PROBLEM SET 1

[1] You are in the market for a new refrigerator for your company’s lounge, and you have narrowed the
search down to two models. The energy efficient model sells for P20,000 and will save you P1000 at the
end of each year of the next five years in electricity costs. The standard model has features similar to the
energy efficient model but provides no future saving in electricity costs. It is priced at only P16000.
Assuming your opportunity cost of funds is 5 percent, which refrigerator should you purchase?

Answer: Purchase Energy Efficient Model of refrigerator.

Energy Efficient Standard

Model Model
Current Price P20,000.00 P16,000.00
PV of Future 4,329.48 -
Savings*
TOTAL P15,670.52 P16,000.00

*Compute PV of P1,000 over the next 5 years:

PV = Cash flow per year x [1-(1+i)-n / i]
= 1,000 x [1-(1.05)-5 / 0.05]
PV = P4,329.48
Since the total cost of Energy Efficient Model less the PV of the savings is less than the cost of
standard model. Therefore, choose to buy the energy efficient model.

[2] Tara is considering leaving her current job, which pays P2,240,000 per year to start a new company
that manufactures a line of special pens for personal digital assistants. Based on market research, she
can sell about 160,000 units during the first year at a price of P800 per unit. With annual overhead costs
and operating expenses amounting to P126,400,000, Tara expects a profit margin of 25%. This margin is
6% larger than that of her largest competitor, Pens, Inc.
[a] if Tara decides to embark on her new venture, what will her accounting costs be during the first
year of operation? Her implicit costs? Her opportunity costs?
Answer:
Accounting Cost – annual overhead costs and operating expenses - P126,400,000.00
Implicit Cost – the forgone salary - P2,240,000.00
Opportunity Cost = AC + IC = P126,400,000 + P2,240,000 = P128,640,000.00

[b] Suppose that Tara’s estimated selling price is lower than originally projected during the first year.
How much revenue would she need in order to earn positive accounting profits? Positive economic
profits?
Answer: Accounting Profit = Total Revenue – Accounting Costs. In order for Tara to have positive
accounting profits, her revenue should be more than her accounting costs amounting to P126,400,000.
Economic Profit = Total Revenue – Opportunity Costs. In order for Tara to have positive
economic profits, her revenue should be more than her opportunity costs amounting to P128,640,000.
[3] Dynamic Sales Center will supply 50 pocket calculators at P100 each. The supply is increased to 80
pieces when the unit price is increased by 20%. (a) Set up the supply function. (b) how many calculators
will be supplied if the unit price is P150? (c) Find the lowest price at which this item would be supplied.
Answer:
(a) Qs= c + dP
(x1 , y1) (50,100)
(x2 , y2) (80, 120) [P120 derived from 100*1.20]

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 ΔQ x 2−x 1
First step, get the value of d (rise over run) or the price coefficient of supply which is =
Δ P y 2− y 1
ΔQ x 2−x 1 80−50 30
= = = = 1.5
Δ P y 2− y 1 120−100 20
QS = c + 1.5P
50 = c + (1.5 x 100)
50 = c + 150
50 -150 = c
-100 = c or c = -100 Thus, Qs = -100 + 1.5P

(b) Qs = -100 + 1.5P

Qs = -100 + 1.5(150)
= -100 + 225
Qs = 125 calculators will be supplied at a unit price of P150

(c ) Qs = -100 + 1.5P
1 = -100 + 1.5P
101 = 1.5P
101 / 1.5 = 1.5P / 1.5
67.33 = P or P = P67.33 will be the lowest price to supply this item.

[4] An entrepreneur engages in the production of virgin coconut oil, a food extract believed to offer cure
to various body ailments. He supplies 500 150-ml. bottles to Wilson Drugstore at P100 per bottle. At P60
pesos per bottle, he refuses to sell his product.
[a] determine the supply equation
Qs= c + dP
(x1 , y1) (500,100)
(x2 , y2) (300 , 60)
500 x 2
=
100 60
100x2 = 500 x 60
100x2 = 30,000
x2 = 300
ΔQ x 2−x 1
d= =
Δ P y 2− y 1
300−500 −200
d= = =5
60−100 −40
Qs= c + dP
500 = c + 5(100)
500 = c + 500
C=0
Qs = 5P

[b] How many bottles are available when the unit price is P120
Qs = 5P
Qs = 5(120)
Qs = 600 bottles are available when the unit price is P120.

We Commit to the highest standards of education, value our stakeholders, Strive for continual improvement
of our products and services, and Uphold the University’s tenets of Truth, Excellence, and Service to produce
globally competitive and morally upright individuals.
 [7] The X corporation produces a good (called X) that is a normal good. Its competitor, Y-Corp., makes a
substitute good that it markets under the name “Y”. Good Y is an inferior good.
[a] How will the demand for good X change if consumer incomes increase?
Answer:

When income increases, the demand curve for normal goods shifts outward as more will be demanded at
all prices. Since X is a normal good, an increase in income indicates a right shift from D 1 to D2

[b] How will the demand for good Y change if consumer incomes decrease?
Answer:

An inferior good increases in demand when consumer income decreases. Since Y is an inferior good, a
decrease in income indicates right shift from D 1 to D2.

[c] How will the demand for good X change if the price of good Y decreases?
Answer:

When price of a substitute good Y decreases, the quantity demanded for good X also decreases.
Therefore, the demand curve for good X will shift to the left.

[d] Is good Y a lower quality product than good X? Explain.

No, inferior good does not mean a lower quantity. It basically means that both income and
demand are inversely related.

[8] Good X is produced in a competitive market using input A. Explain what would happen to the supply
of good X in each of the following situations:

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of our products and services, and Uphold the University’s tenets of Truth, Excellence, and Service to produce
globally competitive and morally upright individuals.
 [a] The price of input A increases.
Answer: Cost of producing good X increases, supplier is less willing to produce more. Thus, supply
of good X will decrease.

[b] An excise tax of P50 is imposed on good X.

Answer: Supplier will be willing to supply the same quantity of good X when they receive
additional P50 per unit of good X. Selling price per unit will increase by P50 excise tax. And supply curve
will shift vertically up by P50 for each output.

[c] An ad valorem tax of 5 percent is imposed on good X.

Answer:

Supplier will supply some quantity of good X when unit price of production will increase by 5%. Selling
price per unit will also increase by 5% ad valorem tax. Supply curve will rotate counter clockwise which
means the new curve will shift further away from original curve when the price increases.

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of our products and services, and Uphold the University’s tenets of Truth, Excellence, and Service to produce
globally competitive and morally upright individuals.
 [d] A technological change reduces the cost of producing additional units of good X.
Answer:

Supplier is willing to produce more; supply of good X will increase. Supply curve will shift to the right.

[9] The demand for good X is given by

1 1 1
Q dx =1,200− P x + P y −8 Pz + M
2 4 10
Research shows that the price of related goods are given by P y=P5,900 and Pz=P90, while the average
income of individuals consuming this product is M=P55,000.
[a] Indicate whether good Y and Z are substitutes or complements for good X.
Answer:
∂Qdx 1
= Because this is positive, there is a positive relationship between the price of
∂ Py 4
good Y and the quantity demanded of good X. this shows that if the price of good Y increased, the
quantity demanded of good X increases. Thus, good Y must be a substitute for good X.
∂Qdx
=−8 Because this is negative, there is a negative relationship between the price of
∂ Pz
good Z and the quantity demanded for good X. this shows that if the price of good Z increases, the
quantity demanded of good X decreases. Thus, good Z must be complement for good X.

[b] Is X an inferior or a normal good?

∂Qdx 1
Answer: = Because this is positive, there is a positive relationship between income
∂ Pz 10
and quantity demanded of good. This shows that as income increases, so too does quantity demanded.
Thus, good X must be a normal good.

[c] How many units of good X will be purchased when P x=P4,910?

1 1 1
Q dx =1,200− P x + P y −8 Pz + M
2 4 10
1 1 1
Q dx =1,200− (4,910)+ (5,900)−8(90)+ (55,000)
2 4 10
Q dx =1,200−2,455+ 1,475−720+5,500
Qdx =5,000 units

[d] Determine the demand function and inverse demand function for good X.
Graph the demand curve for good X.
d 1 1 1
Answer: Q x =1,200− P x + P y −8 Pz + M
2 4 10

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of our products and services, and Uphold the University’s tenets of Truth, Excellence, and Service to produce
globally competitive and morally upright individuals.
 1 1 1
Q dx =1,200− P x + (5,900)−8(90)+ (55,000)
2 4 10
d 1
Q x =1,200− P x +1475−720+5,500
2
d
Q x =7,455−0.5 P x

0.5 P x =7,455−Q x
1
( )
(2∗ P =7,455−Q x ∗2)
2 x
P x =14,910−2 Qx

We Commit to the highest standards of education, value our stakeholders, Strive for continual improvement
of our products and services, and Uphold the University’s tenets of Truth, Excellence, and Service to produce
globally competitive and morally upright individuals.