Razan Aldahmash 2022

Managerial economics

Chap 3 , 5 & 8

1- Summarize the relationship between price elasticity of demand and marginal

revenue.

Marginal revenue is related to price elasticity of demand, where the

responsiveness of quantity demanded a change in the price. This means that if
the marginal revenue is positive, the demand will be elastic, and if the marginal
revenue is negative, the demand is said to be inelastic.

2- What is the profit-maximizing rate of output for the monopolist?

The monopolist maximizes its profits by producing the level of output at which marginal
revenue equals marginal cost.

Explanation:
Usually, a monopolist will select the profit-maximizing level of output where marginal
revenue (MR) is equal to marginal cost (MC), and then charge the price for that quantity of
output as determined by the market demand curve. If that price is above average cost, the
monopolist earns positive profits. If the monopoly produces a lower quantity, then MR > MC
at those levels of output, and the firm can make higher profits by expanding output.

Chap 5:

Explain the difference between fixed costs, sunk costs, and variable costs.
Provide an example that illustrates that these costs are, in general,
different.?
➢ Fixed costs are associated with fixed inputs, and do not change when output changes.

➢ Variable costs are costs associated with variable inputs, and do change when output changes

➢ Sunk costs are costs that are forever lost once they have been paid
Explain the difference between the law of diminishing marginal returns and
the law of diminishing marginal rate of technical substitution?
➢ The law of diminishing returns is the decline in marginal productivity experienced when input
usage increases, holding all other inputs constant.

➢ In contrast, the law of diminishing marginal rate of technical substitution is the rate at which a
firm can substitute among different inputs while maintaining the same level of output.

List down the 5 types of market structure with definition and example for
each type.

Perfect competition: A very large number of buyers and sellers, easy entry, standardized product,
and each buyer and seller has no control over the market price. Example: Diary Companies

Monopoly: A single seller producing a product with no substitutes, effective barriers to entry into
the market. The firm is a price maker. Example: Oil Countries, De Beers Diamond

Natural monopoly: A monopoly that arises because of the existence of economies of scale over the
entire output . A larger firm will always be able to produce output at a lower cost than could a
smaller firm . Only a single firm can survive in a long-run. Example: Real Estate companies.

Monopolistic competition: A large number of firms, The product is differentiated. entry is relatively
easy, and the firm is a price maker that faces a downward sloping demand curve. Example: Fast Food
industry.

Oligopoly: A small number of firms produce the most output, the product may be either
standardized or differentiated, there are significant barriers to entry. Recognized interdependence
exists. Example: Cars, Smartphones.
Chapter 3

1. The demand curve for a product is given by Qdx = 1,200 – 3Px – 0.1Pz

Where Pz = SR300.

a. What is the own price elasticity of demand when Px = SR140? Is demand elastic or
inelastic at this price? What would happen to the firm’s revenue if it decided to charge
a price below SR140?

b. What is the own price elasticity of demand when Px = SR240? Is demand elastic or
inelastic at this price? What would happen to the firm’s revenue if it decided to charge
a price above SR240?

c. What is the cross price elasticity of demand between good X and good Z when Px
=SR140? Are good X and good Z substitutes or complements?

Answer:

a. At the given prices, quantity demanded is 750 units: Q dx = 1200 − 3(140) − 0.1(300) =
750. Substituting the relevant information into the elasticity formula gives:
𝐸𝑄dx,x=−3(𝑃x/𝑄x) = −3(140/750) = −0.56. Since this is less than one in absolute value,
demand is inelastic at this price. If the firm charged a lower price, total revenue would
decrease.

b. At the given prices, quantity demanded is 450 units: 𝑄dx = 1,200 −3(240) −0.1(300) = 450.
Substituting the relevant information into the elasticity formula gives: 𝐸𝑄x,x = −3(𝑃x/𝑄x) =
−3(240/450) = −1.6. Since this is greater than one in absolute value, demand is elastic at
this price. If the firm increased its price, total revenue would decrease.

c. At the given prices, quantity demanded is 750 units, as shown in part a. Substituting the
relevant information into the elasticity formula gives: 𝐸𝑄x,𝑃z = −0.1(𝑃𝑧/𝑄x =
−0.1(300/750) = −0.04.

Since this number is negative, goods X and Z are complements.

2. You are a manger of a firm that receives revenues of SR40,000 per year from product X and

SR90,000 per year from product Y. the own price elasticity of demand for product X is -1.5, and

the cross price elasticity of demand between product Y and X is -1.8. how much will your firm’s

total revenues (revenues from both products) change if you increase the prices of good X by 2

percent?

Total Revenues change if you increase the prices of good X by 2 percent:= -$3,640
Assignments 3,4,5 and 8:

2. Suppose the own price elasticity of demand for good X is -4, its income elasticity is 2,
its advertising elasticity is 3, and the cross price elasticity of demand between it and
good Y is -6. Determine how much the consumption of this good will change if:
a. The price of good X increases by 10%.
b. The price of good Y decreases by 5%.
c. Advertising increases by 14%.
d. Income decreases by 8%.
Answer:
a. Use the own price elasticity of demand formula to write %Δ𝑄dx/10 = −4. Solving,
we see that the quantity demanded of good X will decrease by 40 percent if the
price of good X increases by 10 percent.

b. Use the cross-price elasticity of demand formula to write %Δ𝑄dx/−5 = −6. Solving,
we see that the demand for X will increase by 30 percent if the price of good Y
decreases by 5 percent.

c. Use the formula for the advertising elasticity of demand to write %Δ𝑄dx/14 = 3.
Solving, we see that the demand for good X will increase by 42 percent if
advertising increases by 14 percent.

d. Use the income elasticity of demand formula to write %Δ𝑄dx/−8 = 2. Solving, we

see that the demand of good X will decrease by 16 percent if income decreases
by 8 percent.

3. Suppose the cross price elasticity of demand between goods X and Y is 4. How much
would the price of good Y have to change in order increase the consumption of good
X by 20 percent?
Answer: Using the cross price elasticity formula, 20%/Δ𝑃y = 4. Solving, we see that the
price of good Y would have to increase by 5 percent in order to increase the consumption of
good X by 20 percent.
Chapter 4
1. A consumer has $300 to spend on goods X and Y. the market prices of these two
goods are Px = $15 and Py = $5.
a. What is the market rate of substitution between goods X and Y?
b. Illustrate the consumer’s opportunity set in a carefully labeled diagram.
c. Show how the consumer’s opportunity set changes if income increases by $300.
How does the $300 increase in income alter the market rate of substitution
between goods X and Y?
Answer:
a. The market rate of substitution is –𝑃𝑥/𝑃𝑦 = −15/5 = −3.
b. See diagram in the slides that illustrate income change.
c. Increasing income to $600 (by $300) expands the budget set, as shown in Figure
4-1. Since the slope is unchanged, so is the market rate of substitution.

2. A consumer must divide $600 between the consumption of product X and product Y.
The relevant market prices are Px = $10 and Py = $40.
a. Write the equation for the consumer’s budget line.
b. Show how the consumer’s opportunity set changes when the price of good X
increases to $20. How does this change alter the market rate of substitution
between good X good Y?
Answer:
a. The consumer’s budget line is $600 = $10X + $40Y. Rearranging terms and
solving for Y results in Y = 15 – 0.25X.
b. When the price of X increases to $20, the budget line becomes $600 = $20X +
$40Y, which is equivalent to Y = 15 – 0.5X (after rearranging and simplifying
terms). The market rate of substitution changes from –𝑃𝑥/𝑃𝑦 = −10/40 = −0.25
to –𝑃𝑥/𝑃𝑦 = −20/40 = −0.5

3. Consider the following budget line:

100=1𝑋+5𝑌
a. What is the maximum amount of X that can be consumed?
b. What is the maximum amount of Y that can be consumed?
c. What is rate at which the market trades goods X and Y?
Answer:
a. Maximum X is: 𝑋=100/1 = 100units.
 b. Maximum Y is: 𝑌=100/5 = 20units.
c. Market rate of substitution: −𝑃𝑋/𝑃𝑌 = −1/5.

4. A consumer must spend all of his income on two goods X and Y. In each of the
following scenarios, include whether the equilibrium consumption of goods X and Y
will increase or decrease. Assume good X is a normal good and good Y is an inferior
good.
a. Income doubles.
b. Income quadruples and prices double.
c. Income and all prices quadruples.
d. Income is halved and all prices double.

Answer:
a. Consumption of good X will increase and consumption of good Y will decrease.
b. Consumption of good X will increase and consumption of good Y will decrease.
c. Nothing will happen to the consumption of either good.
d. Consumption of good X will decrease and consumption of good Y will increase

Chapter 5
1. A firm can manufacture a product according to the production function Q = F(K, L) =
K3/4 L1/4
a. Calculate the average product of labor, LPL, when the level of capital is fixed at 10
units and the firm uses 50 units of labor. How does the average product of labor
change when the firm uses 170 units of labor?
b. Find an expression for the marginal product of labor, MPL, when the amount of
capital is fixed at 10 units. Then illustrate that the marginal product of labor
depends on the amount of labor hired by calculating the marginal product of for
10 and 50 units of labor.
c. Suppose capital is fixed at 50 units. If the firm can sell its output at a price of
$210 per unit and can hire labor at $55 per unit, how many units of labor should
the firm hire in order to maximize profits?

Answer:
a. When K = 10 and L = 50, Q = (10)0.75(50)0.25 = 14.95. Thus, APL = Q/L = 14.95/50
= 0.3. When K = 10 and L =170, Q = (10)0.75(170)0.25 = 20.3. Thus, APL =
20.3/170 = 0.12.
b. The marginal product of labor is MPL = (1/4)(10)0.75(L)-3/4 = 1.4(L)-3/4. When L
= 10, MPL = 1.4(10)-3/4 = 0.25. When L = 50, MPL = 1.4(50)-3/4 = 0.08. Thus, as
the number of units of labor hired increases, the marginal product of labor
decreases MPL(10) = 0.25 > 0.08 = MPL(50), holding the level of capital fixed.
 c. We must equate the value marginal product of labor to the wage and solve for L.
Here, VMPL = (P)(MPL) = ($210)4.7(L)-3/4=294(L)-3/4. Setting this equal to the
wage of $55 gives 294(L)-3/4 = 55. Solving for L, the optimal quantity of labor is
𝐿≅47.

2. The manager of a national retailing outlet recently hired an economics to estimate

the firm’s production function. Based on the economist’s report, the manager now
knows that the firm’s production functions given by Q = K1/2L1/2 and that capital is
fixed at 1 unit.
a. Calculate the average and marginal product of labor when 9 units of labor are
utilized.
b. Calculate the marginal product of labor when 9 units of labor are utilized.
c. Suppose the firm can hire labor at a wage of $10 per hour and output can be sold
at a price of $100 per unit. Determine the profit-maximizing levels of labor and
output.
d. What is the maximum price of capital at which the firm still make nonnegative
profits?
Answer:
a. Q = (1)1/2 (9)1/2 = 3. The average product of labor is thus Q/L = 3/9
b. MPL = .5K1/2L1/2 = .5(1)1/2(9)-1/2 = 1/6
c. The profit maximizing level of labor and output is achieved where VMPL = w,
where VMPL = .5($100)L-1/2) and w = $10. Solving for L yields L = $25. The
corresponding level of output is Q = (25) -1/2 = 5
d. The firm’s variable costs are (25)($10), while its total revenues are 5 * $100 =
$500. The maximum price of capital, hence, cannot be greater than $250 per
unit.

3. An economist estimated that the cost function of a single products firm is

C(Q) = 230 + 12Q + 8Q2 + 10Q3

Based on this information, determine:

a. The fixed cost of producing 7 units of output.
b. The variable cost of producing 7 units of output.
c. The total cost of producing 7 units of output.
d. The average fixed cost of producing 7 units of output.
e. Average variable cost of producing 7 units of output.
f. Average total cost of producing 7 units of output.
g. The marginal cost when Q = 7.

Answer:
a. FC = $230.
b. VC(7) = 12(7) + 8(7)2 + 10(7)3 = $3,906
 c. C(7) = 230 + 12(7) + 8(7)2 + 10(7)3 = $4,136
d. 𝐴𝐹𝐶(7) = $23/7 = $32.85
e. 𝐴𝑉𝐶(7) = 𝑉𝐶(7)/7 = $3,906/7 = $558
f. ATC(7) = AFC(7) + AVC(7) = $590.85.
g. MC(7) = 12 + 16(7) + 30(7)2 = $1,594.

Chapter 8
1. A firm sells its product in a perfectly competitive market where other firms charge a
price of $75 per unit. The firm’s total costs are C(Q) = 45 +15Q +3Q 2
a. How much output should the firm produce in the short run?
b. What price should the firm charge in the short run?
c. What are the firm’s short run profits?
d. What adjustment should be anticipated in the long run?
Answer:
a. Set P = MC to get $75 = 15 + 6Q. Solve for Q to get Q = 10 units.
b. $75.
c. Revenues are R = ($75)(10) = $750, costs are C = 45 + 15(10) + 3(10)2 = $495, so
profits are $255.
d. Entry will occur, the market price will fall, and the firm should plan to reduce its
output. In the long-run, economic profits will shrink to zero.

2. You are the manager of a monopoly, and your demand and cost functions are given
by P = 225 – 2Q and C(Q) = 1,100 + 3Q2, respectively.
a. What price –quantity combination maximizes your firm’s profits?
b. Calculate the maximum profits.
c. Is demand elastic, inelastic, or unit elastic at the profit maximizing price quantity
combination?
d. What price-quantity combination maximizes revenue?
e. Calculate the maximum revenue.
Answer:

a. MR = 225 – 4Q and MC = 6Q. Setting MR = MC yields 225 – 4Q = 6Q. Solving yields Q

= 22.5 units. The profit-maximizing price is obtained by plugging this into the
demand equation to get P = 225 - 2(22.5) = $180.
b. Revenues are R = ($180)(22.5) = $4,050 and costs are C = 1100 + 3(22.5)2 =
$2,618.75, so the firm’s profits are $1,431.25.
c. Elastic.
d. TR is maximized when MR = 0. Setting MR = 0 yields 225 – 4Q = 0. Solving for Q yields
Q = 56.25 units. The price at this output is P = 225 – 2(56.25) = $112.5.
e. e. Using the results from part d, the firm’s maximum revenues are R =
($112.5)(56.25) = $6,328.12.
Multiple choices:

1. For perfectly price inelastic supply

a. supply determines price solely.
b. demand determines price solely.
c. only a government can set the price.
d. either supply or demand may set the price.

2. If the quantity demanded of tea increases by 2% when the price of coffee increases by 6%,
the cross‐price elasticity of demand between tea and coffee is
a. -3.
b. 0.33.
c. 3.
d. 12.

3. Marginal utility is the ________ satisfaction gained by consuming ________ of a good.

a. Total; all units
b. total; one more unit
c. additional; all units
d. additional; one more unit

4. The law of diminishing marginal utility is effective when marginal utility is

a. positive and increasing.
b. positive and decreasing.
c. initially zero and then increasing.
d. initially zero and then decreasing.

5. Total utility is
a. the total amount of satisfaction yielded by the consumption of a good or service.
b. the additional satisfaction gained by consuming one more unit of something.
c. used to compare different people’s likes and dislikes.
d. relatively easy to measure.

6. The law of diminishing marginal utility refers to:

a. a consumerʹs decrease in total satisfaction as she consumes more units of a good.
b. a consumerʹs decrease in additional satisfaction as she consumes more and more units
of a good.
c. the idea that total utility is negative.
d. the idea that marginal utility is negative.

7. Total revenue minus total cost equals

a. the rate of return.
b. marginal revenue.
c. profit.
d. net cost.

8. Economic costs include

a. both a normal rate of return on investment and the opportunity cost of each factor of
production.
b. the direct costs of hiring all factors of production.
 c. the opportunity cost of each factor of production minus any interest charges paid on
borrowed funds.
d. total revenue minus accounting profit.

9. A firm ________ if it earns zero economic profit.

a. earns a negative rate of return
b. will leave the industry
c. earns a positive but below normal rate of return
d. earns exactly a normal rate of return

10. The formula for the marginal product of labor is

a. L/Q
b. (ΔL)(Δq).
c. Q/L.
d. ΔQ/ΔL

11. Assume the total product of two workers is 100 and the total product of three workers is
150. The third workerʹs average product is ________ while her marginal product is
________.
a. 40; 20
b. 20; 40
c. 50; 50
d. 150; 100

12. Fixed costs

a. do NOT exist in the long run.
b. depend on a firmʹs level of output.
c. are zero if a firm produces no output.
d. are total costs minus average variable costs.

13. A dairy company, Farley Farm, has total costs of $10,000 and total variable costs of $3,000.
Farley Farmʹs total fixed costs are
a. $0.
b. $7,000.
c. $13,000.
d. indeterminate because the firmʹs output level is not known.

14. Average fixed costs

a. are the costs associated with producing an additional unit of output.
b. provide a per unit measure of costs.
c. fall as output rises.
d. are constant.

15. ________ is(are) most likely a variable cost for a firm.

a. The interest payments made on loans
b. The franchiserʹs fee that a restaurant must pay to the national restaurant chain
c. The monthly rent on office space that it leased for a year
 d. The payroll taxes that are paid on employee wages

16. ________ are likely a fixed cost of a firm.

a. Wages paid to employees
b. The payments for supplies
c. Lease payments for office space
d. Travel expenses to meet with clients

17. Labor is the only variable input for Elliotʹs dog‐walking service. His labor costs are $300 a day
and his service walks 25 dogs per day. His labor costs increase to $315.50 a day to walk 26
dogs per day. The marginal cost of walking that 26th dog is
a. $15.50
b. $19.50.
c. $29.50.
d. indeterminate from the information given.

18. If a firmʹs total costs are $75 when it produces 10 units of output and $80 when it produces
11 units of output, then the marginal cost of producing the 11th unit is
a. $1.
b. $5.
c. $8.09.
d. $10.

19. Assume Dell Computer Company operates in a perfectly competitive market producing
5,000 computers per day. At this output level, price exceeds this firmʹs marginal and average
variable costs. To maximize profits, Dell should
a. make no adjustments as they are already maximizing their profits.
b. increase their output.
c. decrease their output.
d. stop producing since it is earning a loss.

20. Under perfect competition,

a. resources are allocated among firms efficiently.
b. final products are distributed among households efficiently.
c. the system produces the goods and services consumers want.
d. All of the above are correct.

21. An oligopoly is an industry market structure with

a. A single firm in which the entry of new firms is blocked.
b. a small number of firms each large enough to impact the market price of its output.
c. many firms each able to differentiate their product.
d. many firms each too small to impact the market price.

1. Elasticity is:

A. Measures the responsiveness of a percentage change in one variable resulting from a percentage

change in another variable.

2. Isoquants:

A. Capture the trade-off between combinations of inputs that yield the same outputs in the long run,

when all inputs are variable.

3. A monopolists’ market power implies:

c. There is no supply curve for monopolist.

4. Monopoly power, however:

A. Does not guarantee positive profit.

5. The short – run supply curve for a perfectly competitive firm is:

A. Marginal cost curve above the minimum point on the AVC curve.

6. If the own price elasticity of demand is equal to infinity:

A. Demand is perfectly elastic.

7. Which of the following is an incorrect statement about the own price

elasticity:

A. Demand tend to be most elastic in the short-term than in the long term. (incorrect statement)

B. Demand tend to be most elastic in the short-term than in the long term. (incorrect statement)

C. Demand tend to be most elastic in the short-term than in the long term. (incorrect statement)

D. All the above statement are correct

This is what they call tricky question where all statement are equal but reviewing the final choice

(D) you can never say that A,B,C are correct statement è this meant that for D to be incorrect

choice for us to choose if it was saying all above statements are incorrect then there would be no

answer.

8. In the _______________ inputs are used in fixed proportions

A. Liner production function.

9. Market structure in which many firms sell product that are similar but not identical is known as:

A.Monopolistic competition

10.The long run average cost curve will be horizontal, depending whether there are:

B. Constant economic of scale.