MODULE 1.

SUPPLY AND DEMAND & MARKET BEHAVIOR

1. Describe the key features and functions of accounting profit vs. economic profit

Accounting Profit:

● Accounting profit is the difference between a company's total revenue and its explicit

costs.

● Explicit costs are the actual expenses incurred by a company, such as rent, salaries, and

utilities.

● Accounting profit is used to assess a company's financial performance and to prepare

financial statements.

● Accounting profit can be higher than economic profit if it does not take into account

implicit costs, such as the opportunity cost of the resources used in production.

Economic Profit:

● Economic profit is the difference between a company's total revenue and its total

opportunity costs, including both explicit and implicit costs.

● Opportunity costs include the value of the next best alternative forgone, such as the

income that could have been earned if resources were used in a different way.

● Economic profit is used to assess the true profitability of a company and to determine

whether it is generating a return that is covering costs.

● Economic profit can be lower than accounting profit if it takes into account implicit costs,

such as the opportunity cost of the resources used in production.

The difference between accounting profit and economic profit is that accounting profit only

considers explicit costs, while economic profit takes into account both explicit and implicit costs.

Economic profit provides a more accurate picture of a company's profitability because it

considers the opportunity cost of the resources used in production.

2. List and describe the determinants of demand

1. Price of the good or service: As the price of a good or service increases, demand

decreases. As the price of a good or service decreases, demand increases.

2. Income: As income increases, demand for normal goods increases (luxury cars, fine

dining), but demand for inferior goods decreases (generic brands, used clothing, and

public transportation).

3. Tastes and preferences: Changes in consumer preferences, fads, and fashion trends

can affect the demand for a good or service.

4. Price of related goods: The demand for a good or service can be affected by the prices

of substitute goods (goods that can be used in place of the original good) and

complementary goods (goods that are consumed together with the original good).

5. Consumer expectations: Changes in expectations regarding future prices, income, and

availability of a good or service can affect current demand.

6. Number of buyers: An increase in the number of buyers can increase demand, while a

decrease in the number of buyers can decrease demand.

3. Summarize the determinants of supply

1. Production costs: As production costs increase, supply decreases. As production costs

decrease, supply increases.

2. Technology: Advances in technology can lower production costs, increasing supply,

while outdated technology can increase production costs, decreasing supply.

3. Input prices: The cost of raw materials, labor, and other inputs can affect the supply of a

good or service.

4. Price of related goods: The prices of substitute goods in production (goods that can be

used in place of the original good) and complementary goods in production (goods that

are used together with the original good) can affect the supply of a good or service.

5. Number of sellers: An increase in the number of sellers can increase supply, while a

decrease in the number of sellers can decrease supply.

 6. Producer expectations: Changes in expectations regarding future prices, costs, and

availability of inputs can affect current supply.

7. Government policies: Regulations, taxes, and subsidies can affect the supply of goods

or services.

4. Calculate the net present value of expected future cash flows

Present Value = Cash flow / (1 + Discount Rate)^Number of Years

Using this formula, the present value of the cash inflows for each year with a required rate of

return of 10% is:

Year 1: $3,000 / (1 + 0.1)^1 = $2,727.27

Year 2: $4,000 / (1 + 0.1)^2 = $3,305.79

Year 3: $5,000 / (1 + 0.1)^3 = $3,801.72

Next, you sum up the present values of all the cash inflows to get the total present value of

future cash flows:

Total Present Value = $2,727.27 + $3,305.79 + $3,801.72 = $9,834.78

Finally, you subtract the initial investment of $10,000 from the total present value of future cash

flows to get the NPV:

NPV = Total Present Value - Initial Investment = $9,834.78 - $10,000 = -$165.22

In this example, the NPV is negative, which means that the project's expected cash flows are

not sufficient to cover the initial investment and the required rate of return of 10%. Therefore,

this project would not be a profitable investment.

5. Describe how the managerial objective is to maximize the value of expected future profits

The objective is to maximize the value of expected future profits, which means generating

the greatest possible return for its owners or shareholders.

● Forecasting future profits: This involves estimating future revenues, costs, and cash

flows

● Identifying profit-maximizing strategies: Identify strategies to increase revenue or

reduce costs to maximize profits. This may involve improving operational efficiency,

increasing sales, reducing overhead costs, or investing in new business ventures.

● Evaluating investment opportunities: If the investment generates profits that exceed

the required rate of return, then it is considered a profitable investment and adds value

to the business.

6. Compare and contrast how managerial economics differs from microeconomics

Aspect Managerial Economics Microeconomics

Applies microeconomic concepts Examines the behavior of individual

Scope and tools to business economic agents such as
decision-making consumers, firms, and markets

Takes a theoretical and abstract

Perspective Takes a practical and applied approach to understanding
approach to solving economic behavior
 real-world business
problems

Specifically focuses on the Examines economic decisions made by

decisions made by individuals and firms in relation to
Focus
managers in running a the allocation of scarce
business resources

Analyzes the behavior of

Level of individual firms and their Analyzes the behavior of entire markets
analysis specific decision-making and industries
processes

Maximizing profits and Allocating resources efficiently and

Goals
shareholder value maximizing societal welfare
7. Identify various types of managerial processes and their effect on firm performance

Managerial Process Potential Effect on Firm Performance

Gain competitive advantage, increase market share, and

Strategic planning
improve profitability

Budgeting and financial Allocate resources efficiently, reduce costs, and increase
management profitability

Improve productivity, quality, and customer satisfaction, resulting

Operations management
in increased revenue and profitability

Marketing and sales Increase brand awareness, customer acquisition, and revenue
management growth

Human resources Improve employee productivity, retention, and motivation,

management leading to improved firm performance
 Innovation and product Stay competitive, increase market share, and generate new
development revenue streams

Identify and mitigate potential risks, reducing the likelihood of

Risk management
financial losses and improving overall performance

8. Identify the ways in which the principal-agent problem supports the risk of moral hazard

The principal-agent problem refers to the conflict of interest that arises when a principal hires an

agent to act on their behalf, as the agent may have incentives that are not aligned with those of

the principal.

8. Asymmetric information: The principal may not have complete information about the

actions of the agent, which can make it difficult to monitor and control their behavior.

9. Incomplete contracts: can create ambiguity about the agent's responsibilities and the

consequences of their actions, which can give the agent more discretion and freedom to

act in their own interests.

10. Agency costs: The costs associated with monitoring and controlling the behavior of the

agent can be high.

9. Describe the principal-agent problem

A situation where the agent has more discretion and fewer constraints on their behavior, can

increase the risk of moral hazard. To mitigate this risk, principals need to design contracts that

align the incentives of the agent with their own interests and implement monitoring and control

mechanisms to ensure that the agent is acting in their best interests.

10. Describe the key features of supply and demand equilibrium

Market forces are in balance, and the most efficient allocation of resources is achieved.

1. Quantity demanded equals quantity supplied: All goods and services produced are sold and there

is neither a surplus nor a shortage.No excess demand or excess supply

1. Price stability: The equilibrium price level is stable because there is no upward or downward

pressure on the price. If the price is above the equilibrium level, excess supply will create

downward pressure on the price. If the price is below the equilibrium level, excess demand will

create upward pressure on the price.

2. Efficiency: The equilibrium price level and quantity reflect the efficient allocation of resources in the

market, where the quantity supplied matches the quantity demanded at the most efficient price level.

11. Identify the structure of total revenue including the equation TR=P*Q

Total revenue (TR) is the amount of money a company earns from selling its products or services, and it is

calculated by multiplying the price (P) of the product or service by the quantity (Q) sold. The equation for

total revenue is:

TR = P * Q

This equation shows that the total revenue earned by a company depends on the price it charges for its

products or services and the quantity it sells at that price. The structure of the equation reflects the fact

that total revenue increases as either the price or quantity sold increases. However, the relationship

between price and quantity sold is not always straightforward, as changes in price can affect the

quantity sold through the concept of price elasticity of demand.

Quiz 1

Initial Value 27

Percent change 89%

New Value = Initial Value + (Percent Change * Initial Value)

New Value = 27 + (89% * 27)

New Value = 27 + 24.03

New Value = 51.03

Therefore, the new value is 51.03.

The present discounted value of $100 to be received in one year at an annual interest rate of

25% can be calculated as:

Present Discounted Value = Future Value / (1 + r)^n

r=annual interest rate and n=years.

Thus, the present discounted value of $100 to be received in one year is:

Present Discounted Value = $100 / (1 + 0.25)^1 = $80

Therefore, the present discounted value of $100 to be received in one year at an annual interest rate of

25% is $80.
 MODULE 2. ELASTICITY

1. Define the terms point-price elasticity and arc elasticity

Point-price elasticity of demand is a measure of the responsiveness of the quantity demanded of a

product to a change in its price at a specific point along the demand curve. It is calculated as the

percentage change in quantity demanded divided by the percentage change in price at a particular price

and quantity combination.

η = (ΔQ / ΔP)(P / Q)

Let's say you are selling apples at a farmer's market. Initially, you are selling apples at a price of $2 per

pound, and you sell 100 pounds of apples per day. After a decrease in price to $1.50 per pound, you

observe an increase in quantity demanded to 120 pounds per day.

ΔQ = 120 - 100 = 20 (change in quantity demanded)

ΔP = $1.50 - $2 = -$0.50 (change in price)

P = $2 (initial price)

Q = 100 (initial quantity demanded)

Plugging these values into the formula:

η = ((20 / -.50) / ($100 / $2))

Simplifying further:

η = (-40 / 50)

η = -0.8
Point-price elasticity of demand = -0.8. This indicates that a 1% decrease in price leads to an 0.8%

increase in quantity demanded.

Arc elasticity of demand is a measure of the responsiveness of the quantity demanded of a product to

a change in its price over a range of prices along the demand curve. It is calculated as the percentage

change in quantity demanded divided by the percentage change in price over the midpoint of the range of

prices.

η = [ΔQ /(Q1 + Q2)]/[ΔP/(P1 + P2)]

You sell chocolate bars. Initially, the price is $1 per bar, and you sell 100 bars per day. Later, the price

increases to $1.50 per bar, and the quantity demanded decreases to 80 bars per day

Q1 = 100 (initial quantity demanded)

Q2 = 80 (new quantity demanded)

P1 = $1 (initial price)

P2 = $1.50 (new price)

η = [(80 - 100) / (100 + 80)] / [($1.50 - $1) / ($1 + $1.50)]

Simplifying further:

η = [-20 / 180] / [($0.50) / ($2.50)]

η = [-0.111] / [0.2]

η ≈ -0.555
 Arc elasticity of demand= -0.555. This indicates that a 1% increase in price leads to a 0.555% decrease

in quantity demanded.

Market Demand Curve:

A market demand curve will shift to the right when the population increases. An increase in population

leads to a larger consumer base, which can result in a higher demand for goods and services

A firm's demand curve is usually more elastic than the market demand curve. The firm's demand

curve tends to be more responsive to changes in price, making it more elastic compared to the market

demand curve.

Income elasticity of demand formula:

ηI = (ΔQ / ΔI)(I / Q).

Quantity Purchased Per Month

Monthly Income Steaks

$2,000 2 8

$3,000 4 6

Income Elasticity of Demand = (% change in quantity demanded) / (% change in income)

Let's calculate the percentage changes in quantity demanded and income:

For the change in quantity demanded of steaks:

% change in quantity demanded = [(4 - 2) / 2] * 100% = 100%

For the change in income:

% change in income = [(3,000 - 2,000) / 2,000] * 100% = 50%

Now we can calculate the income elasticity of demand:

Income Elasticity of Demand = (100% / 50%) = 2.0

Therefore, Tony's income elasticity of demand for steaks is greater than 1.0. This means that steaks are an

income elastic good for Tony. A 1% increase in his income leads to a more than proportionate increase of

2% in the quantity of steaks demanded.

Marginal Revenue: (MR) represents the change/increase in total revenue (TR) that occurs when output

(quantity) is increased by one unit. It measures the additional revenue generated by selling one additional

unit of output.

Marginal revenue can be defined in terms of price (P) and elasticity (ç) as:

MR = P(1 + 1/η)

If price is $25 when the price elasticity of demand is –0.5, then marginal revenue must be:

MR = $25(1 + 1/(-0.5)) = $25(1 - 2) = $25(-1) = -$25.

Therefore, the marginal revenue is -$25.

Total revenue (TR) is calculated by multiplying the average revenue (AR) per unit of output by the total

output quantity. It represents the total amount of money received from selling a given quantity of goods or

services.
Total revenue decreases as output increases whenever marginal revenue is less than average

revenue. It means that each additional unit of output is generating less revenue than the average revenue

per unit. This indicates that the total revenue decreases as output increases, as the additional revenue

generated from selling one more unit is insufficient to offset the decrease in average revenue caused by

lower prices.

Total revenue is rising with increases in output whenever marginal revenue is positive. When

marginal revenue is positive, it means that each additional unit of output is generating more revenue than

the previous unit.

Along a demand curve with unitary elasticity everywhere, total revenue remains constant as output

increases. When the demand curve has unitary elasticity everywhere, it means that the price elasticity of

demand is equal to -1 at every point along the curve.

Along a linear demand curve, total revenue is maximized near the quantity axis intercept. At this

point, the price is relatively high, and the quantity sold is also relatively high, resulting in the maximum

total revenue.

Cross-price elasticity of demand is defined as the percentage change in the quantity demanded of a

good divided by the percentage change in a different good's price.

η = (ΔQ₁/ΔP₂) * (P₂/Q₁)

Let's consider two goods: coffee and tea. Suppose the price of coffee increases from $4 to $5 per pound,

and as a result, the quantity demanded of tea increases from 100 bags to 120 bags.

Where:
ΔQ₁ is the change in quantity demanded of the first good (coffee)

ΔP₂ is the change in the price of the second good (tea)

P₂ is the initial price of the second good (tea)

Q₁ is the initial quantity demanded of the first good (coffee)

Using the given values:

ΔQ₁ = 120 - 100 = 20 bags (change in quantity demanded of tea)

ΔP₂ = $5 - $4 = $1 (change in price of coffee)

P₂ = $4 (initial price of coffee)

Q₁ = 100 bags (initial quantity demanded of tea)

Plugging these values into the formula:

η = (20 / $1) * ($4 / 100)

Simplifying further:

η = 20 * 0.04

η = 0.8

The cross-price elasticity of demand between coffee and tea in this example is 0.8. This positive value

indicates that coffee and tea are substitute goods. A 1% increase in the price of coffee leads to an

0.8% increase in the quantity demanded of tea.

2. Compare and contrast constant-elasticity and unitary elastic demand functions

Constant-Elasticity Demand Function Unitary Elastic Demand Function

The demand function is expressed as Q = k *

The demand function is expressed as Q = a
P^(-e), where Q is the quantity demanded, P is
- bP, where Q is the quantity demanded, P
the price, e is the price elasticity of demand,
is the price, and a and b are constants.
and k is a constant.

The price elasticity of demand (e) is a constant The price elasticity of demand (e) is equal
value, which means that the percentage to -1, which means that the percentage
change in quantity demanded is proportional change in quantity demanded is equal to
to the percentage change in price. the percentage change in price.

The demand curve is a rectangular hyperbola,

The demand curve is a straight line, which
which means that it is a straight line when
means that it has a constant slope.
plotted on a logarithmic scale.
 Examples of constant-elasticity demand Examples of unitary elastic demand
include luxury goods, such as high-end include staple goods, such as bread or
fashion or sports cars, where changes in price milk, where changes in price have an equal
have a small effect on quantity demanded. effect on quantity demanded.

3. Explain how demand elasticity can analyze changes in price, advertising, product quality and

distribution

1. Demand elasticity measures the degree to which changes in price affect the quantity of goods or services

demanded. A high price elasticity of demand indicates that a small change in price results in a large

change in quantity demanded, while a low price elasticity of demand indicates that changes in price

have a smaller effect on quantity demanded.

2. Demand elasticity can also analyze the impact of changes in advertising on demand. If advertising leads

to increased consumer awareness and desire for a product, it can increase the quantity demanded and

shift the demand curve to the right. However, if advertising is ineffective, it will not lead to an increase in

demand.

3. Changes in product quality and distribution can also affect demand elasticity. Improving product quality

can increase demand by making the product more desirable to consumers, while poor quality can

decrease demand. Similarly, improving the distribution channels for a product can make it more accessible

to consumers and increase demand.

4. Calculate the income elasticity of demand

To calculate the income elasticity of demand, we need to use the following formula:

Income Elasticity of Demand = % Change in Quantity Demanded / % Change in Income

 Suppose that the luxury car brand sells 10,000 cars per year at a price of $100,000 when the average

income level is $100,000 per year. However, the following year, the average income level increases to

$120,000 per year and the quantity demanded increases to 12,000 cars per year.

Using the formula above, we can calculate the income elasticity of demand for this luxury car brand as

follows:

% Change in Quantity Demanded = [(12,000 - 10,000) / 10,000] x 100% = 20%

% Change in Income = [(120,000 - 100,000) / 100,000] x 100% = 20%

Therefore, the income elasticity of demand for the luxury car brand is:

Income Elasticity of Demand = 20% / 20% = 1

Since the income elasticity of demand is equal to 1, we can conclude that the luxury car brand is a

unitary elastic good, which means that a change in income has an equal percentage change in the

quantity demanded

1. When price elasticity of demand is > 1, demand is elastic.

2. When price elasticity of demand is < 1, demand is inelastic.
3. When price elasticity of demand is = 1, demand is unitary.

5. Classify varying methods used to calculate individual firm and industry demand functions

Method Description

Collecting data on consumer preferences, behavior, and purchasing

Surveys and
patterns through surveys and market research to estimate demand
Market Research
functions
 Time Series Analyzing historical sales data to identify patterns and trends in
Analysis consumer demand to estimate demand functions

Using statistical techniques to estimate the relationship between a

Regression
dependent variable (quantity demanded) and one or more independent
Analysis
variables (price, income, advertising, etc.) to estimate demand functions

Using statistical techniques to estimate demand functions based on data

Econometric
on consumer behavior, prices, incomes, and other factors that influence
Modeling
demand

Creating computer models of consumer behavior and demand to

estimate demand functions for individual firms and industries and to
Simulation Models
predict how changes in price, income, and other factors will affect
demand

6. Summarize the different elasticity interpretations (perfectly inelastic, inelastic, unitary elastic,

elastic, perfectly elastic)

Elasticity Interpretation Formula

Quantity demanded does not change

when price changes
Perfectly A perfectly elastic demand curve can be % change in quantity demanded
Inelastic represented by a line parallel to the = 0 / % change in price
horizontal axis. This means that at any
given price, consumers are willing to
 purchase an unlimited quantity of the
product

Quantity demanded changes

% change in quantity demanded
Inelastic proportionally less than the change in
< % change in price
price

Quantity demanded changes

% change in quantity demanded
Unitary Elastic proportionally the same as the change in
= % change in price
price

Quantity demanded changes

% change in quantity demanded
Elastic proportionally more than the change in
> % change in price
price

Perfectly Quantity demanded changes infinitely for % change in quantity demanded

Elastic any change in price = infinity / % change in price

1. When price elasticity of demand is > 1, demand is elastic.

2. When price elasticity of demand is < 1, demand is inelastic.
3. When price elasticity of demand is = 1, demand is unitary.

7. Describe why managers cannot control the competitive environment or the macroeconomy

Managers cannot control the competitive environment because it is influenced by factors such as the

number of competitors, their strengths, and their strategies. Similarly, managers cannot control the

macroeconomy as it is influenced by factors such as government policies, economic growth, and inflation.

8. Identify the structure and components when calculating the market demand function

1. The market demand function is calculated by summing the individual demand functions of all

consumers in the market.

2. The components of a market demand function include the price of the product, the income of

consumers, the prices of other related goods, and other factors that influence consumer demand.
3. The formula for the market demand function is typically expressed as Q = a - bP + cI + dP' + e, where Q is

the quantity demanded, P is the price of the product, I is the income of consumers, P' is the price of other

related goods, and a, b, c, d, and e are constants.

4. Rationalize the determinants of the shape and position of market demand curves

1. The position of market demand curves is influenced by changes in income, prices of related goods,

tastes and preferences, and demographic factors.

2. The shape of market demand curves is determined by the degree of responsiveness of consumers to

changes in price.

3. The degree of responsiveness is affected by the availability of substitutes, the necessity of the good,

and the time period being considered.

4. The demand curve is generally downward sloping, indicating that as price decreases, quantity

demanded increases. Price is Y axis and Demand is X axis.

5. Recognize the distinctions when two goods are substitutes or complements

Two goods are considered substitutes when an increase in the price of one good results in an

increase in demand for the other good.

In contrast, two goods are considered complements when an increase in the price of one good

results in a decrease in demand for the other good.

Substitutes are typically goods that serve the same purpose and can be used interchangeably, while

complements are goods that are typically consumed or used together. For example, coffee and tea are

substitutes, while coffee and creamer are complements.

If an item has several good substitutes, the demand curve for that item is likely to be relatively

elastic.
6. Draw the curves where total revenue is maximized at the point of unit elasticity

TR = P * Q

At the point of unit elasticity, the price elasticity of demand is equal to -1. This means that a 1%

increase in price will result in a 1% decrease in quantity demanded, so the change in revenue from the

price increase will be offset by the change in revenue from the decrease in quantity demanded.

4. When price elasticity of demand is > 1, demand is elastic.

5. When price elasticity of demand is < 1, demand is inelastic.
6. When price elasticity of demand is = 1, demand is unitary.

So at the point of unit elasticity, the percent change in quantity demanded is equal to the percent

change in price.

We can use this information to draw the curves for total revenue maximization at the point of unit elasticity.

At this point, the demand curve will be a straight line passing through the midpoint of the total revenue

curve. The midpoint of the total revenue curve is where the elasticity of demand is equal to -1.

In this graph, the demand curve is the straight line passing through the midpoint of the total revenue

curve. The point where the demand curve intersects the vertical axis is the price at which total revenue is

maximized. The point where the demand curve intersects the horizontal axis is the quantity at which total

revenue is maximized.

7. Describe how the total revenue test can be used to determine price elasticity

If a change in price results in a greater change in revenue, demand is elastic, and if a change in price

results in a smaller change in revenue, demand is inelastic. At the point where revenue is maximized,

demand is unitary elastic or =1 and Marginal revenue is zero. This occurs because at the point of

unitary elasticity, any further increase or decrease in quantity sold will lead to a proportional decrease or

increase in total revenue, resulting in zero change in marginal revenue.

MODULE 3. CONSUMER BEHAVIOR & DEMAND ESTIMATION

1. Identify when a change in price pivots the budget line and in income shifts it parallel

A change in price pivots the budget line when it affects the relative price of one good with respect to

the other. For example, if the price of good X increases (horizontal axis), the budget line pivots inward

or outward depending on whether X is a normal or inferior good. A consumer’s budget constraint

changes slope whenever relative prices change and a consumer’s increase in in come causes the

consumer to buy more of every good.

On the other hand, an increase or decrease in income shifts the budget line parallel to the original line.

This means that the slope of the budget line remains constant, but the consumer now has a higher or

lower amount of income to spend on goods.

2. Solve for corner solutions when consumers choose to consume no units of a good

A corner solution occurs when a consumer chooses to consume zero units of a good, meaning that the

consumer is willing to pay no more than $0 for that good.

Suppose you have a fixed budget of $10 to spend on either apples or oranges. The price of an apple is

$2, and the price of an orange is $1. You want to maximize your fruit consumption within the given budget

constraint.

In this case, a corner solution occurs when you only purchase apples or only purchase oranges, as the

budget does not allow for the purchase of both.

Corner Solution - Only Apples:

If you spend your entire budget on apples, you can buy a maximum of $10/$2 = 5 apples. The quantity of

oranges is zero.
 Corner Solution - Only Oranges:

If you spend your entire budget on oranges, you can buy a maximum of $10/$1 = 10 oranges. The

quantity of apples is zero.

3. Calculate the utility-maximizing point when the indifference curve is tangent to the budget line

Utility refers to the happiness or satisfaction that a person derives from consumption of a good or

service.

Utility maximization=indifference curve is tangent to budget constraint.

Every indifference curve (A.K.A iso-utility curve) must slope downward and to the right and cannot

intersect. The curved shape of an indifference curve implies that the marginal rate of substitution

decreases as X increases (horizontal axis). Points along an indifference curve represent bundles of

goods that deliver equal utility.

Indifference curves describe consumer preferences. They represent different combinations of

goods or services that provide the same level of satisfaction or utility to the consumer.

The marginal rate of substitution (MRS) is the rate at which a consumer is willing to trade one good

for another while remaining indifferent/holding fixed utility, and it is given by the slope of the

indifference curve.

MRS=absolute value of the slope of an indifference curve.

Suppose you have a budget of $50 to allocate between two goods, X and Y. The price of X is $5 per

unit, and the price of Y is $10 per unit. Your utility function is U(X, Y) = X * Y, representing a preference

for equal consumption of both goods.

Budget line equation I = YPf + XPc

Product Y with price Pf measured on the vertical axis

Product X with price Pc measured on the horizontal axis

Budget I

Pf = 3, Pc = 60, I = 300

300 = 3Y + 60X; Y = 100 – 20X

Intercepts: Y = 100, X = 5

The consumer’s optimal consumption of X and Y is characterized by:

MUx / MUy = Px / Py.

Nancy has $100 to spend on books and compact disks. Books cost $10 and compact disks cost $20.

The slope of Nancy’s budget constraint (where the quantity of books is on the horizontal axis) is:

I = YPf + XPc

10Qb + 20Qc = 100

To calculate the slope, we rearrange the equation to isolate Qc:

Qc = (100 - 10Qb) / 20

Now we have the equation of the budget constraint in terms of Qb and Qc. The slope of the budget

constraint represents the rate at which Nancy can trade books for compact disks, which is the ratio of the

change in Qc to the change in Qb.

Taking the derivative of the equation with respect to Qb, we get:

dQc/dQb = -10/20 = -0.5

Therefore, the slope of Nancy's budget constraint is -0.5, which means that for every additional book

Nancy purchases, she must give up 0.5 compact disks to maintain her budget constraint.

The market demand curve is the horizontal summation of the individual demand curves and the sum

of the quantities that each consumer is willing to buy at each price.

Consumer surplus is defined as the difference between the total amount that consumers are willing to

pay for a good or service and the total amount that they actually have to pay.

The inability to isolate a demand curve from observed prices and quantities alone is known as the

identification problem.

Regression analysis is a statistical technique that describes how one variable is related to another.

Estimate the relationship between a dependent variable and one or more independent variables.

A simple, idealized representation of the real world is called a model.

The estimated mathematical relationship between dependent and independent variables derived using

ordinary least squares is called the sample regression line.

In simple regression analysis (Y = a + bX), the estimate of the intercept coefficient a is equal to Ymean –

bXmean.

When the error terms are correlated across observations, one way to address the resulting econometric

problem is to use first differences rather than levels of the variables.

4. Display how market demand can be controlled through pricing, advertising and product quality

1. Pricing: By lowering prices, firms can increase the demand for their products. However, this may not

always be feasible, as firms need to cover their costs and maintain profitability.

2. Advertising: Advertising can be used to create awareness about a product and influence consumer

behavior.

3. Product quality: By improving the quality of their products, firms can increase demand. However, this

can be expensive and may require significant investments in research and development. Additionally,

quality improvements may not always lead to an increase in demand if consumers do not perceive the

improvements as valuable.

5. Apply the Marginal Rate of Substitution to the level of satisfaction attached to a market bundle

The Marginal Rate of Substitution (MRS) represents the rate at which a consumer is willing to substitute

one good for another while maintaining the same level of satisfaction. The MRS can be applied to the

level of satisfaction attached to a market bundle by calculating the ratio of the marginal utility of one

good to the marginal utility of the other good. When the MRS is equal to the ratio of the prices of the

two goods, the market bundle is at the point of consumer equilibrium, where the consumer is

maximizing their satisfaction given their budget constraint.

If the MRS between two goods is high, it indicates that the consumer is willing to give up a relatively

large amount of one good to obtain more of the other, implying a higher level of satisfaction associated

with the market bundle. If the MRS between two goods is low, it suggests that the consumer is less

willing to give up one good to obtain more of the other, indicating a lower level of satisfaction associated

with the market bundle.

6. Recognize the distinctions among the correlation coefficient, R2, t-statistic and F-statistic
The correlation coefficient measures the strength and direction of the linear relationship between two

variables. The coefficient of determination from a regression represents the proportion of variation in

the dependent variable explained by the variation in the independent variables.

R-squared (R2) measures the proportion of the variation in the dependent variable that can be

explained by the independent variable(s).

The t-statistic measures the significance of the individual coefficients in a regression model

F-statistic measures the overall significance of the regression model as a whole. The F-statistic used to

test whether the independent variables taken as a group explain a statistically significant portion of the

variation in the dependent variable.

When the t-ratio statistics on individual coefficients are all near 0 but the F-test statistic is greater than

20, it suggests that multicollinearity is present. Multicollinearity occurs when there is a high correlation

between independent variables in a regression model, making it difficult to assess the individual

effects of each variable. Serial correlation occurs when error terms are correlated across

observations.

Durbin Watson statistic:

2=no serial correlation

< 2 = positive serial correlation

> 2 =negative serial correlation

When the error terms are correlated across observations, one way to address the resulting

econometric problem is to use weighted least squares can also be employed if the correlation structure

of the errors is known.

 The difference between the observed value of a dependent variable and the value estimated

using regression analysis is known as a residual. Residuals represent the unexplained variation in

the dependent variable that is not captured by the regression model. They are also referred to as errors

or prediction errors.

8. Apply the econometric technique of linear regression to estimate demand curves

Linear regression can be used to estimate demand curves by analyzing the relationship between the

quantity demanded and the price of a good or service. By collecting data on both price and quantity, and

running a linear regression analysis, the resulting equation can be used to estimate the demand curve.

This can then be used to predict how much of the good or service will be demanded at different price

levels. Other variables, such as income or advertising, can also be included in the regression analysis to

estimate their impact on demand.

9. List and describe the different types of techniques to measure market demand

1. Survey-based methods: Surveys can be conducted to collect data from potential or actual customers.

The surveys may ask customers about their preferences, willingness to pay, and purchase behavior.

2. Statistical methods: These methods involve the use of statistical tools to estimate demand based on

historical data. Examples include time series analysis, panel data analysis, and regression analysis.

3. Experimental methods: These methods involve conducting experiments to measure demand. For

example, an experimenter may vary the price of a product and observe the resulting change in demand.

4. Consumer data analysis: This involves analyzing consumer data such as sales records, social media

activity, and online search data to estimate demand.

5. Expert opinion: Experts such as market analysts or consultants may provide their insights and

knowledge to estimate market demand based on their expertise in a particular industry or market.
6. Interpret the distinction between positive and negative serial correlation

If there is positive serial correlation, a high value in the past is likely to be followed by a high value in the

future, and a low value in the past is likely to be followed by a low value in the future. Conversely, if there

is negative serial correlation, a high value in the past is likely to be followed by a low value in the future,

and vice versa.

Positive serial correlation is the relationship between a person's age and their height. As people age,

they tend to get taller, resulting in a positive correlation between age and height. On the other hand, an

example of negative serial correlation is the relationship between the amount of rainfall and the

number of sunny days in a month. As the amount of rainfall increases, the number of sunny days tends

to decrease, resulting in a negative correlation between the two variables.

MODULE 4. PRODUCTION FUNCTIONS & COST ANALYSIS

A production function is a table, a graph, or an equation showing the maximum output that can be

achieved from specified levels of inputs.

1. Recognize the distinctions between average product and marginal product

Average Product (AP):

The average product of a factor of production, such as labor or capital, is calculated by dividing the total

product (TP) by the quantity of the factor used (L for labor, K for capital).

AP = TP / L
Where:

● AP is the average product

● TP is the total product

● L is the quantity of the factor used (e.g., labor)

It indicates the average efficiency or productivity of the factor used.

Marginal Product (MP):

The marginal product of a factor of production is the additional output that is produced when one

additional unit of the factor is employed, while keeping other factors constant.

MP = ΔTP / ΔL

Where:

● MP is the marginal product

● ΔTP is the change in total product resulting from a change in the quantity of the factor used

● ΔL is the change in the quantity of the factor used

It helps in determining the optimal level of input to maximize production efficiency.

MP>AP=AP increases

MP<AP=AP decreases

MP=AP, AP is at its max

Whenever average product is declining with increases in input usage marginal product is less than

average product. Whenever marginal product is increasing with increasing use of an input total product is
increasing at an increasing rate.Whenever marginal product is positive and declining with increasing use

of an input total product is increasing at a decreasing rate as input use increases.

Graphical representation: Average product is represented by a smooth, upward-sloping curve that

reaches a maximum at the point where marginal product intersects it. Marginal product is represented

by a curve that starts at zero, rises to a maximum, and then declines. Also the slope of the total product

curve with respect to labor.

2. Apply the Cobb-Douglas production function to compute output elasticity

Production function is given by:

Q = K^0.5 * L^0.5

Q is the output

K is the capital input

L is the labor input.

3. Describe how the law of diminishing marginal returns requires the holding of other inputs

constant

The law of diminishing marginal returns states that as additional units of a variable input (labor,

raw materials) are added to a fixed input (machines, patents), at some point the marginal

product of the variable input will begin to decline. Holding other inputs constant means that only

one variable input is being changed while all other inputs, including the fixed input, are being

kept constant.

4. Identify the causes of increasing returns to scale and the causes of decreasing returns to scale
 Causes of increasing returns to scale:

1. Increased specialization of labor and capital

2. Improved technology and innovation

3. Greater efficiency and coordination of production processes

4. Economies of scale in procurement, production, and distribution

5. Higher utilization of fixed assets such as plant and equipment

Causes of decreasing returns to scale:

1. Diseconomies of scale resulting from increased organizational complexity

2. Diminished coordination and communication among workers and departments

3. Greater bureaucracy and administrative costs

4. Increased difficulty in managing and monitoring large-scale operations

5. Diminishing returns to specialization and division of labor

6. Interpret the distinction between isoquants and isocost curves

Isoquants show all the possible combinations of inputs that yield a constant level of output,

while isocost curves show all the possible combinations of inputs that can be purchased for a

given budget or cost of inputs. The intersection of the two curves determines the optimal

combination of inputs to produce a given level of output at the lowest cost.

Isoquants usually slope downward (from left to right) because marginal products will eventually

decrease.

Isocost are lines that represent bundles of inputs that cost the same total amount are called

isocost curves. Isocost curves represent combinations of inputs that can be purchased given

their prices and the funds available.

7. Calculate the Marginal Rate of Technical Substitution (MRTS)

MRTS is the rate at which one input can be substituted for another while holding the level of

output constant. That is, we need to find the slope of the isoquant (the curve that shows all the

combinations of L and K that can produce a given level of output) at a particular point.

Suppose a firm produces two goods, X and Y, using two inputs: labor (L) and capital (K). The

production function is given by:

Q = 2L^0.5 K^0.5

where Q is the output level.

Let's say the firm is currently using 9 units of labor and 16 units of capital to produce 64 units of

output. At this point, the slope of the isoquant is:

MRTS = (change in K / change in L) = (-1) * (MP_L / MP_K)

where MP_L is the marginal product of labor and MP_K is the marginal product of capital.

At this point, the marginal products are:

MP_L = ∂Q/∂L = K^0.5/L^0.5 = 4

MP_K = ∂Q/∂K = L^0.5/K^0.5 = 4

Therefore, the MRTS is:

MRTS = (-1) * (4 / 4) = -1

This means that the firm can reduce its use of capital by 1 unit for every additional unit of labor it

employs, while keeping output constant.

8. Compare and contrast production functions with one variable input to those with more than one

Production functions with one variable input, also known as single-factor production functions,

focus on the relationship between the quantity of output produced and the quantity of a single

input factor used,

Production functions with more than one variable input, also known as multi-factor production

functions, examine the relationship between output and the number of multiple input factors

used.

In a production function with one variable input, the marginal product of the input factor

eventually diminishes as more of it is used, while in a production function with multiple

input factors, the marginal product of each input factor depends on the level of the other

input factors used. The concept of the marginal rate of technical substitution (MRTS) is

applicable only in multi-factor production functions, where it represents the rate at which one

input factor can be replaced by another input factor without affecting the level of output.

9. List and describe the different types of returns to scale (increasing, decreasing, constant)

Returns to scale refers to the degree of change in output resulting from a proportionate increase

in all factors of production.

1. Increasing returns to scale: If an increase in all inputs results in a more than

proportionate increase in output, the production function exhibits increasing returns to

scale. This indicates that the firm's efficiency has increased with scale, and its average

cost of production decreases as output expands. Increasing returns to scale are

consistent with diminishing marginal returns by all inputs.

 2. Constant returns to scale: If an increase in all inputs results in an equivalent

proportionate increase in output, the production function exhibits constant returns to

scale. This indicates that the firm's efficiency remains constant as it expands production,

and its average cost of production remains unchanged.

3. Decreasing returns to scale: If an increase in all inputs results in a less than

proportionate increase in output, the production function exhibits decreasing returns to

scale. This indicates that the firm's efficiency declines as it increases production, and its

average cost of production increases as output expands.

4. Explain the importance of ridge lines

Lines that separate the economically relevant portion of an isoquant map from the

irrelevant portion. They help to determine the optimal input mix for a given level of output.

They represent the combinations of inputs that result in the same level of output and help to

identify the most cost-efficient production process.

5. Draw the isoquants for perfect substitutes and the isoquants for complements

Isoquants for perfect substitutes are straight lines with a constant slope because the inputs

can be substituted for each other in a fixed proportion without affecting the level of output.

For example, if inputs A and B are perfect substitutes in the production of a good, the isoquant

would be a straight line with a slope of -1, indicating that one unit of A can be substituted for

one unit of B.

Isoquants for complements are L-shaped because the inputs must be used in a fixed

proportion in order to produce a certain level of output. For example, if inputs A and B are

complements in the production of a good, the isoquant would be L-shaped, indicating that the

inputs must be used together in a fixed proportion to produce the desired level of output.
MODULE 5. COST FUNCTIONS

Recognize the distinctions between short-run and long-run cost functions

Short-run cost functions are those that take into account only the fixed costs and variable costs of

producing a given output level with at least one input fixed. At least one input is fixed.

Long-run cost functions, on the other hand, consider all costs associated with producing a given output

level, assuming that all inputs are variable and can be adjusted in response to changes in output. All inputs

are variable.

Explain why Opportunity Costs is a fundamental concept in cost analysis theory

It allows for a more accurate calculation of the true cost of an economic decision by considering the value

of the next best alternative forgone. By recognizing opportunity costs, decision-makers can make more

informed choices by weighing the benefits and costs of different options.

Identify the basic relationships of TC, TFC, TVC and MC

● Total Cost (TC) is the sum of Total Fixed Cost (TFC) and Total Variable Cost (TVC): TC

= TFC + TVC

● Marginal Cost (MC) is the increase in Total Cost resulting from producing one additional

unit of output: MC = ΔTC/ΔQ, where Q is the quantity of output produced

● Total Variable Cost (TVC) is the sum of all costs that vary with the level of output

produced: TVC = AVC x Q

● Total Fixed Cost (TFC) is the sum of all costs that do not vary with the level of output

produced: TFC = FC x Q, where FC is the fixed cost of production and Q is the quantity

of output produced.
Define the term "Sunk Costs"

Sunk costs refer to costs that have already been incurred and cannot be recovered or changed by any

present or future decision. Examples: R & D, equipment, advertising, training, legal fees

Recognize the features of AFC, AVC, ATC and MC

AFC (Average Fixed Cost) is the fixed cost per unit of output, calculated by dividing the total

fixed cost by the quantity of output. It decreases as output increases because fixed costs are

spread over a larger number of units.

AVC (Average Variable Cost) is the variable cost per unit of output, calculated by dividing the

total variable cost by the quantity of output. It typically first decreases and then increases as

output increases, due to the operation of the law of diminishing marginal returns.

ATC (Average Total Cost) is the total cost per unit of output, calculated by dividing the total

cost (fixed cost plus variable cost) by the quantity of output. It is the sum of AFC and AVC. It

typically decreases and then increases as output increases, due to the operation of the law of

diminishing marginal returns.

MC (Marginal Cost) is the cost of producing one additional unit of output. It is calculated by

taking the change in total cost associated with a one-unit change in output. It intersects the AVC

and ATC curves at their minimum points, and is typically U-shaped due to the operation of the

law of diminishing marginal returns.

Summarize how MC = AVC when AVC is at its minimum and MC = ATC at the ATC minimum

When the average variable cost (AVC) is at its minimum, the marginal cost (MC) is equal to

AVC. This is because the AVC curve is U-shaped and intersects with the MC curve at its lowest

point.
 Similarly, when the average total cost (ATC) is at its minimum, the marginal cost (MC) is equal

to ATC. This is because the ATC curve is also U-shaped and intersects with the MC curve at its

lowest point. At this point, the additional cost of producing one more unit is equal to the average

cost of producing that unit.

Calculate the breakeven level of output

Let's assume a company has fixed costs of $10,000, variable costs of $5 per unit, and sells its

product for $15 per unit. We can use the following formula to calculate the breakeven level of

output:

Breakeven quantity = Fixed costs / (Price per unit - Variable costs per unit)

Breakeven quantity = $10,000 / ($15 - $5)

Breakeven quantity = $10,000 / $10

Breakeven quantity = 1,000 units

List and explain economies of scale, diseconomies of scale, and economies of scope

1. Economies of Scale: refer to the cost advantages that a firm can achieve by increasing

its output or size of production in the long run. As production increases, average costs

per unit of output decrease. This may result from various factors such as specialization,

better utilization of resources, and reduced fixed costs per unit.

2. Diseconomies of Scale: refer to the cost disadvantages that a firm can face due to an

increase in its output or size of production beyond a certain point. As production

 increases, average costs per unit of output increase, resulting in reduced efficiency and

increased coordination costs.

3. Economies of Scope: refer to the cost advantages that a firm can achieve by producing

two or more products or services using the same resources or processes. This may

result from the sharing of resources, such as facilities, equipment, and labor, leading to

reduced costs per unit of output for each product or service.

Explain the relationship between implicit costs and explicit costs

Together, implicit and explicit costs make up the total economic cost of production for a firm.

Implicit costs use of personal savings or assets to finance the business. Forgone salary and leisure time

Explicit costs rent, wages, marketing, advertising, materials and supplies

Identify the ways in which managers utilize costs in their decision making to maximize firm value

1. Setting prices: Managers utilize cost information to determine the minimum price that

should be charged for a product or service to ensure profitability.

2. Make or buy decisions: Managers compare the costs of producing a product or service

in-house versus outsourcing it to determine which option is more cost-effective.

3. Investment decisions: Managers use cost information to determine the profitability of

different investment opportunities and choose the ones that will maximize firm value.

4. Budgeting: Managers use cost information to allocate resources and create budgets that

will ensure that costs are managed effectively and that the firm is on track to achieve its

financial goals.

Draw a marginal cost curve

● Represents the relationship between the quantity of output produced and the marginal cost incurred in

producing that output.

● The curve usually slopes upward from left to right, indicating that as the quantity of output produced

increases, the marginal cost of producing an additional unit of output also increases.

● As production increases, additional units of variable inputs are required, which often become more

expensive as production approaches capacity limits.

Recognize the importance of historical costs

1. Represents the actual costs incurred by a firm in the past.

2. These costs are used to determine the value of assets and to calculate the cost of goods sold, Provide

a benchmark for evaluating the efficiency of current operations

3. Help managers make informed decisions about pricing, production, and investment.

Describe the consequences of plant size in producing the most efficient bundle of output

The optimal plant size is the one that minimizes the average total cost of production.

MODULE 6. PERFECT COMPETITION, MONOPOLY & MONOPOLISTIC COMPETITION

Apply cost-plus pricing to the pricing of joint products with fixed and variable proportions

Cost-plus pricing is a pricing strategy that involves adding a markup to the cost of producing a product to

determine its selling price.

Joint products are two or more products that are simultaneously produced from a common input or set of

inputs, where neither product can be produced without the other. A change in the production level of one

product will lead to a corresponding change in the production level of the other product.
 Let's say a firm produces two joint products, A and B, with fixed proportions. The firm incurs a

total cost of $1,000 to produce both products, and the products can be sold separately in the

market. The firm wants to earn a markup of 20% on its total cost.

● The market price of product A is $600 per unit, and the firm needs to produce 2 units of

product A to produce 1 unit of product B.

● The market price of product B is $800 per unit.

To calculate the cost-plus price for each product, we need to allocate the total cost between

products A and B based on their fixed proportions:

● The cost allocated to product A = (2/3) x $1,000 = $666.67

● The cost allocated to product B = (1/3) x $1,000 = $333.33

To determine the cost-plus price for each product, we add the allocated cost to the desired

markup:

● Cost-plus price for product A = ($666.67 / 2) + 20% = $360 + $72 = $432

● Cost-plus price for product B = $333.33 + 20% = $400

Therefore, the firm would set the price of product A at $432 and the price of product B at $400

using cost-plus pricing with fixed proportions.

Determine whether a firm is operating in an increasing-cost, constant-cost or decreasing cost

industry

The relationship between the industry's supply curve and the long-run average cost (LRAC) curve

● If the industry's supply curve intersects the LRAC curve at a higher level of output as

industry output increases, the industry is operating in an increasing-cost industry.

 ● If the industry's supply curve intersects the LRAC curve at the same level of output as

industry output increases, the industry is operating in a constant-cost industry.

● If the industry's supply curve intersects the LRAC curve at a the relationship between the

industry's supply curve and the long-run average cost (LRAC) curve, the industry is

operating in a decreasing-cost industry.

Define the term "market structure"

Are organizational characteristics of a market that influence the behavior and interactions of firms operating

within it, such as:

1. number and size distribution of firms

2. the degree of product differentiation

3. barriers to entry

4. nature of competition

Recognize that a monopsony is a market that consists of a single buyer

A monopsony is a market situation where there is only one buyer for a particular product or service. This

gives the monopsonist buyer considerable market power to influence the price and quantity of the product

or service, potentially leading to market inefficiencies.

1. A company that is the only major employer in a small town and therefore has a significant degree of

market power over the labor market.

2. The government as a buyer of a specific good or service from a single supplier.

3. A large retailer that purchases goods from a single supplier, giving it significant bargaining power

over the supplier.

Compare and contrast perfect competition, monopoly and monopolistic competition

Perfect Monopolistic
Characteristic ompetition Monopoly Competition

Number of firms Many One Many

Barriers to entry Low High Low to medium

Degree of product
None None High
tion

Control over price No Yes Some

Market power None High Some

Downward
Nature of demand curve Perfectly elastic Downward sloping
 Profit maximization point MC=MR MC=MR MC=MR and P>MC

Level of efficiency High Low Low

Retail clothing

Agricultural
Examples Local utilities

MC=MR (Marginal Cost = Marginal Revenue) is a rule used by firms to determine the level of output they

should produce to maximize their profits. The rule states that a firm should produce at a level where the

additional revenue it generates from selling one more unit (MR) is equal to the additional cost of producing

that unit (MC). This is because if a firm produces more than the level where MC=MR, its costs will increase

more than its revenue, leading to lower profits. Conversely, if a firm produces less than the level where

MC=MR, it is missing out on potential revenue that could be generated from producing and selling

additional units.

Identify profit maximization in perfect competition, monopoly and monopolistic competition

 Market Structure Profit Maximization

Perfect Competition A firm in perfect competition maximizes profit where MR=MC.

Monopoly A monopolist maximizes profit where MC=MR, but with P > MC.

Monopolistic In the short run, a firm maximizes profit where MR=MC. In the long
on maximizes profit where P=ATC.

Note: MR is the marginal revenue, MC is the marginal cost, P is the market price, and ATC is

the average total cost.

Calculate the producer surplus and the social welfare function

Suppose a firm is selling 100 units of a product in a perfectly competitive market, and the market price for

each unit is $10. The firm's total cost of producing the 100 units is $800. Calculate the producer surplus

and social welfare function.

To calculate the producer surplus, we need to first calculate the firm's total revenue, which is simply the

market price multiplied by the quantity sold:

Total revenue = $10 * 100 = $1000

The producer surplus is then calculated as the difference between total revenue and total cost:

Producer surplus = Total revenue - Total cost

Producer surplus = $1000 - $800

Producer surplus = $200

To calculate the social welfare function, we need to first calculate the consumer surplus, which is the

difference between what consumers are willing to pay for the product and what they actually pay. In

a perfectly competitive market, the price is equal to the marginal cost, which is the same as the firm's

supply curve. Since the market price is $10, we can assume that consumers are willing to pay up to $10 for

the product. Therefore, the consumer surplus is:

Consumer surplus = (Maximum willingness to pay - Price) * Quantity

Consumer surplus = ($10 - $10) * 100

Consumer surplus = $0

The social welfare function is then simply the sum of the producer surplus and consumer surplus:

Social welfare function = Producer surplus + Consumer surplus

Social welfare function = $200 + $0

Social welfare function = $200

Therefore, in this example, the producer surplus is $200 and the social welfare function is also $200.

Find the shutdown point when P = min AVC

The shutdown point is the point at which a firm temporarily ceases production due to the fact

that it is no longer covering its variable costs. When P = min AVC, the firm is earning just

enough revenue to cover its variable costs, but not enough to cover its fixed costs. Thus, the

firm is better off shutting down temporarily rather than continuing to produce at a loss.
To find the shutdown point, we need to compare the price (P) with the minimum average

variable cost (AVC). If P < AVC, the firm should shut down. If P > AVC, the firm should continue

to produce.

Let's say the demand for cupcakes has fallen due to increased competition and the company

can only sell cupcakes for $1 each.

The AVC is calculated as total variable cost (TVC) divided by quantity (Q).

AVC = TVC / Q

Let's say the company produces 1,000 cupcakes. The TVC is calculated as variable cost per

unit (VC) times quantity (Q).

TVC = VC * Q

TVC = $1.50 * 1,000 = $1,500

AVC = $1,500 / 1,000 = $1.50

Since the price of $1 is less than the minimum AVC of $1.50, the company should shut down in

the short run.

The shutdown point is when price (P) is equal to the minimum average variable cost (min AVC).

In this example, the shutdown point is when P = $1 and min AVC = $1.50.

Regenerate response
MODULE 7. PRICE DISCRIMINATION

Identify the structure and components of bundling and mixed bundling

Bundling is a pricing strategy where two or more products are offered as a package deal for a

single price. Mixed bundling is a pricing strategy where two or more products are offered

together in a package, but they can also be purchased separately.

The components of bundling are:

1. Primary product - the main product being offered

2. Secondary product - the additional product(s) offered as part of the bundle

3. Price - the total price of the bundle

The components of mixed bundling are:

1. Primary product - the main product being offered

2. Secondary product - the additional product(s) offered as part of the bundle

3. Separate price - the price of each individual product

4. Mixed price - the price of the bundle as a whole.

Describe what a demand segment is

A subgroup of consumers with similar characteristics or preferences that can be targeted with a specific

marketing strategy or product offering.

For example, in the airline industry, one demand segment may consist of business travelers who prioritize

schedule flexibility and are willing to pay a premium for it, while another demand segment may consist of

leisure travelers who prioritize price and are willing to sacrifice some flexibility for a lower fare.

Identify the factors that affect intra-firm pricing among wholly-owned subsidiaries
 ● Tax rates and policies in different countries

● Tariffs and trade barriers

● Transfer pricing regulations and enforcement

● Differences in production costs and efficiencies

● Currency exchange rates and fluctuations

● Strategic goals and priorities of the parent company

● Market conditions and demand in different regions

● Intellectual property rights and licensing fees

● Political and regulatory risks in different countries.

Identify the distinction between peak load pricing and two-part tariffs

Both pricing strategies used by firms to increase revenue, but the key distinction between them is the way

in which they charge customers.

Peak load pricing charges different prices for the same product or service based on the time of day or

the level of demand. Electricity companies and airlines.

Two-part tariffs involve charging customers a fixed fee (such as a membership fee) plus a usage fee

based on the quantity consumed. Health clubs and mobile phone providers

Calculate peak load pricing when managers equate MC and MR separately in two periods

Suppose a power company has a constant marginal cost of $20 per unit of electricity. The company can

produce a maximum of 100 units per period. In the first period, the demand for electricity is given by Q1 =

120 - P1, and in the second period, the demand is Q2 = 80 - P2.

To maximize profits, the power company will set its marginal revenue (MR) equal to its marginal cost (MC)

in each period separately, and charge the corresponding prices. This means:

In period 1:

MRC=MC

MR1 = 120 - 2P1 = 20

1. Subtract 120 from both sides of the equation:

120 - 2P1 - 120 = 20 - 120

-2P1 = -100

2. Divide both sides by -2:

-2P1 / -2 = -100 / -2

Solving for P1, we get: P1 = 50

In period 2:

MR2 = 80 - 2P2 = 20

Subtracting 80 from both sides gives:

-2P2 = -60

Dividing both sides by -2 gives:

Solving for P2, we get: P2 = 30

 Therefore, the power company will charge $50 per unit in the first period and $30 per unit in the second

period under peak load pricing with separate MC and MR equations.

Describe how managers use price discrimination to maximize firm value

Strategy used by managers to increase profits by charging different prices to different groups of customers

for the same product or service. This is possible when there are differences in the willingness to pay among

different customer segments

1. Student discounts: Companies offer lower prices to students as they are assumed to

have a lower income and are price-sensitive.

2. Tiered pricing: Companies offer different pricing plans for their products or services,

based on the features and usage limits. This is commonly used by software companies.

3. Time-based pricing: Companies offer different prices for the same product or service,

based on the time of day, day of the week, or season. For example, airlines charge more

for tickets during peak travel periods.

4. Geographical pricing: Companies offer different prices for the same product or service,

based on the location of the customer. This is common in the tourism industry where

prices vary based on the country of origin of the customer.

5. Bundle pricing: Companies offer discounts when customers purchase a bundle of

products or services together. For example, a fast-food chain may offer a meal deal that

includes a burger, fries, and a drink at a lower price than buying each item individually.

Describe the causes and consequences of price discrimination

Positives of price discrimination:

● Increases revenue and profits for the firm.

● Helps firms to reach a wider range of customers by offering different pricing options.
● Can improve market efficiency by allowing firms to better allocate resources and reduce waste.

Negatives of price discrimination:

● Can be seen as unfair by customers who are charged higher prices for the same product or service.

● Can lead to a loss of consumer surplus for some customers.

● Can lead to a reduction in competition if smaller firms are unable to compete with larger firms that engage

in price discrimination.

Summarize the various types of price discrimination (first degree, second degree, third degree)

1. First-degree price discrimination: In this type of discrimination, a firm charges each

customer the maximum amount they are willing to pay for a product or service. An

example of this is when a car dealer negotiates with each customer to find the highest

price they are willing to pay for a specific car.

2. Second-degree price discrimination: This type of discrimination involves charging

different prices based on the quantity purchased. For example, a movie theater may

offer discounts for bulk purchases of tickets.

3. Third-degree price discrimination: This type of discrimination involves charging

different prices to different groups of customers based on their willingness to pay. For

example, a theme park may charge higher admission prices during peak season and

lower prices during the off-season. Another example is when a college charges different

tuition rates to in-state and out-of-state students.

Calculate and interpret price Elasticities among different demand segments

 You need to know the following information:

● Price of the good/service

● Quantity demanded of the good/service

● Income of the consumers

● Price of related goods/services

Price Elasticity of Demand = (% change in quantity demanded) / (% change in price)

Once you have calculated the price elasticities for each demand segment, you can interpret them as

follows:

● If the price elasticity of demand is greater than 1, demand is considered elastic. This means

that a small change in price leads to a relatively large change in quantity demanded. In this case, firms

should be cautious about raising prices as it will lead to a significant decrease in demand.

● If the price elasticity of demand is less than 1, demand is considered inelastic. This means

that a change in price leads to a relatively small change in quantity demanded. In this case, firms can

raise prices without a significant decrease in demand.

● If the price elasticity of demand is exactly 1, demand is considered unit elastic. This means

that a change in price leads to an equal proportional change in quantity demanded.

Recognize the key features of transfer pricing

Practice of assigning a value to the goods or services that are transferred between different units or

divisions within a company. The key features of transfer pricing include:

1. Setting prices that are consistent with arm's length transactions which requires that the

transfer price be similar to the price that would be charged between unrelated parties in

an open market.

2. Complying with relevant tax regulations. Avoiding double taxation.

 3. Allocate profits and costs between different units or divisions of the same company

Draw the effects of an entry fee when managers implement a two-part tariff

A two-part tariff is a pricing strategy in which a fixed fee (entry fee) is charged upfront for access to a

product or service, followed by a per-unit charge.

An entry fee in a two-part tariff can have the following effects:

● It increases the barrier to entry: An entry fee can discourage new entrants into the

market or industry, as it increases the cost of doing business.

● It can increase profit: The entry fee acts as a source of revenue and increases the

overall profit of the firm.

● It can affect the optimal quantity sold: The presence of an entry fee can affect the

optimal quantity sold, as it may reduce the quantity demanded by customers due to the

additional upfront cost.

● It can reduce deadweight loss: If the entry fee is set correctly, it can reduce deadweight

loss by ensuring that the marginal cost of production is covered.

Overall, the effects of an entry fee in a two-part tariff depend on various factors, such as the

level of demand elasticity, the cost structure of the firm, and the competitive environment.

Define the term "Tying" as it related to bundling

Refers to a situation where a firm requires customers to purchase one product (the tying product) in order

to be able to purchase another product (the tied product). Essentially, it is a sales strategy that leverages

the popularity of one product to sell another, less popular product.

For example, Microsoft Office bundles together several programs, and in order to use the popular word

processing program Word, the customer must also purchase the entire package, which includes other

programs such as Excel and PowerPoint.

MODULE 8. OLIGOPOLY AND GAME THEORY

Identify the reasons for and list the types of auctions

Reasons for auctions:

1. To allocate goods or services to buyers in a transparent and competitive manner

2. To determine the market value of goods or services

3. To liquidate assets in a timely manner

1. English auction: A type of open ascending-price auction where the auctioneer starts

with a low price and gradually increases the price until a bidder is willing to pay the price,

and the bidder with the highest price wins.

2. Dutch auction: A type of open descending-price auction where the auctioneer starts

with a high price and gradually decreases the price until a bidder is willing to pay the

price, and the bidder with the highest price wins.

3. First-price sealed-bid auction: A type of closed auction where bidders submit a single

bid in a sealed envelope, and the bidder with the highest bid wins and pays the amount

of their bid.

4. Second-price sealed-bid auction: A type of closed auction where bidders submit a

single bid in a sealed envelope, and the bidder with the highest bid wins but pays the

amount of the second-highest bid. This is also known as a Vickrey auction.

5. All-pay auction: A type of auction where all bidders pay their bid amounts, regardless of

whether they win or lose the auction.

 6. Reverse auction: A type of auction where buyers submit bids for a project or contract,

and the seller selects the lowest bid.

Summarize how collusion increases profits, raises barriers to entry and decreases uncertainty

1. Collusion is an agreement between firms to reduce or eliminate competition among themselves, which can

lead to increased profits for the colluding firms.

2. By agreeing to limit competition, colluding firms can raise barriers to entry for new firms, making it difficult

for them to enter the market.

3. Collusion can also decrease uncertainty by allowing firms to coordinate their actions and reduce the risk of

unpredictable market fluctuations

Apply Cournot Reaction Functions to markets with a few rivals

Cournot reaction functions describe how a firm will adjust its output level in response to a change in its

competitor's output level, assuming that its competitors' outputs remain constant.

For example, suppose that there are two firms, A and B, in a market with the total demand

function Q = 100 - P, where Q is total market quantity and P is price.

Firm A has a constant marginal cost of $20 per unit and will produce a fixed quantity of 30 units.

Firm B has a constant marginal cost of $30 per unit and will produce a fixed quantity of 30 units.

Using this information, we can derive the residual demand function for

Firm A as Qa = (100 - Pb) / 2

Firm B as Qb = (100 - Pa) / 2.

 Using these residual demand functions, we can derive the optimal output level for each firm as

follows:

● Firm A: max (Qa * (P - 20)) = max ((100 - Pb) / 2 * (P - 20))

● Firm B: max (Qb * (P - 30)) = max ((100 - Pa) / 2 * (P - 30))

Solving these equations simultaneously, we can find the Cournot equilibrium output levels for

each firm as QA = QB = 20, and the corresponding price as P = 60.

Describe the key features and functions of Game Theory

Game Theory analyzes decision-making strategies of individuals or organizations based on their

interdependence with other individuals or organizations.

The key features of game theory include:

1. Players: The individuals or organizations making the decisions in the game.

2. Strategies: The different options available to the players for making their decisions.

3. Payoffs: The rewards or costs associated with each possible combination of strategies chosen by

the players.

4. Information: The knowledge that the players have about each other's preferences and actions.

5. Interdependence: The fact that the payoffs for each player depend on the strategies chosen by all

players.

Game theory provides several functions, including:

1. Predicting behavior: Game theory can help predict how individuals or organizations will behave in

certain situations.

2. Designing strategies: Game theory can be used to design optimal strategies for individuals or

organizations in competitive environments.

 3. Analyzing outcomes: Game theory can help analyze the outcomes of different strategies and

identify which ones are most likely to be successful.

4. Understanding complex interactions: Game theory can be used to understand complex

interactions between individuals or organizations and how they affect decision-making.

Draw a kinked demand curve

A kinked demand curve is a model of oligopoly pricing or a few large firms dominate the market

and are able to influence prices. Demand/buyers are more sensitive to price increases than to price

decreases.

Add to the theory of Nash Equilibrium the concept of backward induction

Nash Equilibrium is a concept in game theory where each player in a game makes decisions based on

their assumption about the decisions of others in the game. No player has an incentive to change their

strategy given the strategies of the other players.

Backward induction takes into account the players' rationality and ability to reason backwards from the

end of the game. It involves working backwards from the end of the game to determine what each player's

optimal strategy would be at each stage of the game. This allows players to anticipate the actions of their

opponents and make strategic decisions accordingly, leading to more optimal outcomes.

Draw a game tree, roadmap and payoff matrix

Compare and contrast "Ascending-Bid Time Auctions" and "Sniping"

Ascending-bid timed auction, the auctioneer sets a starting price, and bidders place bids in incremental

amounts until the auction closes at a set time. As the auction progresses, the bidding price increases, and

bidders can adjust their bids accordingly. The winner is the highest bidder when the auction ends.

Sniping, bidders wait until the last few seconds of the auction to place their bids. This strategy aims to

prevent other bidders from having enough time to place a higher bid.
The main differences between the two strategies are:

1. Ascending-bid timed auctions have a set closing time, while sniping involves placing a bid

as close to the end of the auction as possible.

2. Ascending-bid timed auctions allow bidders to see the current highest bid and adjust their

bids accordingly, while sniping aims to surprise other bidders with a higher bid at the last minute.

3. Ascending-bid timed auctions can discourage sniping since they allow for bidding

increments and extend the auction time if a bid is placed close to the end of the auction. Sniping is

more effective in auctions that do not have these features.