ECON3014 (Fall 2011)
22. 9. 2010 (Tutorial 2)
Chapter 1 The Fundamentals of Managerial Economics
Using Marginal Analysis
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The objective of a manager is to maximize net benefits: N(Q) = B(Q) – C(Q)
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Optimal managerial decisions involve comparing the marginal benefits of a decision
with the marginal costs
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Marginal benefit (MB) : the change in total benefits arising from a change in the
managerial control variable Q
Marginal cost (MC): the change in total costs arising from a change in the managerial
control variable Q
Marginal net benefit: MNB(Q) = MB(Q) – MC(Q)
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To maximize net benefits, the managerial control variable should be increased up to the
point where MB = MC.

MB > MC means the last unit of the control variable increased benefits more than it
increased costs.
MB < MC means the last unit of the control variable increased costs more than it
increased benefits.
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The Calculus of Maximizing Net Benefits

The objective is to choose Q so as to maximize net benefits

The first-order condition for a maximum is

The second-order condition requires that the function N(Q) be concave in Q (Second
derivative of the net benefit function be negative)
The slope of the MB curve must be less than the slope of the MC curve
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Example: Demonstration Problem 1-3 (P.24, Baye)
An engineering firm recently conducted a study to determine its benefit and cost structure.
The results of the study are as follows:
and
What is the maximum level of net benefits and the level of Y that will yield that result?
Answers:
Equating MB and MC, Y* = 15
Maximum level of net benefits:
Example: Demonstration Problem 1-4 (P.34, Baye)
Suppose
and
What value of the managerial control variable, Q, maximizes net benefits?
Answers:
Q = 10/6
To verify that this is indeed a maximum, we have to check that the second derivative of N(Q)
is negative:
Therefore, Q = 10/6 is a maximum
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Chapter 2 Market Forces: Demand and Supply
Price Ceilings

The maximum legal price that can be charged

Examples: Gasoline prices in the 1970s, Housing in New York City



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Graphical analysis

Competitive equilibrium price: P*
Shortage under the price ceiling

Full economic price: the dollar amount paid to
a firm under a price ceiling plus the
non-pecuniary price
PF = Pc + (PF – PC)
where
PF = full economic price
PC = price ceiling
PF – PC = non-pecuniary price

The reduction in social welfare (Deadweight
loss)
How goods are allocated under the price ceiling?
Why does the government impose price ceilings?
Who will benefit and who will be worse off under the price ceiling?
Price Floors

The minimum legal price that can be charged

Graphical analysis

Competitive equilibrium price: P*
Surplus/ unsold inventory under the price floor


Why does the government impose price floors?
Examples: Minimum wage, Agricultural price
supports
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Example: Demonstration problem 2-4 (P.54 of Baye)
China recently accelerated its plan to privatize tens of thousands of state-owned firms. The
estimates of the market demand and supply for the goods are given by Q d  10  2P and
Q s  2  2P respectively. Determine the competitive equilibrium price and quantity.
Answer:
Competitive equilibrium is determined when Qs = Qd
10  2P  2  2P
P* = 2, Q* = 6
Example: Demonstration problem 2-5 (P.56 of Baye)
Based on the answers in problem 2-4, the government raises a concern that the free market
price might be too high for the consumers and is planning to set a price ceiling of $1.5.
Determine (a) the quantity demanded, (b) the quantity supplied, (c) the amount of shortage
and (d) the full economic price paid by the consumers if a price ceiling of $1.5 is imposed in
the market
Answer:
(a) Quantity demanded: Q d  10  2(1.5)  7
(b) Quantity supplies: Q s  2  2(1.5)  5
(c) Shortage = 2 units
(d) Full price: 5  10  2P F , PF = 2.5 ($1.5 is in money and $1 is the non-pecuniary price)
Example: Demonstration problem 2-6 (P.59, Baye)
Based on the analysis in problem 2-4 and 2-5, the government worries that the free market
price might be too high for the producers to earn a fair rate of return and is planning to set a
price floor of $4.
Determine (a) the quantity demanded, (b) the quantity supplied, and (c) the amount of surplus
if a price floor of $4 is imposed in the market. (d) What is the cost to the Chinese government
of buying the surplus under the price floor?
Answer:
(a) Quantity demanded: Q d  10  2(4)  2
(b) Quantity supplied: Q s  2  2(4)  10
(c) Surplus: 8 units
(d) Cost of buying the surplus: 8  $4 = $32
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