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Managerial Economics

Managerial Economics
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Section “A”
1) Explain the different factors affecting the Supply with a well-labeled diagram
Supply can be described as the quantity of goods or products, produced by a manufacturer or
planned by a distributor for sale into the market at a given point of time with a specified
price. Different factors such as product pricing, technological aspects environment,
workforce, number of suppliers for the same products, and government subsidies determine
the quality and quantity of Supply. Supply shows the willingness of a seller, with a particular
time and price for a specified amount of the product. Generally the supply of products
depends on its price and cost of production, along with other factors such as natural
condition, technology, transport conditions, and government policies:
Price is one the main factors influencing the products’ supply. Price of a product
always has a relationship with its supply. If the price of products increases, the
supply also increases; and if the price decreases, the supply will also decrease.
This is often described as variation in supply of a product, which is caused by
change in supply with respect to change in price.
Future price speculation can also cause the supply accordingly. An expected rise
in price in future can affect the supply of the products to decrease in the current
market due to expected increased profit in future. However, the decrease in the
price of a product in future causes the supply to increase in the present market.
Production Costs
The supply of a product decreases when the cost of production increases and vice versa. The
supply and cost of production can inversely affect each other. For example, a supplier
supplies a product in less quantity into the present market, when the cost of production
becomes higher than the market price of the product in the current market. In this case the
supplier will wait for the increase in price in future. The cost of production increases because
of several factors, that could be loss of fertility of land, high wages, increase cost of raw
material, transport cost, and tax rate.
A supply curve below can reveal about how quantity of supply changes as the price increase
and decreases, considering the ceteris paribus, means there are no other relevant factors that
are changing. If there are other changing factors, then the supply curve will shift. A shift in
supply results in a change in the quantity supplied at every price.
For instance, we have an initial supply curve for a car. Now illustrate that the price of steel
increases, in that condition, the production cost of car will increase. In the example of the car in
the graph below at curve S0, Point J indicates that if the price is $20,000, the quantity of cars’
supplies will be 18 million cars. Similarly, if the prices increase up to $22,000, the quantity of
supplied cars will increase by 20 million cars, which is point K on the S0 curve. More explanation has
been given in the Table below:
Price and Shifts in Supply:
Decrease to S1
Original Quantity Supplied S0
Increase to S2
10.5 million
12.0 million
13.2 million
13.5 million
15.0 million
16.5 million
16.5 million
18.0 million
19.8 million
18.5 million
20.0 million
22.0 million
19.5 million
21.0 million
23.1 million
Increased production cost resulting in Shift in the Supply:
A supply curve defines the minimum price of production for a given quantity (Rajasulochana
& Ganesh, 2019). The impact after the increase in the cost of production, on the supply curve
can be seen as a shift in the supply because of an increase in the cost of production:
Summary: What Factors Shift Supply
In the graph below, the relevant factors have been identified that change the supply of
products. The figure illustrates that a change in the price of the product is not the one that
shifts the supply curve, but a change in the price of a product usually affect as a change in the
quantity of supply of products or a movement along the supply curve for that specific
product; there is no change by to the supply curve itself to shift.
(a) factors that can cause an increase in the supply from S0 to S1.
(b) Conversely, The same factors can cause a decrease in the supply from S0 to S1.)
Since demand and supply curves have a two-dimensional diagram with only price and
quantity on the axes, this provides an understanding that demand contains all the factors that
affect demand, whereas supply contains all the factors that affect the supply. Other factors
like price factor can affect the demand and supply curve, and they have been shown by using
the shifts in the demand or supply curve. In this context, the two-dimensional demand and
supply model can be used as a powerful tool for analyzing and understanding the economic
conditions that relate to the impacts on the suppliers’ cost of production (Seaman & Young,
Natural conditions:
Climate conditions or environment can directly affect the supply of products. For instance,
the supply of agricultural products during monsoon season increases, but the supply of the
same products decreases during the time of drought. Many crops depend on climate condition
and growth of these crops decreases in unfavorable environment.
Supply many times depends on the technological factors. An advanced technology can
increase the production and thereby the supply of the products increases. For instance,
fertilizers’ production results in the increased production of crops. As a result, the supply of
food grains increases in the market.
Transport conditions:
Improved transport facilities increase the supply of products. Poor transport facilities result in
the delay in delivery of the product. Therefore, poor transport conditions affect the supply of
the product even if the price of product increases.
Government policies:
Government policies such as fiscal policy or industrial policy create a major impact on the
supply of products. For example, an increase in taxes or duties might decrease the supply of a
product. Conversely, lower tax rates increases the supply of a product.
2) Explain the different types of Costs in a tabular format & with a well-
labeled diagram.
There are three types of costs:
1- Total Cost
2- Average Cost
3- Marginal Cost
Total Cost:
Total cost of production is the sum of all incurred expenditure during production of a given
volume of output. This means the total amount spend on production of a product is called
total cost. However, total cost further contains two other types of costs related to two types of
production factors, i.e. fixed costs and variable costs:
a) Fixed cost:
The cost remains fixed at all level of output. This cost must be paid regardless of production
of output incurred or not. These are also known as overhead cost. For example see the
figure below:
b) Variable Costs:
Changes in volume of output also change the costs that are known as variable costs or
prime costs. Sometimes they are also called direct cost. Variable costs include transport,
wages, utilities, raw material etc. variable costs varies as the output varies.
Average Cost
This is total cost per unit of output. In simple words, the average cost of production is the
total cost of production divided by total units produced.
Marginal Cost:
This is an addition to total cost based on production of one more unit of output.
For example, if the total cost of 3 units of output is 1550, and the total cost of 4 units is
1900. The marginal cost of the 4th unit is 350.
3) Demand of a product is usually very sensitive to economic variables,
such as the prices and consumer income. This responsiveness of demand
is elasticity. Compute elasticity in the below scenarios:
a. Yesterday, the price of envelopes was $3 a box, and Jacky was willing to buy 10 boxes.
Today, the price has gone up to $3.75 a box, and Jacky is now willing to buy 8 boxes. Is
Jacky's demand for envelopes elastic or inelastic? What is Jacky's elasticity of demand?
To find Jacky’s elasticity of demand, the percent change in quantity is to be divided by the
percent change in price.
Change in Quantity =
(8-10) / (10) = -0.20
(3.75 – 3.00) / (3.00) = 0.25
| (-20%) / (25%)|= |-0.8|
Change in Price
1. Jacky’s elasticity of demand is the absolute value of -0.8 or 0.8.
2. Jacky’s elasticity of demand is inelastic, because it is less than 1.
b. Katy advertises to sell cookies for $4 a dozen. She sells 50 dozen, and decides that she
can charge more. She raises the price to $6 a dozen and sells 40 dozen. What is the
elasticity of demand?
To find the elasticity of demand, the percent change in quantity has to be divided by the
percent change in price:
Change in Quantity =
(40-50) / (50) = -0.20
(6.00 – 4.00) / (4.00) = 0.50
Change in Price
The elasticity of demand is 0.4.
4) Demand of a product is usually very sensitive to economic variables,
such as the prices and consumer income. This responsiveness of demand
is elasticity. Explain the different types of demand elasticity with
appropriate formulae.
Types of demand elasticity
Based on the variable that affect the demand, the demand elasticity is of following types
(Campbell, 2018):
 Price Elasticity
The price elasticity of demand is a response to quantity demanded for changing the price of
commodity. It can be defined as the income and taste of a customer while the prices of other
products remain stable. It is measured as the amount of change in demanded quantity
percentage divided by the change in price percentage. Following is an illustration:
Ep=Change in Quantity×100Original Quantity Change in Price×100Original Price
=Change in Quantity Original Quantity Original Price Change in Price
 Income Elasticity
This is the amount of demanded quantity that responds to a change in income of customers:
EI=Percentage change in quantity demanded Percentage change in income
 Cross Elasticity
Cross elasticity is the demand of commodity (X) for commodity (Y). it is the change in
demand of commodity (X) because of price change of commodity (Y):
Ec Is the cross elasticity,
Δqx is the original demand of commodity (X)
Δqx is the change in demand of X,
Δpy is the original price of commodity (Y), and
Δpy is the change in price of (Y)
5) Assume the demand being perfectly inelastic, and supply suddenly
doubles due to innovative technique of production. Illustrate in a well
labelled graph, the changes in the equilibrium price, and quantity, and
also is it advisable to do so from supplier point of view.
There is a four-step process that makes us capable of predicting about how a change can
affect the equilibrium price and quantity within a specific supply and demand condition.
(Vanacker, Collewaert & Zahra, 2017). A summary of the four steps is as follows:
Draw a market model: this represents the situation before the changes took place. (the
supply and demand curve)
Determine the economic event: the change affecting the demand or supply should be
Evaluate the effects: analyze whether these changes impact on demand and supply and
cause the curve to shift to the right or increase; or shift to the left, or decrease; and to
draw the new demand or supply curve.
Identify the new equilibrium price and quantity and compare it with the original
equilibrium price and quantity.
Changes in equilibrium price and quantity:
Imagine an event that provides us with the opportunity to make an evaluation of the changes
in equilibrium price and quantity. This even can be the one that affects the demand, like a
change in the population, income, prices, tastes, or expectations of consumers about the
future price of a product. On the other hand, this event can be the one that affects supply, like
a change in natural environment, prices, technology, or government policies that affect the
production of goods.
The four steps summarized above can be examined in detail to determine how an economic
event can affect the equilibrium price and quantity. The four steps are as follows:
 Step 1. Drawing a demand and supply model:
A demand and supply model that represents the conditions before the economic event
happened can be recognized by establishing this model and this requires the following
standard pieces of information:
A downward sloping demand curve
An upward sloping supply curve
Correctly labeled axes: a vertical axis labeled price and a horizontal axis labeled quantity
An initial equilibrium price and quantity. It is a good practice to indicate these on the
axes, rather than in the interior of the graph.
 Step 2: Deciding whether the economic event being analyzed can affect
the demand or supply:
This means we need to evaluate whether the event refers to anything in the demand factors or
supply factors?
 Step 3: Deciding whether the effect on demand or supply can cause the
curve to shift to the right or to the left, and lead to the new demand or
supply curve:
This means we need to assess whether the event changes the price consumers want to buy or
the price producers want to sell on.
 Step 4: Identifying the new equilibrium and compare the original
equilibrium price and quantity with the new equilibrium price and
For this, we need to try it out more than once. Consider an example that involves a shift in
supply, then we will move on to another one that involves a shift in demand. Consequently,
we will consider the example where both supply and demand shift (Adenutsi & Asamoah,
Section “B”
Answer the below questions. Each question carries 20 marks.
1) An economist might say that Starbucks is perfectly competing in a
monopolistically competitive market structure. Because you just need an
espresso maker and some beans, market entry is easy. But to be
Starbucks, through its beans, its barista training and its store design
competed successfully. Also, facing monopolistic competition in large
cities like NY and Chicago, they needed a store on every block. In light
of this
a. Apply your understanding and concepts from microeconomics, to
investigate and summarize the major characteristics of the coffee
An attractive industry for a profit making organization can be where the profit making
company can create its monopoly. In economics this is defined as a condition where an
established company occurs as a sole provider of a product or service that is not available in
market or that doesn’t have a clear competitor. These monopoly companies usually have a
lack of economic competition and typically have no alternatives for their products or services
they provide. The attractiveness of the coffee industry influenced the customers in the United
States where the average American citizen consumes more than 2.3 cups of coffee every day,
in the year 1987 alone, the usage of coffee by American citizen was studied as the highest
consumption as compared to other countries of the world. This heavy usage or attractiveness
was an invitation to coffee producers and makers and they took advantage of an great pool of
potential customers. Starbucks, since its inception, was not behind in the race to offer the
great taste of coffee in an innovative way to its customers. The overall economic impact of
the coffee industry in the United States alone, in 2015 was around $225.2 billion. Similarly,
the coffee related economic activities comprised at time, of around 1.6% of the total United
States gross domestic products. In the year 2015 alone, consumer spent more than $74.2
billion of their income on purchase of coffee. The economic impact of the coffee industry has
been also been on the job sector, as it helped the economy by producing jobs of more than
1,694,710 workers in the US jobs markets. More than $28 billion have been collected by the
US government on account of taxes and duties from the coffee industry alone.
The overall impact of the coffee industry reveals that the activities and investments in
equipment, labor and materials have benefited the economy as well as the other stakeholders
like importers, transporters, roasters and packaging companies, whiteners, sweeteners,
flavoring companies, equipment makers, consumers and federal and state government or tax
or revenue agencies (Brander & Perloff, 2019).
b. Describe and analyze the pricing policies that you would expect to
find in this industry.
Most of the countries around the world consider their commodity trading system to be
increasingly and partially responsible for their loss of share of market value in the context of
coffee industry (Campbell, 2018). The dominant trade paradigm for the coffee industry has
been of setting a pricing strategy, according to the NY and London exchanges. The coffee
industry is a purely economic proposition that does not affect either the environmental or the
social costs of production into its pricing. However, the coffee industry is fully aware to
realize the value of sustainability in two distinct but interrelated means. First one is economic
and the second one is its important social needs.
2) After several years of decline, the market for handmade acoustic guitars
is making a comeback. These guitars are usually made in small
workshops employing relatively few highly skilled luthiers. Assess the
impact on the equilibrium price and quantity of handmade acoustic
guitars as a result of each of the following events. In your answers
indicate which curve(s) shift(s) and in which direction.
a. Environmentalists succeed in having the use of Brazilian rosewood
banned in the United States, forcing luthiers to seek out alternative,
more costly woods.
The cost of production of handmade acoustic guitars has increased because of the reason that
more costly woods have been in use to create them. This decreases the supply, as lutheirs
offer a small number of guitars at any given price. This can be described by a leftward shift
of the supply curve that results in an increase in the equilibrium price and a decrease in the
equilibrium quantity.
b. A foreign producer reengineers the guitar-making process and floods
the market with identical guitars.
This provides a rightward shift of the supply curve that result in a decrease in the equilibrium
price and an increase in the equilibrium quantity.
c. Music featuring handmade acoustic guitars makes a comeback as
audience’s tire of heavy metal and grunge music.
As the demand by customers has been increased, the music played on acoustic guitars has
also increased, which are an input into the production of the music, the demand for these
guitars by musicians and music lovers has increased also. This represents a rightward shift of
the demand curve, resulting in a higher equilibrium price and quantity (Rao & Rao, 2016).
d. The country goes into a deep recession and the income of the average
American falls sharply.
If average American income decreases significantly, the demand for handmade acoustic
guitars will decrease with the same pace accordingly, because of guitars being normal goods.
This represents a leftward shift of the demand curve, resulting in a lower equilibrium price
and quantity (Perloff & BranderJ. 2017).
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