Assignment 1

Course name: Managerial Economics (MSC506)

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1. In economics, the word marginal refers to a rate of change, or a derivative or a differential
that we denote as d/dx.

Thus, if C(x) is the total cost of producing x items, that is cost is a function of output x, here
output is denoted by x, then the marginal cost represents the instantaneous rate of change of
total cost C with respect to the number of items produced x e.g. dC/dx. That is, if x is increased
by a very small amount h and h tends to zero or h is infinitesimally small, by how much does
C increase or decrease. This is the marginal change. This is also captured through the slope of
the tangent at the initial point of change.

Similarly, the marginal revenue is the derivative of the total revenue function and the marginal
profit is the derivative of the total profit function.

C(x) represents the total cost of producing x items, not the cost of producing a single item.

To find the cost of producing a single item, we use the difference of two successive values of
C(x):

Total cost of producing x + 1 items = C(x + 1)

Total cost of producing x items = C(x)

Exact cost of producing the (x + 1)st item = C(x + 1) - C(x)

This is a more crude measure of marginal change (discrete case).

Now, imagine a company manufactures fuel tanks for automobiles.

The total weekly cost (in Rupees) of producing x fuel tanks is given by the cost function

C(x) = 10,000 + 90x - 0.05x2

(A) Find the marginal cost (MC) function in both the continuous case (instantaneous change
e.g. derivative or differential) and the discrete case (e.g. change in x is 1 unit).

(B) Find MC at a production level of 500 tanks per week and interpret the results.

(C) Find the exact cost of producing the 501st item.

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2. A firm knows from production data that the total benefit function is B(Q) = 100 + 36Q - 3Q2
and total cost function is C(Q) = 80 + 12Q where Q is the output of a firm:

(A) Write the net benefit (NB) function of the firm in terms of Q?

(B) Please write a schedule of different NB values for Q = 0, 1, 2, ….10. Please plot these
against Q.

(C) From the schedule, please denote at what level of output, Q*, the net benefit function is
maximised?

(D) Show that at the maximum of NB e.g. at Q*, the rate of change of the NB function or in
other words its differential (dNB/dQ) is equal to zero. Please point out this maximum on the
plotted graph.

[Hint: Differentiate the NB function and substitute Q * value in the differential]

(E) Find the second derivative of the NB function. What does its value imply?

[Hint: Differentiate the dNB/dQ function]

(F) Find the MB and MC function. Is MB greater than, equal to or less than MC at Q = 2. What
is the intuitive implication of your finding?

3. The market research department of a company recommends that the company manufacture
and market a new transistor radio. After suitable test marketing, the research department
presents the following price–demand equation where x is demand and Px is own price:

x = 10,000 - 1,000Px (1)

The financial department provides the following cost function:

C(x) = 7,000 + 2x (2)

where Rs 7,000 is the estimate of fixed costs (tooling and overhead) and Rs 2 is the

estimate of variable costs per radio (materials, labor, marketing, transportation, storage, etc.).

(A) Find the inverse demand function e.g. take Px as the independent variable and bring it to
left hand side LHS. Plot the inverse demand function on the x-Px plane.

(B) We know the prices cannot be negative, e.g. P > 0. Find the domain of the function defined
by the price–demand equation (1), e.g. the range of values of x for P > 0.

(C) Find the marginal cost function and interpret.

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(D) We also know that the revenue is the amount of money, R, received by the company for

manufacturing and selling x radios at Rs Px per radio.

R (in Rs) = x (in units) * Px (in Rs/unit)

Find the revenue function as a function of x. (Hint: use inverse demand function)

(E) Find the marginal revenue at 3000, 5,000, and 7,000. Interpret these results. [Hint: MR is
the first derivative of R function]

(F) If Marginal Revenue is the marginal benefits you have already studied, then what is the
optimal manufacture of the new transistor radio?

4. Suppose B(Q) = 10Q - 2Q2 and C(Q) = 2 + Q2

What value of the managerial control variable, Q, maximizes net benefits?

5. Suppose the total benefit derived from a given decision, Q, is

B(Q) = 25Q - Q2 and the corresponding total cost is C(Q) = 5 + 2Q2.

a. What is total benefit when Q = 2? Q = 10?

b. What is marginal benefit when Q = 2? Q = 10?

c. What is marginal cost when Q = 2? Q = 10?

d. What level of Q minimizes total cost?

e. What level of Q maximizes net benefits?

5. Interest Rate is 10 per cent or i = 0.1. A financial asset promises to make pay-outs of Rs
20,000 per year for 5 years. Please schedule them. What is the maximum value you would
be willing to pay for the asset if someone comes to sell it to you today?

6. Rs 200,000 is your yearly earnings from stock market investment, while you spend Rs
75,000 to buy stocks and bonds. Recently you received two job offers—one paying Rs
100,000 per year and travelling expenses Rs 10000, and the other paying Rs 80,000 and
travelling expenses of Rs 5000.

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 a. What is your accounting profit?
b. What is your economic profits?
c. Do you think you should take up the job offers? If so, which one?

7. You are in the market for a new refrigerator for your company’s lounge, and you have
narrowed the search down to two models. The energy efficient model sells for Rs 500 and
will save you Rs 25 at the end of each of the next five years in electricity costs. The standard
model has features similar to the energy efficient model but provides no future saving in
electricity costs. It is priced at only Rs 400. Assuming your opportunity cost of funds is 5
percent, which refrigerator should you purchase?

8. A firm’s current profits are Rs 550,000. These profits are expected to grow
indefinitely at a constant annual rate of 5 percent. If the firm’s opportunity
cost of funds is 7 percent, determine the value of the firm:

a. The instant before it pays out current profits as dividends.

9. Suppose market dd curve is Qd = 10 – 2P and market ss curve is Qs = 2 +2P for a market of

(A) What is the equilibrium price-output combination? Please plot a graph of the dd-ss
curves showing the equilibrium.

(B) What is the quantity demanded and quantity supplied at a price level of Rs 1.50? Is there
shortage or excess supply in the market? Please plot this on your graph.

(C) What is the quantity demanded and quantity supplied at a price level of Rs 2.25? Is there
shortage or excess supply in the market? Please plot this on your graph.

(D) Calculate the supply elasticity w.r.t. own price at a price of Rs 1.50, Rs 2.00 and Rs
2.25. Can you reason why the supply elasticity is changing along the supply curve.

(E) Now, suppose, market supply has increased and supply curve So has shifted to newer S1

Qs = 4 + 2.5 P. What is the new equilibrium price-quantity combination? Show this