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Unit Name: Managerial Economics

Lecturer Name: Dr. Ambili Sunil

Managerial Economics.
Submission Date: 04th Sep 2021
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Table of Contents

QUESTION 1:..........................................................................................................................................4
Demand:..................................................................................................................................................4
Supply:.....................................................................................................................................................4
Equilibrium:.............................................................................................................................................4
Conclusion:..............................................................................................................................................4
Question 2:.............................................................................................................................................5
Answer for A:...........................................................................................................................................5
Answer for B:...........................................................................................................................................5
Question 3:.............................................................................................................................................5
Introduction:............................................................................................................................................5
a. Restricting Supply:...........................................................................................................................6
b. Decreasing demand:........................................................................................................................6
c. Purchasing the surplus at the floor price:........................................................................................6
Question 4:.............................................................................................................................................6
Answer A:................................................................................................................................................7
Answer for B:...........................................................................................................................................7
Answer for C:...........................................................................................................................................7
Question 5:.............................................................................................................................................8
Law of Diminishing Marginal Returns:.....................................................................................................8
Question 6:...........................................................................................................................................10
Monopolistic Competition:....................................................................................................................10
Equilibrium of Monopolistic competition in long run:...........................................................................10
How Monopolistic companies makes profit:.........................................................................................11
Answer for A:.........................................................................................................................................11
Answer for B:.........................................................................................................................................11
QUESTION 7:........................................................................................................................................12
Externalities:..........................................................................................................................................12
Answer for 7:.........................................................................................................................................12
QUESTION 8:........................................................................................................................................13
Shutdown:.............................................................................................................................................13
Answer for 8:.........................................................................................................................................13
Bibliography.........................................................................................................................................13
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QUESTION 1:

Assume that both the supply of bottled water and the demand for bottled water rise during the
summer but that supply increases more rapidly than demand. What can you conclude about
changes in equilibrium price and equilibrium quantity?

Demand: Demand is an economic principle referring to a consumer's willingness to purchase

goods and services and ready to pay a price for a particular good or service. Considering every
other factor constant, an increase in the price of a good or service decrease in the price of a good
or service will increase the demand. Market demand is the total quantity demanded of a specific
product across all consumers in a market. Collective demand is the total demand for all goods
and services in an economy. [ CITATION Inv6 \l 1033 ]

Supply: Supply is a fundamental economic concept that describes the total amount of a specific
good or service that is available to consumers. Supply can identify with the sum accessible at a
particular cost or the sum accessible across a scope of costs whenever showed on a chart. This
relates near the interest for a goods or services at a particular value; all else being equivalent, the
stock given by makers will rise if the value rises since all organizations hope to expand benefits. [
CITATION Sup \l 1033 ]

Equilibrium: Equilibrium is the state in which market supply and demand balance each other,
and as a result prices become stable. Generally, an over-supply of goods or services causes prices
to go down, which results in higher demand—while an under-supply or shortage causes prices to
go up resulting in less demand. The balancing effect of supply and demand results in a state of
equilibrium. [ CITATION inv1 \l 1033 ]

Conclusion: Whenever supply and demand both increase, equilibrium quantity will rise
and the equilibrium price will fall.
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Question 2:

Will the equilibrium price of orange juice increase or decrease in each of the following
situations?

a. A medical study reporting that orange juice reduces cancer is released at the same time
that a freak storm destroys half of the orange crop in Florida.
b. The prices of all beverages except orange juice fall in half while unexpectedly perfect
weather in Florida results in an orange crop that is 20 percent larger than normal.

Answer for A: The medical study reporting that orange juice reduces cancer will cause the
demand curve for orange juice to shift to the right which means the demand is getting increase.
However, on the other side when the storm that destroys half the orange crop in Florida will
cause the supply curve for orange juice to shift to the left which means the supply of the oranges
goes down.  Considering these two shifts occurring at the same time, where the demands go high
and the supply goes down the price of orange juice will increase.

Answer for B: When the prices of other beverages fall in half, people tend to choose the
cheaper product so the demand for orange juice will fall. Thus, the demand curve for orange
juice will shift to the left.  At the same time, the perfect weather that results in the increase of
crop of oranges in Florida will cause the price of oranges to fall as the supply gets increase.
Because oranges are the only ingredient in orange juice, the price of producing orange juice will
also fall, thereby increasing the profits of orange juice makers and encouraging them to produce
more orange juice.  Thus, the supply curve for orange juice will shift to the right.  These two
shifts occurring at the same time price of orange juice will decrease.

Question 3:
Suppose that you are the economic advisor to a local government that has to deal with a
politically embarrassing surplus that was caused by a price floor that the government recently
imposed. Your first suggestion is to get rid of price flood, but the politicians don’t want to do
that. Instead, they present you with the following list of options that they hope will get rid of the
surplus while keeping the price floor. Identify each one as either could work or can’t work.

a. Restricting supply.
b. Decreasing demand.
c. Purchasing the surplus at the floor price.

Introduction:

Price floor is a situation when the price charged is more than or less than the equilibrium
price determined by market forces of demand and supply. By observation, it has been found
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that lower price floors are ineffective. Price floor has been found to be of great importance in
the labour-wage market. [ CITATION Eco1 \l 1033 ]

a. Restricting Supply:

There is currently a surplus because, at the floor price, quantity supplied exceeds quantity
demanded. If the supply is more than the demand the price will fall. If the government can
restrict supply, it will be able to reduce the size of the surplus and if it can restrict supply and
shift the supply curve to the left by exactly the amount of the surplus, it will be able to
completely eliminate the surplus. So, the policy of restricting supply will work if
implemented correctly.

b. Decreasing demand:

There is already surplus in the market because quantity supplied exceeds quantity demanded.
If the government decrease the demand, then the gap would only be made worse and surplus
will get increased if demand decreases. So, decreasing demand won’t work. In fact, the
government might want to try the opposite, increasing demand to match the surplus in the
market.

c. Purchasing the surplus at the floor price:

There is a surplus because the quantity that producers wish to supply at the floor price
exceeds the quantity that consumers wish to purchase at the floor price i.e, more than the
demand of the market. The government needs to get rid of the surplus and one way is that the
government can buy those unsold surpluses at the floor price. In crux, the surplus disappears
because the government increases private demand with government demand. Together, the
two sources or demand are enough to purchase the total amount supplied at the floor price.
Thus, this policy could work to cut down the surplus in the market if the government is
willing to spend the money necessary to purchase the entire surplus at the floor price.

Question 4:

Use the table below to answer the questions that follow:

a. If this table reflects the supply of and demand for tickets to a particular world cup soccer
game, what is the stadium capacity?
b. If the present ticket price is $45, would we expect to see a secondary market for tickets?
Why or why not? Would the price of a ticket in the secondary market be higher than, the
same or lower than the price in the primary (original) market?
c. Suppose for some other world cup game the quantities of tickets demanded are 20,000
lower at each ticket price that shown in the table. If the ticket price remains $45, would
the even be a sell-out?
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Answer A:

The quantity supplied is constant as 60 thousand, the capacity of the stadium should be exactly the
same as supplied. The quantity of the capacity is 60,000.

Answer for B:

If the preset ticket price is $45, the quantity demand may exceed the quantity supplier so we would
expect to see a secondary market because there is a shortage of tickets at this price. Thus, the buyers
and owners will look out for the equilibrium price of $55 or $65, which implies some individuals are
willing to pay between $55 and $65 for the tickets. Thus, the price in the secondary market would be
higher.

Answer for C:

If we rearrange the table below with the new demand 20,000 at $45 the demand is less than the
quantity supplied, hence it will not sell out.

QD New QD=QD- QS
(Thousands) 20,000 Price $ (Thousands)
80 60 35 60
75 55 35 60
70 50 45 60
65 45 55 60
60 40 65 60
55 35 75 60
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50 30 85 60

Question 5:

A firm has fixed costs of $60 and variable costs as indicated in the table at the bottom of this page.
Complete the table.

TP TFC TVC TC AFC AVC ATC MC

0 60 0 60 0 0 0 0
1 60 45 105 60 45 105 45
2 60 85 145 30 42.5 72.5 40
3 60 120 180 20 40 60 35
4 60 150 210 15 37.5 52.5 30
5 60 185 245 12 37 49 35
6 60 225 285 10 37.5 47.5 40
7 60 270 330 8.57 38.57 47.14 45
8 60 325 385 7.5 40.63 48.13 55
9 60 390 450 6.67 43.33 50 65
10 60 465 525 6 46.5 52.5 75

a. Graph total fixed cost, total variable cost and total cost. Explain how the law of diminishing
returns influences the shapes of the variable-cost and total-cost curves.

Law of Diminishing Marginal Returns:

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The law of diminishing marginal returns is a theory in economics that predicts that after some
optimal level of capacity is reached, adding an additional factor of production will actually result
in smaller increases in output. [ CITATION Inv7 \l 1033 ]

Total variable cost and Total cost increases at diminishing rate due to increasing returns to the
variable inputs arising from further utilization of fixed factors and greater specialization. It
increases at an increasing rate due to diminishing returns to the variable inputs arising from
difficulty of management and overutilization of fixed factory. Thus, behaviour of Total Variable
cost curve and Total cost curve follows directly from the law of variable proportions.

b. Graph AFC, AVC, ATC and MC. Explain the derivation and shape of each of these four curves and
their relationship to one another. Specifically, explain in nontechnical terms why the MC curve
intersects both the AVC and the ATC curves at their minimum points.
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Average fixed cost curve falls continuously since a fixed amount of capital cost is spread over more units
of output.

The Marginal cost, Average variable cost and Average total cost curve are U-Shared, reflecting the
influence of first increasing and then diminishing returns.

The Average total cost curve sums Average fixed cost and Average variable cost curve vertically. The
Average total cost curve falls when the Marginal cost curve is below it, the Average total cost curve rises
when the Marginal cost curve is above it. This mean that Marginal cost curve must intersect the Average
total cost and Average variable cost curve at its minimum point.

Question 6:

Critically evaluate and explain:

a. In monopolistically competitive industries, economic profits are completed away in the long run.
Hence, there is no valid reason to criticize these industries performance and efficiency.

Monopolistic Competition:

Monopolistic competition characterizes an industry in which many firms offer products or services
that are similar, but not the same. Restrictions to entry and exit in a monopolistic competitive
industry are low, and the decisions of any one firm do not directly affect those of its competitors.
Brand differentiation is the key strategy in the Monopolistic competition.[ CITATION Inv8 \l 1033 ]
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Equilibrium of Monopolistic competition in long run:

Long Run Equilibrium of Monopolistic Competition: In the long run, a firm in a monopolistic
competitive market will product the amount of goods where the long run marginal cost (LRMC) curve
intersects marginal revenue (MR). The price will be set where the quantity produced falls on the
average revenue (AR) curve.

How Monopolistic companies makes profit:

Also like a monopoly, a monopolistic competitive firm will maximize its profits by producing goods to
the point where its marginal revenues equal its marginal costs. The profit maximizing price of the
good will be determined based on where the profit-maximizing quantity amount falls on the average
revenue curve. [ CITATION Lum \l 1033 ]

Answer for A:

The first part of the statement may well be true; however, it contradicts with the to the second
point logically. The criticism of monopolistic competition is not with reference to the profit level
as it relates to the fact that the firms do not produce at the point of minimum ATC and do not
equate price and Marginal cost. This results in an under-allocation of resources as well as an
efficiency loss and excess production capacity at each and every firm in the industry. If each firm
produces at point where demand curve intersects the MC curve, fewer firms would be needed to
produce the industry output. This is the unavoidable consequence of imperfect competition and
its downward sloping demand curves. With P > MC, the firm is not allocating resources in
accordance with society’s desires; the value society sets on the product (P) is greater than the
cost of producing the last item (MC).

Answer for B:
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In the long run, firms will enter a profitable monopolistically competitive industry and exit and
unprofitable one. So, a monopolistic competitor will earn only a normal profit in the long run.
Thus, there is no economic profit. The firm is producing where the demand curve is tangent to
the ATC curve and the ATC is slightly higher than optimal (minimum ATC). Thus, the price is at a
higher point than purely competitive price which is nothing but monopolistic price. Thus, in the
long run, monopolistic competition leads to a monopolistic price but not to monopolistic profits.

QUESTION 7:
What information does a government need if it wants to attempt to reduce a widespread negative
externality like air pollution? Who, typically, is actually in possession of that information? How do
markets in tradeable emissions permits solve the asymmetric information problem affecting pollution
abatement efforts?

Externalities:

An Externalities occur in an economy when the production or consumption of a specific good or service
impacts a third party that is not directly related to the production or consumption of that good or
service. externality is a cost or benefit caused by a producer that is not financially incurred or received
by that producer. The externality can be both positive or negative and can stalk from either the
production or consumption of a good or service. An example of positive externalities shall be a
construction of roads and example of a negative externalities shall be the air pollution from an industry.
The costs and benefits can be both private—to an individual or an organization—or social, meaning it
can affect society as a whole. [ CITATION Inv9 \l 1033 ]

Answer for 7:

Government should make strong policies and set the right procedures to the Environment Protection
Agency (EPA) and Pollution Control Board (PCB). These agencies should have their periodic audits to the
industries in the specific areas and have their data handy to be produced at any time. The diluted
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agencies may have severe effects to the society, for example., In state of Tamil Nadu recently they have
found that the copper producing company called “Vedanta” has violated all the rules and regulations on
the disposal of the harmful sulphuric and Hydrochloric acids from the factory. They corrupted the board
members and disposed the acids in the land nearby the factory for more than decades and recent
studies found that the people live near by the factory suffers various type of disease like Cancer,
Tuberculosis etc.,

There are several cases like this in all over Tamil Nādu, example the waste from the leather industries in
Ranipet area was disposed in the nearby river which cause severe impact on the people health living
near by the river banks. The government needs to know how much rate of tax is applicable on the
polluted air or water produced by these industries. Negative externality can be tackled by taxing goods
and services that cause issues. The positive externalities that create spill over benefits can be used by
the government can be given subsidies.

Tradable permits solve the confusion of the common by restricting resource access and privatising the
subsequent access rights. Setting a limit on use access to the resource is the first step. In the case of
above examples this should be the amount of waste disposed. It usually indicates the total amount of
emissions allowed in the relevant control region for pollution control. This limit specified the total
number of times a resource can be accessed.

QUESTION 8:
“Even if a firm is losing money, it may be better to stay in business in the short run. “Is this statement
ever true? If so, under what conditions (s)?

Shutdown:

A shutdown refers to a short-run decision not to produce anything during a specific period of time
because of current market conditions. Exit refers to a long-run decision to leave the market. The short-
run and long-run decisions differ because most firms cannot avoid their fixed costs in the short run but
can do so in the long run. That is, a firm that shuts down temporarily still has to pay its fixed costs,
whereas a firm that exits the market saves both its fixed and its variable costs. [ CITATION NGr09 \l 1033
].

Answer for 8:

Yes, the statement is true, even if a firm is losing money as long as price exceeds the average variable
cost the firm should produce in the short run given fixed cost.

For example, assume the firm has a fixed cost of $2,000 which it must pay even if it stops production.
Now assume that average variable cost is $20 per unit and price of the product is $25 per unit. Finally
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assume that output equals 100 units using the MR = MC rule. This implies total revenue equals $5,000,
variable cost equals $4,000, and total cost equals $6,000 (the sum of variable and fixed cost). The firm is
losing money because profit equals -$1000 (= $5000 – $6000). However, this loss is less than the fixed
cost it would incur in the short run if it shut down, which equals a $2,000. Thus, it is better to stay in
business and lose $1000 rather than close down and lose a $1000 in the short run.

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