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Managerial Economics 2016-17
Topic 3 Answers
Basic concepts and applications
(1)
A demand schedule is defined as a table, graph or a mathematical expression linking the
(own) price of a good/service to the quantity demanded. The demand curve is a graphical
illustration of a simplified demand schedule that shows how quantity varies when price
varies.
(2)
Usually, at higher prices of the good less is demanded as other goods and services
become more attractive.
(3)
Change in any of the factors held constant when the demand curve is drawn.
(4)
For definitions see the textbook
(5)
When the demand is inelastic, an increase in price of a good will increase the consumer
spending on it and, thus, the total revenue of the seller. For illustration see the figure
linking price elasticity of demand to sales revenue in the textbook, chapter 5.
(6)
When buyers judge quality by price and buy more of a good because it is more
expensive. More correctly, demand slopes upwards when the good under consideration is
regarded by buyer as being so inferior that less of it is bought when it becomes cheaper
(other goods are substituted for it).
(7)
(a)
Not much if the return to the previous price level is fully anticipated.
(b)
Ditto. If the cyclical behaviour of petrol prices is well understood and fully
anticipated, the demands for lubricating oil and car engines are determined on the
basis that petrol prices will follow the cycle.
(c)
If petrol prices increase and are expected to remain at higher level for
considerable period of time, car users find cars more expensive to run and reduce
their use accordingly. Since lubricating oil is a complement to fuel, less of it will
be demanded as the usage of cars declines.
Car engines present more complex problem. If they are complements, fewer of
them will be demanded as the demand for cars decreases. On the other hand, if
people substitute more economical new cars for some of the existing stock of cars,
the demand for car engines as components of new cars may actually increase.
(8)
See the figures linking price elasticity of demand to sales revenue in the textbook (ch.5).
(9)
'Certain demand' refers to a case when all determinants of the quantity demanded are
fully known (perfect knowledge). 'Expected demand' refers to a family of demand curves,
each curve dependent on the occurrence of random events where the knowledge of these
events is limited (conditions of uncertainty or risk) and where the quantity demanded at a
particular price level can be expressed as the sum of quantities derived from each demand
curve in the family weighted by the corresponding probability of that demand being the
true demand curve.
(10)
People vary in their attitudes to risk-bearing. More risk-averse people may decide to buy
insurance in circumstances in which less risk-averse or risk-loving people may decide to
save themselves the cost of insurance premium and accept those risks which the purchase
of home insurance would have shifted to the insurer.
(11)
P
P2
Price Range
Demand
P1
Q
Multiple choice questions
(12)
Cross-price elasticity is defined as:
E(Pab) 
% change Q b Qb Pa


 3
% changeP a
Qb
Pa
When Pa increases, Qb decreases.
Pb
Demand for b
Qb
a. False. It shifts to the left
b. True
c. False. Shift not movement along
d. False. Shift not movement along
e. False. Shift to the left is the predicted response
(13)
Q = 150 - 2P + 0.5 I
Q = 150 - 8 + 100 = 242
E ( P)
P=4
P = 125 - 0.5Q
Q P Q P
4
4


 2

 2
Q
P
P Q
242
121
I = 200
a. False. See above
Q I dQ I
200 50


 0.5

 0.5
Q
I
I Q
242 121
b. True. E(I) = 50/121>0
E ( P)
c. False. See above
d. False. TR = P.Q = (125-0.Q)Q = 125Q - 0.5Q 2
MR = 125 - Q
if P = 8 then TR = 1872
if P = 4 then TR = 968
If P = 3 then TR = 732
e. False. See above
(14)
(15)
(16)
Two goods are included in the same market if they are perfect substitutes, that is: E (P ab)
= % change Qb / % change Pa = infinity
a. False
E(I) is irrelevant in this case
b. False
E(P) is irrelevant in this case
c. True
See above
d. False
See above
e. False
See above
When Pa increases Qb increases (see Q.13 above)
a. True
Qb increases
b. False
Qb increases
c. False
Shift, not movement along
d. False
Shift, not movement along
e. False
The predicted response is an increase in Qb.
Q = 200/P
P = $10
Q = 200/10 = 20
E ( P)
Q P Q P dQ P
10



 200 P 2 .  1
Q
P
P Q dP Q
20
 1

 1

MR 
 1  10
 1  0
 1 
 E ( P) 
a. False
Since MR=0, Total Revenue does not change
b. False
As above
c. False
As above
d. True
As shown above
e. False
As shown above
(17)
False
 1

MR P 
 1
 E ( P)

When demand is inelastic -1<E(P)<0 then MR is negative
so Total Revenue increases as MR increases.