BEPMC 311 (MANAGERIAL ECONOMICS)

MODULE 3: MARKET MECHANISM

LEARNING ASSESSMENT M3D

PROBLEMS

1. Consider the following: If the price per unit of good A is P200 quantity purchased is valued at 1,500
units. If price changes (increase or decrease) by P1, quantity demanded changes (decreases or
increases) by 4 units.
A. Determine the demand function expressed as a price function. (2 points)

Demand Function as Price function:

Price (x)(P) Quantity Demanded (y)(Q)
200 1,500
201 1,496
x-x2= ((x2 -x1)/(y2 - y1))y- y1
P-200= ((201-200)/(1496-1500))Q-1500
P-200= 1.-4(Q-1500)
P-200= -0.25Q + 375
P = -0.25Q + 575

B. Set up a demand schedule for this function and determine the price elasticity of demand at
various P and Qd combinations using point-price elasticity formula. (Make sure that all
elasticity concepts are found on the same demand curve.) (10 points)

Demand Schedule for Q=−4 P+2,300 ( P=−0.25Q+575) Slope = -4

P Qd Applying the elasticity formula εd Type

575 0 Ed= -4 (575/0) α Perfectly
Elastic
550 100 Ed = -4 (550/100) Ι 22 Ι
525 200 Ed = -4 (525/200) Ι 10.5 Ι
500 300 Ed = -4 (500/300) Ι 6.67 Ι
475 400 Ed = -4 (475/400) Ι 4.75 Ι
450 500 Ed = -4 (450/500) Ι 3.6 Ι
425 600 Ed = -4 (425/600) Ι 2.83 Ι Elastic
400 700 Ed = -4 (400/700) Ι 2.29 Ι
375 800 Ed = -4 (375/800) Ι 1.88 Ι
350 900 Ed = -4 (350/900) Ι 1.56 Ι
325 1000 Ed = -4 (325/1000) Ι 1.3 Ι
300 1100 Ed = -4 (300/1100) Ι 1.09 Ι
287.5 1150 Ed = -4 (287.5/1150) Ι1Ι Unitary
Elastic
275 1200 Ed = -4 (275/1200) Ι 0.92 Ι
 250 1300 Ed = -4 (250/1300) Ι 0.77 Ι
225 1400 Ed = -4 (225/1400) Ι 0.64 Ι
200 1500 Ed = -4 (200/1500) Ι 0.53 Ι
175 1600 Ed = -4 (175/1600) Ι 0.44 Ι
150 1700 Ed = -4 (150/1700) Ι 0.35 Ι Inelastic
125 1800 Ed = -4 (125/1800) Ι 0.28 Ι
100 1900 Ed = -4 (100/1900) Ι 0.21 Ι
75 2000 Ed = -4 (75/2000) Ι 0.15 Ι
50 2100 Ed = -4 (50/2100) Ι 0.10 Ι
25 2200 Ed = -4 (25/2200) Ι 0.05 Ι
0 2300 Ed = -4 (0/2300) Ι0Ι Perfectly
Inelastic

C. Determine the TR and MR functions. (4 points)

TR function:

Let demand function be: P ¿−0.25 Q+ 575

TR = P(Q)
TR = (-0.25Q + 575) Q
TR= -0.25Q2 + 575Q

MR function:

TR= -0.25Q2 + 575Q

MR = 2(-0.25)Q + 575
MR = -.050Q + 575

D. Graph the demand curve and the TR curve (TR curve just below the demand curve) (6 points)
E. At what P and Qd combination will TR be maximum? (2 points)

P Qd εd TR (P x Qd)
575 0 α 0
550 100 Ι 22 Ι 55000
525 200 Ι 10.5 Ι 105000
500 300 Ι 6.67 Ι 150000 TR is increasing as
475 400 Ι 4.75 Ι 190000 P decreases and
demand is elastic
450 500 Ι 3.6 Ι 225000
425 600 Ι 2.83 Ι 255000
400 700 Ι 2.29 Ι 280000
375 800 Ι 1.88 Ι 300000
350 900 Ι 1.56 Ι 315000
325 1000 Ι 1.3 Ι 325000
300 1100 Ι 1.09 Ι 330000
287.5 1150 Ι1Ι 330625 TR is maximum
275 1200 Ι 0.92 Ι 330000
250 1300 Ι 0.77 Ι 325000
225 1400 Ι 0.64 Ι 315000
200 1500 Ι 0.53 Ι 300000
TR is decreasing as P
175 1600 Ι 0.44 Ι 280000 decreases and
150 1700 Ι 0.35 Ι 255000 demand is inelastic
125 1800 Ι 0.28 Ι 225000
100 1900 Ι 0.21 Ι 190000
75 2000 Ι 0.15 Ι 150000
50 2100 Ι 0.10 Ι 105000
25 2200 Ι 0.05 Ι 55000
0 2300 Ι0Ι 0

Total Revenue will be at maximum when P=287.5 and Qd=1150.

TR= P x Qd
TR= 287.5 x 1150
TR= 330625
2. Suppose the own price elasticity of demand for good X is –2, its income elasticity is 3, and the cross-
price elasticity of demand between it and good Y is –6.

A. Interpret the elasticity coefficients. (6 points)

Price Elasticity of Demand
For every 1% change (increase or decrease) in P, Qd changes (increase or decrease) by 2%.
The good is elastic where Qd is responsive or sensitive to P. (% in Qd> % in P)

Income Elasticity of Demand

Since the income elasticity coefficient is positive, then the good under consideration (X) is a
normal good. Further, the coefficient is greater than 1, therefore good X is a luxury good.

Cross-Price Elasticity of Demand

Since the cross-price elasticity coefficient is negative, then goods X and Y are complements
inferior; also, since the coefficient is less than negative one, then goods X and Y are weak
complements.

B. Determine how much consumption of this good will change if:

B.1 The price of good X increases by 5%. (2 points)
If the price of good X increases by 5%, the quantity demanded will decrease by 10%.

B.2 The price of good Y increases by 10%. (2 points)

If the price of good Y increases by 10%, the quantity demanded will decrease by 60%.

B.3 Income falls by 3%. (2 points)

If the income falls by 3%, the quantity demanded will decrease by 9%.