Chapter 3: Answers to Questions and Problems

1.
a. When P = $12, R = ($12)(1) = $12. When P = $10, R = ($10)(2) = $20. Thus,
the price decrease results in an $8 increase in total revenue, so demand is elastic
over this range of prices.
b. When P = $4, R = ($4)(5) = $20. When P = $2, R = ($2)(6) = $12. Thus, the
price decrease results in an $8 decrease total revenue, so demand is inelastic over
this range of prices.
c. Recall that total revenue is maximized at the point where demand is unitar
elastic. We also !now that marginal revenue is zero at this point. "or a linear
demand curve, marginal revenue lies halfwa between the demand curve and the
vertical axis. #n this case, marginal revenue is a line starting at a price of $1$ and
intersecting the %uantit axis at a value of & ' (.). Thus, marginal revenue is * at
(.) units, which corresponds to a price of $+ as shown below.
$0
$2
$4
$6
$8
$10
$12
$14
0 1 2 3 4 5 6
Quantity
Price
Demand
MR
Figure 3-1
Managerial Economics and Business Strategy, 4e Page 1
,.
a. -t the given prices, %uantit demanded is +** units.
( ) ( ) 1*** , 1)$ .*, $** +**
d
x
Q = + =
. /ubstituting the relevant information into
the elasticit formula gives. ,
1)$
, , *.$$
+**
x x
x
Q P
x
P
E
Q
= = =
. /ince this is less
than one in absolute value, demand is inelastic at this price. #f the firm charged a
lower price, total revenue would decrease.
b. -t the given prices, %uantit demanded is (** units.
( ) ( ) 1*** , ()$ .*, $** (**
d
x
Q = + =
. /ubstituting the relevant information into
the elasticit formula gives.
,
()$
, , ,.(0
(**
x x
x
Q P
x
P
E
Q


= = =



. /ince this is
greater than one in absolute value, demand is elastic at this price. #f the firm
increased its price, total revenue would decrease.
c. -t the given prices, %uantit demanded is +** units.
( ) ( ) 1*** , 1)$ .*, $** +**
d
x
Q = + =
. /ubstituting the relevant information into
the elasticit formula gives.
,
$**
.*, .*, *.*11
+**
x Z
Z
Q P
x
P
E
Q


= = =



. /ince this
number is positive, goods 1 and 2 are substitutes.
(.
a. The own price elasticit of demand is simpl the coefficient of ln Px, which is 3
*.). /ince this number is less than one in absolute value, demand is inelastic.
b. The cross4price elasticit of demand is simpl the coefficient of ln Py, which is 3
,.). /ince this number is negative, goods 1 and 5 are complements.
c. The income elasticit of demand is simpl the coefficient of ln M, which is 1.
/ince this number is positive, good 1 is a normal good.
d. The advertising elasticit of demand is simpl the coefficient of ln A, which is ,.
$.
a. 6se the own price elasticit of demand formula to write
7
,
)
d
x
Q
= . /olving,
we see that the %uantit demanded of good 1 will decrease b 1* percent if the
price of good 1 increases b ) percent.
b. 6se the cross4price elasticit of demand formula to write
7
0
1*
d
x
Q
= . /olving,
we see that the demand for 1 will decrease b 0* percent if the price of good 5
increases b 1* percent.
c. 6se the formula for the advertising elasticit of demand to write
7
$
,
d
x
Q
=

.
/olving, we see that the demand for good 1 will decrease b 8 percent if
advertising decreases b , percent.
Page 2 Michael R !a"e
d. 6se the income elasticit of demand formula to write
7
(
(
d
x
Q
=

. /olving, we
see that the %uantit demanded of good 1 will decrease b 8 percent if income
decreases b ( percent.

). 6sing the cross price elasticit formula,
)
7
)*
=

y
P
. /olving, we see that the price of
good 5 would have to decrease b 1* percent in order to increase the consumption of
good 1 b )* percent.
0. 6sing the change in revenue formula for two products,
( ) ( ) [ ]( ) (,* $ *1 . 1 . 1 *** , +* $ ) . , 1 *** , (* $ = + = R . Thus, a 1 percent increase in
the price of good 1 would cause revenues from both goods to increase b $(,*.
+. Table (41 contains the answers to the regression output.
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.62
R Square 0.39
Adjusted RSquare 0.37
Standard Errr 190.90
!"ser#atins 100.00
ANOVA
degrees of freedom SS MS F Significance F
Re$ressin 2.00 2%223%017.77 1%111%508.88 30.50 0.00
Residual 97.00 3%535%019.49 36%443.50
&tal 99.00 5%758%037.26
Coefficients Standard Error t Stat P-value Lower 95% Uer 95%
'nter(ept 187.15 534.71 0.35 0.73 )880.56 1%254.86
*ri(e + , )4.32 0.69 6.26 0.00 )5.69 )2.96
'n(-e 0.09 0.02 4.47 0.00 0.05 0.14
#able 3-1
a. 18+.1) $.(, .*8
d
x x
Q P M = + .
b. 9nl the coefficients for the :rice of 1 and #ncome are statisticall significant at
the ) percent level or better.
c. The R4s%uare is fairl low, indicating that the model explains onl (8 percent of
the total variation in demand for 1. The ad;usted R4s%uare is onl marginall
lower <(+ percent=, suggesting that the R4s%uare is not the result of an excessive
number of estimated coefficients relative to the sample size. The F4statistic,
however, suggests that the overall regression is statisticall significant at better
than the ) percent level.
8. The approximate 8) percent confidence interval for a is
, 1* , >
>
=
a
a
. Thus, ou can
be 8) percent confident that a is within the range of 8 and 1,. The approximate 8)
Managerial Economics and Business Strategy, 4e Page 3
percent confidence interval for b is
1 ) . , ,
>
>
=
b
b
. Thus, ou can be 8) percent
confident that b is within the range of 3(.) and 31.).
8. The result is not surprising. ?iven the available information, the own price elasticit of
demand for :alm@s brand of :A-s is
*0 . 8
1+
1(+
,
=

=
P Q
E
. /ince this number is
greater than one in absolute value, demand is elastic. B the total revenue test, this
means that a reduction in price will increase revenues.
1*. The regression output is as follows.
S.MMAR/ !.&*.&
Regression Statistics
Multiple R 0.97
R Square 0.94
Adjusted R Square 0.94
Standard Errr 0.00
!"ser#atins 49
A0!1A
df SS MS F Significance F
Re$ressin 2 0.00702 0.004 370.38 0.0000
Residual 46 0.00044 0.000
&tal 48 0.00745
Coefficients Standard Error t Stat P-value Lower 95% Upper 95%
'nter(ept 1.29 0.41 3.12 0.00 0.46 2.12
20 *ri(e )0.07 0.00 )26.62 0.00 )0.08 )0.07
20 'n(-e )0.03 0.09 )0.33 0.74 )0.22 0.16
#able 3-2
Thus, the demand for our batteries is given b
ln 1.,8 *.*+ln *.*(ln Q P M =
.
/ince this is a log4linear demand e%uation, the best estimate of the income elasticit
of demand for our product is 4.*(. 5our batteries are an inferior good. Cowever, note
the estimated income elasticit is ver close to zero <impling that a ( percent
reduction in global incomes would increase the demand for our product b less than
one tenth of one percent=. Dore importantl, the estimated income elasticit is not
statisticall different from zero <the 8) percent confidence interval ranges from a low
of 4.,, to a high of .10, with a t4statistic that is well below , in absolute value=. 9n
balance, this means that a ( percent decline in global incomes is unli!el to impact
the sales of our product. Eote that the R4s%uare is reasonabl high, suggesting the
model explains 8$ percent of the total variation in the demand for this product.
Fi!ewise, the F4test indicates that the regression fit is highl significant.
Page $ Michael R !a"e
11. Based on this information, the own price elasticit of demand for Big ? cereal is
) . 1
,
(
,
=

=
P Q
E
. Thus, demand for Big ? cereal is elastic <since this number is
greater than one in absolute value=. /ince Fuc! Gharms is one particular brand of
cereal for which even more substitutes exist, ou would expect the demand for Fuc!
Gharms to be even more elastic than the demand for Big ? cereal. Thus, since the
demand for Fuc! Gharms is elastic, one would predict that the increase in price of
Fuc! Gharms resulted in a reduction in revenues on sales of Fuc! Gharms.
1,. 6se the income elasticit formula to write +) . 1
$
7
=

d
Q
. /olving, we see that coffee
purchases are expected to decrease b + percent.
1(. To maximize revenue, ?D should charge the price that ma!es demand unit elastic. 6sing
the own price elasticit of demand formula, ( )
,
1.,) 1
1**, *** 1.,)
Q P
P
E
P

= =

.
/olving this e%uation for P implies that the revenue maximizing price is
*** , $* $ = P
.
1$. 6sing the change in revenue formula for two products,
( ) ( ) [ ] ( ) million 8 . 8 $ *1 . , . * $** $ ) . , 1 0** $ = + = R , so revenues will
increase b $8.8 million.
1). The estimated demand function for residential heating fuel is
M P P P Q
E NG RHF
d
RHF
*) . * 8, . 11 88 . $( 08 . 81 80 . 1(0 + = , where
RHF
P is the
price of residential heating fuel, NG
P
is the price of natural gas,
E
P is the price of
electricit, and M is income. Cowever, notice that coefficients of income and the
price of electricit are not statisticall different from zero. -mong other things, this
means that the proposal to increase the price of electricit b $) is unli!el to have a
statisticall significant impact on the demand for residential heating fuel. /ince the
coefficient of
RHF
P is 481.08, a $, increase in
RHF
P would lead to 18(.(8 unit
reduction in the consumption of residential heating fuel <since <481.08=<$,= ' 4 18(.(8
units=. /ince the coefficient of
NG
P
is $(.88, a $1 reduction in
NG
P
would lead to
$(.88 unit reduction in the consumption of residential heating fuel <since <$(.88=<4$1=
' 4$(.88=. Thus, the proposal to increase the price of residential heating fuel b $,
would lead to the greatest expected reduction in the consumption of residential
heating fuel.
Managerial Economics and Business Strategy, 4e Page %
10. The regression output is as follows.
S.MMAR/ !.&*.&
Regression Statistics
Multiple R 0.97
R Square 0.94
Adjusted R Square 0.94
Standard Errr 0.06
!"ser#atins 41
A0!1A
df SS MS F Significance F
Re$ressin 1 2.24 2.24 599.26 0.00
Residual 39 0.15 0.00
&tal 40 2.38
Coefficients Standard Error t Stat P-value Lower 95% Upper 95%
'nter(ept 4.29 0.12 37.17 0.00 4.06 4.53
ln 3*ri(e4 )1.38 0.06 )24.48 0.00 )1.50 )1.27
#able 3-3
Thus, the least s%uares regression line is
ln $.,8 1.(8ln Q P =
. The own price
elasticit of demand for broilers is 31.(8. "rom the t4statistic, this is statisticall
different from zero <the t4statistic is well over , in absolute value=. The R4s%uare is
relativel high, suggesting that the model explains 8$ percent of the total variation in
the demand for chic!en. ?iven that our current revenues are $+)*,*** and the
elasticit of demand is 31.(8, we ma use the following formula to determine how
much ou must change price to increase revenues b $)*,***.
( ) [ ]
x
x
P Q x x
P
P
E Q P R
x x

+ =
,
1

( ) [ ]
x
x
P
P
= (8 . 1 1 *** , +)* $ *** , )* $
/olving ields
1+) . *
*** , ,8) $
*** , )* $
=

x
x
P
P
. That is, to increase revenues b
$)*,***, ou must decrease our price b 1+.) percent.
Page & Michael R !a"e
1+. The regression output <and corresponding demand e%uations= for each state are presented
below.
ILLINOIS
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.29
R Square 0.09
Adjusted R Square 0.05
Standard Errr 151.15
!"ser#atins 50
ANOVA
degrees of freedom SS MS F Significance F
Re$ressin 2 100540.93 50270.47 2.20 0.12
Residual 47 1073835.15 22847.56
&tal 49 1174376.08
Coefficients Standard Error t Stat P-value Lower 95% Uer 95%
'nter(ept )42.65 496.56 )0.09 0.93 )1041.60 956.29
*ri(e 2.62 13.99 0.19 0.85 )25.53 30.76
'n(-e 14.32 6.83 2.10 0.04 0.58 28.05
#able 3-$
The estimated demand e%uation is
$,.0) ,.0, 1$.(, Q P M = + +
. While it appears
that demand slopes upward, note that coefficient on !"#$ is not statisticall different
from zero. -n increase in "n#%&$ b $1,*** increases demand b 1$.(, units. /ince
the t4statistic associated with "n#%&$ is greater than , in absolute value, "n#%&$ is a
significant factor in determining %uantit demanded. The R4s%uare is extremel low,
suggesting that the model explains onl 8 percent of the total variation in the demand
for HBG microbrews. "actors other than !"#$ and "n#%&$ pla an important role in
determining %uantit demanded.
Managerial Economics and Business Strategy, 4e Page '
INDIANA
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.87
R Square 0.76
Adjusted R Square 0.75
Standard Errr 3.94
!"ser#atins 50
ANOVA
degrees of freedom SS MS F Significance F
Re$ressin 2 2294.93 1147.46 73.96 0.00
Residual 47 729.15 15.51
&tal 49 3024.08
Coefficients Standard Error t Stat P-value Lower 95% Uer 95%
'nter(ept 97.53 10.88 8.96 0.00 75.64 119.42
*ri(e )2.52 0.25 )10.24 0.00 )3.01 )2.02
'n(-e 2.11 0.26 8.12 0.00 1.59 2.63
#able 3-%
The estimated demand e%uation is
M P Q 11 . , ), . , )( . 8+ + =
. This e%uation sas
that increasing !"#$ b $1 decreases %uantit demanded b ,.), units. Fi!ewise,
increasing "n#%&$ b $1,*** increases demand b ,.11 units. /ince the t4statistics for
each of the variables is greater than , in absolute value, !"#$ and "n#%&$ are
significant factors in determining %uantit demanded. The R4s%uare is reasonabl
high, suggesting that the model explains +0 percent of the total variation in the
demand for HBG microbrews.
Page ( Michael R !a"e
MICHIGAN
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.63
R Square 0.40
Adjusted R Square 0.37
Standard Errr 10.59
!"ser#atins 50
ANOVA
degrees of freedom SS MS F Significance F
Re$ressin 2 3474.75 1737.38 15.51 0.00
Residual 47 5266.23 112.05
&tal 49 8740.98
Coefficients Standard Error t Stat P-value Lower 95% Uer 95%
'nter(ept 182.44 16.25 11.23 0.0000 149.75 215.12
*ri(e )1.02 0.31 )3.28 0.0020 )1.65 )0.40
'n(-e 1.41 0.35 4.09 0.0002 0.72 2.11
#able 3-&
The estimated demand e%uation is
M P Q $1 . 1 *, . 1 $$ . 18, + =
. This e%uation sas
that increasing !"#$ b $1 decreases %uantit demanded b 1.*, units. Fi!ewise,
increasing "n#%&$ b $1,*** increases demand b 1.$1 units. /ince the t4statistics
associated with each of the variables is greater than , in absolute value, !"#$ and
"n#%&$ are significant factors in determining %uantit demanded. The R4s%uare is
relativel low, suggesting that the model explains about $* percent of the total
variation in the demand for HBG microbrews. The F4statistic is zero, suggesting that
the overall fit of the regression to the data is highl significant.
Managerial Economics and Business Strategy, 4e Page )
MINNESOTA
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.64
R Square 0.41
Adjusted R Square 0.39
Standard Errr 16.43
!"ser#atins 50
ANOVA
degrees of freedom SS MS F Significance F
Re$ressin 2 8994.34 4497.17 16.67 0.00
Residual 47 12680.48 269.80
&tal 49 21674.82
Coefficients Standard Error t Stat P-value Lower 95% Uer 95%
'nter(ept 81.70 81.49 1.00 0.32 )82.23 245.62
*ri(e )0.12 2.52 )0.05 0.96 )5.19 4.94
'n(-e 3.41 0.60 5.68 0.00 2.20 4.62
#able 3-'

The estimated demand e%uation is
81.+* *.1, (.$1 Q P M = +
. This e%uation sas
that increasing !"#$ b $1 decreases %uantit demanded b *.1, units. Fi!ewise, a
$1,*** increase consumer "n#%&$ increases demand b (.$1 units. /ince the t4statistic
associated with "n#%&$ is greater than , in absolute value, it is a significant factor in
determining %uantit demanded. The R4s%uare is relativel low, suggesting that the
model explains $1 percent of the total variation in the demand for HBG microbrews.
Page 1* Michael R !a"e
MISSOURI
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.88
R Square 0.78
Adjusted R Square 0.77
Standard Errr 15.56
!"ser#atins 50
ANOVA
degrees of freedom SS MS F Significance F
Re$ressin 2 39634.90 19817.45 81.81 0.00
Residual 47 11385.02 242.23
&tal 49 51019.92
Coefficients Standard Error t Stat P-value Lower 95% Uer 95%
'nter(ept 124.31 24.23 5.13 0.00 75.57 173.05
*ri(e )0.79 0.58 )1.36 0.18 )1.96 0.38
'n(-e 7.45 0.59 12.73 0.00 6.27 8.63
#able 3-(
The estimated demand e%uation is
1,$.(1 *.+8 +.$) Q P M = +
. This e%uation sas
that increasing !"#$ b $1 decreases %uantit demanded b *.+8 units. Fi!ewise, a
$1,*** increase in "n#%&$ increases demand b +.$) units. /ince the t4statistic
associated with !"#$ is not greater than , in absolute value, however, the estimated
!"#$ coefficient is not statisticall different from zero. The R4s%uare is reasonabl
high, suggesting that the model explains +8 percent of the total variation in the
demand for HBG microbrews.
Managerial Economics and Business Strategy, 4e Page 11
OHIO
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.99
R Square 0.98
Adjusted R Square 0.98
Standard Errr 10.63
!"ser#atins 50
ANOVA
degrees of freedom SS MS F Significance F
Re$ressin 2 323988.26 161994.13 1434.86 0.00
Residual 47 5306.24 112.90
&tal 49 329294.50
Coefficients Standard Error t Stat P-value Lower 95% Uer 95%
'nter(ept 111.06 23.04 4.82 0.0000 64.71 157.41
*ri(e )2.48 0.79 )3.12 0.0031 )4.07 )0.88
'n(-e 7.03 0.13 52.96 0.0000 6.76 7.30
#able 3-)
The estimated demand e%uation is
111.*0 ,.$8 +.*( Q P M = +
. This e%uation sas
that increasing !"#$ b $1 decreases %uantit demanded b ,.$8 units. Fi!ewise,
increasing "n#%&$ b $1,*** increases demand b +.*( units. /ince the t4statistics
associated with each of the variables is greater than , in absolute value, !"#$ and
"n#%&$ significant factors in determining %uantit demanded. The R4s%uare is ver
high, suggesting that the model explains 88 percent of the total variation in the
demand for HBG microbrews.
Page 12 Michael R !a"e
ISCONSIN
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.999
R Square 0.998
Adjusted R Square 0.998
Standard Errr 4.79
!"ser#atins 50
ANOVA
degrees of freedom SS MS F Significance F
Re$ressin 2 614277.37 307138.68 13369.30 0.00
Residual 47 1079.75 22.97
&tal 49 615357.12
Coefficients Standard Error t Stat P-value Lower 95% Uer 95%
'nter(ept 107.60 7.97 13.49 0.00 91.56 123.65
*ri(e )1.94 0.25 )7.59 0.00 )2.45 )1.42
'n(-e 10.01 0.06 163.48 0.00 9.88 10.13
#able 3-1*

The estimated demand e%uation is
1*+.0* 1.8$ 1*.*1 Q P M = +
. This e%uation sas
that increasing !"#$ b $1 decreases %uantit demanded b 1.8$ units. Fi!ewise,
increasing "n#%&$ b $1,*** increases demand b 1*.*1 units. /ince the t4statistics
associated with !"#$ and "n#%&$ are greater than , in absolute value, !"#$ and
"n#%&$ are both significant factor in determining %uantit demanded. The R4s%uare is
ver high, suggesting that the model explains 88.8 percent of the total variation in the
demand for HBG microbrews.
Managerial Economics and Business Strategy, 4e Page 13