FIN 6204 Managerial Economics

Chapter 2 Tutorial

Tutorial Answers
1. Which one of the following will increase the demand for Kazi Dairy’s mango twist yogurt?

(a) A decrease in the price of the mango used to make yogurt.

(b) A decrease in the price of yogurt.
(c) An increase in the price of the milk used to make yogurt.
(d) An increase in the price of ice cream, a substitute for yogurt.

Answer: If you answered B, you made a common mistake. A change in the price of a
good cannot change overall market demand. It can only cause a movement along an
existing curve. So, as important as price changes are, they are not the right answer in
this case. Instead, you need to look for an event that shifts the entire curve.
Choices A and C refer to the prices of Mango and milk. Because these are the inputs of
production for yogurt, a change in their prices will shift the supply curve, not the
demand curve. That leaves choice D as the only possibility. Choice D is correct
because the increase in the price of ice cream will cause consumers to substitute away
from ice cream and towards yogurt. This shift in consumer behavior will result in an
increase in the demand for the yogurt at all its prices.

2. Consider the market for smartphones.

(a) Scenario 1: Using a supply and demand graph, show what will happen to the
current equilibrium price and quantity of the Samsung Galaxy S21 5G smartphone
if people expect the price of this smartphone to fall in the future.
Answer: Demand will decrease because consumers will want to wait until the price
drops. Supply will increase because suppliers will want to sell now while the price
is high. The current equilibrium price will fall. We don’t know what will happen to
the current equilibrium quantity. If the demand effect is greater than the supply
effect, the current equilibrium quantity will fall. If the supply effect is greater than
the demand effect, the current equilibrium quantity will rise.
Note: The way it is drawn on the graph below, there is a very slight drop in the
current equilibrium quantity.

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 (b) Scenario 2: Now, using a second supply and demand graph, show instead what will
happen to the current equilibrium price and quantity of the Samsung S21 5G if the
price of an iPhone 12 Pro rises.
Answer: The demand for the Samsung Galaxy S21 5G will increase, because the
iPhone 12 Pro is a substitute for the Samsung phone. The current equilibrium price
and quantity will increase.

(c) Scenario 3: You observe that the price of the Samsung Galaxy S21 5G has
increased. Can you definitively conclude that there has been an increase in
demand? If not, what besides an increase in demand could explain the price
increase? Answer: No. It is possible that the price increase is due to a decrease in
supply.

3. Suppose that the demand and supply for cheese in an economy are given by

P = 40–2Q (demand)
P = 16 + 2Q (supply)

(a) Find the equilibrium price and quantity of cheese.

Answer:
40–2Q = 16 + 2Q = 4Q = 24 = Q = 6
P = 40–2Q = P = 40–12 = P = $28
P = 16 + 2Q = P = 16 + 12 = P = $28
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(b) Illustrate the equilibrium. Make sure to include both curves and label the y-intercept
values, equilibrium price and quantity.

(c) At a price of $22, find the actual shortage or surplus and indicate this on the graph.
Answer:
40–2Q = 22
2Q = 18
Qd = 9

16 + 2Q = 22
2Q = 6
Qs = 3

4. We are
given the following equations where P is price and Q is quantity: Equation 1: P = 120
 − 5Q
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Equation 2: P = 3Q

(a) Which equation represents the demand curve? Why?

Answer: Equation 1 represents the demand curve. The slope of this equation is
negative, representing a negative relationship between price and quantity. By the
law of demand and holding all else constant, as price increases, the quantity
demanded decreases, and vice versa, showing a negative relationship.
(b) What is the equilibrium price and equilibrium quantity?
Answer:
120–5Q = 3Q ⇒ 8Q = 120 ⇒ Q = 15
P = 120–(5 × 15) = $45
P = 3 × 15 = $45
(c) At a price of $30, is there a shortage, surplus, or neither? If there is a shortage or
surplus, what is the amount of that shortage or surplus?
Answer:
30 = 120–5Q ⇒ 5Q = 90 ⇒ Qd = 18
30 = 3Q ⇒ Qs = 10
Shortage of 8 units.

5. The rent on an apartment in a particular building near university is $1,300 per month. If
Mark would be willing to pay up to $1,400, Gabriele would be willing to pay up to
$1,600, Frank would be willing to pay up to $1,700, and Keith would pay no more than
$900, what is the consumer surplus for this group of students who would like to live in
the building? Explain how you calculated this consumer surplus.
Answer: Mark rents the apartment, because he can spend $1,300 to gain something he
considers to be worth $1,400. He comes out $100 ahead ($1,400 – $1,300). By similar
reasoning, Gabriele and Frank rent the apartment and come out $300 and $400 ahead,
respectively. Keith considers the rent overpriced and therefore is not a consumer of this
particular good. The total consumer surplus is $100 + $300 + $400 = $800.
6. A history teacher’s salary is $60,000 per year at a High School. If Mr. Davis would be
willing to do the work for as little as $65,000 per year, Ms. Adams would do it for as little
as $43,000, Ms. Curzon would do the work for as little as $46,000, and Mr. James, who
cannot imagine working in another job, would do the work for $19,000 per year, what is
the producer surplus for this group of workers in a given day when everyone who wants
to work as a history teacher at the High School does so? Explain how you calculated
producer surplus.
Answer: Ms. Adams works a history teacher because she can earn $60,000 doing
something she would be willing to do for as little as $43,000. She comes out $17,000
ahead ($60,000 – $43,000). By similar reasoning, Ms. Curzon and Mr. James work as
history teachers and come out $14,000 and $41,000 ahead, respectively. Mr. Davis
does not find work as a history teacher at Melbourne High School sufficiently lucrative,
and therefore is not a provider of this service. The total producer surplus is $17,000 +
$14,000 + $41,000 = $72,000.

Chapter Problems (Answers will not be provided) 1.

Suppose that the demand and supply functions for good X are

Qd = 50 − 8P
 Qs = −17.5 + 10P

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(a) What are the equilibrium price and quantity?
(b) What is the market outcome if price is $2.75? What do you expect to happen?
Why? (c) What is the market outcome if price is $4.25? What do you expect to
happen? Why?
(d) What happens to equilibrium price and quantity if the demand function becomes Qd
= 59 − 8P?
(e) What happens to equilibrium price and quantity if the supply function becomes Qs =
−40 + 10P (demand is Qd = 50 − 8P)?

2. Construct a graph showing equilibrium in the market for movie tickets. Label both axes
and denote the initial equilibrium price and quantity as P0 and Q0. For each of the
following events, draw an appropriate new supply or demand curve for movies, and
predict the impact of the event on the market price of a movie ticket and the number of
tickets sold in the new equilibrium situation:

(a) Movie theaters double the price of soft drinks and popcorn.
(b) A national video rental chain cuts its rental rate by 25 percent.
(c) Cable television begins offering pay-per-view movies.
(d) The screenwriters’ guild ends a 10-month strike.
(e) Kodak reduces the price it charges Hollywood producers for motion picture film.

3. Suppose you are the manager of a California winery. How would you expect the
ollowing events to affect the price you receive for a bottle of wine?

(a) The price of comparable French wines decreases.

(b) One hundred new wineries open in California.
(c) The unemployment rate in the United States decreases.
(d) The price of cheese increases.
(e) The price of a glass bottle increases significantly due to new government
antishatter regulations.
(f) Researchers discover a new wine-making technology that reduces production
costs. (g) The price of wine vinegar, which is made from the leftover grape mash,
increases. (h) The average age of consumers increases, and older people drink less
wine.

4. Rising jet fuel prices recently led most major U.S. airlines to raise fares by
approximately 15 percent. Explain how this substantial increase in airfares would affect the
following:

(a) The demand for air travel.

(b) The demand for hotels.
(c) The demand for rental cars.
(d) The supply of overnight mail.
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