Economics Assignment 5

Economics Assignment 5 includes solved exercises on marginal revenue, price elasticity of demand, total profit function, full-cost pricing, partitioning the price of the Chef Volt and more. It discusses the rationales for charging different prices for different courses of study, income distribution effects of a pricing scheme that charges the same fee to all students, and the impact of full-cost pricing on the efficiency of resource allocations within the university.

ECONOMICS ASSIGNMENT 5
Economics Assignment 5

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ECONOMICS ASSIGNMENT 5
Calculation
Chapter 14 Exercise # 2
The relation between Marginal Revenue (MR), Price (p) and price elasticity of demand (e) is
as follows:
MR= P(1+1/e)
At profit maximization: MR= MC, so optimal price or profit maximizing price P* is:
MC= P*(1+1/e) or P*= MC/(1+1/e)
Here MC= $120
Price elasticity of demand for first class passengers= -1.3
So, Optimal fare (P*) for first-class passengers = $120/ (1+(1/-1.3)) =$120/ (1-1/1.3)
Or P* for 1st class passenger= $520 per passenger
Price elasticity of demand for unrestricted coach= -1.4
P* for unrestricted coach=$120/ (1+(1/-1.4)) =$420
Price elasticity of demand for restricted discount coach= -1.9
P* for restricted discount coach=$120/ (1+(1/-1.9)) =$250.33
For the same change in price, the section of consumers with higher price elasticity exhibits
greater changes in demand as compared to other section of consumers (Hirschey, 2008).
Hence, the higher the price elasticity of demand, the closer the optimal price to the marginal
revenue/ marginal cost to ensure profit maximization.
Chapter 14 Exercise # 3
(a)
Total profit function= Total Revenue – Total Cost
Demand function for manufactured items: P1= 100 – 2Q1
Revenue from manufactured items (R1) = (P1) *(Q1) = (100 – 2Q1) *(Q1) =100Q1 - 2Q12

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Demand function for semi-manufactured raw materials: P2= 80 –Q2
Revenue from semi-manufactured raw materials (R2) = (P2) *(Q2)
= (80 –Q2) *(Q2) =80Q2 – Q22
Total Revenue (TR)= 100Q1 - 2Q12 + 80Q2 – Q22
Total Cost (TC) = 20+4(Q1 + Q2)
Total Profit function = TR-TC= 100Q1 - 2Q12 + 80Q2 – Q22 - (20+4(Q1 + Q2))
= - 20+ 96Q1+76Q2- 2Q12 – Q22
(b)
For Profit maximizing levels of price and output for the two freight categories:
MR1=MR2=MC
Profit maximizing levels of price and output for manufactured goods:
MR1= dR1/d Q1 = 1st derivative of revenue function from manufactured goods= 100- 4 Q1
MC= 1st derivative of Total Cost function= dTC/d Q1= 4
MR1= MC
Or, 100- 4 Q1= 4 Or, Q1= 24 tons
P1= 100 – 2Q1= $52 per ton
Profit maximizing levels of price and output for semi-manufactured raw materials:
MR2= dR2/d Q2 = 1st derivative of revenue function from semi-manufactured raw materials
= 80- 2Q2
MC= 1st derivative of Total Cost function= dTC/d Q2= 4
MR2= MC
Or, 80- 2Q2=4
Or, Q2=38 tons
P2= 80 –Q2=$42 per ton

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ECONOMICS ASSIGNMENT 5
(c.)
Marginal Revenue in manufactured goods market= 100- 4 Q1=$4
Marginal Revenue in semi-manufactured raw materials market= 80- 2Q2 =$4
(d)
Total Profits if different prices are charged=Total Revenue – Total Cost= - 20+ 96Q1+76Q2-
2Q12 – Q22=-20+2,304+2,888-1,152-1,444=$2,576
(e)
If charged same rate for all output:
P1= P2
Or, 100 – 2Q1= 80 –Q2
2Q1–Q2=20 or Q1=10+ Q2/2
Total Revenue (TR)= 100Q1 - 2Q12 + 80Q2 – Q22
Substituting for Q1, TR= 1000+50Q2 -2(100+ Q22 /4+10 Q2) + 80Q2 – Q22
Or TR= 800+110Q2 – 1.5Q22
MR= 110-3Q2
TC= 20+4(Q1 + Q2) = 60+6Q2
MC= 6
For Profit maximization, MR= MC
110-3Q2= 6
Or, Q2= 34.67 tons of semi-manufactured raw materials
Price= 80 –Q2=$45.33
Q1=10+ Q2/2=27.34 tons of manufactured goods
Profit= 800+110Q2 – 1.5Q22-(60+6Q2)=800+3,813.7-1,803.01-(60+208.02)= $2542.67

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ECONOMICS ASSIGNMENT 5
(f)
Calculation of Point price elasticity(e)
At profit maximization: MR= MC, so optimal price or profit maximizing price P* is:
MC= P*(1+1/e) where MC= 6, P*=$45.33
Point price elasticity under uniform price-output solution= -1.15
For differential pricing,
Point price elasticity for manufactured goods:
MC= P(1+1/e) where MC= 4, P=52
Price elasticity of demand= -1
Point price elasticity for semi-manufactured raw materials:
MC= P(1+1/e) where MC= 4, P=42
Price elasticity of demand= -1.11
Profit under differential pricing is higher than under uniform pricing by $33.33. With uniform
pricing, the absolute level of point price elasticity of demand increases vis-à-vis point price
elasticities under differential pricing (Frischmann, 2012). With more elastic demand, any
price changes would result in greater adverse impacts on total revenue. As is observed, along
with fall in total revenue the quantities demanded has also fallen for both categories of goods.

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ECONOMICS ASSIGNMENT 5
Chapter 14 Exercise # 6
Discuss several possible rationales for charging different prices for different courses of
study.
Possible Rationales for charging different prices for different courses of study are:
1. Courses high in demand like those ending with higher-paying jobs have lower price
sensitivity and can be charged more (Strange, 2013).
2. Pricing as per input cost: Some courses like Science, Technology, Engineering and
Mathematics disciplines require higher teaching and infrastructure costs for delivery
hence these should be charged accordingly.
3. Differential pricing to reflect higher earnings outcomes: For example, with doctors get
earning more than nurses after graduation, course fees need to reflect the earnings
potential.
What are the income distribution effects of a pricing scheme that charges the same fee
to all students?
With uniform pricing, courses which demand higher teaching or infrastructure costs would
have to be borne by students of other courses, thus compelling them to pay extra. Again,
student loans would require more years for repayment in case of students who will get lower
pay. This will result in income getting redistributed to more privileged segments of
population bagging high-pay jobs like engineers and doctors.
If universities adopted a system of full-cost (or marginal cost) pricing for various
courses, what would you expect the impact on the efficiency of resource allocations
within the university to be?

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ECONOMICS ASSIGNMENT 5
In case of full-cost (or marginal cost) pricing, each of the courses would generate enough to
pay for the respective cost incurred for the respective course as well as meet other overhead
costs (Thompson, 2019). However, it would ignore the possibility for the university to
maximize profits by charging higher fees for courses which are less price elastic. Overhead
allocations would be arbitrary and there would be no incentive to control costs leading to
inefficient resource allocations.
Would you complain less about large lecture sections taught by graduate students if
these were priced significantly lower than small seminars taught by outstanding
scholars?
Yes, I would complain less. While small seminars by outstanding scholars would be more
accurate with respect to the topic discussed, they would come with higher fees which the less
privileged but deserving students may not be able to afford. Large lecture sessions by
graduate students would address the low-cost requirements and also provide more time for
clearance of doubts, thus serving as an alternative for more accurate lectures.
What problems could you see arising from a university that adopted such a pricing
scheme?
Adopting a full-cost pricing scheme would lead to arbitrary allocation of indirect costs and
almost always higher course fees in case of overestimated budgeted costs (Thompson, 2019).
Since the pricing would not be based on demand elasticity, profit optimization would not be
realized. Again, there would be no incentive to control costs leading to inefficient resource
allocations.

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Case Exercise: Partitioning the price of the Chef Volt
1. Although being a clean energy model, electric vehicles are still in their nascent stage,
technological advancements are faster than conventional models with a lot of focus on
increasing durability, replacement time and longer charging times of batteries (Toma,
2017). At this level, the obsolescence of older technologies is much faster than for
gasoline cars, raising concerns of resale value after year 5 (Stewart, 2014). The
perceived value-in-use is depreciating much faster due to improved batteries
providing much better model additions during the same time, leaving the older owners
at a loss.
2. Incurring warranty expense is a more appropriate stance for Chevrolet considering the
level of use of cars by the customers. For some customers, the car usage would be
lower resulting in lower warranty cost. Conversely, going for a lease for the battery
pack would lead to higher cost for Chevrolet because the agreement would have to be
honored at a fixed residual irrespective of the level of battery wear and tear. Further,
the warranty expense would be favored more by the customers.
3. Bundling maintenance costs with purchase price would lead to the inclusion of
maintenance cost on loans resulting in a small increase in monthly payments (Hanley,
Tesla Is Bundling Insurance & Maintenance Costs Into Price Of Cars In Asian
Markets, 2017). While this will not pinch the car owner much, it will provide the
peace of mind with regard to a commitment by Chevrolet for aiding the owner
directly as and when required without leaving them at the mercy of dealers. This
would thus shore up the brand equity of the company.
Conversely, demand for electric roadside assistance is much lower since commuters
are aware of their car capacity and use their vehicles accordingly (Hanley, AAA

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Electric Car Recharging Trucks Seldom Used , 2016). Hence bundling these costs
with purchase price would not be worthwhile.
4. Yes, emergency roadside assistance for EVs should be partitioned for the segment of
customers who commute. The demand for this assistance is much lower at present
considering the awareness of commuters regarding the capacity of their cars. The
extra expense is not trivial and not pivotal to the primary benefit of those customers
who are not regular commuters. This assistance would be helpful for regular
commuters and offered accordingly without mandatorily adding to the cost of the
vehicle.

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References
Frischmann, B. M. (2012). Infrastructure: The Social Value of Shares Resources. Oxford:
Oxford University Press.
Hanley, S. (2016, August 22nd). AAA Electric Car Recharging Trucks Seldom Used .
Retrieved from Gas 2: https://gas2.org/2016/08/22/aaa-electric-car-recharging-trucks-
seldom-used/
Hanley, S. (2017, March 1st). Tesla Is Bundling Insurance & Maintenance Costs Into Price
Of Cars In Asian Markets. Retrieved from Clean Technica:
https://cleantechnica.com/2017/03/01/tesla-bundling-insurance-maintenance-costs-
price-cars-asian-markets/
Hirschey, M. (2008). Fundamentals of Managerial Economics. Boston: Cengage Learning.
Stewart, J. (2014, March 31st). The electric car's biggest threat may be its battery. Retrieved
from BBC: http://www.bbc.com/future/story/20140331-electric-cars-biggest-threat
Strange, K. (2013, May 8th). Differential Pricing in Undergraduate Education: Effects on
Degree Production by Field . Retrieved from University of Michigan: http://www-
personal.umich.edu/~kstange/StangeDiffPricing2013.pdf
Thompson, S. (2019, Jan 26th). Differences Between Full-Cost & Marginal-Cost Pricing
Strategies. Retrieved from Chron: https://smallbusiness.chron.com/differences-
between-fullcost-marginalcost-pricing-strategies-66005.html
Toma, S. (2017, Nov 6th). Six Problems With Electric Cars That Nobody Talks About.
Retrieved from Autorevolution: https://www.autoevolution.com/news/six-problems-
with-electric-cars-that-nobody-talks-about-112221.html