MANAGERIAL ECONOMICS (MBA 504)
TERM EXAMINATION I
Please read the instructions for each section carefully. There are VI sections. You are required to answer
1 question from each section. If you answer more than one question from a section, only the first question
will be graded. Clearly state the question you are answering at the top of each response. Points for each
section are in parentheses. Write your name on this test paper and hand it in after the test. Total points:
42
SECTION I: You are required to answer this question (6 )
1.
You are the sales manager of region 3 of your company. You asked your intern to determine the
demand function for your region and present a report to your boss. You gave your intern data on
quantity demanded (Qx), price of your product (Px), price of a substitute (Py), and average Income
levels (Income). Your intern decided to run the regression using the logs of the values to obtain
meaningful results. Following her presentation to your boss, you received the following note from
your boss.
“One of your MBA interns sent this spreadsheet in response to the question I asked regarding the
potential impact of the 2.85% decline in incomes that has been forecasted for regional market. This
is nuts – do they not teach people how to speak in words anymore? Can you help me out?” All I need
to know are
a. How good is this model in explaining our sales? Explain
b. Do you detect any problems in her output? Explain
SUMMARY OUTPUT
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
Intercept
lnPx
lnPy
lnincome
0.908
0.825
0.797
0.059
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Coefficients
-3.24
2.020
-0.583
0.332
Standard Error
3.74
0.44
0.56
0.42
t Stat
-0.87
4.60
-1.041
0.761
P-value
0.394
0.000
0.308
0.035
ANSWER
a) This model is very good in explaining our sales as per the R-square and the adjusted R-Square. It
states that about 80 percent of the variation in our price, the price of a substitute, and income
explain our sales.
b) The sign of lnPx should be negative (Law of Demand or direct price elasticity) and the sign of lnPy
should be positive (for being a substitute)
SECTION II: Answer only one question. You should draw graphs to illustrate and enhance your answer (9)
Q.5
1
You are the manager of PC Solutions. You arrived at your office and glanced at the front page of your local
newspaper waiting on your desk. One of the articles contained statements from executives of two of South
Korea’s largest semiconductor manufacturers—Samsung Electronics Company and Hynix Semiconductor—
indicating that they would increase all their memory chip production for the coming months. The article
went on to say that another large semiconductor manufacturer was likely to follow suit. Collectively, these
three chip manufacturers produce about 99.9% of the world’s basic semiconductor chip.
Your company is a small but growing company that assembles personal computers and sells them in the
highly competitive market. You experienced 20% downsizing last year and are in the process of interviewing
recent graduates in an attempt to increase your workforce.
Assuming that the information contained in the newspaper is correct, determine what the impact will be in
your market and advice your bosses if they should go ahead with hiring more workers. Illustrate with a graph
and explain fully.
ANSWER:
You should recognize that an increase in chip production will ultimately lead to lower chip prices. Since
chips are a key input in the production of PCs, a decrease in the price of chips would in turn lead to an
increase in the market supply of PCs, a rightward shift in the supply curve. This shift will lower the
equilibrium price and increase the equilibrium quantity sold.
In light of the anticipated increase in PC sales, you should advise your bosses to go ahead with their plans
to increase your workforce at this time.
SHOW ON A DD-SS DIAGRAM
OR
Q.6
You are the manager of IB Industries, a small firm that sells nails in a competitive European market (the nails
your company sells are a standardized commodity. Stores view your nails as identical to those available from
hundreds of other firms). You are concerned about two events you recently learned through trade
publications: (1) Due to recent profit margins in the industry, several American firms will enter your market
(2) The world economy is declining. Based on these two pieces of information, determine what will happen
to equilibrium quantity and equilibrium price of your nails.
Since you are a perfectly competitive firm, the price you charge is determined in a competitive market. The
two events summarized will result in an increase in market supply and a decrease in the market demand
(assuming nails are normal goods), resulting in a lower market price (from P0 to P1 in the graphs below)
and an indeterminate quantity. (eventual Q will depend on extend of shifts and elasticities). Your profitmaximizing response to lower price is to lower output. This is because you are a price taker (hence P = MR
= the demand for our product) and the lower price from P0 to P1 means that MR <MC at our old output. It
is profitable to decrease output from q0 to q1, as shown below.
OR
Q.7
You manage a small sector of the Ministry of Agriculture in your country. An unexpected flood has destroyed
parts of the lettuce crops planted in the main farming valleys. How does this affect the price, quantity and
quality of lettuce in the short run (SR), medium run (MR) and long run (LR)?
In the SR, farmers may try to save their remaining crops. Lettuce is harvested earlier and lettuce heads are
smaller. The increase SS reduces prices despite a lower stock of lettuce. In the MR, less lettuce arrives at
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the markets (Decrease in SS). The price increases due to the lettuce shortage. In the LR, when all
adjustments have been made, supply may return to its original level.
Please note that I allow for some creativity with this question.
SECTION III. Answer only one question (5)
Q.8
True or False and why:
It is clear that competitors can also be complementors. It is also clear that customers and suppliers can only
be complementors because customers give us their money and suppliers allow us to create value to
customers?
False. Customers and suppliers may also be present competitors and potential competitors. After buying
a product, a customer may learn how to make the same product and sell it to others. The customer then
becomes a supplier after being a demander. A supplier of leather may easily enter the market for leather
shoes bypassing the initial producer after receiving sales information
OR
Q.9
True or False and why:
The same dollar increase in both premium (higher priced) gas and regular (lower priced) gas will leave
relative prices and relative consumption unchanged.
False. Regular gas will be relatively more expensive. An example: original prices $100 and $200. Relative
price of regular gas is 0.5 of premium. If same dollar increase of $20, then new relative price is 120/220 =
0.54. Regular gas relative price is 0.54 of premium. More expensive
OR
Q 10
What is the concept of “balance price” and why is it useful for decision making? You may provide an
example
PPC/PRP or PPC-PRP. Firms have different customers and just focusing on the price paid by customers
(PPC) ignores many factors affecting profitability. The final price paid by customer is not necessarily fully
received by the producer because of quantity discounts offered to wholesalers, rebates to customers and
distributors, rewards, bonuses, ad costs, taxes, etc. Balance price strips price of the ‘distortions’ and show
what producers actually pocket
OR
Q.11
Some have argued that higher cigarette prices do not deter smoking. While there are many arguments both
for and against this view, some find the following arguments to be the most persuasive of all. “The laws of
supply and demand indicate that higher prices are ineffective in reducing smoking. In particular, higher
cigarette prices will reduce the demand for cigarettes. This reduction in demand will push the equilibrium
price back down to its original level. Since the equilibrium price will remain unchanged, smokers will
consume the same number of cigarettes”. Do you agree or disagree with this view? Explain
You better not agree with this statement. The argument confuses a movement along the curve ( increase
in quantity demanded) with a shift in the curve (an increase in demand). Higher cigarette prices will
reduce the quantity demanded not demand
SECTION IV: Answer only one question. (6)
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Q.12
Carrot Farmer Bradley is happy because he expects a record crop of carrots (he will harvest lots of carrots)
this year. Farmer Bradley is fully aware that all carrot farmers will have record crops as well. Why is Farmer
Bradley so happy? Explain fully.
Farmer Bradley knows that a record crop will increase the supply of carrots which will reduce the price of
carrots. He is so happy because he believes that the price elasticity of carrots is elastic, (relatively flat
curve or he will operate on the elastic portion of the curve). He knows that with an elastic demand, a
reduction in price will lead to increases in total revenue. He’s laughing all the way to the bank.
OR
Q.13
You manage Tabitha Stores in Nanaimo. Your company sells coffee, coffee with milk, and milk based drinks.
In a meeting to discuss the higher price of coffee beans, a purchasing manager says: “The higher price of
coffee beans will reduce our purchases of coffee beans and our purchases of milk as we increase the price of
coffee based drinks. Do you agree? Why? Explain fully
No, because milk purchases may increase. Although a higher price of coffee based drinks reduces the
quantity demanded of those drinks and leads to less milk purchased by the company, some customers may
switch to milk-based drinks, thereby increasing the demand for milk.
SECTION V You are required to answer this question
Q.14
You manage a brewing company that sells its beer in several regions of your country. However, you are
interested in the demand and pricing strategy for your brew in your local village. The company’s marketing
department has collected data from its distributors in your village and has converted them all into natural
logarithmic form to ease calculation. The data consists of quantity and price (per case) of your microbrew,
the price of product Y, the price of product Z, average income, and your advertising budget.. Your assistant
has provided you with the following data:
Year
Pbeer
Qd beer
Py
2009
2.00
4.00
6.00
2010
1.00
6.02
2.52
Except for the Years, all variables are in natural log.
Pz
1.00
2.67
Income
10.00
16.31
Advertising
15.00
16.40
a.
Calculate the own (direct) price elasticity, cross price elasticity with product Y, cross price elasticity
with product Z, income elasticity, and advertising elasticity (1 mark each).
Own Price elasticity
Cross Price elasticity with product Y
Cross price elasticity with product Z
Income elasticity
Advertising elasticity
-2.02
-0.58
1.21
0.32
1.45
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The following events occur:
i) price of product Y drops by 20%
ii) price of product Z drops by 10%
iii) your advertising budget increased by 10%
iv) Average income level rise by 5%.
a.
What is the total effect of these events on your product? (6)
=(-20%*-0.58) +(1.21*-10%)+(1.45*10%)+(0.32*5%)= 15.6%
Quantity demanded of your product will increase by 15.6%
b.
What action can you take to offset this effect? (in other words, what action can you take to restore
your quantity sold back to its original position before the events occurred)? (3)
to restore your quantity back to where it was before, you need to increase your price by 15.6%/2.02 =
7.72%
SECTION VI You are required to answer this question. (7)
Q.15
The monthly market demand for your services is Qd  250  5P and the market supply is
P  ( 1 )Qs  ( 1 )110  0.12t where P is the monthly price of your service and t is the tax rate. Your
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4
government is considering a tax reform that would dramatically cut tax rates from 50 percent to a 10 percent
on your services.
a.
How much money would a typical consumer save each month as a result of the proposed legislation?
Original equilibrium before the new policy Qs = Qd =Qe = 250-5[(1/4)Qe + (110/4) +0.12 (0.50)] => Qe =
49.85 =50 and P = 40.03=40
After tax reform, Qs = Qd =Qe = 250-5[(1/4)Qe + (110/4) +0.12 (0.10)] => Qe = 49.95 =50 and P = 40.01=40
Typical consumer will save approximately 3 dollars after taking the difference between the two total
revenues or zero if numbers were rounded up to the nearest dollar.
b.
What is the effect of the tax reduction on your total revenue? Calculate.
Before policy TR = P*Q = 40* 50 = 2000
After policy TR = 39.25* 53.73 = 2109.09
Your TR has increased by $109.09
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