Managerial Economics Assignment

PART 1.

Q1.

Water is inexpensive to produce in most parts of the world while diamonds require difficult search and discovery, expensive mining, and extensive transportation and security expenses. In other words, diamonds cost more than water, so minimum asking prices of suppliers dictate the higher market value observed for diamonds.

                                                        (McGuigan, Moyer, Harris 2014)

According to demand and supply theory, market price equilibrium is related to use value, production cost and scarcity results from simultaneous interaction of buyers and sellers. However, the concept of marginal use suggestsadditional to total use value, production cost and scarcity, the price may also be determined by its marginal use value. The marginal use value is resulting from its most important use to a person.When someone possesses a good, he will use it to satisfy the highest priority need. Once the highest priority need is satisfy, he will use it to less important uses as long as the more urgent uses have been satisfied.

Eugen von, Böhm-Bawerk (1891) exemplifies a farmer with five sack of grain. From the first grain, he will make bread as sustenance to survive. From the second sackof grain, he will make another bread to be strong to work. Then, the third sackof grain he will feed his farm animal. The forthsackof grain, he will used it to make whisky, and the fifthof grain he will feed to the pigeons. If one of those sack of grain gone, he will not reduce each of those activities proportionately, but he will stop feeding the pigeons. Therefore the value of the fifth sackof grain equal to the satisfaction feeding the pigeons. If he sells the fifth sack of grain and not feeding the pigeons, his least productive use of the forthsackof grain is to make whisky. Hence, the value of forth sackof grain is the value of whisky. But if he loses four sacks of grain, only then that he will start eating less. The last sack of grain is worth of his life.

In other words, it is not the total usefulness of that matter, but the usefulness of each additional unit to a person that govern the price. The total usefulness of water isvital to sustaining life. But the water is abundant in supply and inexpensive to produce in most part of the world. Once the highest priority need for water is satisfied,the usefulness of each additional unit of water becomes low.

Therefore, additional unit of water becomes less value as the supply of water increases. Oppositely, diamonds are very low in supply. Such low supply that makes the usefulness of one additional unit of diamond is greater than one additional unit of water that abundant in supply. This makes diamond worth more than water. Therefore, people who want diamond are willing to pay a higher price for one diamond and seller of diamonds will sell one diamond higher than water.

[pic 1]

Extracted from James R. McGuigan, R. Charles Moyer, FrederickH.deB. Harris,.(2014). Managerial Economics.Cengage Learning. Singapore.

Thediagram shows marginal cost of producing water is cheap up to 90 gallons which is a typical household’s daily consumption. While marginal cost of producing diamond are very steep even small quantity (two carat). However, buyer still regards the cosmetic diamond as highly valuable uses. Therefore, THE equilibrium market price of diamond should be traded exceed equilibrium market price of water.

Q2.

Event:        1. Firm plan to increase the price of its product next period.

2. The firm also anticipates that consumers’ disposal incomes will also increase.

From price elasticity of demand, ED = %ΔQD/(%ΔP), the effect of price increase on quantity demanded is equal to %ΔQD = ED(%ΔP).

From income elasticity formula, Ey =%ΔQD/(%ΔY), the effect of income increase on quantity demanded is equal to %ΔQD =EY(%ΔY)

Assumption:priceand income effects are independent and additive, the quantity demanded next period, Q2 equal to current period demand, Q1 plus changes caused by the price and income increases

Each of price elasticity of demand, EDandincome elasticity formula, Ey, percentage changesmultiplied by current period demand, Q1 to get the changes inquantity demanded caused by the price and income increases.

Q2 = Q1 + Q1ED(%ΔP) + Q1EY(%ΔY)] or

Q2 = Q1[1 + ED(%ΔP)+ EY(%ΔY)]Š

Example:

ABCplan to increase price of its product 6 percent next period and anticipates that disposable income will also increase 5 percent next period. The price elasticity of demand estimated −1.2 and the income elasticity estimated at 2.0. ABC currently sells 3 million units per year.

Assumption:

1. Both elasticities constant over the range of price and income changes anticipated.

2.Otherfactors that influence demandunchanged.

Using this formula:

Q2 = Q1[1 + ED(%ΔP)+ EY(%ΔY)]

The quantity demanded next period,

Q2 = 3,000,000 [1+ (- 1.2)(0.1) + (2.0)(0.05)]

=3,084,000 units

Therefore the estimate demand for next period is 3,084,000 units. It display that the anticipated income increaseoffsetthe decline in quantity demanded related to price increase.

PART 2

1. Quadratic Production Function

Using quadratic model: Q = β0 + β1K + β2L + β3L2 + β4LK