MASTER’S DEGREE PROGRAMME IN BUSINESS ADMINISTRATION

Module: Managerial Economics (MBA50)

Academic Year: 2022-23

1st Written Assignment (WA1)

Subject 1: Monopoly (30%)

Nick is the only supplier of bobbins in White Stone (a village in the mountains of Central
Greece). There are only three consumers of bobbins in the village and, depending on the price,
they can buy up to three bobbins each. The table shows the marginal willingness to pay (MWP)
of each of the three consumers for bobbins.

MWP (in Euros)

st
Consumer 1 1 bobbin 0.80
2nd bobbin 0.50
3rd bobbin 0.20

MWP (in Euros)

st
Consumer 2 1 bobbin 1.00
2nd bobbin 0.90
3rd bobbin 0.20

MWP (in Euros)

st
Consumer 3 1 bobbin 0.95
2nd bobbin 0.70
3rd bobbin 0.55

The marginal and average cost of a bobbin is 0.55.

(a) Assume that Nick knows the MWPs and applies perfect (first-degree) price
discrimination. Determine the number of bobbins that will be sold, the consumers that
will purchase them, Nick’s profit, the consumer surplus for each consumer, and the total
level of welfare generated by the market for bobbins in White Stone. (Mark: 1.5)
[Notes: (1) Resale of bobbins among consumers is not feasible; (2) when a consumer is
indifferent between purchasing or not, please assume that she(he) will buy the bobbin.]
(b) Assume that the market for bobbins in White Stone is perfectly competitive. Determine
again the number of bobbins that will be sold, the consumers that will purchase them,

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 MASTER’S DEGREE PROGRAMME IN BUSINESS ADMINISTRATION

Nick’s profit, the consumer surplus for each consumer, and the total level of welfare.
(Mark: 1.25)
[Note: Again, when a consumer is indifferent between purchasing or not, please assume
that she(he) will buy the bobbin.]
(c) Compare and comment on your findings from (a) and (b). (Mark: 0.25)
[Marking scheme: economic intuition 10%, use of appropriate arguments 40%, correct
application 30%, overall presentation 20%]

Indicative Answer
(a) For each bobbin sold Nick charges the buyer’s MWP. Since consumer 2 has the highest
MWP for the first bobbin (1st for her (him)), Nick will sell it to her (him) at a price equal
to 1. Consumer 3 will buy the second bobbin in the market (the 1stt for her(him)) at a
price equal to 0.95. Consumer 2 will buy the third bobbin in the market (the 2ndt for
her(him)) at a price equal to 0.9. Consumer 1 will buy the fourth bobbin in the market
(the 1st for her(him)) at a price equal to 0.8. Consumer 3 will buy the fifth bobbin in the
market (the 2nd for her(him)) at a price equal to 0.7. Consumer 3 will buy the sixth bobbin
(the 3rd for her(him)) at a price equal to 0.55. Nick, will not supply any more bobbins in
White Stone market since the MWPs of consumers for an additional bobbin are all below
the average and marginal cost of a bobbin (0.55). The total sales for Nick will be,
therefore, 6.
Consumer 3 will buy three bobbins, consumer 2 will buy two, while consumer 1 will buy
only one bobbin. Nick’s profit will be (1 − 0.55) + (0.95 − 0.55) + (0.9 − 0.55) +
(0.8 − 0.55) + (0.7 − 0.55) + (0.55 − 0.55) = 1.6. Since Nick applies perfect price
discrimination, the individual and the aggregate consumer surplus will be equal to zero.
The total level of welfare (W) in White Stone will be equal to Nick’s profit; that is, 𝑊 =
1.6.
(b) Under perfect competition, the equilibrium level of bobbins in the White Stone Market
will be determined by the condition MWP = marginal cost = price, which is satisfied for
6 bobbins in the market. Consumer 3 will buy three bobbins, consumer 2 will buy two,
while consumer 1 will buy only one bobbin. The surplus for consumer 3 will be
(0.95 + 0.7 + 0.55) − (3 × 0.55) = 0.55, for consumer 2 will be, (1 + 0.9) −
(2 × 0.55) = 0.8 and for consumer 1 it will be 0.8 − 0.55 = 0.25. The aggregate
consumer surplus will be 1.6. Given p=MC=AC, Nick’s profit will be zero. The total
level of welfare will be equal to the aggregate consumer surplus (that is, 𝑊 = 1.6).
(c) The perfect (first-degree) price discrimination and the perfect competition bring the
welfare-maximizing (efficient) quantity into the White Stone market. Also, the consumer
choices are exactly the same. The difference is that, under the first-degree price

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discrimination, the total level of welfare equals to Nick’s profit whereas, under perfect
competition, it equals the aggregate consumer surplus.

Subject 2: Elasticties (20%)

When Super Cars Ltd sets the price to 20,000 euros and the average disposable income is 40,000
euros, it sells 800 cars. When, for the same price, the average disposable income rises to 55,000
euros it sells 1500 cars.
(a) Are the cars sold by Super Cars Ltd a necessity, a luxury or an inferior good? Explain.
(Mark: 1.0)
(b) Fast Cars Ltd is a competitor of Super Cars Ltd. When Fast Cars Ltd sets the price to
38,000 euros, Super Cars Ltd sells 250 cars. The cross-price elasticity of demand for the
cars of the two firms is 1.22. Suppose now that Fast Cars Ltd reduces the price for its
cars by 1,000 euros while Super Cars Ltd leaves the price for its cars the same. What will
the effect of price reduction be on the sales (in number of cars) of Super Cars Ltd?
(Mark:1.0)
[Note: Round your result to the closest integer.]
[Marking scheme: economic intuition 10%, use of appropriate arguments 40%, correct
application 30%, overall presentation 20%]

Indicative Answer
(a) The formula for arc income elasticity of demand is
𝑑 %Δ𝑄 𝑑 𝑄 𝑑 −𝑄𝑑 [(𝑀 +𝑀 )⁄2]
𝜀𝑀 = = (𝑀2 −𝑀1 ) ∗ [(𝑄𝑑1 +𝑄𝑑2)⁄2] (1)
%Δ𝑀 2 1 1 2
Replacing in (1) the relevant values for the disposable income and the number of cars
sold one obtains
𝑑 1500−800 [(40000+55000)⁄2] 700 (47500)
𝜀𝑀 = (55000−40000) ∗ [(800+1500)⁄2]
=(15000) ∗ (1150)
= 1.93.
𝑑
Since 𝜀𝑀 > 1, a car sold by Super Cars Ltd is a luxury good, meaning that the quantity
demanded rises (ceteris paribus) faster than the disposable income does.
(b) The formula for arc cross-price elasticity of demand is
1 +𝑝2 )⁄2]
𝑑 𝑄 𝑑 −𝑄𝑑 [(𝑝𝑦 𝑦
𝜀𝑞,𝑦 = ( 𝑝22 −𝑝11 ) ∗ [(𝑄𝑑 +𝑄𝑑 )⁄2]. (2)
𝑦 𝑦 1 2
𝑑
Equating 𝜀𝑞,𝑦 to 1.22 and replacing the relevant values for the prices and the number of
Qd −250 [(75000)⁄2]
2
cars sold in (2) leads to 1.22 = ( −1000 ) ∗ [(250+Qd)⁄ ]. Solving the last equation for 𝑄2𝑑
2 2

one obtains 𝑄2𝑑 = 242 (rounded to the closest integer). Therefore, the sales of Super Cars
Ltd will be reduced by 250 − 242 = 8 cars. This has been expected as the goods are
substitutes (they have a positive cross-price elasticity).

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Subject 3: Demand, Supply, Tax (20%)

The market for cigarettes in country A is perfectly competitive with demand and supply
functions 𝐷(𝑝) = 190 − 4𝑝 and 𝑆(𝑝) = −50 + 2𝑝, respectively. The quantities and prices
refer to packets of 1,000 cigarettes.
(a) Compute the pair (quantity, price) at the market equilibrium. (Mark: 0.25)
(b) Assume now that, as a disincentive to smoking, the government imposes a tax 𝑡 = 15 per
packet of cigarettes sold. Compute the quantity in the market, the price the consumer pay,
and the price the producers receive at the market equilibrium with the tax. (Mark: 0.75)
(c) Compute and comment on (explain) the tax incidence in the market. (Mark: 1.0)
[Marking scheme: economic intuition 30%, use of appropriate arguments 30%, correct
application 20%, overall presentation 20%]

Indicative Answer
(a) 𝐷(𝑝) = 𝑆(𝑝) ⇒ 190 − 4𝑝 = −50 + 2𝑝 ⇒ 𝑝 = 40. Then from the demand or from the
supply function it follows that 𝑄 = 30.
(b) Let p be the price the producers receive after the imposition of the tax. At the new
equilibrium, 𝐷(𝑝 + 𝑡) = 𝑆(𝑝) ⇒ 190 − 4(𝑝 + 𝑡) = −50 + 2𝑝 ⇒ 190 − 4(𝑝 + 15) =
−50 + 2𝑝 ⇒ 𝑝 = 30. The consumers pay 30 + 15 = 45. Substitution of 30 into the
supply function or of 45 into the demand function yields the new equilibrium quantity
𝑄 = 10.
(c) The tax incidence (i) is the percentage of the tax passed on to the consumers. Here, the
price the consumers pay increases by 5 = 45 − 40 whereas the price the producers
receive falls by 10 = 40 − 30. Therefore, 1⁄3 of the tax burden goes to consumers and
2⁄3 of it goes to producers. The tax incidence is directly related to the price elasticities
of demand and supply at the market equilibrium without the tax. Indeed, 𝑖 =
𝑒𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 𝑜𝑓 𝑠𝑢𝑝𝑝𝑙𝑦
. The elasticity of supply is 2 × (40⁄30) = 2.666
𝑒𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 𝑜𝑓 𝑠𝑢𝑝𝑝𝑙𝑦−𝑒𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 𝑜𝑓 𝑑𝑒𝑚𝑎𝑛𝑑
2.666 1
and the elasticity of demand is −4 × (40⁄30) = −5.333. Therefore, 𝑖 = 2.666+5.333 = 3.
The absolute value of the elasticity of demand > elasticity of supply. The producers are
less flexible relative to consumers and, thus, they undertake the largest part of the tax
burden.

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Subject 4: Perfect Competition, Long-run Equilibrium (30%)

𝑄
In a perfectly competitive industry, the demand function is 𝑝 = 55 − 20. All firms operating in
this industry face the same technological conditions described by the cost function 𝑐 = 200 +
𝑞2
+ 10𝑞.
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(a) Determine the quantity produced by the individual firm, the market price as well as the
number of firms in the long-run industry equilibrium (Mark: 1.5)
(b) Assume that the Government restricts individual sales to 10 units per firm (i.e., no firm
is allowed to produce more than 10 units). Determine the quantity produced by the
individual firm, the market price as well as the number of firms in the new long-run
industry equilibrium. Comment on your findings. (Mark: 1.5)
[Marking scheme: economic intuition 30%, use of appropriate arguments 30%, correct
application 20%, overall presentation 20%]

Indicative Answer
200 𝑞
(a) The marginal and average cost functions are 𝑀𝐶 = 𝑞 + 10 and 𝐴𝐶 = + 2 + 10,
𝑞
200 𝑞
respectively. In the long-run equilibrium, it holds that 𝑀𝐶 = 𝐴𝐶 ⇒ 𝑞 + 10 = +2+
𝑞
10 ⇒ 𝑞 ∗ = 20. The equilibrium price should be equal to the marginal and the average
cost at 𝑞 ∗ . Substitution of 20 into either the MC or the AC function yields 𝑝∗ = 30. Then,
𝑄
from the market demand function, 30 = 55 − 20 ⇒ 𝑄 ∗ = 500. Therefore, the number of
500
firms is 𝑛 = = 25.
20
(b) In the unrestricted long-run equilibrium it holds that 𝑝 = 𝑚𝑖𝑛𝐴𝐶 (i.e., MC equals AC
when the latter is at its minimum). As shown in the following graph, under the
government restriction, each firm in the new industry equilibrium will produce a lower
quantity than the one minimizing AC. The individual firm cannot increase its production.
At the same time (because in perfect competition firms are price takers) it is not profitable
for it to reduce its production as this would come at a higher AC. Therefore, it should be
the case that 𝑝∗ = 𝐴𝐶(10) ⇒ 𝑝∗ = 35. Then from the market demand function 35 =
𝑄
55 − ⇒ 𝑄 ∗ = 400. The number of firms in the long-run equilibrium under the
20
400
individual production quota is 𝑛 = = 40. It is obvious that the policy will increase
10
the number of firms in the industry and the equilibrium price.

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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
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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.
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Good luck!!