Answers of Test Bank Questions
Managerial Economics Test Bank
Homework #1
1. Between 2001 and 2003, China Mobile’s number of subscribers grew from 90.6 to
141.6 million as the company added subscribers and acquired service providers in the
poorer inland regions of China. However, over the same period, its average revenue
per user (APRU) fell from 141 to 102 yuan per month and its proportion of
subscribers using pre-paid service rose from 48% to 64%.
a. How would the entry of China Unicom affect the demand for China
Mobile service?
b. How would China Mobile’s provision of pre-paid service affect
the demand for its post-paid (contract) service?
c. Compare the demand for pre-paid service in the inland regions with that in
the wealthier coastal regions.
d. Relate your discussion in (b) and (c) to China Mobile’s decline in ARPU.
Answer:
(a) Would lower the demand.
(b) Would lower the demand as some subscribers switch from post-paid to
pre- paid service.
(c) If pre-paid service is an inferior product, the demand in the inland regions
would be higher.
(d) ARPU is lower for pre-paid than contract service. ARPU is lower in poorer
areas than richer areas. Both of these factors explain China Mobile’s decline
in ARPU.
2. The price of Chanel perfume is around $200 per fluid ounce, while the price of
Arrowhead bottled water is $1 per gallon. Nancy buys 2 fluid ounces of Chanel and
10 gallons of bottled water a month.
a. Using relevant demand curves, illustrate Nancy's choices. Illustrate how
the following changes will affect Nancy's demand for Chanel perfume: (i)
price increase to $220 per fluid ounce, and (ii) cut in price of another of
Nancy's favorite perfumes.
1
,Answers of Test Bank Questions
b. Nancy spends more money each month on perfume than bottled water.
Does this necessarily mean that perfume gives her more total benefit than
water? Use appropriate demand curves to address this question.
Answer:
(a) This will decrease the quantity demanded of Chanel perfume -- movement
down along the demand curve; (ii) This will decrease the demand for Chanel
perfume -- the demand curve shifts to the left.
(b) No. Total benefit is the area under the demand curve (which is not the same
as expenditure). The area under the demand curve for perfume could be much
smaller than that for water. Implication: Nancy is getting much more buyer
surplus from her purchases of water than from her purchases of perfume.
3. This question applies the techniques introduced in the math supplement. Suppose
that a typical household's demand for long-distance calls is represented by the
equation, D = 200 - 4p + 0.4Y, where D is the quantity demanded in minutes a
month, p is the price of calls in cents per minute, and Y is the household's income in
thousands of dollars a year. Assume that Y = 100.
a. Draw the household's demand curve.
b. How many minutes will the household buy at a price of 25 cents a minute?
c. What is the maximum lump sum that a long-distance carrier can charge the
household for a package of 140 minutes of calls?
Answer:
(a) The demand curve will be downward sloping.
(b) 140 minutes.
(c) $59.50 = (.25 x 140) + .5[(.60 - .25) x 140].
4. Among commercial users such as apartment buildings, hotels, and offices, the
demand for water is estimated to have an own-price elasticity was -0.36, the elasticity
with respect to the number of commercial establishments was 0.99, and the elasticity
with respect to the average summer temperature was 0.02 (Williams and Suh, 1986).
a. Intuitively, would an increase in the number of commercial
establishments increase or reduce the demand for water? Is the estimated
elasticity consistent with your explanation?
2
, Answers of Test Bank Questions
b. Intuitively, would a rise in the average summer temperature increase or
reduce the demand for water? Is the estimated elasticity consistent with
your explanation?
c. By considering the own-price elasticity of demand, explain how the water
company could increase its profit.
Answer:
(a) It would increase the demand for water. This is consistent with a
positive valued elasticity of 0.99.
(b) It would increase the demand for water. This is consistent with a
positive elasticity of 0.02.
(c) The own-price elasticity of demand is inelastic, hence an increase in price will
increase total revenue.
5. At Boston-area service stations, the elasticity of the demand for gasoline with
respect to price (combining the pure price effect with the effect on waiting times)
was
-3.3, the elasticity with respect to station fueling capacity was 0.7, and the elasticity
with respect to the average price at nearby stations was 1.2 (Png & Reitman, 1984).
a. Explain why the elasticity with respect to the average price at nearby
stations is a positive number.
b. Amy’s station is the only competitor to Al’s. Al's station has 3% more
fueling capacity. Originally, both stations charged the same price. Then Amy
reduced her price by 2%. What will be the percentage difference in quantity
demanded between the two stations?
c. If Amy raises capacity from 6 to 7 fueling places, by how much could
she increase price without affecting sales?
Answer:
(a) Because they are substitutes---an increase in the price at nearby stations (e.g.
by 1%) will raise the quantity demanded at the service station under
consideration (e.g. by 1.2 %).
(b) Al's station has 3% greater fueling capacity. This implies that the quantity
demanded at Al's station will be 3% x 0.7 = 2.1% greater. Amy’s price is 2%
lower, hence her quantity demanded will be 2% x3.3 = 6.6% greater and
Al’s quantity demanded will be 2% x1.2=2.4% lower. The combined effect
3
Managerial Economics Test Bank
Homework #1
1. Between 2001 and 2003, China Mobile’s number of subscribers grew from 90.6 to
141.6 million as the company added subscribers and acquired service providers in the
poorer inland regions of China. However, over the same period, its average revenue
per user (APRU) fell from 141 to 102 yuan per month and its proportion of
subscribers using pre-paid service rose from 48% to 64%.
a. How would the entry of China Unicom affect the demand for China
Mobile service?
b. How would China Mobile’s provision of pre-paid service affect
the demand for its post-paid (contract) service?
c. Compare the demand for pre-paid service in the inland regions with that in
the wealthier coastal regions.
d. Relate your discussion in (b) and (c) to China Mobile’s decline in ARPU.
Answer:
(a) Would lower the demand.
(b) Would lower the demand as some subscribers switch from post-paid to
pre- paid service.
(c) If pre-paid service is an inferior product, the demand in the inland regions
would be higher.
(d) ARPU is lower for pre-paid than contract service. ARPU is lower in poorer
areas than richer areas. Both of these factors explain China Mobile’s decline
in ARPU.
2. The price of Chanel perfume is around $200 per fluid ounce, while the price of
Arrowhead bottled water is $1 per gallon. Nancy buys 2 fluid ounces of Chanel and
10 gallons of bottled water a month.
a. Using relevant demand curves, illustrate Nancy's choices. Illustrate how
the following changes will affect Nancy's demand for Chanel perfume: (i)
price increase to $220 per fluid ounce, and (ii) cut in price of another of
Nancy's favorite perfumes.
1
,Answers of Test Bank Questions
b. Nancy spends more money each month on perfume than bottled water.
Does this necessarily mean that perfume gives her more total benefit than
water? Use appropriate demand curves to address this question.
Answer:
(a) This will decrease the quantity demanded of Chanel perfume -- movement
down along the demand curve; (ii) This will decrease the demand for Chanel
perfume -- the demand curve shifts to the left.
(b) No. Total benefit is the area under the demand curve (which is not the same
as expenditure). The area under the demand curve for perfume could be much
smaller than that for water. Implication: Nancy is getting much more buyer
surplus from her purchases of water than from her purchases of perfume.
3. This question applies the techniques introduced in the math supplement. Suppose
that a typical household's demand for long-distance calls is represented by the
equation, D = 200 - 4p + 0.4Y, where D is the quantity demanded in minutes a
month, p is the price of calls in cents per minute, and Y is the household's income in
thousands of dollars a year. Assume that Y = 100.
a. Draw the household's demand curve.
b. How many minutes will the household buy at a price of 25 cents a minute?
c. What is the maximum lump sum that a long-distance carrier can charge the
household for a package of 140 minutes of calls?
Answer:
(a) The demand curve will be downward sloping.
(b) 140 minutes.
(c) $59.50 = (.25 x 140) + .5[(.60 - .25) x 140].
4. Among commercial users such as apartment buildings, hotels, and offices, the
demand for water is estimated to have an own-price elasticity was -0.36, the elasticity
with respect to the number of commercial establishments was 0.99, and the elasticity
with respect to the average summer temperature was 0.02 (Williams and Suh, 1986).
a. Intuitively, would an increase in the number of commercial
establishments increase or reduce the demand for water? Is the estimated
elasticity consistent with your explanation?
2
, Answers of Test Bank Questions
b. Intuitively, would a rise in the average summer temperature increase or
reduce the demand for water? Is the estimated elasticity consistent with
your explanation?
c. By considering the own-price elasticity of demand, explain how the water
company could increase its profit.
Answer:
(a) It would increase the demand for water. This is consistent with a
positive valued elasticity of 0.99.
(b) It would increase the demand for water. This is consistent with a
positive elasticity of 0.02.
(c) The own-price elasticity of demand is inelastic, hence an increase in price will
increase total revenue.
5. At Boston-area service stations, the elasticity of the demand for gasoline with
respect to price (combining the pure price effect with the effect on waiting times)
was
-3.3, the elasticity with respect to station fueling capacity was 0.7, and the elasticity
with respect to the average price at nearby stations was 1.2 (Png & Reitman, 1984).
a. Explain why the elasticity with respect to the average price at nearby
stations is a positive number.
b. Amy’s station is the only competitor to Al’s. Al's station has 3% more
fueling capacity. Originally, both stations charged the same price. Then Amy
reduced her price by 2%. What will be the percentage difference in quantity
demanded between the two stations?
c. If Amy raises capacity from 6 to 7 fueling places, by how much could
she increase price without affecting sales?
Answer:
(a) Because they are substitutes---an increase in the price at nearby stations (e.g.
by 1%) will raise the quantity demanded at the service station under
consideration (e.g. by 1.2 %).
(b) Al's station has 3% greater fueling capacity. This implies that the quantity
demanded at Al's station will be 3% x 0.7 = 2.1% greater. Amy’s price is 2%
lower, hence her quantity demanded will be 2% x3.3 = 6.6% greater and
Al’s quantity demanded will be 2% x1.2=2.4% lower. The combined effect
3
