MASTER’S DEGREE PROGRAMME IN BUSINESS ADMINISTRATION

Module: Managerial Economics (MBA50)

Academic Year: 2021-22

1st Written Assignment (WA1)

Subject 1: Monopoly (30%)

A pharmaceutical firm (monopolist) sells a medicine in two markets (1 and 2). In market 1,
the demand function is 𝑄𝑄1 = 16 − 𝑝𝑝1 and in market 2 it is 𝑄𝑄2 = 2 × (10 − 𝑝𝑝2 ). The firm’s
cost function is 𝐶𝐶(𝑄𝑄) = 2𝑄𝑄, with 𝑄𝑄 = 𝑄𝑄1 + 𝑄𝑄2 .
(a) Assume that price discrimination is feasible. Compute the prices charged and quantities
sold in each market. What is the firm’s profit under price discrimination? What is the
aggregate consumer surplus? [Mark: 1.0]
(b) Calculate the Lerner’s index of monopoly power in market 1 and in market 2 and relate
each one of them to the corresponding price elasticity of demand. What do you observe?
Provide an economic explanation of your findings. [Mark: 0.75]
(c) Assume now that price discrimination is not feasible. Compute the price charged, the
firm’s profit, and the aggregate consumer surplus. [Mark: 0.75]
(d) Compare and comment on your results from (a) and (c). [Mark: 0.5]

[Marking scheme: economic intuition 10%, use of appropriate arguments 40%, correct
application 30%, overall presentation 20%]

Indicative Answer
(a) The profit maximization rule under 3rd degree price discrimination is 𝑀𝑀𝑀𝑀1 = 𝑀𝑀𝑀𝑀2 =
𝑀𝑀𝑀𝑀. Here, 𝑀𝑀𝑀𝑀1 = 16 − 2𝑄𝑄1 , 𝑀𝑀𝑀𝑀2 = 10 − 𝑄𝑄2 , and 𝑀𝑀𝑀𝑀 = 2. From these, it follows that
𝑄𝑄1 = 7 and 𝑄𝑄2 = 8. Substituting the quantities into the respective demand functions
one obtains 𝑝𝑝1 = 9 and 𝑝𝑝2 = 6. The firm’s profit under discrimination is 𝜋𝜋 𝑑𝑑 =
(16−9)×7
(9 × 7) + (6 × 8) − (2 × 15) = 81. Also, 𝐶𝐶𝐶𝐶1𝑑𝑑 = 2
= 24.5 and 𝐶𝐶𝐶𝐶2𝑑𝑑 =
(10−6)×8
2
= 16. Therefore, the aggregate consumer surplus is 40.5.
9−2 7 6−2 2
(b) The Lerner’s index in market 1 is 𝐿𝐿𝑑𝑑1 = 9
= 9
and in market 2 it is 𝐿𝐿𝑑𝑑2 = 6
= 3.
The monopoly power is higher in market 1. We know that in a monopolistic market
1
𝐿𝐿 = − 𝑒𝑒, where 𝑒𝑒 is the price elasticity of demand. Using the last relation, one obtains
9 3
𝑒𝑒1𝑑𝑑 = − 7
and 𝑒𝑒2𝑑𝑑 = − 2
. Clearly, the monopoly power is greater in market 1 where the
price elasticity of demand is lower (in absolute value terms). In market 1, consumers are
less flexible (have fewer alternatives) relative to those in market 2.

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 MASTER’S DEGREE PROGRAMME IN BUSINESS ADMINISTRATION

(c) Under uniform pricing, the aggregate demand function is 𝑄𝑄 = 36 − 3𝑝𝑝. Using the
standard rule for profit maximization, 𝑀𝑀𝑀𝑀 = 𝑀𝑀𝑀𝑀, one obtains 𝑄𝑄 = 15 and 𝑝𝑝 = 7.
Substituting the uniform price into the demand functions for markets 1 and 2 yields
𝑄𝑄1 = 9 and 𝑄𝑄2 = 6. The firm’s profit is 𝜋𝜋 𝑢𝑢 = (7 − 2) × 15 = 75 < 81. Also, 𝐶𝐶𝐶𝐶1𝑢𝑢 =
(16−7)×9 (10−7)×6
2
= 40.5 and 𝐶𝐶𝐶𝐶2𝑢𝑢 = 2
= 9. Therefore, the aggregate consumer surplus is
49.5.
(d) The firm experiences a decrease in profit under uniform pricing because it is not able to
exploit the difference in elasticities between the two markets anymore. Consumers in
market 1 prefer uniform pricing. The opposite is true for consumers in market 2.

Subject 2: Perfect Competition (20%)

The market for an agricultural commodity is perfectly competitive. The long-run average cost function
of the representative farm in the market is U-shaped, with Minimum Efficient Scale (MES) equal to 2
and minimum average cost equal to 5.
(a) If the long-run demand function is 𝐷𝐷(𝑝𝑝) = 1,200 − 100𝑝𝑝, determine the market price,
the quantity supplied by the representative farm, the aggregate quantity traded, and the
number of farms in the long-run market equilibrium. Show the market and the
representative farm equilibria on the same graph. [Mark: 1.0]
(b) Suppose now that the demand for the commodity increases to 𝐷𝐷 𝑆𝑆 (𝑝𝑝) = 1,500 − 100𝑝𝑝
and that, because of biological constraints, the farms cannot adjust their production to
the new demand conditions. Also, the number of farms in the market remains the same.
Determine the market price and the profit of the representative farm under 𝐷𝐷 𝑠𝑠 . Show the
market and the representative farm equilibria on the same graph (Hint: Assume a
constant cost industry). [Mark: 1.0]

[Marking scheme: economic intuition 10%, use of appropriate arguments 40%, correct
application 30%, overall presentation 20%]

Indicative Answer
(a) In the long-run equilibrium 𝑝𝑝 = 𝑚𝑚𝑚𝑚𝑚𝑚{𝐿𝐿𝐿𝐿𝐿𝐿} = 5. The representative farm operates at its
MES and supplies 2 units. The aggregate quantity traded is 𝑄𝑄 = 1,200 − (100 × 5) =
700 and the number of firms in the long-run equilibrium is 700⁄2 = 350.

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 MASTER’S DEGREE PROGRAMME IN BUSINESS ADMINISTRATION

𝑝𝑝 𝑝𝑝
𝐿𝐿𝐿𝐿𝐿𝐿

5
Long-run market
supply curve

𝐷𝐷

𝑄𝑄(𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚) = 700 𝑄𝑄 𝑀𝑀𝑀𝑀𝑀𝑀 = 2 𝑞𝑞

MARKET REPRESENTATIVE FARM

(b) In the short-run, the market supply is perfectly inelastic at 𝑄𝑄(𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚) = 700. The
short-run equilibrium price is determined at the intersection of the inelastic aggregate
supply and the 𝐷𝐷 𝑠𝑠 . Therefore, 700 = 1,500 − 100𝑝𝑝 implying 𝑝𝑝 = 8. The representative
farm produces quantity equal to its MES and its profit is 𝜋𝜋 = (8 − 5) × 2 = 6.

𝑝𝑝 Short-run market 𝑝𝑝
𝐿𝐿𝐿𝐿𝐿𝐿
supply curve
8

5
𝐷𝐷 𝑆𝑆

𝑄𝑄(𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚) = 700 𝑄𝑄 𝑀𝑀𝑀𝑀𝑀𝑀 = 2 𝑞𝑞

MARKET REPRESENTATIVE FARM

Subject 3: Elasticities (25%)

The manager of British Steel Corp. (BS), which produces steel in the United Kingdom, has
estimated that the elasticities of demand for steel (S) are: 𝑒𝑒𝑆𝑆 = −2 (own- price); 𝑒𝑒𝑀𝑀 = 1
(income), and 𝑒𝑒𝑆𝑆,𝐴𝐴 = 1.5 (cross-price with respect to aluminum). Next year, the marketing
department of BS is planning to increase the price of steel by 6%, while economic forecasts

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 MASTER’S DEGREE PROGRAMME IN BUSINESS ADMINISTRATION

suggest that next year consumers’ income (M) in the UK will rise by 4% and the price of
aluminum will fall by 2%.
(a) Comment on the relationship between steel and aluminum. [Mark: 0.5]
(b) If the total sales for steel during this year are 1,200 tones, how many tones of steel will
BS sell next year? [Mark: 1.0]
(c) If BS wants its volume of sales next year to be exactly the same as in this year, by how
much (in % terms) must it change its price? [Mark: 1.0]

[Marking scheme: economic intuition 30%, use of appropriate arguments 30%, correct
application 20%, overall presentation 20%]

Indicative Answer
(a) The positive cross-price elasticity of demand �𝑒𝑒𝑆𝑆,𝐴𝐴 = 1.5 > 0� suggests that an increase
in the price of aluminum works towards an increase in the demand for steel. Therefore,
steel and aluminum are substitutes.
(b) Since 𝑒𝑒𝑆𝑆 = −2 < 0, the increase in the price of steel will lead to a reduction in the
quantity of steel demanded. The change of sales will be 𝑄𝑄𝑆𝑆 % = 𝑒𝑒𝑆𝑆 × 𝑝𝑝𝑆𝑆 % = −2 ×
6% = −12%. Given that 𝑒𝑒𝑀𝑀 = 1, the increase in consumer income by 4% will lead to
an increase in demand for steel by 4% as well. Since 𝑒𝑒𝑆𝑆,𝐴𝐴 = 1.5 > 0, the fall in the price
of aluminum will result into a decrease in the demand for steel by 𝑄𝑄𝑆𝑆 % = 𝑒𝑒𝑆𝑆,𝛢𝛢 ×
𝑝𝑝𝛢𝛢 % = 1.5 × (−2%) = −3%. Therefore, the next year’s volume of sales will be
1,200 × (1 − 0.12 + 0.04 − 0.03) = 1,068 tones.
(c) The increase in income and the fall in the price of aluminum will change the volume of
sales by 4% − 3% = 1%. To just offset the increase, the price of steel should rise by
𝑝𝑝𝑆𝑆 % = −1%⁄𝑒𝑒𝑆𝑆 = 0.5%.

Subject 4: Market Welfare (25%)

Assume that in a small island of Greece there are only four consumers with different
preferences towards sailing boats: Consumer A is willing to pay 70,000€, consumer B
20,000€, consumer C 80,000€ and consumer D 40,000€. In the area, there are only four
firms that are producing identical sailing boats at the following cost conditions: Sun Co with
30,000€, Sea Co with 60,000€, Moon Co with 40,000€ Co and Beach Co with 20,000€.
Each firm can produce at most one sailing boat. Suppose that the government nationalizes the
sector and distributes the sailing boats to consumers for free.
(a) Determine the number of sailing boats that maximize the social surplus (i.e., the
difference between consumers’ willingness to pay for sailing boats and the cost of

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 MASTER’S DEGREE PROGRAMME IN BUSINESS ADMINISTRATION

producing those boats). Which of the firms will be producing? Which consumers will be
enjoying the sailing boats? [Mark: 1.0]
(b) Find the social surplus generated in the nationalized sector. [Mark: 0.5]
(c) Suppose now that there are free market conditions. Find the market equilibrium price
and quantity of sailing boats. Calculate producer, consumer and social surpluses and
comment on your findings. [Mark: 1.0]

[Marking scheme: economic intuition 30%, use of appropriate arguments 30%, correct
application 20%, overall presentation 20%]

Indicative Answer
(a) If the government wants to maximize the surplus generated in the nationalized sector of
sailing boats it should serve consumer with the highest willingness to pay producing the
sailing boats by the firm with the lowest cost.
Consumers WTP Firms Cost
C 80,000€ Beach Co 20,000€
A 70,000€ Sun Co 30,000€
D 40,000€ Moon Co 40,000€
B 20,000€ Sea Co 60,000€
Therefore only 3 sailing boats will be produced by firms Beach Co, Sun Co and Moon
Co as the last consumer evaluates the sailing boat less than its cost of production.
(b) The social surplus in this case would be equal with individual valuation minus the cost
of producing the three sailing boats. That is, (80,000€ + 70,000€ + 40,000€) −
(20,000€ + 30,000€ + 40,000€) = 100,000€.
(c) If the market is free, the equilibrium price will be 40,000€. Total utility enjoyed by the
three consumers is 80,000€ + 70,000€ + 40,000€ = 190,000€. The cost of
purchasing the boats will be 3 × 40,000€ = 120,000€ (the revenues enjoyed by the
three firms). So their surplus will be 70,000€. On the other hand, the three firms will
gain surplus equal with their revenues minus the cost of production: 120,000€ −
90,000€ = 30,000€. Hence total welfare will be again 70,000€ + 30,000€ =
100,000€. The difference is that in this case part of the social welfare is enjoyed by the
three firms.

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 MASTER’S DEGREE PROGRAMME IN BUSINESS ADMINISTRATION

Assignment guidelines
• It is important that the coursework reflects your knowledge rather than it being simply an
accumulation of information.
• The assignment should be well structured and easy to read.
• The assignment should clearly present all aspects and perspectives of the subject area, i.e.:
o efficiently develop all necessary elements
o refer to actual case studies or statistics if required
o present reasonable argumentation
o omit irrelevant material
• All questions are compulsory. The assignment should not exceed 2500 words or 10 pages long
with font size 12pt. Any necessary graphs, figures, tables, references and equations do count in
the final length. Note also that although a violation up to 20% of the maximum length is
acceptable, a penalty of 8% of your final grade applies beyond that threshold.
• Each question accounts for a percentage of the total mark. This is clearly marked at the
beginning of each question.
• You are strongly advised to use the template for WAs provided by the Hellenic Open University.
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Good luck!!