand for airline tickets from New York to Boston:

Price

Quantity Demanded

(business

travellers)

Quantity Demanded

(vacationers)

$150 2,100 tickets 1,000 tickets$200 2,000 tickets 800 tickets$250 1,900 tickets 600 tickets$300 1,800 tickets 400 tickets


a) As the price of tickets rises from $200 and $250, what is the

price elasticity of demand for (i) business travellers and (ii)

vacationers? (Use the midpoint method in your calculations)

Price elasticity of demand (using midpoint) for

i) Business Travellers.

Price elasticity

of demand (PED)

= % change in Qty

demanded

% change in

Price

X

Midpoint of Qty

demanded

Midpoint of

Price

PED = (1900 - 2000) / (250 - 200) x (250+200)/2 / (1900

+2000)/2

= -100/50 x 225 / 1950

= -22500 / 97500

= - 0.23

Price elasticity of demand for business travellers is -

0.23

ii) Vacationers

Price elasticity

of demand (PED)

= % change in Qty

demanded

% change in

Price

X

Midpoint of Qty

demanded

Midpoint of

Price

PED = (600 - 800) / (250 - 200) x (250+200)/2 / (600

+800)/2

= -200/50 x 225 / 700

= -45000 / 35000


= - 1.29

Price elasticity of demand for vacationers is -1.29

b) Why might vacationers have a different elasticity from business

travellers?

Business travelers have inelastic demand which is less than 1,

this is because for the business travellers expenses are

beared by the company and ticket cost is small compare to the

total income.

Vacationers have elastic demand which is more than 1, this is

because for the total income is low and if the price of ticket

increase which will have a drastic effect on demand.


Assignment Question no: 6a)General Mills and Kellogg are two of the biggest players in the

market for breakfast cereals. At their current level of operation,

each makes $6 million per year in profit. Both are considering

costly new advertising campaigns to gain market share. If one moves

forward with the advertising campaign but the other does not, the

one that moves forward expands market share and increases profit to

$8 million while the other loses market share and profit falls to $2

million. If both adopt a new costly advertising campaign, then both

companies’ profits fall to $4 million. Set up a payoff matrix to

describe this decision-making situation.

Figure 2 Payoff Matrix

From the above diagram below are the key points:

Both of the companies will enjoy the profit of $6 million profit if

they don’t carry out the advertising campaign (In this scenario the

combined profit of $12 million).


Suppose if one company carryout the advertising campaign, that

company will enjoy profit of $8 million while the other company enjoy

only $2 million (In this scenario the combined profit of $10

million).

Suppose if both companies carryout the advertising campaign, in this

each company’s profit will be $4 million (In this scenario the

combined profit of $8 million). This is called Nash equilibrium where

none of the company optimizes the equilibrium path or gets the

maximum benefit.

The best strategy for maximizing industry profit as per the Payoff

matrix is not to carry out advertising campaigns by both companies,

by this both companies enjoys $6 million as a profit. This will not

happen unless both firms work in cooperative manner.

In prisoners dilemma concept both companies cooperates on not to

carry out the advertising campaign but if one carryout advertising

campaign will be rewarded a profit of $8 million.

b)Why is the drug cartel more effective than the oil cartel?

A cartel is a formal or informal agreement between firms to regulate

market supply and price (Mohayidin & Titley, 2007). The best known

cartel is OPEC (Organization of the Petroleum Exporting Countries)

that attempts to manage the world supply of crude oil in order to

determine the price and work together to maximise their profit. The

cartel works as a monopolist by intending to maximise the industry

profit. Normally the in the agreements oils are supplied to member

countries by setting up oil production quotas.


In this type of cartel main issue is that there is a strong incentive

to cheat; OPEC member countries cheat their quotas by producing a

little more oil, this way the individual country earn more but through

this when every country cheats the prices will be normal and the

possibility of enjoying the profit is not available to any country.

A drug cartel works as a criminal organization to carry out the drug

trafficking operations. They operate agreement with many drug

traffickers. The most well-known Drug Cartel is called Mexico Drug

Cartel. In such operations the actions are very strict if any of the

people doesn’t follow the orders and cheat on their agreements. Such

actions would be killing, kidnapping and it will be end of the

business. Due to these strict actions Drug cartel is more effective

than oil cartel.


Assignment Question no: 7Suppose labour is a variable input and capital is a fixed input, and

consider a firm's short-run average, average variable, and marginal

cost curves.

a) What geometric relationships hold among these three curves?

Figure-3 Cost curves of firm

All the curves are presented in similar manner like a U shape,

average costs curve is illustrated in that shape where the firms

enjoys economies of scale by increasing the production up to a

point where average costs is at minimum level, further increase

of a production of an item will increase the cost.

The difference between average cost and average variable cost is

the average fixed cost and when producing additional unit will

increase these costs.

The point is shown as Q1 is the point where average cost is at

minimum level when the marginal cost curve will meet at average

cost curve.


b) How would these curves be affected by an increase in the wage rate

paid to labour?

An increase in the wage rate will affect average cost variable cost

and the marginal costs which is represented in the below diagram.

Figure-10 Increase in variable costs

In such situation where an increase of wage rate will bring all the

curves to shift upwards

The average costs curve shift from AC to AC’.

The marginal cost curve shift from MC to MC’

The average variable cost curve shift from AVC to AVC’.


c) How would these three curves be affected by an increase in the

rental rate paid to capital?

An increase in the rental rate paid to capital will only affect

average costs as it is fixed cost of the firm. This is represented in

the below diagram.

Figure-11 Fixed costs affects to the firms cost curves

In the above diagram which indicates that only the Average cost shift

up from AC to AC’ because it is an increase in the fixed cost and all

other curves in such instance will remain unchanged.


Assignment Question no: 8Suppose the demand curve for a good is given by the equation Q = 100 -

P and the supply curve is given by the equation Q = 0.25P, where P

represents the price of the good (measured in dollars per unit) and Q

represents the quantity of the good (measured in units per week)

a) Find the equilibrium price and quantity for this market.

Equilibrium Price: 100-P= 0.25P

100= 1P+0.25P

P =1001.25

Equilibrium price is $80

Equilibrium quantity = 100-P

100-80=20

Equilibrium quantity is 20 units

b) Suppose quantity demanded for the good rises by 10 units at every

possible price while at the same time quantity supplied falls by 5

units at every possible price (with the exception that quantity

supplied cannot drop below zero units at any price). Find the new

equilibrium price and quantity in this market.

In the above scenario the new quantity demand equation will be

Q=110-P and the new Quantity supply equation will be Q=0.25P-5

Quantity demand (Qd)= Quantity supply (Qs)

110 -P = 0.25P -5

110 + 5 = 0.25 +1P

115 = 1.25P


115/1.25 = P

92 = P

Therefore equilibrium price is $92.00

And the Equilibrium Quantity is = 110-P

Qd = 110-92 =18 units, which is the Equilibrium quantity

c) Given the change in demand, how large would the fall in supply need

to be (given the same 10 unit rise in demand) in order for the price

to decrease instead of increasing as in part (b)?

In this case the Equilibrium Price is;

110-P=0.25P

P =1101.25

Price =88

In this case the Equilibrium quantity is;

Q=110-88=22

Quantity =22

The below diagram represents that a right ward shift of demand curve

which shows the equilibrium price increase from $80 to $88 and

equilibrium quantity increases to 22 units.


Figure-12 Shift in Demand curve

The additional quantity supply needed if for price reduced to $80.

Equilibrium quantity is;

Q=110-P

Q=110-80

Q=30

Additional supply needed is X;

Quantity supply = 0.25p + (X)

30=0.25P+X

30=0.25(80) +X

X=30-20

X=10


In the below diagram can be seen that the supply curve shifted to left

where the equilibrium price to be increased more than $88 and

equilibrium quantity will be decrease more than 22 units.

Figure-13 Shift in Demand and Supply Curve


Reference

Arnold, R. A. (2010). Microeconomics, 9th ed. South-Western Cengage

Learning, Mason, Ohio

Dan Moynihan & Brian Titley. (2007). Economics.Oxford university

press.

Miller, N. H., & Jensen, R. T. (2007). Giffen Behavior: Theory and

Evidence. USA: Harvard University.

Mohayidin, M. G. (2011). BMME5103 Managerial Economics . Selangor

Darul Ehsan: Meteor Doc. Sdn. Bhd.

Riley, G. (2012). ECON1 Economics: Markets and Market Failure.

Retrieved at March 23, 2014. Retrieved from

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