Course Name: Managerial Economics

Individual Assignment One and Two

Briefly explain the following questions (your answer to each question should be provided in
hand written form)

1. Kebede is the owner of a small grocery store in a busy section of Addis Ababa, Ethiopia.
Kebede’s annual revenue is $200,000 and his total explicit cost (Kebede pays himself an
annual salary of $30,000) is $180,000 per year. A supermarket chain wants to hire Adam as
its general manager for $60,000 per year.
A. What is the opportunity cost to Kebede of owning and managing the grocery store?
B. What is Kebede’s accounting profit?
C. What is Kebede’s economic profit?
2. The opportunity cost of any decision includes the value of all relevant sacrifices, both
explicit and implicit. Do you agree? Explain.
3. The “law of demand” is not a law. Do you agree with this statement? Explain
4. Many owners of small businesses do not pay themselves a salary. What effect will this
practice have on the calculation of the firm’s accounting profit? Economic profit? Explain.
5. Firms that earn zero economic profit should close their doors and seek alternative
investment opportunities. Do you agree? Explain.
6. Suppose that the total market demand for a product comprises the demand of three
individuals with identical demand equations.
QD,1= QD,2=QD,3=50-25P

What is the market demand equation for this product?

7. The market demand and supply equations for a product are where Q is quantity and P is
price. What are the equilibrium price and quantity for this product
QD =25-3P
QS =10+2P

Where Q is quantity and P is price. What are the equilibrium price and quantity for this product?

8. The market supply and demand equations for a given product are given by the expressions
QD =200-50P
QS = - 40 + 30P
A. Determine the equilibrium price and quantity.
B. Suppose that there is an increase in demand to
QD =300-50P
Suppose further that there is an increase in supply to
QS =-20+30P
What are the new equilibrium price and quantity?
C. Suppose that the increase in supply had been
QS = 140 + 30P
Given the demand curve in part b, what are the equilibrium price and quantity?
D. Diagram your results.
9. Define and give an example of each of the following demand terms and concepts. Illustrate
diagrammatically a change in each.
A. Quantity demanded

Quantity demanded is a term used in economics to describe the

total amount of a good or service that consumers demand over a
given interval of time. It depends on the price of a good or service in
a marketplace, regardless of whether that market is in equilibrium.

The relationship between the quantity demanded and the price is

known as the demand curve, or simply the demand. The degree to
which the quantity demanded changes with respect to price is
called the elasticity of demand.

Example of Quantity Demanded

Say, for example, at the price of $5 per hot dog, consumers buy two hot dogs
per day; the quantity demanded is two. If vendors decide to increase the price
of a hot dog to $6, then consumers only purchase one hot dog per day. On a
graph, the quantity demanded moves leftward from two to one when the price
rises from $5 to $6. If, however, the price of a hot dog decreases to $4, then
customers want to consume three hot dogs: the quantity demanded moves
rightward from two to three when the price falls from $5 to $4. 

By graphing these combinations of price and quantity demanded, we can

construct a demand curve connecting the three points.

Using a standard demand curve, each combination of price and quantity

demanded is depicted as a point on the downward sloping line, with the price
of hot dogs on the y-axis and the quantity of hot dogs on the x-axis. This
means that as price decreases, the quantity demanded increases. Any
change or movement to quantity demanded is involved as a movement of the
point along the demand curve and not a shift in the demand curve itself. As
long as consumers' preferences and other factors don't change, the demand
curve effectively remains static.

Price changes change the quantity demanded; changes in consumer

preferences change the demand curve. If, for example, environmentally
conscious consumers switch from gas cars to electric cars, the demand curve
for traditional cars would inherently shift.
B. Demand

Demand is an economic principle that refers to the willingness and

ability of consumers to make discretionary purchases at a given
price. All else being equal, demand will decrease as price increases
and vice versa, but there are many factors which affect demand.
Demand is closely related to supply which is the amount
of goods available to be sold in an economic market.
For example, if a consumer is hungry and buys a slice of pizza, the first slice
will have the greatest benefit or utility. With each additional slice, the consumer
becomes more satisfied, and utility declines. In theory, the first slice might fetch a
higher price from the consumer.
 C. Substitute good

Substitute goods or substitutes are at least two products that could be used for the
same purpose by the same consumers.

If the price of one of the products rises or falls, then demand for the substitute goods or
substitute good (if there is just one other) is likely to increase or decline. The other
products – the substitutes – have a positive cross-elasticity of demand.

Substitute goods are identical, similar, or comparable to another product, in the

eyes of the consumer.

Substitute goods can either fully or partly satisfy the same needs of the customers.
Therefore, they can replace one another, so the consumer believes.

Pepsi-Cola is a substitute good for Coca-Cola, and vice-versa. When the price of Coca-
Cola goes up, demand for Pepsi-Cola will subsequently rise (if Pepsi does not raise its
price).

Examples of substitute goods

Below is a list of some common substitute goods:

 Coke & Pepsi

 McDonald’s & Burger King
 Colgate & Crest (toothpaste)
 Tea & Coffee
 Butter & Margarine
 Kindle & Books Printed on Paper
 Fanta & Crush
 Potatoes in one Supermarket & Potatoes in another Supermarket.
 D. Complementary good

Complementary good is a product or service that adds value to another. In

other words, they are two goods that the consumer uses together. For
example, cereal and milk, or a DVD and a DVD player.
On occasion, the complementary good is absolutely necessary, as is the
case with petrol and a car. However, a complementary good can add value
to the initial product. For instance, pancakes and maple syrup.
Complementary goods are goods/services that are typically

used together, for example keyboard and computers, tennis

balls and rackets, and milk and cookies. When the price of a

certain good decreases, the demand for its complementary

good will increase.

Examples

1. Tennis Balls and Tennis Racket

 2. Mobile Phones and Sim Cards
3. Petrol and Cars
4. Burger and Burger Buns
5. PlayStation and Games
6. Movies and Popcorn
7. Shoes and Insoles
8. Pencils and Notebooks

E. Income expectation (high and low)

The consensus estimate of analysts and other experts as to a company's earnings for a
given period of time. If earnings expectations are high, the price of a company's stock may
increase as investors seek to take advantage of the added value or dividend.

Example of high

1. (of a person) earning a higher than average income. 2. (of a financial instrument)

providing a higher than average income.
low
not having or earning much money: Many struggle to make ends meet, particularly
those from low-income families. low-income areas/communities/countries The fund helps
low-income countries to increase their renewable energy use.
10. Does the following statement violate the law of demand? The quantity demanded of
diamonds declines as the price of diamonds declines because the prestige associated with
owning diamonds also declines.
Yes b/c If the diamond is very costly (expensive) it will be considered as more prestigious.
The consumer will buy fewer diamonds if the price of diamonds is low because, with the
fall in price, its prestige value goes down whereas; the consumer will buy more
diamonds if the price increases.

11. At a price of $25, the quantity demanded of good X is 500 units. Suppose that the price
elasticity of demand is -1.85. If the price of the good increases to $26, what will be the new
quantity demanded of this good?
12. Briefly explain the determinants of price elasticity of demand?

There are several factors that affect how elastic (or inelastic) the price elasticity of demand
is, such as the availability of substitutes, the timeframe, the share of income, whether
a good is a luxury vs. a necessity, and how narrowly the market is defined.
The four factors that affect price elasticity of demand are
(1) availability of substitutes,
(2) if the good is a luxury or a necessity,
(3) the proportion of income spent on the good, and
(4) how much time has elapsed since the time the price changed.

13. For each of the following production functions, determine whether returns to scale are
decreasing, constant, or increasing when capital and labor inputs are increased from K = L =
1 to K = L = 2. (Explain your answers)

1. Q = 2K + 3L: To determine the returns to scale, we will begin by

increasing both K and L by m. Then we will create a new production
function Q’. We will compare Q’ to Q.Q’ = 2(K*m) + 3(L*m) = 2*K*m +
3*L*m = m(2*K + 3*L) = m*Q
1. After factoring, we can replace (2*K + 3*L) with Q, as we were given
that from the start. Since Q’ = m*Q we note that by increasing all of
 our inputs by the multiplier m we've increased production by
exactly m. As a result, we have constant returns to scale.
2. Q=.5KL: Again, we increase both K and L by m and create a new
production function. Q’ = .5(K*m)*(L*m) = .5*K*L*m2 = Q * m2
1. Since m > 1, then m2 > m. Our new production has increased by more
than m, so we have increasing returns to scale.
3. Q=K L0.2: Again, we increase both K and L by m and create a new
0.3

production function. Q’ = (K*m)0.3(L*m)0.2 = K0.3L0.2m0.5 = Q* m0.5

1. Because m > 1, then m0.5 < m, our new production has increased by
less than m, so we have decreasing returns to scale.

14. Define each of the following (Support your answer with the necessary graph)
A. Stage I of production

The first stage of the production function is the period of increasing return in which each
additional variable input will produce more output This is the period of output growth in the
production of a firm.

Stage one is the period of most growth in a company's production. In this period, each
additional variable input will produce more products. This signifies an increasing marginal
return; the investment on the variable input outweighs the cost of producing an additional
product at an increasing rate
B. Stage II of production

Stage II is the stage of diminishing returns. Stage II of production begins at

the point where the average and marginal products are equal. Q. "Whenever
marginal product is equal to average product, total product is at its maximum.
C. Stage III of production
he onset of Stage III results due to negative marginal returns. In this stage of
short-run production, the law of diminishing marginal returns causes marginal
product to decrease so much that it becomes negative.
there are three key stages that take place in the production of any film: pre-
production (planning), production (filming), and post-production (editing,
color-grading, and visual effects)
15. What it meant by
A. Short run in production
The term “short-run production” refers to a production cycle in which at least
one factor is fixed. Most companies have multiple factors that they use to
produce goods or services. Also known as input factors, they can consist of
labor, materials, equipment, capital and real property.

B. Long run in production

The long run is a period of time in which all factors of production
and costs are variable. In the long run, firms are able to adjust all
costs, whereas in the short run firms are only able to influence
prices through adjustments made to production levels.
Additionally, while a firm may be a monopoly in the short term,
they may expect competition in the long run.

In economics, the long-run is a theoretical concept in which all markets are in

equilibrium, and all prices and quantities have fully adjusted and are in
equilibrium. The long-run contrasts with the short-run, in which there are some
constraints and markets are not fully in equilibrium.

16. Suppose that output is a function of labor and capital. Assume that labor is the variable input
and capital is the fixed input. Explain the law of diminishing marginal product. How is the
law of diminishing marginal product reflected in the total product of labor curve?

the Law of Diminishing Marginal Productivity?

The law of diminishing marginal productivity is an economic principle usually
considered by managers in productivity management. Generally, it states that
advantages gained from slight improvement on the input side of the
production equation will only advance marginally per unit and may level off or
even decrease after a specific point. 

the Law of Diminishing Marginal Productivity

The law of diminishing marginal productivity involves marginal increases in
production return per unit produced. It can also be known as the law of
diminishing marginal product or the law of diminishing marginal return. In
general, it aligns with most economic theories using marginal analysis.
Marginal increases are commonly found in economics, showing a diminishing
rate of satisfaction or gain obtained from additional units of consumption or
production.

The law of diminishing marginal productivity suggests that managers find a

marginally diminishing rate of production return per unit produced after
making advantageous adjustments to inputs driving production. When
mathematically graphed this creates a concave chart showing total
production return gained from aggregate unit production gradually increasing
until leveling off and potentially starting to fall.

17. Briefly explain the following concepts related to isoquant curve

A. What does a linear isoquant illustrate?
This curve shows the perfect substitutability between the factors of
production. This means that any quantity can be produced either employing
only capital or only labor or through “n” number of combinations between these
two.
 B. Isoquants cannot intersect. Do you agree? Explain.
Yes Isoquants cannot intersect b/c Isoquant curves cannot be tangent or
intersect one another. Curves that intersect are incorrect and produce
results that are invalid, as a common factor combination on each of the curves
will reveal the same level of output, which is not possible.

18. Suppose that the total cost function of a firm is given as

A. Determine the output level that minimizes average total cost (ATC). At this output
level, what is TC? ATC? MC? Verify that at this output level MC = ATC, and that
ATC intersects MC from below.
B. Determine the output level that minimizes average variable cost (AVC). At this
output level, what is TC? AVC? MC?
C. Diagram your answers to parts a and b.

1. Perfect competition
A local microbrewery has total costs of production given by the equation TC=500+10q+5q 2. This implies that
the firm's marginal cost is given by the equation MC=10+10q (you do not need to be able to show this). The
market demand for beer is given by the equation QD=105 – (1/2)*P.

a) Write the equations showing the brewery's average total cost and average variable cost and average fixed
cost, each as a function of q. Show the firm's MC, ATC and AVC on one graph.

ATC = TC/q = (500+10q+5q2)/q = 500/q+10+5q

AVC = VC/q = (10q+5q2)/q = 10+5q

AFC = FC/q = 500/q

b) What is the breakeven price and breakeven quantity for this firm in the short run?

Note that MC crosses ATC at its minimum. Hence, MC = ATC at that level of output that corresponds to the
intersection of the ATC and MC curves.
MC = 10 +10q = 500/q + 10 + 5q = ATC

5Q = 500/q

5q2 = 500

q2 = 100

q = 10

Then P = MC = ATC = 10 + 10q = 110

c) What is the shutdown price and shutdown quantity for this firm in the short run?

From the picture above, it is clear that AVC is minimized at q = 0.

P = MC = AVC = 10+5(0) = 10

Short-run Equilibrium

d) If the market price of the output is $50, how many units will this firm produce?

The firm will set MC=P=50. Thus, 10 + 10q = 50, hence q* = 4.

e) Given a market price of $50, how many firms are in this market?

Plug P = 50 in the market demand curve. Thus, we get QD = 105 – (1/2)50 = 80

Thus, the number of firms in the short run is equal to: N = 80/4 =20 firms.

Long-run Equilibrium

f) Assuming the beer industry is perfectly competitive, what output would be produced by the firm in long-
run equilibrium? What would be the long-run equilibrium price?
In long run equilibrium, there must be zero profits. Therefore, rewriting the profit function,

 = TR – TC = P*q – ATC*q = (P – ATC) *q

We can see that zero profit requires that P = ATC. Since in perfect competition it is always the case that P =
MC for a profit maximizing firm, we need to find the price at which MC = ATC. Note that this is the breakeven
price and breakeven quantity for the firm found in part (b).

Long run equilibrium quantity for the firm: q = 10

Long run equilibrium price: P = 110

g) How many firms will be in the industry in long-run equilibrium?

We already know that the long run equilibrium price must be 110. From this information and the demand
curve we can find the quantity demanded in this market in the long run.

QD=105-(1/4)*P = 105 – (1/2)*110 = 50

In equilibrium, the market demand must equal the market supply. Thus, the number of firms:

N = QD/q = 50/10 = 5 firms

2. Monopoly

Suppose Charter Communications is a monopolist in providing cable television services to local consumers in
Madison. The market demand curve faced by Charter Communications is P = -Q + 30, and Charter’s cost is
given by TC=Q2/2 + 20, and Charter Communication’s marginal cost is given by MC=Q.

a) What is the equation for Marginal Revenue for this monopolist?

MR = -2Q + 30

b) Draw the Demand curve, Marginal Revenue curve, and Marginal Cost curve for this monopolist in a graph.

MC

30

MR D

15 30 Q

c) What is the monopolist’s profit-maximizing production quantity, Q M? What price, PM , will the monopolist
charge?
Use MR=MC, we have -2Q + 30 = Q , and we can get QM = 10

Plug QM = 10 into demand equation, we have PM = -10 + 30 = $20

d) Compute the Consumer surplus, producer surplus and profits for the monopolist

CS = 10x10/2 = $50

PS = 10x10 + 10x10/2 = $150

In order to get the profit,

First,

ATC = Q/2 + 20/Q

Second,

Profits = TR – TC

TR = PMQM = 20x10 = $200

TC = ATC (at QM)xQM = (10/2 + 20/10)x10 = $7x10 = $70

Then,

Profits = TR – TC = $200 - $70 = $130

Now, suppose there is a technological change for the monopolist and the result of this technological change
is that the firm’s cost curves change. Charter Communications total cost is now given by TC = 10Q, and its
marginal cost is given by MC = 10.

e) What is the monopolist’s profit-maximizing production quantity Q M? What price, PM, will the monopolist
charge?
Use MR=MC, we have -2Q + 30 = 10, and we can get QM = 10

Plug QM = 30 into demand equation, we have PM = -10 + 30 = $20

f) Suppose this market was a perfectly competitive market (i.e., the monopolist’s demand curve is still the
market demand curve, but now there are many firms providing cable television services for the market).
Given the market is perfectly competitive, what would be the equilibrium price (P pc) and quantity (Qpc) in this
competitive market? Assume that each firm’s MC curve is given by MC = 10 for this question.

The competitive market equilibrium price should satisfy P=MC, so Ppc = 10

Plug Ppc = 10 into demand, we get 10 = -Q + 30, Qpc = 20.

Now, let us compare the monopoly and perfect competition outcomes. Consider the last technology where
the firm faces TC = 10Q and MC=10.

g) What is the difference between the consumer surplus in the monopoly case and the consumer surplus in
the perfect competition case?

CS(monopoly) = 10x10/2 = $50

CS(perfect competition) = 20x20/2 = $200

So the difference is $50 - $200 = -$150

h) What is the difference between the producer surplus in the monopoly case and the producer surplus in the
perfect competition case?

PS(monopoly) = 10x10 = $100

PS(perfect competition) = $0

So the difference is $100 - $0 = $100

i) What is the dead weight loss caused by the monopolist?

DWL = [CS(perfect comp.)+PS(perfect comp.)] - [CS(monopoly)+PS(monopoly)]

DWL = [200+0] - [50+100] = $50

3. Natural monopoly

a) Suppose Madison Gas and Electric (MGE) is a natural monopoly in Madison for electricity. This firm
faces a demand function P =20 −2Q and has a total cost function TC = 12+8Q. We can find this firm’s
marginal cost function by taking the first derivative of the total cost function with respect to Q. If you do
not know how to do this or your calculus skills are rusty, then here is the firm’s MC curve: MC = 8. On a
graph illustrate the Demand curve, Average Total Cost curve, Marginal Cost Curve, and Marginal
Revenue Curve for this firm.

20
0

ATC
MC
8

MR D

5 10 Q

Since there is only one firm q=Q

b) The government decides to regulate this market using marginal cost pricing. That is, the firm is told to
produce that level of output where MC is equal to P for the last unit produced. Calculate the minimum
amount of subsidy that will be necessary in order to keep this monopolist in business.

$
20
0

PAC ATC
MC
PMC=8

MR D

QAC QMC=6 10 Q

The minimum amount of subsidy is the amount that gives zero profit to the monopolist.

P=MC=8

Plug P=8 into demand, then we get Q MC=6

Profit=TR-TC

TR=PxQMC

=8x6 = $48

TC=ATC(atQMC)xQMC

ATC(atQMC)=10/QMC + 8 = $10

Then

TC=$10x6 = $60

Thus,

Profit = -$12

Therefore, the minimum amount of total subsidy is $12 (or, $2 per unit of the good produced).
c) Suppose the government decides to use average cost pricing regulation. That is, the government tells
the monopoly to produce that level of output where the firm earns zero economic profit. Identify in
your graph the equilibrium price and quantity that corresponds to this type of regulation (don’t compute
the values, just mark what the Pac and Qac are in your graph). Is this price and output combination
allocatively efficient?

In the picture, the equilibrium is when Demand=ATC.

Profit = 0.

NO, this price and output combination is not allocatively efficient.

4. Price discrimination

A monopolist faces demand from two groups of consumers.

Demand from class 1 is given by: Q1=20 – P

Demand from class 2 is given by: Q2=22 – (1/2)P

A monopolist has costs given by:

TC=10 + 0.5Q2

MC=Q

The firm is able to price discriminate between the two markets.

a) Which group of customers has the more elastic demand curve?

We can see that the demand from class 1 is more sensitive to changes in price.
b) Which group do you expect will pay a higher price under 3rd degree price discrimination?

Demand from class 2 is relatively inelastic compared to class 1. We would thus expect class 2 to pay a higher
price.

c) What is the equation for Marginal Revenue for each class of consumers?

TR from class 1 = PQ1 = 20Q1 – Q12

MR from class 1 = 20 – 2Q1

TR from class 2 = PQ2 = 44Q1 – 2Q22

MR from class 2 = 44 – 4Q2

d) What quantities will the monopolist sell in the two markets?

The monopolist will set marginal revenue in each class equal to the (common) marginal cost. Hence, in
equilibrium

MR1 = 20 – 2Q1 = Q1+Q2 = Q = MC

MR2 = 44 – 4Q2 = Q1+Q2 = Q = MC

This is an equation system with two equations and two unknowns. From the first equation we obtain
Q2 = 20 – 3Q1

Replacing in the second equation

44 – Q1 = 5(20 – 3Q1)

14Q1 = 56

Q1 = 4

Replacing in Q2 = 20 – 3Q1 = 8

e) What price will the monopolist charge in each market? Are the optimal prices in each class consistent with
your prediction in part (b)?

The equilibrium prices are found simply by plugging the equilibrium quantities into the demand functions.

For demand from class 1

P = 20 – Q1 = 20 – 4 = 16

For demand from class 2

P = 44 – 2Q2 = 44 – 16 = 28

We found that class 2 pays a higher price, which is consistent with our prediction.
f) Which class generates the highest revenue for the monopolist?

TR from class 1 = P1Q1 = 16x4 = 64

TR from class 2 = P2Q2 = 28x8 = 244

5. Game theory

Now consider Julia and Peter. Peter likes Julia, but Julia doesn't like Peter that much, only a little. Each knows
this, and neither wants to call the other before deciding what to do this weekend: stay at their respective
homes or go to the econ party. 

Here is the payoff matrix providing a measure of the benefits that Julia and Peter receive depending upon
whether they stay home or go to the party. In each cell the first number refers to Julia’s benefit while the
second number refers to Peter’s benefit.  

    Peter

Home Party

Home (2,0) (2,1)

Julia
Party (3,0) (1,22)

a) Is there any strictly dominant strategy for Julia? Explain your answer.

No

In this case, Julia's best strategy depends on what Peter does. If Peter stays at home, then the best decision
for her is to go to the party. But If Peter goes to the party, then the best decision for her is to stay at home.
b) Is there any strictly dominant strategy for Peter? Explain your answer.

Yes.

For Peter, regardless the decision of Julia, the best decision is to go to the party. So it is his dominant
strategy.

c) What is the equilibrium you can predict from this game?

Julia knows that Peter will always go to the party, so she will choose to stay at home, thus (Home, Party) = (2,
1) is the equilibrium for this game.

19. Explain the following concepts (support your answer with the necessary graph)
A. Expansion path
an expansion path (also called a scale line) is a path connecting optimal input
combinations as the scale of production expands. which is often represented
as a curve in a graph with quantities of two inputs, typically physical capital and
labor, plotted on the axes.

B. Economies of scale

Economies of scale refers to cost advantages experienced by

companies as they grow and become more efficient. An economy
of scale is realized as a company increases in size and is able to
 spread out the cost of production over a larger number of units of
a good.

20. Suppose that a perfectly competitive industry comprises 1,000 identical firms. Suppose,
further, that the market demand (QD) and supply (QS) functions are
QD =170,000,000-10,000,000P
QS =70,000,000+15,000,000P
A. Calculate the equilibrium market price and quantity?
B. Given your answer to part a, how much output will be produced by each firm in
the industry?
C. Suppose that one of the firms in the industry goes out of business. What will be the
effect on the equilibrium market price and quantity?
21. Firms in perfectly competitive industries may be described as price takers. What are the
implications of this observation for the price and output decisions of profit-maximizing
firms?
22. Briefly explain the difference and similarity between the four types of market structure
(perfectly competitive, monopolistically competitive, oligopoly and monopoly)
23. Briefly explain the six basic steps of decision making?
24. Briefly explain the following concepts:
A. Managerial economics
B. Opportunity cost
C. Explicit and implicit cost
D. Economic and Accounting cost
25. Explain approaches used to measure national income?
A. Gross Domestic Product (GDP)
B. Gross National Product (GNP)
C. Discuss approach used to measure GNP/GDP