Managerial Economics

Group Homework 1

Group: J8
Section: J

Group Members:
PG ID NAME
62110648 Aakash Beniwal
62110599 Anvita Mahajan
62110540 Harmanpreet Singh
62110800 Milind Agrawal
62110949 Sonali Gaur

Problem 1:
A computer products retailer purchases laser printers from a manufacturer at a price of
Rs. 25,000 per printer. During the year, the retailer will try to sell the printers at a price
greater than Rs. 25,000, but may not be able to sell all the printers. At the end of the year,
the manufacturer will buy back any unsold inventory at 40 percent of the original price.
No one other than the manufacturer would be willing to buy these unsold printers at the
end of the year.
a. At the beginning of the year, before the retailer has purchased any printers, what
is the opportunity cost of a laser printer?
b. After the retailer has purchased the laser printers, what is the opportunity cost
associated with selling a laser printer to a customer? (Assume that if this
customer does not buy the printer, it will be unsold at the end of the year.)
c. Suppose that on December 1, the retailer still has a large inventory of unsold
printers. The retailer has set a retail price of Rs. 30,000 per printer. The manager
of the store proposes that they should cut the price by half and sell the printers
at Rs. 15,000 each. The owner of the store disagrees, pointing out that at Rs.
15,000 each, they would lose Rs. 10,000 on each printer sold. Is the owner’s
argument correct?

Answer:
a. Opportunity cost is defined as the payoff associated with next best alternatives that was not
chosen. Here, the opportunity cost associated with buying a laser printer would be the
benefit derived by the retailer from spending the Rs. 25,000 on the next best alternative. For
instance, the retailer may spend the money on investing in other computer products.
b. The opportunity cost associated with selling a laser printer to a customer would be the next
best alternative of returning the laser printer back to the manufacturer at a buy back price of
40% of the original price, that is Rs. 10,000.
c. The owner’s argument is incorrect as he seems to have fallen prey to the sunken cost fallacy.
He purchased the printer at a price of Rs.25,000 and considering a sale at Rs.15,000 he is
assuming a loss of Rs.10,000. Instead of comparing the purchase price of Rs.25,000 with
Rs.15,000, the offer price of Rs.15,000 should be compared with Rs.10,000 which he would
be earning in case the manufacturer has to buy back the printers. Considering this
comparison, he would be earning an extra Rs.5,000.
Problem 2:
Consider the demand curve for the latest wearable fitness device, Q D = 40,000 - 4P.
a. Plot the demand curve
b. Find the price and quantity at which the demand is unit elastic
c. Compute the elasticity of demand when the staring price is
i. Rs. 2,000
ii. Rs. 1,000

Answer:
a. The quantity demanded is given by the function,
QD = 40,000 - 4P

Quantity Demanded Price

40000 0
0 10000

b. Given that price elasticity of demand ϵd = -1

Demand curve equation
QD = 40000 - 4P
𝑑𝑄/𝑑𝑃 = −4
ϵd = 𝑑𝑄/𝑑𝑃 *𝑃/𝑄
-1 = −4 * (P / (40000 − 4P))
P= Rs. 5000
Substituting P=5000 in the demand equation Q D = 40000-4P,
We get, Q = 20000

Demand is unit elastic at Price = Rs. 5000 and Quantity Demanded = 20,000 devices
c. (i) P = Rs. 2,000

Given, P = Rs.2000
To find the quantity (Q),
Substituting, P=Rs. 2000 in the demand equation Q D = 40000-4P
We get, Q = 32000

Using price elasticity formula:

ϵd = 𝑑𝑄 /𝑑𝑃 *P/Q
𝑑𝑄/𝑑𝑃 = −4
ϵd = − 4 * (2000 /32000)
ϵd = − 0.25

The elasticity of demand when the starting price is Rs.2,000 is -0.25.

(ii) P = Rs. 1,000

Given, P = Rs. 1000

To find the quantity (Q),
Substituting, P = Rs. 1000 in the demand equation Q D = 40000-4P
We get, Q = 36000

Use price elasticity formula:

ϵd = 𝑑Q/dP * P/Q
𝑑𝑄/𝑑𝑃 = −4
ϵd = − 4 * (1000/36000)
ϵd = - 0.11

The elasticity of demand when the starting price is Rs.1,000 is -0.11.

Problem 3:
The demand for beer in Gachibowli is given by: Q D = 700 - 20P – 10Pc + 0.1I, where P is
the price of beer, Pc is the price of chips, and I is the average consumer income.
a. Please provide an expression for the elasticity of demand for beer with respect
to the price of chips. Based on your answer, are beer and chips complements or
substitutes?
b. Calculate the own price elasticity, the cross price elasticity and the income
elasticity of the demand for beer when P = 50, Pc = 15, and I = 14,000
c. Graph the demand curve for beer when Pc = 15, and I = 14,000
Answer:

a. Cross Price elasticity of demand for beer with respect to the price of chips (ϵ bc) can be
written as:

ϵbc = 𝑑𝑄D/𝑑𝑃𝑐 × Pc/QD

𝑑𝑄D/𝑑𝑃𝑐 = −10
ϵbc = −10 × 𝑃𝑐 / QD

Beer and Chips are complementary goods since ϵbc is negative (PC and QD can never be
negative), indicating an inverse relationship between price of chips and demand for beer.

If price of chips goes up, the demand for beer goes down and vice versa.

b. Calculating own price elasticity:

Demand function:
QD = 700 - 20P – 10Pc + 0.1I
Substituting P = 50, PC = 15, and I = 14,000 into the demand function:
We get, QD = 950

Formula for own price elasticity of demand for beer:

ϵd = 𝑑QD/𝑑𝑃 × 𝑃/QD
𝑑QD/𝑑𝑃 = -20
ϵd = -20 X 50 / 950
ϵd = -1.053

Formula for cross price elasticity of demand for beer and chips:
ϵbc = 𝑑QD/𝑑PC × PC/QD
𝑑QD/𝑑PC = -10
ϵbc = -10 X 15 / 950
ϵbc = -0.158

Formula for income elasticity of demand for beer:

ϵI = 𝑑QD/𝑑I × I/QD
𝑑QD/𝑑I = 0.1
ϵI = 0.1 X 14000 / 950
ϵI = 1.474
c. The demand curve is given as:
QD = 700 - 20P – 10Pc + 0.1I

Substituting, Pc = 15, and I = 14,000,

We get, QD = 1950 - 20P

Quantity Demanded Price

1950 0
0 97.5
Problem 4:
The demand curve for pedicures is given by: QD = 20 - 4P + 0.2I, where P is the price of a
pedicure, and I is the average consumer income. Assume that I is 400.
a. What is the consumer surplus when P is 15? By how much does the consumer
surplus change if P falls to 10?
b. At a market price of 20, what is the pedicurist’s revenue? Suppose the
pedicurist wants to increase her revenue. Should she increase or decrease the
price of a pedicure?
c. Assume now that consumer income increases to 500. What is the consumer
surplus at P = 15?

Answer:
a. QD = 20 - 4P + 0.2I
At I = 400; demand function is written as,
Q = 20 – 4P + 0.2 (400)
Q = 100-4P

At P = 15, Q can be found by plugging this value in the demand function,

Q = 100-4P
Q = 100 – 4 (15)
Q = 40

CE B
D

Consumer Surplus is the area of the triangle above the price and below the demand curve.

Consumer Surplus (at P=15) = Area of triangle ABC = 1/2 x Base x Height
= 1/2 x 40 x (25-15)
= Rs. 200
The consumer surplus when P is 15 is Rs. 200.

Consumer Surplus (at P=10) = Area of triangle ADE = 1/2 x Base x Height
= 1/2 x 60 x (25-10)
= Rs. 450

Change in consumer surplus = 450 – 200 = Rs. 250

b. Demand function: QD = 100-4P (Assuming I = 400)

Substituting, P = 20, in the demand function, Q D = 100 - 4P

Q = 100 – 4(20)
Q = 20
Pedicurist’s Revenue = Price × Quantity = 20 × 20 = Rs. 400

At a market price of 20, the pedicurist’s revenue is Rs. 400.

At price=20, Price Elasticity can be calculated as,

ϵd = dQ/dP *P/Q
𝑑𝑄/𝑑𝑃 = −4
ϵd = -4*(20/20)
ϵd = -4

Considering the highly elastic relationship between price and quantity demanded, small
reduction in price will lead to a disproportionately greater increase in quantity demanded
and vice versa. Therefore, the pedicurist should decrease the price of a pedicure to
increase her revenue.

c. Demand Function: QD = 20 - 4P + 0.2I

Substituting, I = 500 and P = 15, in the demand function, Q D = 20 – 4P + 0.2I

We get,
Q = 20 – 4 (15) + 0.2 (500)
Q = 60

C B

Consumer Surplus is the area of the triangle above the price and below the demand curve.

Consumer Surplus (at P=15) = Area of triangle ABC = 1/2 x Base x Height
= 1/2 x 60 x (30-15)
= Rs. 450

Consumer Surplus at P=15 is Rs.450

Problem 5:
Suppose you are analyzing the demand for buttermilk at the Goel dining hall at the ISB
Hyderabad campus. Consider each of the following scenarios and explain whether it
would lead to an increase, decrease, or no change in demand:
a. Term break
b. A thunderstorm that brings down the temperature by several degrees
c. A decrease in the price of buttermilk
d. A decrease in the price of watermelon juice
e. A decrease in the price of photo copying
f. The latest campus fad – “veganism”

Answers:
a. During the term break, some of the students might return to their homes. Thus,
the overall population size demanding buttermilk will fall.
This will lead to a decrease in demand of buttermilk.
Demand curve shifts to the left.

b. Since the temperature has fallen due to the thunderstorm, fewer people will prefer
having cold beverages like buttermilk.
This will lead to a decrease in demand of buttermilk.
Demand curve shifts to the left.

c. As per the Law of Demand, there is an inverse relationship between the price and
quantity demanded.
A decrease in price of buttermilk will lead to an increase in its quantity demanded.
However, there is no shift in the demand curve.

d. Watermelon juice is a substitute for buttermilk. Decrease in price of watermelon

juice will lead to an increase in its quantity demanded.
This will lead to a decrease in demand of buttermilk.
Demand curve shifts to the left.

e. Photocopying and consuming buttermilk are unrelated activities.

There will be no change in the demand for buttermilk.
There is no shift in the demand curve.

f. As ‘Veganism’ increases, the population demanding dairy products will decrease.

This will lead to a decrease in demand of buttermilk.
Demand curve shifts to the left.
Problem 6:
Suppose there are 2 countries, X and Y, capable of producing 2 goods: sense and
nonsense. The output per worker in Country X is 8 units if the worker produces sense and
4 units if he/she produces nonsense. In Country Y, the output per worker is 6 units of
sense or 2 units of nonsense. What is the pattern of absolute and comparative advantage?

Answer:

Country Sense Non Sense Opportunity Cost of Opportunity Cost of

producing one unit of producing one unit of
Sense in terms of Non Non Sense in terms of
Sense given up Sense given up
X 8 4 1/2 2
Y 6 2 1/3 3

Absolute Advantage:
Country X has the absolute advantage in producing both sense and nonsense because X
uses fewer inputs to produce both the goods relative to country Y.

Comparative Advantage:
X has lower opportunity cost in producing nonsense.
Y has lower opportunity cost in producing sense.
Country X has comparative advantage in producing nonsense &
Country Y has comparative advantage in producing sense.