ECO 550 Week 2 Problem Set

Managerial Economics and Globalization – ECO 550

Week 2 Problem Set

1. For each of the following cases, what is the expected impact on total revenue of the firm? Explain your reasoning.

a. Price elasticity of demand is known to be -0.5, and the firm raises prices by 10 percent.

b. Price elasticity of demand is known to be -2.5, and the firm lowers price by 5 percent.

c. Price elasticity of demand is known to be -1.0, and the firm raises price by 1 percent.

2. You have the following information for your product:

The price elasticity of demand is -2.0

The income elasticity of demand is 1.5

The cross price elasticity of demand between your good and a related good is -3.5

What can you determine about consumer demand for your product from this information?

3. For each of the following cases, calculate the arc price elasticity of demand, and state whether demand is elastic, inelastic, or unit elastic.

1. When the price of milk increases from $2.25 to $2.50 per gallon, the quantity demanded falls from 100 gallons to 90 gallons.

2. When the price of paperback books falls from $7.00 to $6.50, the quantity demanded rises from 100 to 150.

3. When the rent on apartments rises from $500 to $550, the quantity demanded decreases from 1,000 to 950.

   4. The following table shows the results of a multiple regression study of the demand for ethical or prescription drugs, using panel data across seven countries [France, West Germany, Italy, Japan, Spain, the United Kingdom, and the United States], from 1980 to 1987. [The United States variable is omitted from the results because it is the country used for comparison.] The authors hypothesized that:

   a. Price would be inversely related to quantity demanded.

b. Income differences across countries would affect the demand for these drugs, which are hypothesized to be normal goods.

1. An increase in the number of doctors across countries would increase the demand for prescription drugs because doctors are required to write prescriptions and a larger number of doctors reduce wait times for prescriptions.

2. A time trend variable is needed to control for factors, such as country demographics, that change over time.

   f. The demand differs by country, given varying political and health care institutions, so that dummy variables that take on the value of zero or one are included to control for the effects of each country on drug demand.