MGEC: Session 2

Practice Problems Answer Key

Practice Problem 1

The Dolan Corporation, a maker of small engines, determines that in 2008 the demand curve for its
product is P = 2000 - 50Q, where P is price (in dollars) of an engine and Q is the number of engines
sold per month.
a) To sell 20 engines per month, what price would Dolan have to charge?

Given, demand curve for small engines:

P = 2000 - 50Q ……………………………………………..………………………………………………………………..………(1)
At Q = 20, P can be found by plugging Q = 20 in the equation (1)
P = $1000

b) If managers set a price of $500, how many engines will Dolan sell per month?

To find the number of engines (Q) which Dolan will sell per month, plug P = $500 in equation (1).
Q = 30

c) What is the price elasticity of demand if price equals $500?

𝑑𝑄 𝑃
ϵd = ×
𝑑𝑃 𝑄

Demand Equation: P=2000-50Q. At price = $500, we can find the corresponding quantity by
plugging it into the demand equation:

500 = 2000 − 50𝑄

50𝑄 = 1500
𝑄 = 30

Also, the demand equation can be expressed in terms of Q;

𝑃 = 2000 − 50𝑄
50𝑄 = 2000 − 𝑃
𝑃
𝑄 = 40 −
50
𝑑𝑄 −1
Differentiating the demand function 𝑑𝑃 = 50

Now, we have to substitute the values in the elasticity formula:

𝑑𝑄 𝑃
ϵd =𝑑𝑃 × 𝑄

−1 500
ϵd = 50 × 30
 −1
ϵd = 3

d) At what price, if any, will demand for Dolan's engines be unitary elastic?

We know that ϵd = -1

𝑑𝑄 𝑃
Since, ϵd =𝑑𝑃 × 𝑄

−1 (2000−50𝑄)
-1 = 50 × 𝑄

Solve for Q, Q=20

To find Price, plug Q = 20 it into the demand function;

𝑃 = 2000 − 50𝑄
𝑃 = 2000 − 1000
𝑃 = $1000

Thus, demand for Dolan's engines will be unitary elastic at a price of $1000.
Practice Problem 2

After a careful statistical analysis, the Chidester Company concludes the demand function for its
product is Q = 500 - 3P + 2Pr + 0.1I where Q is the quantity demanded of its product, P is the price of
the product, Pr is the price of its rival's product, and I is per capita disposable income (in dollars). At
present, P = $10, Pr = $20 and I = $6000.

a) What is the price elasticity of demand for the firm's product?

Demand function:
Q = 500 - 3P + 2Pr + 0.1I
Plugging P = $10, Pr = $20 and I = $6000 into the demand function; Q=1110
Formula for price elasticity of demand:

𝑑𝑄 𝑃
ϵd = ×
𝑑𝑃 𝑄

10
ϵd = −3 × 1110

ϵd = -3/111 = -0.027

b) What is the income elasticity of demand for the firm's product?

Formula for income elasticity of demand:

𝑑𝑄 𝐼
ϵI = 𝑑𝐼
×𝑄

6000
ϵI = 0.1 × 1110

ϵI = 60/111 = 0.54

c) What is the cross-price elasticity of demand between its product and its rival's product?
Formula for cross elasticity of demand:

𝑑𝑄 𝑃𝑟
ϵxy = 𝑑𝑃𝑟 × 𝑄

20
ϵxy = 2 × 1110

ϵxy = 4/111 = 0.0360

d) What is the implicit assumption regarding the population in the market?

The population is assumed to be constant.
Practice Problem 3

From November 2007 to March 2008, the price of gold increased from $865 per ounce to over $1,000
per ounce. Newspaper articles during this period said there was no increased demand from the
jewelry industry but significantly greater demand from investors who were purchasing gold because
of the falling dollar. For each of the following demand curves, indicate whether the curve shifted
inwards, outwards, or did not shift at all.

a) Gold demand by jewelry industry: No shift in demand curve

b) Gold demand by investors: Demand curve shifts outwards

c) Aggregate demand for gold: Market demand curve shifts outward as it is horizontal summation
of gold demand by jewelry industry and investors.
Practice Problem 3

Given demand equation Q=40000-4P,

a. Find the revenue that the firm may earn if the price is Rs. 5000.
Revenue = Price * Quantity
At price of Rs. 5000, quantity demanded will be 20000 units. (Plug 5000 in the demand
equation)
Revenue = Price * Quantity
Revenue = 5000*20000 = Rs. 100,000,000
b. Graph the function and use the ‘area under the curve’ approach to do the above
computation.

Q = 40000-4P
Price

10000

5000

0 20000 40000 Quantity

Using ‘area under the curve’ approach, revenue will be the area (L*B) of the blue triangle.
Revenue = 5000*20000 = Rs. 100,000,000

c. Find the consumer surplus

Consumer surplus is given by the area of the triangle; above market price (P=5000) and below
1
the demand curve. We can use the formula for area of a triangle = 2 × base × height, to
calculate the consumer surplus. In this case the base of the triangle is 20000 and the height is
5000 (10000-5000), therefore

1
Consumer Surplus = × 20000 × 5000 = 50,000,000
2
 Q = 40000-4P
Price

10000

Consumer Surplus

5000

0 20000 40000 Quantity

d. Find change in revenue and change in consumer surplus if the price increases to Rs. 7500.
If price increase to Rs. 7500, the quantity demanded will be 10000 units.
New Revenue = 7500*10000 = Rs. 75,000,000
Revenue falls by Rs. 25,000,000
1
New Consumer Surplus = 2 × 10000 × 2500 = 12,500,000
Consumer surplus falls by 37,500,000.

Q = 40000-4P
Price

10000 New Consumer Surplus

7500 New Revenue

5000

0 10000 20000 40000 Quantity