Practice Problems

1. In an article about financial problems of USA Today, Newsweek reported that the paper was losing about $20 million a year. A wall street analyst said that paper should raise its price from 50 cents to 75 cents., which he estimated would bring an additional $65 million a year. The papers publisher rejected the idea, saying that the circulation could drop sharply after a price increase, citing The Wall Street Journals experience after it increased its price to 75 cents. What implicit assumptions are the publisher and analyst making about price elasticity? 2. The price elasticity of demand for imported whiskey is estimated to be 0.20 cents over a wide interval of prices. The federal government decides to raise the import tariff on foreign whiskey, causing its price to raise by 20 per cent. Will sales of whiskey rise or fall, and by what percentage amount? 3. A manager of the Citywide Racquet Club, you must determine the best price to charge for local rentals. Assume that the marginal cost of providing lockers is zero. The monthly demand for lockers is estimated to be Q = 100- 2P, where P is the monthly rental price and Q is the number of lockers rented per month. a. What price would you charge? b. How many lockers are rented monthly, at this price? c. Explain why you chose this price? 4. The demand curve for haircuts at Terry Bernards Hair Design is P=15 0.15Q, where Q is the number of cuts per week and P is the price of a haircut. Terry is considering raising her price above the current price of $9. Terry is unwilling to raise price, if the price hike will cause revenues to fall. a. Should Terry raise the prices of haircuts above $9? Why or why not? b. Suppose demand for Terrys haircuts increases to P = 22 0.22Q. At the current price of $9, should Terry raise the price of haircuts? Why or why not? 5. The Dallas Morning News reported the findings of a study by the Department of Transportation that the examined effect on average airfares when new, lowpriced carriers, such as South-West airlines or Vanguard airlines entered one of the three city-pair markets: Baltimore Cleveland, Kansas City San Francisco or Baltimore Providence. Use the following excerpts of the newspaper and answer the questions given below: i. (In) Baltimore Cleveland, for example just 12790 people flew between these cities in last 3 months of 1992, at an average fare of $233. Then Dallas-based South-West airlines entered the market. In last 3 months of 1996, 115040 people flew between the cities at an average fare of $66.

ii. (On) the Kansas City San Francisco connection (during) the last quarter of 1994, some 35690 people made the trip at an average fare of $165. Two years later, after the arrival of Vanguard airlines, fares have dropped to an average of $107 and traffic has nearly doubled to 68100. iii. On the Baltimore Providence, R I, route, where average fare fell from $196 to $57, the number of passengers carried jumped from 11960 to 94116. a. Compare the elasticities on each of the routes. b. Comment on passenger responsiveness on each of these routes. c. What would happen to the total revenue of airline industry on each of these three routes? 6. Firms A and B both produce good X, and each firm plans to produce 1000 units per day of good X. The firms can choose either of the two following production processes (i.e., input combinations) to produce 1000 units daily: Process1 Process2 Labour 10 8 Capital 20 25 a. Is it possible for both processes to be technically efficient? Explain why or why not? b. Firm A must pay $200 per day for a unit of labour and $100 for unit of capital. For firm A, process ______ is economically efficient. c. Firm B must pay $250 per day for a unit of labour and $75 for unit of capital. For firm B, process ______ is economically efficient. 7. The following table shows the amount of total output produced from various combinations of labour and capital: Units of Capital Units of Labour 1 2 3 4 1 50 120 160 180 2 110 260 360 390 3 150 360 510 560 4 170 430 630 690 5 160 480 710 790 a. Calculate the marginal product and average product of labour when capital is held constant at 2 units. When the average product of labour is increasing, what is the relation between average product and marginal product? What about when the average product of labour is decreasing? b. Calculate the marginal product of labour for each of the capital stock. How does the marginal product of second unit of labour change as the capital stock increases? Why? 8. Suppose a firm is currently employing 20 workers, the only variable input, at a wage rate of $60. The average product of labout is 30, the last worker added 12 units to the total output, and total fixed cost is $3600. a. What is the marginal cost?

b. What is the average variable cost? c. How much output is being produced? d. What is the average total cost? e. Is the average variable cost increaseing, constant or decreasing? What about average total cost? Source: Thomas, C R and Maurice, S C (2006), Managerial Economics Concepts and Applications, Tata McGraw-Hill, New Delhi, 8th Ed.