KSOM, KIIT University, Bhubaneswar

Programme – BBA (2016-19 Batch)

KIIT School of Management

KIIT University, Bhubaneswar
Programme – MBA-I (2017-20 Batch)

Autumn Mid Semester Examination, Semester – I

Subject: Managerial Economics ( BM5401 ) Date: 18.09.17
Time: 1.5 Hours Full Marks: [40]

Answer all parts from Q1 and Q2. Answer any 3 parts from Q3 and Q4.
Read the questions properly before answering.
Candidates are required to give their answers in their own words as far as
practicable and all parts of a question should be answered at one place only.

Q.1 Choose the correct option and Justify . (5*2=10)

i) Economists assume that the typical person who starts his/her own business does so with
the intention of
a. Donating the profits from her business to charity.
b. Capturing the highest number of sales in her industry.
c. Maximizing profits.
d. Maximizing revenue.

ii) "I ate 3 slices of Pizza till I was fully satisfied. The additional satisfaction I got from the
third piece was less than that of the second piece, which was in turn less that of the first
piece”. Which of the following statements best captures this?
a) The MU of the last slice was negative.
b) The MU for all three slices was positive and the same.
c) The TU was positive but the MU for the second and third slices were negative.
d) The MU of all 3 slices are positive. MU of first slice> MU of second slice > MU of
third slice

iii) Only one of these is correct. Point that out with justification.
a) Public (Government subsidized) education has higher income elasticity of demand
than Private Education.
b) Visits to the Doctor has higher income least elasticity of demand than purchase of
sailboats
 c) Demand for gasoline over a decade has higher price elasticity than demand for
gasoline over a few days.
d) Clothing (all categories) has a higher price elasticity of demand than Levi’s Jeans.

iv) Aisha decides to spend two hours taking a nap rather than attending her M.E classes.
She could also have worked and earned Rs 2400. However she prefers her M.E.
education to earning money. Her opportunity cost of napping is
a. the value of the knowledge she would have received had she attended the M.E
class.
b. the Rs.2400 she could have earned if she had worked at her job for those two
hours.
c. the value of her nap less the value of attending class.
d. nothing, since she valued sleep more than attendance at class.

v) Assuming that an individual's preferences is expressed as U(X,Y) = XY, and PX = 50 and

PY = 100. Which of the following (X, Y) Bundles will this person purchase, if his/her
income is Rs. 3000.
a) (30,10)
b) (10, 40)
c) (30,20)
d) (10,25)

Q.2 Study the case properly before answering the questions (8)

Starbucks decided to raise its drink prices by as much as 8% (maximum increase of 30

cents), They are doing this just when customers are cutting back on their Starbucks trips and
switching to cheaper alternatives from McDonalds and Dunkin Donuts.
The conventional “wisdom” on pricing is, when recession pushes customers to cut back on
expenses and switch from your products to cheaper alternatives, you cut your prices to keep
the customers. While this is a usually accepted and followed practice, it is neither wisdom nor
based on analysis. To be successful, businesses cannot make decisions based on hunch, gut
feel, latest management fad, or so called conventional wisdom. Decisions need to be based on
data and analysis which is easier said than done.

In the case of Starbucks, how did they arrive at price increase, going against the flow? The
simplest calculation here is, when price conscious customers moved out all they are left with
are price insensitive customers who prefer their products. Hence it makes sense to charge
more for them as long as the loss in profit from further drop in customers is less than the
increase in profit from higher price. (Here is an attempt at formal proof on why increasing
prices yields better profits).
Starbucks has a gross margin of 22%. This is however the average. On their high priced
premium drinks we can assume that their margins are at least twice as much. So let us say it
is 44% gross margin. Their premium drinks retail for $3.75 or higher, so the new price is
$4.05 and at 44% margin, their profit per cup is$1.78 . (Please note that gross margin
numbers from GAAP income statements are not based on just marginal costs and include
fixed cost allocations.)
However, there is bound to be fall in sales. But how far should the sales fall to negate the
benefits of price increase?

Let us say the sales falls from by ΔN cups, then lost profit from this lost sales is 1.78ΔN

Their price increase will result in net loss only if 1.78ΔN > 0.3N, that is sales has to fall by
17% from its current levels. One in six people has to stop buying the premium drink. (Note:
We assumed a 44% margin, if it is lower than that then the sales have to drop much more
than 17% to make the price increase option unattractive).

You can see how Starbucks would have made this counter-intuitive decision – because it is
based on evidence and analysis. Unfortunately this does not come naturally to most
marketers, because no one wants to go against the flow or stand-up to authority. Worse, most
marketers accept conventional wisdom without a challenge because they lack inclination
and wherewithal to seek the right data and do the relevant analysis.

On the basis of the above case answer the following-

a) What are the factors determining the elasticity of demand for Starbucks. Enlist and
illustrate it on the basis of the given case. (3)

b) As can be inferred from the case, the demand of Starbucks coffee is inelastic. Assuming an
estimated elasticity of 0.5 and that a decrease of sales of 17% (before any losses were made),
show that Starbucks increased prices well within the allowable range of ? (2)

c) With a price change will it have any effect upon the Total Revenue of Star Bucks? Give
proper justification. (3)

Q.3 Answer any three from the following- ( 3 x 4 =12 )

a) Use shifts or movement of demand /supply to explain the change in market equilibrium
in the following instances.

(i) Research has shown that Dark Chocolate is beneficial for the heart. Based on this
research , the government aggressively advertises the positive health benefits of dark
Chocolate among its population. As a result a greater quantity of chocolates are sold
in the market.
(ii) The rural areas around Nagpur are known for the cultivation of Oranges. Oranges
require moderate temperatures to grow. A sustained period of extremely cold
weather around Nagpur results in an increased price of orange juice throughout the
country.

b) Study the diagram and answer. Is it a shift or a movement along the curve? Identify the
shifters and Explain the relation between Good X & Y.
 State about Good X State about Good X

State relationship between Good X and State relationship between Good X & Y
Y

c) The General Manager of ‘Tampa Bay Bucaneers’ (a football team) estimates the
demand for football tickets from historical data as:

𝑄𝑑 = 49800 − 750𝑃 + 0.85𝑀 + 400𝑃𝐿 − 625𝑃𝑃 where 𝑄𝑑 is the quantity of football

tickets demanded, 𝑃 is the price of a football ticket, 𝑀 is the average household income in the
locality, 𝑃𝐿 is the price of a hockey ticket charged by a rival firm-‘Tampa Bay Lightening’
and 𝑃𝑃 is the price of a parking ticket for the football game.

(i) For a 2$ increase in the price of a football ticket, all other factors staying the
same, what is the change in quantity of football tickets demanded? Explain how
the negative coefficient of 𝑃 supports the ‘Law of Demand’.
(ii) Interpret the coefficient of 𝑀. Are football tickets a ‘normal’ or ‘inferior’ good?
(iii) Based on the sign of the slope coefficient of 𝑃𝐿 , would you say football and
hockey tickets are substitutes or complements in consumption? Explain.
(iv) Based on the sign of the slope coefficient of 𝑃𝑝 , would you say football and
parking tickets are substitutes or complements in consumption? Explain.

d) "A lower market price will usually increase consumer surplus . On the contrary, a
higher market price will usually reduce consumer surplus. " Is this statement True?
Justify your reasoning with an illustration and diagram.
Q.4 Solve any three from the following- (10)

a) The following linear equations represent possible demand functions for two commodities
X and Y. (3)

𝑄𝑋 = 340 − 4𝑃 and 𝑄𝑌 = 120 + 25𝑃

i) What are the associated price elasticities at P=5 ? Comment on the values obtained.
ii) Which of the two is a Giffen's good? Explain.

b) Indian Curry and Dawat are two Indian restaurants on the high street of a large town in
California. Last week, the Indian Curry introduced a special mid-week discount that reduced
the average price of a meal from $40 to $35 per person. The number of customers on that
evening at Dawat fell by 50%. Calculate the elasticity of demand. Does Total revenue
earned by Dawat increase or decrease? Explain. (3)

c) Which method you would follow to calculate Ed and why in the following two cases- (4)
i. When the price of cement in India increased by 20%, building contractors reduced the
no. of apartments constructed from 400 to 350 units.
ii. When wage rate increased from Rs. 100 to Rs. 150 per hour, the no. of job applicants
rose from 200 to 320 people.

d) You plan to consume only hot dogs and cokes at a baseball game. A hot dog costs you
$5 and a coke costs you $4. You have a limited budget of $40 and as a rational consumer,
you intend to consume hot dogs and coke so as to maximize your Utility subject to your
budget constraint. The table below describes the marginal utilities of hot dogs and coke
bottles for each additional unit of hot dogs/cokes. (4 )

Units of hot Marginal 𝑀𝑈𝐻 Marginal 𝑀𝑈𝑐

dogs/ Cokes Utilities of hot 𝑃𝐻 Utilities of 𝑃𝑐
dogs (MUH) Cokes (MUc)
1 40 120
2 30 80
3 25 40
4 20 32
5 15 16
6 10 8

(i) Comment on the trend in marginal utilities of both hot dogs and cokes with each
additional unit of consumption.
(ii) Explain the economic significance of the marginal utilities to price ratios in your
decision making.
(iii) Using these MU/P ratios, determine the optimal consumption of hot dogs and cokes.

________________________________All the Best_____________________________