Managerial Economics

1. The demand curve for a product is given by Qxd= 2,000 – 5Px + 0.2Pz, Where, Pz = $500.

a. What is the own price elasticity of demand when Px = $120? Is demand elastic or inelastic at this price?
What would happen to the firm’s revenue if it decided to charge a price below $120?
b. What is the own price elasticity of demand when Px = $250? Is demand elastic or inelastic at this price?
What would happen to the firm’s revenue if it decided to charge a price above $250?

2. As the manager of a local hotel chain, you have hired an econometrician to estimate the demand for
one of your hotels (H). The estimation has resulted in the following demand function: QH = 2,000 – PH – 1.5PC
– 2.25PSE = 0.8POH + .01M , where
PH is the price of a room at your hotel,
PC is the price of concerts in your area,
PSE is the price of sporting events in your area,
POH is the average room price at other hotels in your area,
M is the average income in the United States.

What would be the impact on your firm of
a. A $500 increase in income?
b. A $10 reduction in the price charged by other hotels?
c. A $7 increase in the price of tickets to local sporting events?
d. A $5 increase in the price of concert tickets, accompanied by an $8 increase in income?
3. Your firm’s research department has estimated the income elasticity of demand for Art Deco lawn
furniture to be 1.5. You have just learned that due to an upturn in the economy, consumer incomes are
expected to rise by 8 percent next year. How will this event affect your ordering decision for PVC pipe,
which is the main component in your furniture?
4. You are a manager at the DaimlerChrysler. Daimler-Chrysler has lost money on the Smart car since the
first model rolled off the assembly line in 1998. By bringing its little car into the huge U.S. market, the
firm hopes to reverse its fortunes. Former race car driver Roger Penske has signed on to develop a network of
up to 50 Smart dealerships across the U.S. Penske says the car is not just smart, it is also safe. If your
marketing department estimates that the annual demand for the Smart Car is Q = 200,000 – 8.0P, what price
should you charge in order to maximize revenues from sales of the Smart Car?
5. A stockholder named Sue must cast a vote for chair of the board. Sue prefers Mr. Lee to Ms. Doe, Ms.
Doe to Mr. James, and Mr. James to Mr. Lee.
a. Are Sue’s preferences consistent with our assumptions about consumer behavior? Explain.
b. If all stockholders had the same preferences as Sue, who would win the appointment as chair of the board?

6. Airlines give away millions of tickets each year through their frequent flyer programs, with the typical
airline awarding a free ticket for each 25,000 miles flown on the airline. The average airline ticket costs
$500 and is for a 2,500-mile round trip. Given this information, evaluate the following statement: Airlines
could have the same effect on demand by eliminating their frequent flyer programs and simply lowering the
average ticket price by 10 percent.

Answer 7Aa or 7B
7A. In the accompanying figure, a consumer is initially in equilibrium at point C. The consumer’s income is
$300, and the budget line through point C is given by $300 = $50X + $100Y. When the consumer is given a $50
gift certificate that is good only at store X, she moves to a new equilibrium at point D.
a. Determine the prices of goods X and Y.
b. How many units of product X could be purchased at point A?
c. How many units of product X could be purchased at point E?
d. How many units of product X could be purchased at point B?
e. How many units of product X could be purchased at point F?
f. Based on this consumer’s preferences, rank bundles A, B, C, and D in order from most preferred to least
g. Is product X a normal or an inferior good?
7B. While at a discount shoe store, a customer asked a clerk, “I see that your shoes are ‘buy one, get one
free -limit one free pair per customer.’ Will you sell me one pair for half-price?” The clerk answered, “I
can’t do that.” When the customer started to leave the store, the clerk hastily offered, “However, I am
authorized to give you a 40 percent discount on any pair in the store.” Assuming the consumer has $200 to
spend on shoes (X) or all other goods (Y), and that shoes cost $100 per pair, answer the following questions:
a. Illustrate the consumer’s opportunity set with the “buy one, get one free” deal and with a 40 percent
b. Why was the 40 percent discount offered only after the consumer rejected the “buy one, get one free” deal
and started to leave the store?
c. Why was the clerk willing to offer a “buy one, get one free” deal, but unwilling to sell a pair of shoes
for half-price?

8. In February 2004, the Federal Communications Commission (FCC) effectively deregulated the broadband
industry in a close 3–2 vote that changed the rules of the 1996 Telecommunications Act. Among other things,
the decision eliminates a rule that required the Baby Bells–BellSouth, Qwest Communication International, SBC
Communications, and Verizon Communications–to provide rivals access and discounted rates to current broadband
facilities and other networks they may build in the future. Providers of digital subscriber lines (DSL) that
use the local phone loop are particularly affected. Some argue that the agreement will likely raise many DSL
providers’ costs and reduce competition. Providers of high-speed Internet services utilizing cable, satellite
or wireless technologies will not be directly affected, since such providers are not bound by the same
facilities-sharing requirements as firms using the local phone networks. In light of the recent FCC ruling,
suppose the News Corp., which controls the United States’ largest satellite-to-TV broadcaster, is
contemplating launching a Spaceway satellite that could provide high-speed Internet service. Prior to
launching the Spaceway satellite, suppose that News Corp. used least squares to estimate the regression line
of demand for satellite Internet services. The best-fitting results indicate that demand is Qsatd = 168
-.9Psat + 1.05 PDSL + 1.10 Pcable (in thousands), where Psat is the price of satellite Internet service, PDSL
is the price of DSL Internet service, and Pcable is the price of high-speed cable Internet service. Suppose
that after the FCC’s ruling the price of DSL, PDSL, is $25 per month and the monthly price of high-speed
cable Internet, Pcable, is $30. Furthermore, News Corp. has identified that its monthly revenues need to be
at least $14 million to cover its monthly costs. If News Corp. set its monthly subscription price for
satellite Internet service at $60, would its revenue be sufficiently high to cover its cost? Is it possible
for News Corp. to cover its cost given the current demand function? Justify your answer.