Managerial Economics

Assignment 2(b)

Submitted to:
Mam Hira Ikram
Submitted by:
Muhammad Hammad Aqdas

Roll no:

70120251

Class:
MBA (Spring 2021)

Department:
Lahore Business School (LBS)

Institute:
UNIVERSITY OF LAHORE
QNo.1
The demand curve for a product is given by Pz = $400.
1. What is the own price elasticity of demand when Px = $154? Is demand elastic or
inelastic at this price? What would happen to the firm’s revenue if it decided to
charge a price below $154?
2. What is the own price elasticity of demand when Px = $354? Is demand elastic or
inelastic at this price? What would happen to the firm’s revenue if it decided to
charge a price above $354?
3. What is the cross-price elasticity of demand between good X and good Z when Px =
$154? Are goods X and Z substitutes or complements?
Solution:
1. What is the own price elasticity of demand when Px = $154? Is demand elastic or
inelastic at this price? What would happen to the firm’s revenue if it decided to
charge a price below $154?

Qdx =1,000 - 2Px +.02Pz

On, differentiating with respect to Px, we get
d(Qdx)/dPx=-2

Value of Qdx at Px=$154 and Pz=$400

Qdx=1000-2*154+0.02*400=700

Own price elasticity of demand= [d(Qdx)/dPx] *[Px/Qdx]

=-2*(154/700 )= -0.44

Absolute value of own price elasticity of demand is less than 1, we can say that demand is
inelastic at Px=$154.

In case of inelastic demand, total revenue will decrease if price decreases. We can say that total
revenue will fall if firm changes a price below $154

2. What is the own price elasticity of demand when Px = $354? Is demand elastic or
inelastic at this price? What would happen to the firm’s revenue if it decided to
charge a price above $354?
Px = $240, plugging this value, we get,
Qx = 1000 – 2*354 – 0.02*400
Qx = 284 units.
E = -2 * 354/284.
E = -2.49
The demand is elastic because the absolute value is less than one. If the firm charges a price
above $354, then the firm would lose out on its revenue because % change in demand is more
than the price.
3. What is the cross-price elasticity of demand between good X and good Z when Px =
$154? Are goods X and Z substitutes or complements?
Cross price elasticity of demand Es = Qx/ Pz * Pz/Qx.
Qx/ Pz = -0.02
Es = -0.02 * 400/700.
Es = -0.011
The goods are complements of each other. As the price of one increases, the demand for other
would fall, and vice-versa.

QNo.2
For each of the following pair of goods, which good would you expect to have more
price elastic demand and why?

a) Textbooks recommended by lecturers or mystery novels.

b) Beethoven recordings or classic music recordings in general.
c) Heating oil during the next six months or heating oil during the next five
years.
d) Lemonade and water.

Solution:

a) Required textbooks are necessary and have no close substitutes. Thus, the demand for
textbooks is inelastic. Mystery novels have close substitutes, thus their demand is elastic.
Therefore, mystery novels have more elastic demand.

b) Beethoven recordings have more elastic demand than classic music recordings in general so it
is easy to find close substitutes for them.

c) Heating oil during the next five years have more price elasticity since goods have more elastic
demand over longer time horizons and inelastic demand over shorter time horizons.

d) Lemonade have more elastic demand than water because it has close substitutes, while water
is a necessity with no close substitutes.
QNo.3:

Pharmaceutical drugs have an inelastic demand, and computers have an elastic demand.
Suppose that technological advance doubles the supply of both products (i.e.
quantity supplied at each price is twice what it was). Use supply and demand
diagrams to answer the following questions:

a. What happens to the equilibrium price and quantity in each market?

b. Which product experiences a larger change in price?
c. Which product experiences a larger change in quantity?
d. What happens to total consumer spending on each product?

Solution:

(a) The equilibrium price in each market will fall, and the equilibrium quantity in each market
will increase.

(b) Pharmaceutical drugs will experience a larger change in price.

(c) Computers will experience a larger change in quantity.

(d) The total consumer spending falls in the case of pharmaceutical drugs with inelastic demand.
The total consumer spending increases in the case of computers with elastic demand.
QNo.4

You have just opened a new grocery store. Every item you carry is generic (generic beer,
generic bread, generic chicken, etc.). You recently read an article in the Wall Street
Journal reporting that the price of recreation is expected to increase by 15 percent. How
will this affect your store’s sales of generic food products?

Solution:

QNo.5

The demand for personal computers can be characterized by the following elasticities:
price elasticity =−5; cross-price elasticity with software =−4; and income elasticity =2.5
Based on these numbers, explain why each of the following statements is either true or
false.

A) A decrease in the price of personal computers will increase both the number of units
demanded and the total revenue of sellers.

B) The cross-price elasticity indicates that a 5 percent decrease in the price of personal
computers translates to a 20 percent increase in software demand.

C) Demand for personal computers is price elastic, and computers are normal goods.

D) Decreasing software prices will increase revenues received by sellers of both computers
and software.

E) A 2 percent decrease in the price of personal computers would be necessary to overcome

the effects of a 1 percent decline in income

Solution:

A. True.

The price elasticity of demand for personal computers is -5, meaning that a 1% decrease in
the price of the product will increase the quantity demanded by 5% and a 1% decrease in
price will increase the quantity demanded by 5%.

Therefore an increase in the price of computers will reduce the quantity demanded of
computers.

The demand for computers is elastic since |E| = 5>1. When the demand is elastic, an increase
in the price reduces the total revenue and a decrease in the price increases the total revenue.

B. True.
The cross-price elasticity of demand for personal computers and software is -4, meaning that a
1% increase in the price of software will decrease the quantity demanded of computers by 4%.

C. True.

The demand for computers is elastic since |Ed| = 5>1.

Computers are normal goods, which is indicated by a positive income elasticity of demand. The
consumption of normal goods increases with an increase in the consumer's income and it
decreases with a decrease in income.

D. True.

Decreasing the software price will increase the demand for both personal computers and
software. Thus, the total revenue received by the sellers of both computers and softwares will
increase.

E. False.

the income elasticity of demand is 2.5, if the consumer's income decreased by 2%, the quantity
demanded of computers will decrease by -2.5%

QN0.6

Distinctive Designs, Inc., imports and distributes dress and sport watches. At the end of the
company’s fiscal year, brand manager Charlie Pace has asked you to evaluate sales of the
sports watch line using the following data:

A. Indicate whether there was or was not a change in each respective independent
variable foreach month pair during the past year
B. Calculate and interpret the average advertising arc elasticity of demand for sports
watches.

C. Calculate and interpret the average arc price elasticity of demand for sports
watches.

D. Calculate and interpret the average arc cross-price elasticity of demand between
sports and dress watches
Solution:

A.

Month-Pair Sports Watch Sports Watch Price, Dress Watch Price,

Advertising P PD
Expenditure, A
Jul-Aug No Change Change No Change
Aug-Sep Change No Change No Change
Sep-Oct No Change No Change Change
Oct-Nov Change Change Change
Nov-Dec No Change Change No Change
Dec-Jan Change Change No Change
Jan-Feb Change No Change No Change
Feb-March Change No Change Change
March-April Change Change Change
April-May No Change Change No Change
May-June No Change No Change Change

B. In calculating the arc advertising elasticity of demand, only consider consecutive

months when there was a change in advertising but no change in the prices of
sports and dress

August–September
EA = ∆Q A2 + A1
∆A Q 2 + Q1
= 4,500 – 5,500 $9,200 + $10,000
$9,200 – $10,000 4,500 + 5,500
= 2.4
January–February
EA = ∆Q A2 + A1
∆A Q 2 + Q1
= 4,000 – 5,000 $7,850 + $8,350
$7,850 – $8,350 4,000 + 5,000
= 3.6
On average, EA = (2.4 + 3.6)/2 = 3 and demand will rise 3%, with a 1% increase in advertising.
Thus, demand appears quite sensitive to advertising.

C. Calculate and interpret the average arc price elasticity of demand for sports watches

July–August
EP = ∆Q P2 + P1
∆P Q 2 + Q1
= 5,500 – 4,500 $24 + $26
$24 – $26 5,500 + 4,500
= –2.5
November–December
EP = ∆Q P2 + P1
∆P Q 2 + Q1
= 15,000 – 5,000 $20 + $25
$20 – $25 15,000 + 5,000
= –4.5
April–May
EP = ∆Q P2 + P1
∆P Q 2 + Q1
= 4,000 – 6,000 $26 + $24
$26 – $24 4,000 + 6,000
= –5

D. Calculate and interpret the average arc cross-price elasticity of demand between sports
and dress watches

September–October
EPX = ∆Q PX2 + PX1
∆PX Q2 + Q1
= 3,500 – 4,500 $46 + $50
$46 – $50 3,500 + 4,500
=3
May–June
EPX = ∆Q PX2 + PX1
∆PX Q2 + Q1
= 5,000 – 4,000 $57 + $51
$57 – $51 5,000 + 4,000
=2
On average, EPX = (3 + 2)/2 = 2.5. Because EPX > 0, sports and dress watches are substitutes.