University of Economics, HCMC MBA Program

International School of Business PS1

ECONOMICS PG
PROBLEM SET 1 – ANSWER KEYS
Due date:
1. At the beginning of the year, an audio engineer quit his job and gave up a salary of $175,000 per year
in order to start his own business, Sound Devices, Inc. The new company builds, installs, and maintains
custom audio equipment for businesses that require high-quality audio systems. A partial income
statement for the first year of operation for Sound Devices, Inc., is shown below:

To get started, the owner of Sound Devices spent $100,000 of his personal savings to pay for some of the
capital equipment used in the business. During the first year of operation, the owner of Sound Devices
could have earned a 15 percent return by investing in stocks of other new businesses with risk levels
similar to the risk level at Sound Devices.

a) What are the total explicit, total implicit, and total economic costs for the year?

Total explicit = 555,000 + 45,000 + 28,000 + 165,000 = $793,000

Total implicit = 175,000 + (100,000 x 15%) = $190,000
Total economic costs = Total explicit + Total implicit = 793,000 + 190,000 = $983,000

b) What is accounting profit?

Accounting profit = 970,000 – 793,000 = $177,000

c) What is economic profit?

Economic profit = Total revenue – Total economic costs = 970,000 – 983,000 = - $13,000

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University of Economics, HCMC MBA Program
International School of Business PS1
d) Given your answer in part c, evaluate the owner’s decision to leave his job to start Sound Devices.

If the owner decides to leave his job to start Sound Devices, he would be losing $13,000 per year
because the economic profit for Sound Devices, Inc is in negative in the first year. Therefore, he
should not start a new business.

2. For each of the following managers, decide whether the manager is likely to be a price-setter (possesses
market power) or a price-taker (does not possess market power).
a. The loan officer at a bank decides what interest rate to charge on car loans made to Chicago-area
buyers of new cars.
ANS: Price-taker. Many banks provide car loans in Chicago. The price of a car loan, which
is the interest rate, is determined by market forces of demand and supply

b. The owner-manager of a McDonald’s hamburger restaurant, which is the first hamburger restaurant to
open in a new suburban neighborhood.
ANS: Price-setter. At this time, McDonald’s is the only hamburger restaurant in the area and consequently
enjoys some degree of market power. Over time, however, new restaurants will enter the market if a profit
can be earned

3. For each of the firms below, identify the market structure that best matches the competitive
characteristics found in that firm’s market.
a. Microsoft Corporation, in the market for business-application software, such as word processing,
spreadsheet, and database.
ANS: Oligopoly. In office applications, Microsoft is one of just a few firms providing such software and the
firms recognize their mutual interdependence in matters of pricing, software features, and service.

b. Becker Brothers Farms, a 1,000-acre wheat farm near Beaver City, Nebraska.
ANS: Perfect Competition. Becker Bros. Farms is one of thousands of relatively small producers of a
standardized product. Furthermore, there are no barriers to entry in wheat farming.

c. The Jumping Bean, a family-owned Mexican food restaurant in San Antonio, Texas.
ANS: Monopolistic competition. The market for Mexican food in San Antonio is characterized by a large
number of restaurants producing somewhat differentiated dining experiences without any protection from
entry of new rival restaurants

3. Suppose the quantity demanded of good (Qd) depends only on the price of the good (P), monthly
income (M), and the price of a related good R (PR):
Qd = 1,000 −15P − 0.8M + 20PR
a. On the axes below, construct the (direct) demand curve for the good when M = $1,000 and PR = $5.
The equation for demand is Qd = 300 – 15P
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University of Economics, HCMC MBA Program
International School of Business PS1

b. Interpret the intercept and slope parameters for the demand equation in part a.
Intercept parameter: a = 300 . If price is zero, consumers will take only 300 units
Slope parameter: b = -15 . For each $1 increase in price, consumers buy 15 fewer units

c. Let income decrease to $950. Construct the new demand curve. This good is _________________
(normal, inferior). Explain using your graph.
ANS: The demand curve is shown in the figure above as Qd = 340 – 15P. This good is inferior good
because decreasing income from $1,000 to $950 results in an increase in demand, which can only
happen for inferior goods.

d. For the demand curve in part c, find the inverse demand function:
P = (340 - Qd ) / 15 = 22.67 – 0.067 Qd

e. Let the price of good R increase to $6 (income remaining at $950). Construct the new demand curve.
Good R is a _______________________ (substitute, complement) good. Explain using your graph.
ANS: The demand curve is shown in the figure above as Qd = 360 – 15P. Good R is a substitute
good because increasing the price of R from $5 to $6 results in an increase in demand

f. For the demand curve in part e, the demand price for 20 units is $ 22,67 . At a price of $4, the
maximum amount consumers are willing and able to purchase is 300 units.
g. For the demand curve in part e, find the equilibrium price and quantity when supply is Qs = −10 + 10P
ANS: Set Qd = Qs
360 – 15P = −10 + 10P
PE = (360+10) / 25 = $14.8
and QE = 360 – (15 x 14.8) = 138 units

Construct the supply curve and verify your answer.

h. For the equilibrium in part g, the consumer surplus is $ 634.8 (=0.5 x (24-14.8) x138) . Producer
surplus is $ 952.2 (=0.5x (14.8-1) x 138). Social surplus is $ 1587. The net gain to society created by the
market for this good is $ 1587.

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 University of Economics, HCMC MBA Program
International School of Business PS1
Graph here

30
Qs = −10 + 10P

2524
Price (dollars)

22.67
20

1514.8

10

5 Qd = 340 – 15P Qd = 360 – 15P

Qd = 300 – 15P
1
138 340 360
100 200 300 400 500 600

4. Consider the following demand and supply functions for tomatoes:

Qd = 6,000 – 4,000 P
Qs = − 1,000 + 10,000P
a. Plot the demand and supply functions on the axes below.
b. At a price of $1.00 per tomato, 2,000 [= 6,000 – 4,000 x 1] tomatoes is the maximum amount that can
be sold. A price of $1 per tomato is the maximum price that consumers will pay for 2,000 tomatoes,
which is the demand price for 2,000 tomatoes.
c. The maximum amount of tomatoes that producers will offer for sale if the price of tomatoes is $0.30 is
2,000 [=-1,000 + 10,000 x 0.3] . The minimum price necessary to induce producers to offer voluntarily
2,000 tomatoes for sale is $ 0.3 , which is called the supply price for 2,000 tomatoes.
d. In equilibrium, the price of tomatoes is $ 0.5 and 4,000 tomatoes will be sold (see point E)
e. In equilibrium, the quantity of tomatoes produced is 4,000 tomatoes.
f. In equilibrium, the quantity of tomatoes consumed is 4,000 tomatoes.
g. Are your answers to parts e and f the same? Why or why not?
ANS: Yes because in equilibrium, the quantity consumed equals the quantity produced (Qd = Qs)
h. Congress imposes a $0.30 per tomato ceiling price on tomatoes. This results in a shortage (surplus,
shortage) of 2,800 tomatoes.

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University of Economics, HCMC MBA Program
International School of Business PS1

Qs = − 1,000 + 10,000P

Qd = 6,000 – 4,000 P

4,800

5. A decision maker is choosing the levels of two activities, A and B, so as to maximize total benefits
under a given budget. The prices and marginal benefits of the last units of A and B are denoted PA, PB,
MBA, and MBB.
a. If PA= $20, PB = $15, MBA= 400, and MBB = 600, what should the decision maker do?
MBA / PA = 400 / 20 = 20
MBB / PB = 600 / 15 = 40
=> decision maker use more B and use less A while keeping total expenditure on X and Y constant

b. If PA = $20, PB = $30, MBA = 200, and MBB = 300, what should the decision maker do?
MBA / PA = 200 / 20 = 10
MBB / PB = 300 / 30 = 10
=> the decision maker should make no changes

c. If PA = $20, PB = $40, MBA = 300, and MBB = 400, how many units of A can be obtained if B is
reduced by one unit? How much will benefits increase if this exchange is made?
MBA / PA = 300 / 20 = 15
MBB / PB = 400 / 40 = 10
If there is a 1 unit reduction in B it reduces cost by $40, and can then purchase 2 more units of A
at $20.

d. If the substitution in part c continues to equilibrium and MBA falls to 250, what will MBB be?
In equilibrium MBA / PA = MBB / PB
MBB = (MBA / PA ) x PB = (250/20) x 40 = 500

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University of Economics, HCMC MBA Program
International School of Business PS1

6. Janice Waller, the manager of the customer service department at First Bank of Jefferson County, can
hire employees with a high school diploma for $20,000 annually and employees with a bachelor’s degree
for $30,000. She wants to maximize the number of customers served, given a fixed payroll. The following
table shows how the total number of customers served varies with the number of employees:

a. If Ms. Waller has a payroll of $160,000, how should she allocate this budget in order to maximize
the number of customers served?

Total No. of customer served Marginal Product of labor

Number of High school Bachelor’s MPLA MPLB MPLA / PA MPLB / PB

employees diploma (A) degree (B)

1 120 100 120 100 0.006 0.0033

0.005 0.003
2 220 190 100 90
0.004 0.002667
3 300 270 80 80
0.0035 0.002
4 370 330 70 60
0.003 0.001667
5 430 380 60 50
0.002 0.001
6 470 410 40 30

ANS: to maximize the number of customers served she should choose 5 high school diploma and 2
bachelor’s employees ( 5 x 20,000 + 2 x 30,000 = $ 160,000)

b. If she has a budget of $150,000 and currently hires three people with high school diplomas and three
with bachelor’s degrees, is she making the correct decision? Why or why not? If not, what should she do?
(Assume she can hire part-time workers.)

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 University of Economics, HCMC MBA Program
International School of Business PS1
ANS: She made wrong decision because at three people with high school diplomas and three with
bachelor’s degrees the MPA / PA > MPB / PB (0.004 > 0.002667). She should hire more people with
high school diplomas

c. If her budget is increased to $240,000, how should she allocate this budget?
ANS: she should allocate this budget with 6 high school diploma employees and 4 bachelor’s degree
employees : 6 x 20,000 + 4 x 30,000 = $240,000

7. Pork (l) and chicken (g) are the two types of meat that Ms. Hoa’s family often eat. The utility function
of Ms. Hoa's is Cobb - Douglas U (l, g) = l*g; and her family's budget for these two foods is VND
20,000,000 VND; market prices of pork and chicken are pl = VND 200,000/kg and pg = VND 160,000
VND/kg, respectively.
a) Draw a budget line for Ms Hoa's family.

150
Quantity of Pork (L)

125 IC1 IC2

100

75

50 l1* & l2*

25
g1* g2* B1 B2
62.5 77 153.8
25 50 75 100 125 150 175 200
Quantity
Total effect
of Chicken (G)
Substitution Income
effect effect
Budget line:
M = PL*QL + PG*QG
20,000,000=200,000*L+160,000*G

b) Find the optimal consumption point (L1 *, G1 *) of Ms. Hoa's family.

Maximum quantity of chicken that Ms.Hoa’s family can consume if consuming only chicken:
QG = 20,000,000 / 160,000 = 125
Maximum quantity of pork that Ms.Hoa’s family can consume if consuming only pork:
QL = 20,000,000/200 = 100

The optimal consumption point is the tangent of the indifference curve and the budget line. So the
slope of the budget line equals the slope of U(L,G).

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University of Economics, HCMC MBA Program
International School of Business PS1
MUL = dUL/dl and MUG= dUG and U(L,G) = L*G
⇒ MUL/MUG= G/L =PL/PG= 5/4 ⇒ G=5/4L
Replace G value into Income equation:

20,000,000 = 200,000*L + 160,000*(5/4)L

⇒ L = 20,000,000 / 400,000 = 50 ⇒ G = 50 x 5/4 = 62.5

Therefore, the optimal consumption point of Ms.Hoa’s family is (50, 62.5)

c) Now suppose the chicken price drops to VND 130,000/kg. To simplify the analysis, suppose the price
of pork is constant, draw a budget line and find a new optimal consumption point (l2 *, g2*) of Ms. Hoa's
family.
New budget Line: M = PL*QL + PG*QG

20,000.000 = 200,000*L + 130,000*G

Same with explanation in b, we have MUL/MUG= G/L =PL/PG= 20/13 ⇒ G=(20/13)L

Replace G value into Income equation:

20,000,000 = 200,000*L + 130,000*(20/13)L

⇒ L = 20,000,000 / 400,000 = 50 ⇒ G = 50 x (20/13) = 77

Therefore, the new optimal consumption point of Ms.Hoa’s family is (50, 77)

d) Analyze both qualitatively (graphically) and quantitatively (numerically) the income effects,
substitution effects, and the sum of the two effects on the chicken and pork demand when chicken price
reduces from VND 160,000/kg to VND 130,000/kg. (Note: for the substitution effect the total utility is
constant)
We have Total effect (Green arrow) on the chicken and pork demand when chicken price reduces is
(77 - 62,5) = 9,5.

In order to figure it out the substitution effect, draw another budget line which is parallel with M =
20,000,000 = 200,000*L + 130,000*G and shift to left, this will tangent with the original indifference
curve at A. Because of this, we have at A:

G*=(20/13)L* (get from c)

Optimization U* = L*.G* = 50 * 63 = 3.125

L* = 45 and G* = 69

Thus, substitute effect for chicken (Red arrow) = 69 - 63 = 6; for pork = 45– 50 = -5

Income effect for chicken (Orange arrow) = 77 – 69 = 8; for pork 50 – 45 = 5

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University of Economics, HCMC MBA Program
International School of Business PS1

8. The general linear demand for good X is estimated to be:

Q = 250,000 - 500P - 1.50M - 240PR
where P is the price of good X, M is average income of consumers who buy good X, and PR is the price of
related good R. The values of P, M, and PR are expected to be $200, $60,000, and $100, respectively. Use
these values at this point on demand to make the following computations.
a. Compute the quantity of good X demanded for the given values of P, M, and PR.
Q = 250,000 - 500P - 1.50M - 240PR = 250,000 – (500 x 200) – (1.50 x 60,000) – (240 x 100) = $ 36,000

b. Calculate the price elasticity of demand E. At this point on the demand for X, is demand elastic,
inelastic, or unitary elastic? How would increasing the price of X affect total revenue? Explain.
ANS:
E = (∆Q/∆P) x(P/Q) = -500 x (200/36,000) = - 2.78
 At this point on the demand for X, is demand elastic because |E| > 1. When the demand is
elastic, increasing the price of X will make total revenue falls.

c. Calculate the income elasticity of demand EM. Is good X normal or inferior? Explain how a 4 percent
increase in income would affect demand for X, all other factors afecting the demand for X remaining the
same.
EM= (∆Q/∆M) x (M/Q) = -1.5 x (60,000 / 36,000) = -2.5
 Good X is inferior good because EM < 0 (negative)
%∆Q = %∆M x EM = 4% x (-2.5) = - 10%
If income increases by 4%, the quantity demanded of X will decrease by 10%

d. Calculate the cross-price elasticity EXR. Are the goods X and R substitutes or complements? Explain
how a 5 percent decrease in the price of related good R would affect demand for X, all other factors
affecting the demand for X remaining the same.
EXR= (∆QX / ∆PR) x (PR/QX) = -240 x (100/36,000) = - 0.67
 The goods X and R are complements because EXR < 0 (negative)
%∆QX = %∆PR x EXR = -5% x (-0.67) = 3.35%
If the price of related good R decreases by 5%, the quantity demanded of X will increase by 3.35%

9. The figure below shows the long-run and short-run expansion paths as originally illustrated in Figure
9.17 (Textbook A). Continue to assume that the price of labor is $40 per unit and the price of capital is
$60 per unit. The manager is operating in the short run with 60 units of capital. Suppose the manager
wants to produce 8,000 units of output.
a. In the short run, the cost-minimizing input combination is 30 units of labor and 60 units of capital.

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University of Economics, HCMC MBA Program
International School of Business PS1
b. The short-run total cost of producing 8,000 units is $ 4,800 (=30 x 40 + 60 x 60) and ATC is $ 0.6
(=4,800/ 8,000) per unit.
c. If the manager plans to continue producing 8,000 units in the long run, the manager could lower the
total cost of producing 8,000 units by $ 4,400 (= 50 x 40 + 40 x60) by employing 50 units of labor and
40 units of capital.
d. Construct the new short-run expansion path once the long-run adjustment in part c has been completed.

new short-run
expansion path

10. Small, local artisan jewelry makers in the American Southwest design, manufacture, and sells silver
rings (R) and bracelets (B) to tourists. The multiproduct total costs for various combinations of rings and
bracelets (measured in units per month) is given in the table below:
R B LTC (R, B)
______________________
50 0 $ 5,000
75 0 11,250
0 80 25,600
0 100 40,000
50 80 28,600
75 100 47,500
50 100 42,500
75 80 33,850

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University of Economics, HCMC MBA Program
International School of Business PS1
a. If a silver jeweler specializes in ring production, does the firm experience economies of scale in ring
production over the range of 50 to 75 rings per month? Explain.
ANS: No, there are diseconomies of scale over the range 50 to 75 rings:
LAC (50,0) = LTC (50,0)/50 = $5,000/50 = $100 per ring
LAC (75,0) = LTC (75,0)/75 = $11,250/75 = $150 per ring
Diseconomies of Scale exist in ring production over this range of R since LAC rises as ring
production increases

b. If a silver jeweler specializes in bracelet production, does the firm experience economies of scale in
bracelet production over the range of 80 to 100 rings per month? Explain.
ANS: No, there are diseconomies of scale over the range 80 to 100 bracelets:
LAC (0,80) = LTC (0,80)/80 = $25,600/80 = $320 per bracelet
LAC (0,100) = LTC (0,100)/100 = $40,000/100 = $400 per bracelet
Diseconomies of Scale exist in ring production over this range of B since LAC rises as bracelet
production increases

c. Suppose tourists demand 50 rings and 80 bracelets per month. At this level of ring and bracelet
production, are there economies of scope in ring and bracelet production. Why or why not?
Apply the definition of scope economies to find:
ANS:
LTC (50,0) + LTC (0,80) > LTC (50,80)
5,000 + 25,600 = $31,600 > $28,600
 Economies of scope in ring and bracelet production

d. If a jeweler is currently producing 50 rings and 100 bracelets, what is the jeweler’s marginal cost of
increasing ring production to 75 rings? Does this indicate the presence of scope economies? Explain
carefully.
ANS:
The marginal cost of adding 25 bracelets when a firm is already making 50 rings is
= LTC(75,100) – LTC(50,100) = $47,500 – $42,500 = $5,000
=> the marginal cost of each ring increasing is = 5,000 / 25 = $200, lower than the marginal cost of
each ring increasing from 50 to 75 while the firm just producing rings [LTC(75,0) - LTC(50,0)] / 25
= ($11,250 – $5,000)/25 = $250. This indicates the presence of scope economies.

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