Questions to Managerial Economics - Assignment Example

Answers to Questions: MANAGERIAL ECONOMICS Question The demand in Japan for new automobiles is elastic and sensitive to market prices. Given that,describe the effect of each of the following on the quantity demanded or the demand for new autos in Japan. Indicate whether the effect of each is an upward or downward movement along a given demand curve or instead involves an outward or inward shift in the demand curve for new autos. Explain your answers. a. A decrease in the average price of new Japanese automobiles. b. A fall in Japanese interest rates. c. A rise in the price of public transportation in Japan. d. A rise in the price of food in the United States Answers: a. A decrease in the average price of Japanese cars in Japan will cause an increase in the quantity of automobiles demanded: The movement is downward to the right along the same demand curve. b. A fall in Japanese interest rates, assuming it is a significant one, will cause Japanese consumers to want to hold more spendable cash rather than invest or save them in banks. Because of such increased liquidity, the tendency is for the demand curve to shift downward to the right, indicating an increase in demand for automobiles, all other things remaining constant. c. Public transportation is a substitute for cars; therefore, a rise in the price of public transportation in Japan will cause consumers to increase the quantity of cars demanded. d. A rise in the price of food in the United States has no direct effect on the demand for automobiles in Japan. [However, allow me to analyzed the thrust of this question. There will be less purchasing power for consumers in the United States because the demand for food is relatively inelastic, and they would rather spend on food than on cars. Consumers there will reduce their consumption of goods which are characterized by elastic demand, such as cars – (American cars, Japanese cars, and others). Japanese car manufacturers will be able to sell less number of cars than before, and less income flows to the Japanese economy. However, such an eventuality has a very remote bearing, if any, on consumer demand for cars in Japan. Also, Japan is not dependent on the United States for food imports. There are substitutes, or alternative, cheaper sources of food imports. The demand for cars in Japan is not likely to be affected by the increase in food prices in the United. States]. Question 2 Suppose the demand for beer is characterized by the following point elasticities: own price elasticity = -2.5 cross-price elasticity with soda = +3 income elasticity = +2 Based on the given elasticities, answer the following. Explain your answers. a. If a firm in the industry wishes to increase total sales revenue (ignoring cost considerations), will it raise or lower its selling price? Why? b. What happens to the demand for beer if the price of soda falls by 2%? Explain your answer. c. What happens to the demand for beer if consumer income rises by 5%? Be specific. d. Is beer a normal or inferior good? Explain. Answers. a. In general, if a firm in an industry wishes to increase total sales revenue (P x Q), ignoring cost considerations, it may lower the selling price if the demand for its product is elastic, inasmuch as there will be a greater percentage increase in quantity demanded for every unit percentage decrease in price. Thus total revenue will increase. On the other hand, if the demand elasticity is less than 1 (relatively inelastic), it pays to increase the price of its product because the decrease in quantity demanded will be correspondingly less than the price increase in percentage terms. In the case of the beer industry, the demand is relatively elastic at 2.5; therefore, it will be profitable for the company to reduce its price in order to increase total revenue. It would be disastrous to increase the price because doing so will cause a disproportionately greater decrease in quantity demanded, and total revenue would drop significantly. b. Soda has positive cross-elasticity with beer of 3; therefore it is a substitute for beer. If the price of soda falls by 2%, the quantity demanded for beer will decrease by 3 times that much, or by 6%, as consumers will instead buy the cheaper soda. c. Income elasticity is +2; therefore, an increase in income by 5% will cause the quantity of beer demanded to increase by 10%. d. Beer is a normal good because as a consumers incomes rise, they are more likely to buy and consume more of it. Question 3 Good X is produced in a competitive market using input A. Explain what would happen to the supply of good X in each of the following situations: a. The price of input A increases. b. An excise tax is imposed on good X. c. An ad valorem tax of 5% is imposed on good X. d. A technological change reduces the cost of producing additional units of good X. Answers. a. If the price of input A increases, the supply curve would shift to the left. The seller would be willing to produce and sell less at the same price. The equilibrium price between the demand and supply curves will have to be higher than the previous level, depending on the shape of the demand curve, to make it worthwhile for the supplier to continue selling. b. According to Investopedia, an excise tax is either ad valorem or specific. For ad valorem tax, a fixed percentage is charged on the value of a particular good. For specific excise tax, a fixed dollar amount dependent upon the weight, volume or number of units is charged. An excise tax imposed on a commodity will cause the seller’s costs to rise, so he is likely to reduce the quantity he sells. The tax burden, called a wedge, will have to be shared between the buyer and seller, depending on the elasticity of the demand curve and the supply curve. Assuming as constant the shape of the supply curve, if the demand for the product is relatively inelastic, the supplier can shift more, or more than half, of the tax burden to the buyer. However, if the demand is relatively elastic (that is, greater than 1), the supplier will have to bear more than half of the tax burden. In a theoretical case of perfectly inelastic demand (where the demand curve is vertical), the supplier can shift the full amount of the tax burden to the buyer. c. An ad valorem tax of 5% will cause a shift in the supply curve to the left (a shift in supply occurs). The seller will reduce the quantity he will supply the market by the stated percentage of the tax, and will try to compensate for it by selling at high price which depends on the elasticity of the demand curve. The sharing of the tax burden will be the same as described in the above answer (b.). d. A technological change will cause production to be more efficient, thus there will be an increase in supply in the short run – that is, the supply curve will shift to the right. It will not necessarily be beneficial to the producer/seller, particularly if the demand for the product is inelastic, such as agricultural products. In this case, the percentage increase in the quantity produced will be less than percentage decrease in price, and total revenue would drop. In the long run, the producer will probably make an adjustment by way of rejecting the technology or reducing production in order to recover the previous revenue level or increase revenue. Question 4 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 argument 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. Answer. I disagree. The argument is very muddled and betrays a lack of knowledge of basic economics. Firstly, the laws of supply and demand only states that, all other things being equal, the decrease in price of a good will cause an increase in the quantity demanded; and conversely, that an increase in the price will have the opposite effect of decreasing the quantity demanded. In the case of cigarettes, an increase in price should bring about a reduction of the amount of cigarettes demanded and bought, and consequently a reduction in smoking. The law of supply and demand does not imply higher prices being unable to reduce cigarette smoking. Also, the second sentence of the statement contradicts the first. The first statement says that higher prices do not reduce smoking; whereas the second sentence says that (in particular) higher prices will reduce demand for cigarettes. This writer maintains that the demand for cigarettes can only result from the desire to smoke! Secondly, the statement asserts that there is an original equilibrium price, a price that will not change. The argument begs the question. An original equilibrium price can only be asserted for a specific set of facts, place, time, and circumstance, which here are not given. Also, it is a fact that an equilibrium price can change (it is never static), depending on the interaction of supply and demand at a specific point in time. A continuous process of adjustment from a state of shortage or surplus towards equilibrium is taking place all the time, and sometimes that theoretical equilibrium is not reached in reality. Thirdly, because of this weakness in the argument, the statement that smokers will consume the same number of cigarettes does not hold. It is not plausible in the real world that consumption will remain the same; it may in fact increase, particularly because, as asserted in the first statement, higher prices are not effective in reducing smoking. Question 5 Revenue at Palm Inc. was .4 billion for the nine months ending March 2, up 97% over revenues for the same period last time. Management attributes the increase in revenues to a 137% increase in personal digital assistant (PDA) shipment, despite a 17% drop in the average blended selling price of Palms line of PDAs. Given this information, it is surprising that Palms revenue increased when it decreased the average selling price of its PDAs? Explain. Answer. It is not surprising at all that shipment of PDAs increased 137% when average blended selling price of the product was reduced by only 17%. Note that the demand elasticity (the ratio of percentage change in quantity demanded to the percentage change in price) is 8.06 (137 divided by 17). Under such circumstances, where the demand elasticity is very high, it would be pay to reduce the price, and, all other things remaining the same, such reduction in price will be rewarded with an eight-fold percentage increase in the volume of sales. Read More