Managerial Economics Week 2

I need assistance with the attached homework in managerial economics. Please explain answer. I have also attached supporting slides. Please assign asma. I need it by Wednesday April 3rd 12 noon EST. Thank you

BUSN6120

HOMEWORK 2

Problem 1

Suppose a firm has the following demand equation:

Q = 1,000 – 3,000P + 10A,

where Q = quantity demanded

P = product price (in dollars)

A = advertising expenditures (in dollars)

Assume for the questions below that P = $3 and A = $2,000

a. Suppose the firm dropped the price to $2.50. Would this be beneficial? Explain. Illustrate your answer with the use of a demand schedule.

b. Suppose the firm raised the price to $4.00 while increasing the advertising expenditures by $100. Would this be beneficial? Explain. Illustrate your answer with the demand schedule.

Problem 2

A bookstore opens across the street from the University Book Store (UBS). The new store carries the same textbooks but offers a price 30 % lower than UBS. If the cross-elasticity is estimated to be 1.5, and UBS does not respond to its competition, how much of its sales is it going to lose?

Chapter Three
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Chapter 3

Supply and
Demand
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Chapter Three
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Overview
Market demand
Market supply
Market equilibrium
Comparative statics analysis
short-run analysis, long-run
analysis
Supply, demand, and price
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Chapter Three
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Market demand

Demand for a good or service is defined
as quantities that people are ready
(willing and able) to buy at various prices
within some given time period

Other factors besides price are held
constant
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Chapter Three
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Market demand
Market demand is the sum of all the individual demands
Example: demand for pizza
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Market demand
The inverse relationship between price and the quantity demanded of a good or service is called the Law of Demand
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Chapter Three
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Market demand
Changes in price result in changes in the quantity demanded
This is shown as movement along the demand curve

Changes in non-price factors result in changes in demand
This is shown as a shift in the demand curve

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Chapter Three
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Market demand
Nonprice determinants of demand
tastes and preferences
income
prices of related products
future expectations
number of buyers

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Market supply

The supply of a good or service is defined as quantities that people are ready to sell at various prices within some given time period

Other factors besides price held constant
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Market supply
Changes in price result in changes in the quantity supplied
 shown as movement along the supply curve

Changes in non-price determinants result in changes in supply
 shown as a shift in the supply curve
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Chapter Three
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Market supply
Nonprice determinants of supply
costs and technology
prices of other goods or services offered by the seller
future expectations
number of sellers
weather conditions

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Market equilibrium

Equilibrium price: the price that equates the quantity demanded with the quantity supplied
Equilibrium quantity: the amount that people are willing to buy and sellers are willing to offer at the equilibrium price level

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Market equilibrium
Shortage: a market situation in which the quantity demanded exceeds the quantity supplied
 shortage occurs at a price below the equilibrium level

Surplus: a market situation in which the quantity supplied exceeds the quantity demanded
 surplus occurs at a price above the equilibrium level
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Market equilibrium
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Chapter Three
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Comparative statics analysis

Comparative statics is a form of sensitivity (or what-if) analysis

Commonly used method in economic analysis
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Comparative statics analysis
Process of comparative statics analysis:
state all the assumptions needed to construct the model
begin by assuming that the model is in equilibrium
introduce a change in the model, so a condition of disequilibrium is created
find the new point of equilibrium
compare the new equilibrium point with the original one

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Comparative statics: example
Step 1
assume all factors except the price of pizza are constant
buyers’ demand and sellers’ supply are represented by lines shown

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Comparative statics: example
Step 2
begin the analysis in equilibrium as shown by Q1 and P1

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Comparative statics: example
Step 3
assume that a new study shows pizza to be the most nutritious of all fast foods
consumers increase their demand for pizza as a result

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Chapter Three
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Comparative statics: example
Step 4
the shift in demand results in a new equilibrium price (P2)
and a new equilibrium quantity (Q2)

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Comparative statics: example
Step 5
comparing the new equilibrium point with the original one, we see that both equilibrium price and quantity have increased

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Comparative statics analysis
The short run is the period of time in which:
sellers already in the market respond to a change in equilibrium price by adjusting variable inputs
buyers already in the market respond to changes in equilibrium price by adjusting the quantity demanded for the good or service

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Chapter Three
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Comparative statics analysis
Short run changes show the rationing function of price

The rationing function of price is the change in market price to eliminate the imbalance between quantities supplied and demanded is the change in market price to eliminate the imbalance between quantities supplied and demanded
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Short-run analysis
an increase in demand causes equilibrium price and quantity to rise

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Short-run analysis
a decrease in demand causes equilibrium price and quantity to fall

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Short-run analysis
an increase in supply causes equilibrium price to fall and equilibrium quantity to rise

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Short-run analysis
a decrease in supply causes equilibrium price to rise and equilibrium quantity to fall

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Long run analysis
The long run is the period of time in which:
new sellers may enter a market
existing sellers may exit from a market
existing sellers may adjust fixed factors of production
buyers may react to a change in equilibrium price by changing their tastes and preferences

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Long run analysis
Long run changes show the allocating function of price
The guiding or allocating function of price is the movement of resources into or out of markets in response to a change in the equilibrium price

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Long-run analysis
initial change: decrease in demand from D1 to D2
result: reduction in equilibrium price and quantity (to P2,Q2)
follow-on adjustment:
movement of resources out of the market
leftward shift in the supply curve to S2

 equilibrium price and quantity (to P3,Q3)
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Long-run analysis
initial change: increase in demand from D1 to D2
result: increase in equilibrium price and quantity (to P2,Q2)
follow-on adjustment:
movement of resources into the market
rightward shift in the supply curve to S2

 equilibrium price and quantity (to P3,Q3)
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Supply, demand, and price:
the managerial challenge
in the extreme case, the forces of supply and demand are the sole determinants of the market price, not any single firm
this type of market is ‘perfect competition’

in many cases, individual firms can exert market power over price because of their:
dominant size
ability to differentiate their product through advertising, brand name, features, or services

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Chapter Four
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Chapter 4
Demand
Elasticity
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Chapter Four
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The economic concept of elasticity

Elasticity: the percentage change in one variable relative to a percentage change in another.

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Price elasticity of demand
Price elasticity of demand: the percentage change in quantity demanded caused by a 1 percent change in price

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Price elasticity of demand
Arc elasticity: elasticity which is measured over a discrete interval of a curve

Ep = coefficient of arc price elasticity
Q1 = original quantity demanded
Q2 = new quantity demanded
P1 = original price
P2 = new price
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Price elasticity of demand
Point elasticity: elasticity measured at a given point of a demand (or a supply) curve

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Price elasticity of demand
The point elasticity of a linear demand function can be expressed as:

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Price elasticity of demand

Elasticity varies
along a linear
demand curve
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Chapter Four
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Price elasticity of demand
Categories of elasticity
Relative elasticity of demand: Ep > 1
Relative inelasticity of demand: 0 < Ep < 1 Unitary elasticity of demand: Ep = 1 Perfect elasticity: Ep = ∞ Perfect inelasticity: Ep = 0 Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. Chapter Four Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. * Price elasticity of demand Factors affecting demand elasticity ease of substitution proportion of total expenditures durability of product possibility of postponing purchase possibility of repair used product market length of time period Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. Chapter Four Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. * Price elasticity of demand A long-run demand curve will generally be more elastic than a short-run curve As the time period lengthens consumers find ways to adjust to the price change, via substitution or shifting consumption Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. Chapter Four Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. * Price elasticity of demand The relationship between price and revenue depends on elasticity Why? By itself, a price fall will reduce receipts … BUT because the demand curve is downward sloping, the drop in price will also increase quantity demanded  Q: which effect will be stronger? Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. Chapter Four Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. * Price elasticity of demand As price decreases revenue rises when demand is elastic revenue falls when it is inelastic revenue reaches it peak if elasticity =1  the lower chart shows the effect of elasticity on total revenue Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. Chapter Four Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. * Price elasticity of demand Marginal revenue: the change in total revenue resulting from changing quantity by one unit Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. Chapter Four Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. * Price elasticity of demand marginal revenue curve is twice as steep as the demand curve Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. Chapter Four Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. * Price elasticity of demand at the point where marginal revenue crosses the X-axis, the demand curve is unitary elastic and total revenue reaches a maximum Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. Chapter Four Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. * Price elasticity of demand Examples: some real world elasticities coffee: short run -0.2, long run -0.33 kitchen and household appliances: -0.63 meals at restaurants: -2.27 airline travel in U.S.: -1.98 beer: -0.84, Wine: -0.55 white pan bread:-0.69 cigarettes: short run -0.4, long run -0.6 wine imports: -0.15 crude oil: -0.06 internet services: -0.6/-0.7 Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. Chapter Four Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. * Cross-elasticity of demand Cross-elasticity of demand: the percentage change in quantity consumed of one product as a result of a 1 percent change in the price of a related product Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. Chapter Four Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. * Cross-elasticity of demand Arc cross-elasticity Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. Chapter Four Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. * Cross-elasticity of demand Point cross-elasticity Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. Chapter Four Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. * Cross-elasticity of demand The sign of cross-elasticity for substitutes is positive The sign of cross-elasticity for complements is negative Two products are considered good substitutes or complements when the coefficient is larger than 0.5 (in ab. value) Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. Chapter Four Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. * Income elasticity Income elasticity of demand: the percentage change in quantity demanded caused by a 1 percent change in income Y is shorthand for income Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. Chapter Four Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. * Income elasticity Arc income elasticity Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. Chapter Four Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. * Income elasticity Categories of income elasticity superior goods: EY > 1
normal goods: 0 ≤ EY ≤ 1
inferior goods:
EY < 0 Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. Chapter Four Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. * Other demand elasticities Examples: elasticity is encountered every time a change in some variable affects demand advertising expenditure interest rates population size Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. Chapter Four Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. * Elasticity of supply Price elasticity of supply: the percentage change in quantity supplied as a result of a 1 percent change in price The coefficient of supply elasticity is a normally a positive number Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. Chapter Four Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. * Elasticity of supply Arc elasticity of supply Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. Chapter Four Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. * Elasticity of supply When the supply curve is more elastic, the effect of a change in demand will be greater on quantity than on the price of the product When the supply curve is less elastic, a change in demand will have a greater effect on price than on quantity Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. B in change percent A in change percent Elasticity of t Coefficien = Price % Quantity % E D D = p 2 / ) ( 2 / ) ( 2 1 1 2 2 1 1 2 P P P P Q Q Q Q E p + - ¸ + - = 1 1 ε P P dQ x dPQ = 1 1 Q P P Q ´ D D = p e Quantity MR D D = Revenue Total B A x P Q E D D = % % 2 / ) ( 2 / ) ( 2 1 1 2 2 1 1 2 B B B B A A A A P P P P Q Q Q Q E X + - ¸ + - = B B A A X P P Q Q E D ¸ D = Y Q E Y D D = % % 2 / ) ( 2 / ) ( 2 1 1 2 2 1 1 2 Y Y Y Y Q Q Q Q E Y + - ¸ + - = Price % Supplied Quantity % E D D = S 2 / ) ( 2 / ) ( 2 1 1 2 2 1 1 2 P P P P Q Q Q Q E s + - ¸ + - =

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