Part Two, Demand Analysis, Salvatore, 7e

C2. The statistics department of an appliance manufacturer has estimated that the
demand function (number purchased a n n u a l l y ) for their (Brand X) automatic
washer is as follows:

Qx = W7,000- K)OPX + 50PY + 0.0251 -f 0.02,4 + 10,000^,

where
Qx = quantity purchased,
PY = the price of the company's washer,
Py = the price of a major competitor's washer,
/ = the average household income,
A - the a n n u a l dollars spent on advertising, and
PI = cost of doing one load of wash in a ^elf-service laundry.

a. . I f P v = $300, / - $40,000, A = $200,000, and P, = $.30, find the price elasticity of

demand between Px = $350 and P v = $400. (When Px = $400, with the values
of the other variables as given above, then Qx - 180,000.)
b. Is EI> elastic, inelastic, or unitary elastic? Why? If the price is cut, does total
revenue increase, decrease, or not change?
c. Find the income elasticity of demand for Qx, given Px - $400. The other vari-
ables are as given in part (a). Interpret your answer—that is, what does it say,
if anything, about the demand for Brand X washers?
C3. Alpha Company has estimated that the demand curve for its product is repre-
sented by the equation Q - 2,840 - 20P where Q is the quantity sold per week
and P is the price per unit.
a. Based on the estimated demand curve, write the equations for Alpha's
(i) Average revenue,
(ii) Total revenue, and
(iii) Marginal revenue.
b. What will be the maximum total revenue per week that Alpha can obtain
from sales of its product? (Give the exact dollar amount and explain how you
determine it.)
c. Calculate the point price elasticity of demand for Alpha's product when Q =
1,600. Is demand elastic or inelastic at this quantity? How do you know?
d. Calculate the arc price elasticity of demand for Alpha's product between Q -
1,000 and Q = 1,100. Interpret your result and relate it to what will happen to
total revenue if Alpha is initially at Q = 1,000 and decides to cut price to
increase its sales from 1,000 to 1,100 units.
 Chapter 6, Production Theory, Salvatore, 6e

8. A small local plumbing contractor is trying to decide whether to rent a backhoe

or to hire more labor for an especially large plumbing job. The contractor esti-
mates that 6(JD tons of dirt and rocks must be dug and moved. It is believed that
a backhoe could move 1(3 tons of dirt per hour and would cost $30 per hour to
rent (including the operator). On the average a worker can move 2 tons of dirt
per hour, and the wage rate is $9 per hour.
a. Should the contractor rent a backhoe or hire enough workers to do the job?
Why?
b. Suppose the backhoe could be rented on a full eight-hour-day basis only (a
full day would be charged for any partial days). Would this change your
answer in part (a)? Why or why not?

Cl. A production function for a firm has the following relationship between the
level of output (Q) and the levels of capital (K) and labor (/„).

a. Find the isoquant equation for Q - 100.

b. Derive the expression, or function, that gives the slope of the isoquant (in
terms of quantities of K and L).
c. Derive the marginal product of labor function from the preceding production
function if K is fixed at 5 units.

d. If K is fixed <it 5 u n i t s , where do d i m i n i s h i n g returns to labor set in?

Chapter 7, Cost Theory, Salvatore, 6e

8. Complete the following table, assuming that L is the only variable i n p u t and
that its price, P{, is fixed.

SMC MPL TVC

(Marginal (Marginal L TPL = ax (Total STC
Cost) Product) (Input) (Output) Variable Cost) (Total Cost)
5 100 200 600
10 200
15 450
20 550
4.00 10
25 600 1,000
30 625
10.00 4
35 645
40 660 2,000

a. Now calculate the following:

i. Average fixed cost at an o u t p u t of Q - 200.
ii. Average product of L at an output of Q = 600.
b. Suppose total fixed cost is increased by 25 percent. Which of the numbers in
the table would change? Why?

C7. Suppose the total cost function is 550 + C)Q - 0.15Q2 + 0.005Q3.
a. Find the marginal cost, average variable cost, average cost, and the average
fixed cost functions.
b. Sketch the functions that you derived in part a.
c. At what level of output does the SMC reach its minimum? AVC? AFC?
d. Find SMC and AVC when AVC is at its minimum.
Part Four, Market Structure, Salvatore, 6e

5. In the following table, complete the cost and revenue data for a particular model
of side-by-side refrigerator-freezer sold in a department store. What is the
profit-maximizing price and output?

Arc Arc Arc

p Q TR MR MC AFC TVC TC Mn
900 0 —
500
875 10
400
850 20
350
800 30
300
750 40 150
250
675 50
200
600 60
180
500 70
200
400 80
300
200 90

C5. Traumco sells a specialized medical monitoring device. It estimates the monthly
quantity demanded to be represented by the equation

Q - 350 - 0.25P, where P is price.

Its monthly cost function is

STC = 20,000 + 200Q - yy 2 + (1/3) Q3.

Determine the profit-maximizing quantity sold and price for the monitor. How
much will the m a x i m u m monthly profit be?
 Part Four, Market Structure, Salvatore, 6e

C8. Lone Star Instruments, Inc. (LSI), makes two deluxe printing models of calcula-
tors—a scientific model and a business and financial model. The demand func-
tion for the scientific model is

Qs = 20,000- IOOPS,

where

Q5 = a n n u a l quantity demanded of the scientific model,

and

Ps - price of the scientific model.

The demand function for the business and financial model is

Q/{ - 50,000 - 400PH,

where
QH ~ a n n u a l q u a n t i t y demanded of the business and financial model,
and

P/? = price of the business and financial model.

The total cost function for LSI is given by

STC - $100,000 f 25Q.

where

Q = Qs + Q»-
LSI also has a capacity limitation of 17,300 calculators per year.
a. Find the p r o f i t - m a x i m i z i n g quantity and price for each model of calculator.
b. Solve for the Lagrangian multiplier. What does its value tell you?
Part Four, Market Structure, Salvatore, 6e

8. Complete the revenue and cost data in the following table, assuming that the
firm, Calabasa Consolidated Cable, is a monopoly that has been allowed to set
its own price for home TV cable service in the very small town of Calabasa, Wis-
consin. (Q refers to number of subscribers, and the revenue and cost data are per
month.)

MR P Q TR STC AVC TVC MC

110 1100 600
100 20 1500 35.00
20
30 2700 1700 900
30
80 40 2000
70 3500 32.00
50
60 3600
50 70 3500 2700

a. What output and price will Calabasa Cable choose? Explain why, relating
your answer to the general condition for a profit maximum.
b. How much total profit will Calabasa have at the maximum?
c. In the table, $300 per month of the cable company's total fixed cost is a fran-
chise fee paid to the city. If no other data change, but the city raises the fran-
chise fee to $500 per month, what will be the effect on the company's output,
price, and total profit? Explain.

C3. A monopoly firm has the following demand curve:

Q = 2,000 - 25P,

where Q is its monthly output. Given that its monthly short-run total cost is
described by the function

STC = 500 + 8Q + 0.035Q2,

answer the following questions.

a. What w i l l be its p r o f i t - m a x i m i z i n g price and o u t p u t 7
b. How much profit w i l l it have at the preceding o u t p u t ?
 Part Four, Market Structure, Salvatore, 6e

( S, Stanley Straing has a soft-drink concession monopoly at the Tort Tippecanoe,

Indiana, Countv i'air. 1 le believes his total cost for supplying the dunks will be

s/"C = SOO -4- 0.20 f 0.000 KJ2.

If the County Pair Board tells him he must charge $0.80 and demand for the
drinks during the fair is given by the demand curve Q - 3,000 - 2,500 P, deter-
mine the following:
a. The number of drinks sold and Stanley's total profit at the fixed price of SO.SO
per drink.

b. Whether the amount Stanley wants to sell is consistent with the amount con-
sumers want to buy at the $0.80 price.
c. Stanley's profit-maximizing output, price, and profit if he were allowed to set
his own price instead of having to charge $0.80.
Part Four, Market Structure, Salvatore, 6e

5. Suppose a large firm that is a price leader in an industry characterized also by

many small, competing firms estimates the market demand for its product to be

QM = 81,000-200P,

and that it expects small firms in the industry to supply output according to the
following function:

Q s = 1,000 +SOP.

The large firm's marginal cost function is

MCL - 100 + 0.014Q;.

a. What price w i l l the large firm set?

b. How much w i l l the large firm sell?
c. What q u a n t i t y will the small firms sell?

7. A cartel is m a x i m i z i n g profit at a price of $37.30 per barrel for its product. I h e

demand curve tor the members' product is given by the equation (J - 21)0,000 -
4,OOOP, so that MR = 50 - O.OOO^Q. Suppose there aiv three f i r m s in the cartel
w i t h the f o l l o w i n g respective m a r g i n a l cost f u n c t i o n ^

/VIC, - 2 + 0.001Q,,
MC2= 1.9 + 0.00 12Q 2/

and

1 low much o u t p u t should be allocated to each cartel member? (Assume t h a t Qj is

yearly o u t p u t in barrels and t h a t MCt is marginal cost per barrel.)

Cl. C.noma Pest Control Company specializes in pest control services for single-
family homes. Entry is easy in the local market, and a large number of local
firms offer similar services. The typical contract provides whole-house service,
including one interior spraying per month and a yearly foundation spray. The
cost to the company can be regarded as a constant amount per u n i t at

AVC - $5 per month per home.

Advertising and image are important to pest control firms in the local market,
since this method is about the only way they can differentiate what is otherwise
a fairly homogeneous output. Gnoma's management advertised heavily to get
the firm established but has recently cut the firm's advertising by one-half.
 Part Four, Market Structure, Salvatore, 6e

Management now estimates the firm's demand curve for household service to
be
Q - 25,000 - 2,OOOP
where Q is the quantity of homes under service contract and P is the ///<>/i////i/
service charge.
a. Based on management's estimate of demand, at what price and q u a n t i t y sold
should Cnoma be able to maximize profit?
b. If monthly fixed costs are $12,000, what will monthly profit be?
After the reduction in advertising, Gnoma's sales fell to 5,250 homes
under monthly contract. A market analyst states that this drop occurred
because Gnoma's market share fell when advertising expenditures were cut.
The analyst further states that under conditions of the current advertising
level, Gnoma should estimate its demand curve as

Q' - 22,000 - 2,000P.

The analyst states that Gnoma can either maximize profit subject to the pre-
ceding demand curve (Q') or spend an additional $5,000 per month on adver-
tising and move back to the originally estimated demand curve, recovering
its market share.
c. If Gnoma's management maximizes profit subject to

Q' = 22,000 -2,OOOP,

what is the firm's optimal output and price?

d. Is the preceding profit greater or less than the profit that would be obtained
by spending the $5,000 per month on advertising and returning to

Q -25,000- 2,000P?

e. What should Gnoma do?

C2. A firm's research department has estimated that if other firms in the industry are
indifferent to changes in the price of its product, its demand curve w i l l be

Q = 700 - 50P.

However, if other firms always charge the same price it does, the firm's demand
curve w i l l be

Q'= 200-1 OP.

a. If the firm's marginal cost equals $8.00, what o u t p u t and price w i l l maximize
profit? (Assume that the other firms will not follow a price rise above $12.50
but that they will follow a price cut below $12.50.)
b. If the firm's marginal cost equals $11.50, what o u t p u t and price w i l l maxi-
mize profit?