MBA ECON MIDTERM STUDY PREP 11-20

11. Demand and supply functions for Florida orange juice are as follows: QD = 4,500,000 – 1,200,000P + 2,000,000PS + 1,500Y
+ 100,000T; QS = 8,000,000 + 2,400,000P – 500,000PL – 80,000PK – 120,000T
Where P is the average price of Florida per case, PS is the average retail price of canned soda, Y is the income, T is the average daily
high temperature, PL is the average price of unskilled labor, and PK is the average cost of capital.
(A)What are the Florida demand and supply functions if PS = $5, Y = $12, 000 billion, T = 75 degrees, PL = $6, and PK = 12.5%. (A)
QD = 4,500,000 – 1,200,000P + 2,000,000PS + 1,500Y + 100,000T;
QD = 4,500,000 – 1,200,000P + 2,000,000(5) + 1,500(12,000) + 100,000(75); QD = 4,500,000 – 1,200,000P + 10,000,000 +
18,000,000 + 7,500,000; QD = 40,000,000 – 1,200,000P: Demand Curve
QS = 8,000,000 + 2,400,000P – 500,000PL – 80,000PK – 120,000T; QS = 8,000,000 + 2,400,000P – 500,000(6) – 80,000(12.50) –
120,000(75); QS = 8,000,000 + 2,400,000P – 3,000,000 – 1,000,000 – 9,000,000; QS = -5,000,000 + 2,400,000P: Supply Curve
(B)Calculate the surplus or shortage of Florida orange juice when P = $5.(B) At P=$5: QD = 40,000,000 – 1,200,000P = 40,000,000
- 1,200,000(5) = 40,000,000 – 6,000,000 = 34,000,000; QS = -5,000,000 + 2,400,000P = -5,000,000 + 2,400,000(5) = -5,000,000 +
12,000,000 = 7,000,000. The firm’s demand is more than its supply, so there is a shortage. Shortage = QD - QD = 34,000,000
– 7,000,000 = 27,000,000
(C)Calculate the market equilibrium price and quantity. (C) Market equilibrium requires: QD = QS, that is, 40,000,000 – 1,200,000P =
-5,000,000 + 2,400,000P → 40,000,000 + 5,000,000 = 2,400,000P + 1,200,000P → 45,000,000 = 3,600,000P
45,000,000
→P= =$ 12.50 : Equilibrium price; Plugging in the value of P in the demand curve equation yields,
3,600,000
Q=40,000,000 – 1,200,000 P=40,000,000−1,200,000(12.50) →Q =40,000,000−15,000,000=25,000,000 :
Equilibriu
(D)At what price the Florida won’t supply at all? (D) When supply is zero, QS = 0, that is, QS = -5,000,000 + 2,400,000; 0 =
5,000,000
-5,000,000 + 2,400,000P; 5,000,000 = 2,400,000P; P= =$ 2.08 ; That is, the firm won’t supply at the price of $2.08
2,400,000
12. Last month, Rick's Bike Shop, Inc. increased the price on the 24 ounce can of bearing grease by 1%. In response, sales dropped by
4%. Calculate the optimal price for bearing grease if marginal cost is $4.50 Answer: Price elasticity of demand:
Percentage change∈quantity − 4
ε = Percentage change∈ price =1 =−4 ;
Optimal price : P=
MC = 4.50 = 4.50 = 4.50 = $ 6

1 1 (1−0.25) 0.75
( 1+ ε ) ( 1+ −4 )
13. KRDY-FM is contemplating a T-shirt advertising promotion. Monthly sales data from T-shirt shops marketing the “Listen to
KRDY-FM” design indicate that: Q = 15,000 – 800P
where Q is T-shirt sales and P is price.
(a)How many T-shirts could KRDT-FM sell at $15 each? Q = 15,000 – 800P = 15,000 – 800(15) = 15,000 -12,000 = 3,000
(b)What price would KRDY-FM have to charge to sell 5,000 T-shirts? 5,000 = 15,000 – 800P
10,000
→ 800 P=15,000−5,000 → 800 P=10,000→ P= =$ 12.50
800
(c)At what price would T-shirt sales equal zero?
15,000
When Q=0 : Q =15,000−800 P→0=15,000−800 P→ 800 P=15,000 →P= =$ 18.75
800
(d) How many T-shirts could be given away? When something is given away, that means no price is charged or P =
0. Q = 15,000 – 800P ¿ 15,000−800 (0 )=15,000−0=15,000 So, 15,000 T-shirts will be given
away.
(c) Calculate the point price elasticity at a price of $15.At P = $15:
Q=15,000−800 P=15,000−800 (15 )=15,000−12,000=3,000
Differentiating the demand equation with respect ¿ Q yields , change Q/change P ¿−800 ; Therefore,
∂Q P 15
ε= . =−800. =−4
∂P Q 3,000
14. Last week, Wally’s Burgers, Inc. reduced the average price on the ½ pound Papa burger by 1%. In response, sales jumped by
2%. Calculate the point elasticity of demand for Papa burgers.
Calculate the optimal price for Papa burgers if marginal cost is $1 per unit.

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 Percentage change∈quantity 2
Answer: (a) Price elasticity of demand: ε= = =−2 ; (b)

Optimal price : P= Percentage change∈ price −1

MC 1 1 1
= = = =$ 2
1 1 (1−0.50) 0.50 ; The optimal (profit-maximizing) price is $2.
(1+ ) (1+ )
ε −2
15. Assume that amazon.com dropped the price on a men’s Seiko watch from $120 to $60, and sales jumped from 50 to 100 units per
day.
Calculate the implied arc price elasticity of demand.
Calculate the implied point price elasticity of demand at the price of $60.
Is a further price decrease warranted?
(a) Here, P1 = $120, P2 = $60, Q1 = 50, and Q2 = 100;
Arc price elasticity : Q −Q1 P 2+ P1 100−50 60+120
E = 2
50 . = . = . 180 =−9,000 =−1
P
P2−P1 Q 2+Q1 60−120 100+50 −60 150 9,000
(b) Point price elasticity : Q2−Q1 P2 100−50 60 −3,000
ε 60 = =−0.5 ; The absolute value of
= . = . = .
50
P
P2−P1 Q2 60−120 100 −60 100 6,000
point price elasticity is 0.5, that is, the demand is
inelastic. When demand is inelastic lowering the price actually lowers the total revenue. Therefore, the firm should, in fact, should
consider raising the price rather than lowering it.
16. Glenco Motors sells an average of 20 Toyota Camry XLE four-door sedans per month. Evanston Toyota sells twice as many.
Based upon data obtained in the financing process, Glenko customers earn an average household income of $100,000 per year,
while Evanston customers earn $125, 000 per year.
Calculate the implied arc income elasticity of demand. (a) Here, I1 = $100,000, I2 = $125,000, Q1 = 20, and Q2 = 2(20) = 40
Q 2 − Q1 I 2 +
Arc income elasticity : E = . 40−20 125,000+100,000
I1 ¿ .
I
I 2 − I1 Q2 +Q 125,000−100,000 40+ 20
1
20 225,000 4,500,000
¿ . = =3 (b) How would you characterize the demand for Toyota Camry? (b) The value of the arc
25,000 60 1,500,000
income-elasticity of demand for Toyota Camry is
greater than 1. Therefore, the demand for Toyota Camry is cyclically normal.
17. During the past year, the average price of lots along Lake Michigan in Carol Beach rose from $2,500 to $3,000 per foot of
lakefront. At the same time, sales of new homes located off the Lake roseL from 40 to 70 units.
(a) Calculate the implied cross-price elasticity of demand. (a) Here, P = $2,500, PL = $3,000, QH = 40, and QH =
H H
Q −Q 1 2 1 2
PLL + 70−40 3,000+ 30 5,500 165,000
70; Arc
2 cross elasticity : EC = L 1
L .
P2 1 . 2,500 = . = =3 ;
P −P Q H = 3,000−2,500 70+ 500 110 55,000
+QH 40
2 1 2 1
(b) Are lakefront lots and new homes complements or substitutes? (b) The value of the arc cross-elasticity of demand for
Toyota Camry is 3, which is positive. Therefore, lots along Lake Michigan in Carol Beach and new homes located off the Lake
are substitutes.
18. Boris Yeltsin Products, Inc. has hired you to analyze demand in 30 regional markets for product Y, a new vodka beverage. A
statistical analysis of demand in these markets shows (standard errors in parentheses): QY = 500 – 8P + 5PX + 0.05A + 0.025I; (350)
(2.5) (2) (0.03) (0.011); R2 = 93%
Here QY is the quantity demanded, P is the price of vodka, PX is the price of substitute product, A is the advertising expenditure, and
I is the average household income.
The critical t-value with 25 (=30-5) degrees of freedom at 5% significance level is 2.06.
Does each independent X variable have a significant effect on the dependent variable?
What percentage of demand variation is explained by this model?
Will a recession (decrease in household income) reduce the quantity demanded? (Hint: Test the hypothesis if the coefficient associated
with household income is positive, at 5% significance level with the same degrees of freedom (i.e. 30)).
Answer:
Parameter estimate −8
t = For price of vodka ( P) : t = =−3.2 →|t|=|−3| →The variable is
=3>2.06=t signific
Any variable C
Standard 2.5
error
For price of the substitute product ( ) : t = 5 =2.5 →|t|=|2.5| →The variable is significnat . For
P advertis
=2.5>2.06=t
X C
2
2
Since the value of R is 93%, 93 percent variable in the dependent variable is explained by this model.
Since the average household income variable has turned out to be positive and significant, an increase in the income increases will
increase and a decrease in the income will decrease the quantity demanded. Also, during a recession, the average household income
declines. Therefore, a recession will lower the quantity demanded.
Linux Servers, Inc. is a leading supplier of high-speed servers with enormous storage capacity. Average price and annual unit sales
data for the VAX7500 high-speed machine are as follows:

2001 2002 2003 2004 2005

Price($) $90,000 $80,000 $60,000 $50,000 $30,000
Units sold 250,000 500,000 1,000,000 1,250,000 1,750,000

A. Derive the linear demand curve for this company.

Answer:

A linear demand curve takes the following form:

P=α + βQ
Where, P is the price, Q is the quantity of output; and α and β are parameters to be estimated.
Plugging in the value of P and Q for year 20001 and 2002 in the above equation yields,

90,000=α + β (250,000) (1)

80,000=α + β (500,000) (2)

Subtracting equation (2) from (1) yields,

90,000−80,000=α + β (250,000 )−α −β (500,000)

→10,000=−β(250,000)
−10,000
→β= =−0.04
250,000
Plugging in the value of β in equation (1) yields,

90,000=α +(−0.04)(250,000)
→ 90,000=α −10,000
→ 90,000+ 10,000=α
→α=100,000
Plugging in the value of α ∧β from above into the demand equation yields the following
demand curve for the company,
P=100,000−0.04 Q
→Q =2,500,000−25 P

The production function: Q = 5K0.8L0.5exhibits an increasing return to scale, whereas, the production function: Q = K + 2L exhibits a
constant return to scale.

Answer:
In a general form, a production function is expressed as,

Q=f ( K , L)

Where Q is the quantity of output, K is the quantity of capital, and L is the quantity of labor. Suppose, the quantity of K and L are
increased by a multiple of k and, as a result, the output increases by a multiple of h, such that,

hQ=f ( kK , kL)
 h
If >1, the production function exhibits an increasing returns ¿
scale , k
h
If <1, the production function exhibits adecreasing returns ¿ scale
,∧¿ k
h
If =1,the production function exhibits aconstant returns ¿
scale . k

Now, let’s first consider the first production function, Q = 5K0.8L0.5.

If k =2, then

2K
¿
¿
2L 0.8 0.8 0.5 0.5 0.8+ 0.5
¿ = 5( 2 K ¿(2 L ) =5( 2 ¿ K 0.8 L0.5 =5 ( 21.3 ) K 0.8 L0.5
¿
hQ=5
¿
¿ 5(2.46) K 0.8 L0.5
To obtain the value of h divide hQ by Q,

hQ
h= = 5(2.46) K 0.8 L0.5
Q =2.46
h 5 K
0.8 0.5
L
2.46
Since, = = 1.23 > 1, therefore, the production function exhibits and increasing returns to scale.
k 2
But there is simple way to determine the type of returns to scale in case of a power function such as above. For example, if
the sum of the powers to the independent variables is greater than, less than, or equal to 1, the production function exhibits
increasing returns to scale, decreasing returns to scale, or constant returns to scale respectively. Let’s examine the sum for the above
power production function.

The ∑ of the powers ¿ the independent variables=0.8+ 0.5=1.3

Since the sum is greater than 1, the production function exhibits increasing returns to scale.

Now let’s check the other production function. As you know, we have assumed k = 2 for both production functions. So,

Q=K +2 L
→ hQ=(2) K+ 2(2 L)=2 K +4 L=2( K +2 L)
hQ K+ 2 L h 2
Therefore, = =2 and = =1
Q 2( K + 2 L) k 2
Since h/k equals 1, the above production function exhibits constant returns to scale.

The hiring of an input, input X, is optimal if the marginal revenue (MR) times the marginal product of X (MPX) is equal to the price of
the input (PX). But if
MR. MPX > PX then the employment of the input should be expanded, and if
MR. MPX < PX then the employment of the input should be contracted.
If demand function is given by: P = $1,000 - $4Q, the Marginal Revenue (MR = $1,000 - $8Q).
Total cost minimization occurs at the point where MC = 0.
Average cost minimization occurs at the point where MC = AC.

Total revenue is maximized where MR = 0.

When Average Cost is falling, AC is greater than
MC. When Average Cost is rising, AC is smaller than
MC. Profit-maximizing occurs where MR = MC.
Also, when marginal profit is zero, profit is maximized.
A demand curve expresses the relation between the quantity demanded and the “price.”
Quantity demanded is positively affected by consumers’ income, population, price of its substitutes, and advertising expenditures and
negatively affected by its own price, price of its complements, and the interest rate.
Quantity supplied is positively affected by its own price and negatively affected by the price of its inputs and the interest rate.
If two goods are complements, a decrease in the price of one will “increase the demand for the other.”
If two goods are complements, an increase in the price of one will “decrease the demand for the other.”
If two goods are substitutes, a decrease in the price of one will “decrease the demand for the other.”
If two goods are substitute, an increase in the price of one will “increase the demand for the other.”
If two goods or services provide the same amount of satisfaction or utility, the consumer is said to display indifference.
All combinations of goods and services that provide the same utility are identified by the indifference curve.
If the quantity of all inputs are increased by a multiple of k, and, as a result, the output increases by a multiple of h, then the
production function exhibits an increasing returns to scale if h > k, a decreasing returns to scale if h < k, and a constant returns to scale
if h = k.
A consumer will obtain the maximum level of utility if MUX/MUY = PX/PY or MUX/PX = MUY/PY.
Because moviegoers like to consume buttered popcorn and soda at the theater, movies, buttered popcorn and soda are all
complements.
Holding all else constant, a given percentage increase in the price of X and Y will cause the budget constraint to shift inward in a
parallel manner.
Holding all else constant, a given percentage increase in the price of X will cause the budget constraint to become more steeply sloped
(i.e. move inward along the X-axis only while maintaining a fixed Y-intercept).
Holding all else constant, a given percentage decrease in the price of X will cause the budget constraint to become more flatly sloped
(i.e. move outward along the X-axis only while maintaining a fixed Y-intercept).
Holding all else constant, a given percentage increase in the price of Y will cause the budget constraint to become more flatly sloped
(i.e. move inward along the Y-axis only while maintaining a fixed X-intercept).
Holding all else constant, a given percentage decrease in the price of Y will cause the budget constraint to become more steeply sloped
(i.e. move outward along the Y-axis only while maintaining a fixed X-intercept).
Point elasticity measures elasticity at a spot on a function.
Arc elasticity measures elasticity over a given range along a function.
With elastic demand, a price increase lowers the total revenue (causes a more than proportionate decline in quantity demanded).
With elastic demand, a price decrease raises the total revenue (causes a more than proportionate increase in quantity demanded).
With inelastic demand, a price increase raises the total revenue (causes a less than proportionate decline in quantity demanded).
With inelastic demand, a price decrease lowers the total revenue (causes a less than proportionate increase in quantity demanded).
With unitary elastic demand, a price increase does not raise or lower the total revenue (causes a proportionate decline in quantity
demanded).
With unitary elastic demand, a price decrease does not raise or lower the total revenue (causes a proportionate increase in quantity
demanded).
A direct relation exists between the price of one product and the demand for substitutes.
An indirect relation exists between the price of one product and the demand for complements.
The demand for a product tends to be inelastic if a small portion of a consumer’s income is spent on the good.
The demand for a product tends to be elastic if a large portion of a consumer’s income is spent on the good.
Two products are complements if the cross-price elasticity of demand is less than zero.
Two products are substitutes if the cross-price elasticity of demand is greater than zero.
If the income elasticity of demand for a good is greater than one, the good is a cyclical normal good.
If the income elasticity of demand for a good is greater than zero but less than one, the good is a noncyclical normal good.
If the income elasticity of demand for a good is less than zero, the good is an inferior good.
If the income elasticity of demand for a good is zero, the good is neither a normal nor an inferior good.
A product that enjoys rapidly growing demand over time is likely to be a cyclical normal good.
When the product demand curve is Q = 140 – 10P the point price elasticity at the price of $10 is (-2.5).
When the product demand curve is Q = 140 – 10P and the price is decreased from P1 = $10 to P2 = $9, the quantity increases by (10).
If the point price elasticity of demand equals -2 and the marginal cost per unit is $5, the optimal price is ($10).
If εP = -3 and MC = $0.66, the optimal (profit maximizing) price is ($0.99).
A linear model implies a constant effect of X on Y.
A rhythmic annual pattern in sales or profits is called seasonal variation.
Linear trend analysis assumes a constant period-by-period unit change in an important economic variable over time.
Growth trend analysis assumes a constant period-by-period percentage change in an important economic variable over
time. A secular trend is the long-run pattern of increase or decrease in a series of economic data.
If an economic time series is growing by a constant dollar amount each period, the most accurate forecast model is a linear model.
2 ESS
R = TSS
 (k−1)
E , F = RSS
S ( n−k)
S
A F-statistic is used to test the overall significance of the model whereas a
t-statistic is used to test the significance of an individual independent variable.
A one--tailed test is conducted to test if an independent variable has any effect (negative or positive) on the dependent variable.
A two--tailed test is conducted to test if an independent variable has either negative or positive effect on the dependent variable.