Part A: MCQs

Answers:
1
D

2
D

3
A

4
C

5
B

6
C

7
E

8
D

9
A

10
B

NOTE: Questions and detailed answers for the part A is shown on pages 10 to 15.
Suitable answers for 9 cannot be found in the given list, see page 15.
-------------------------------------------------------------------------------------------------------Part B: Short Answer Questions
01. Nihal takes a year off from his job to train the Asian Games 400 metres event to be
held one year later. The annual income from his job is Rs.600,000. His training costs
(coachs fee) amount to Rs.180,000 and meal expenses amount to another
Rs.200,000.Being a promising athlete, the Ministry of Sports has given Nihal a sports
scholarship worth Rs.100,000.
a) Calculate the opportunity cost involved in Sunil's decision to take one year off
from his job to train for the Asian Games Championships?
b) What is the annual opportunity cost to the country of training this athlete?
-------------------------------------------------------------------------------------------------------Answer 01:
Train for the Asian Games
Salary of his job
Rs, 600,000

Doing Nihals Job

Scholarship value - Training Cost
Rs, 100,000

- Rs. 180,000

Rs. - 80,000
Assumptions:

Training cost to be paid by Nihal.

There is no special food to be taken during his training period. Irrespective to
these two options, Nihal anyway has to bear the cost of food Rs, 200,000 for

his survival.
Training cost of Rs, 180,000 to be paid by Nihal.
Page | 1

a) As per the above analysis considering two options of Nihal and considering the
definition of opportunity cost, cost or value of the best alternative forgone
(highest valued opportunity lost), the opportunity cost involved in Nihals
decision to take year off from his job to train for Asian games championship is
Rs, 600,000.
b) Annual opportunity cost to the country of training this athlete is Rs, 100,000.
Since the government would have been spent this Rs. 100,000 somewhere else.
-------------------------------------------------------------------------------------------------------02. The table below shows the demand and supply schedules for CDs
Price (Rs. per Quantity
CD)
(CDs)
500
600
700
800
900

Demanded Quantity Supplied (CDs)

300
250
200
150
100

100
150
200
250
300

A) Draw the diagram & state the equilibrium price & quantity.
B) If the price of a CD is Rs. 600, describe the situation in the CD market. Explain
how market equilibrium is restored
C) If the price of a CD is Rs. 800, describe the situation in the CD market. Explain
how market equilibrium is restored
D) A rise in incomes increases the quantity of CDs demanded by 100 at each price.
What is the new equilibrium price and quantity?
E) An increase in the number of recording studios increases the quantity of CDs
supplied by 75 at each price. People download more music from the internet and the
quantity demanded of CDs decreases by 25 at each price. With no change in
incomes, what is

the new equilibrium price and quantity?

Answer 02:
Page | 2

A)
1000
900
800
Price (Rs/ CD)

700
600
500
400
50

100

150

200

250

300

350

Qty (CDs)

Graph(0201)
Consumers andproducers react differently to price changes. Higher prices tend to
reducedemandwhileencouragingsupply,andlowerpricesincreasedemandwhile
discouragingsupply.
Economictheorysuggeststhat,inafreemarkettherewillbeasinglepricewhich
bringsdemandandsupplyintobalance,calledequilibriumprice.

Asperthegivenschedule,equilibriumpriceisRs,700at200CDs.

B)WhenthepriceofaCDisRs.600,Qtysupply&Qtydemandcanbeidentifiedby
pointAandBasshowninGraph(0202).Inthissituation,anexcessdemandof100
[250150]CDiscreated.
Howeverduetothisexcessdemandconsumerwillingtopaymoreandtheyinfluence
the supplier to produce more at higher price. As a result price starts rising and
eventuallystabilizesatP=Rs.700andQ=CDs200

Page | 3

650
600
550
Price (Rs/ CD)

500
450
400
50

100

150

200

250

300

Qty (CDs)

Graph(0202)
C) WhenthepriceofaCDisRs.800,Qtysupply&Qtydemandcanbeidentifiedby
pointEandFasshowninGraph(0202).InthissituationanexcessSupplyof100
(250150)CDiscreated.
However due to this excess supply supplier wants to sell their excess stock &
competition is created to sell at lower price. As a result price starts falling and
eventuallystabilizesatP=Rs.700andQ=CDs200
D) WhentheDemandforCDsateachpriceincreasesby100unitsthedemandcurve
shifts torightasshownbyD1ontheGraph(0203).This generates anew
equilibriumasshownbyOintheGraph(0203)wherethepriceisRs.800and
quantityis250CDs.
1000
900
800
Price (Rs/ CD)

700
600
500
400
50

100

150

200

250

300

350

400

450

Qty (CDs)

Page | 4

Graph(0203)
E) TheincreaseinthenumberCDsby75isshownbyS1inGraph(0204).The
decreaseinCDsby25isshownbyD1inGraph(0204).Asthereisnoincome
change there is no change in Demand due to income. Therefore the new
equilibriumisarrivedattheintersectionofD1andS1wherePriceisRs.600and
thenumberofCDsis225.
650
600
550
Price (Rs/ CD)

500
450
400
50

100

150

200

250

300

350

400

450

Qty (CDs)

Graph(0204)

03. The price of bottled water rises from Rs. 19 to Rs. 21 a bottle, and the
quantity demanded falls from 11,000 to 9,000 bottles a week. Use the Arc price
elasticity of demand formula to calculate:
A) The percentage change in the price of bottled water
B) The percentage change in the quantity demanded of bottled water
C) The price elasticity of demand for bottled water on the Arc PED formula
D) At what price is the price elasticity of demand for bottled water equal to your
answer in part C?
E) Is the demand for carbonated drinks likely to be more elastic or less elastic
than the demand for bottled water? Why?
F) Calculate the change in the total revenue of sellers of bottled water due to the
change in price?
Page | 5

G) If the demand curve for bottled water is a straight-line demand curve, is the
price at which the demand for bottled water unit elastic a higher price or a
lower price than your answer to part (C)? Why?
-------------------------------------------------------------------------------------------------------Answer 03:
Price / Water bottle,
Rs
19

Qty Demanded/ Week

21

9,000

A) Percentage change in Price of

11,000

(New Price Initial Price)

x 100

(New Price + Initial Price)/2

Water bottle

(21-19)

x100

(21+19)/2

B) Percentage change in Qty

Demanded

[2 / 20] x 100

10%
(New Qty demand Initial Qty demand)

x 100

(New Qty demand+ Initial Qty demand)/2

(9000-11000)

x100

(9000+11000)/2

C)

[-2000 / 1000] x 100

-20%

Arc price elasticity of demand

= { Q/

P} X

[P1+P2] /2

[Q1+Q2] / 2

= {(9000-11000) / (21-19)}X

[19+21] / 2
[11000+9000] / 2

= {-2000 / 2} X [40 / 20000]

=

-2

Page | 6

OR
Priceelasticityofdemandforbottledwater=

Percentage Change in Qty demanded

Percentage Change in Price

=20%/10%
= -2
D) Bydefinitionofarc elasticity it is calculated attheaverageprice andaverage
quantity. Therefore in this case it has to be Rs, 20 where the average price is
[19+21]/2.
E) Substitute is one of the determinants of elasticity of demand.
Carbonated drinks as a whole inelastic, because whether or not the price
increases/decreases, demand would not decrease/increase by a whole lot, since it's the
consumers' preferred choice of drinks (just like milk is inelastic). Just because the price
increases, doesn't mean that consumers will start to drink water all the time, they'll just
drink less amounts of soft drink than usual (and vice versa). But if we get certain brand
like Coca Cola it is elastic, since it has many alternative brands.
But demand for carbonated drinks likely to be more elastic than the demand for
bottled water in long run. This is because carbonated drinks as a whole have more
substitutes like water, milk, fruit drinks etc. than water.
F) Total revenue selling at Rs 19 /bottle
Total revenue selling at Rs 19 /bottle
The change in the total revenue

= 19 x 11000
= Rs, 209,000
= 21 x 9000
= Rs, 189,000
= 189000 209000
= Rs, - 20,000

Therefore the change in the total revenue of sellers of bottled water due to the change
in price is Rs, 20,000 lower than the original.

G)

Page | 7

Elasticity of demand will decrease along the length of the downward sloping straightline demand curve, being infinite where it touches the vertical axis and zero where it
touches the horizontal axis.
Answer for (C) is 2 and it is in the range of Ed > 1 region of the above graph.
Therefore the demand for bottled water unit elastic i s a t a lower price than the
answer to part (C).
--------------------------------------------------------------------------------------------------------04. A computer chip manufacturer has estimated the following relation between
the marginal cost (MC) of production and monthly output
MC= $100+$ 0.004Q
A) Calculate the MC of production at 2500, 5000, and 7500 units of output
B) Calculate the output level when MC= $100, $125, and $ 150
C) Calculate the profit maximizing level of output if price is stable at $ 150 per chip
-------------------------------------------------------------------------------------------------------Answer 04:
A) Calculate MC based on given Q values as per the table (04 01) using formula,
MC= $100+$ 0.004Q
Q, Units of Output

Marginal Cost (MC)

2500

110

5000

120

7500

130

Table (04 01)

B) Calculate Q based on given MC values as per the table (04 02) using formula,
MC= $100+$ 0.004Q
Page | 8

Marginal Cost (MC)

Q, Units of Output

100

125

6250

150

12500

Table (04 02)

Graph (04 01)

Outpu
t,Q
0

MC,
Rs
100

Price,
Rs
150

2500

110

150

5000

120

150

6250

125

150

7500

130

150

12500

150

150

MR =

TR /

TR,Rs
0
37500
0
75000
0
93750
0
11250
00
18750
00

MR,
Rs
150
150
150
150
150
150

TR = Price x Q

Since piece is stable at $ 150, MR graph is a straight line which is parallel to the X
axis, as shown in Graph (04 01). When profit maximization MC = MR which is the
point [12500,150].
Therefore the profit maximizing level of output is 12500, if price is stable at $ 150 per
chip.
Page | 9

Master of Business Administration (MBA 2014)

Course: MBA 502 Economic Analysis for Business
Assignment 1
(Questions & Answers)
Part A: MCQs

1) What is the opportunity cost of unemployed labour

A) Wages that the unemployed could have earned
B) Output the unemployed could have produced
C) Government funds to support the unemployed
D) Zero
2) Which of the following would cause the production possibility frontier for an
economy to shift outwards?
i) A reduction in the level of unemployment
ii) A rise in the rate of investment
iii) A fall in the price of one factor of production
iv) A rise in output per worker
A) (i) & (ii) only
B) (i), (ii) & (iii) only
C) (i), (iii) & (iv) only
D) (ii) & (iv) only
3) In a free enterprise economy, (based on the price system), the allocation of scarce
resources between alternative uses is determined
A) According to profitability in the product market
B) By the tastes and preferences of consumers
C) According to the greatest opportunity cost of the factors
D) By a central planning authority

Page | 10

4) Demand curve DD shows that

Price of X

A) More X is demanded as its price rises

B) As more X is demanded, the price rises

C) More X is demanded as its price falls

D
Qty of X

D) The only factor that affects demand is its own price

5) The If the demand curve for lemons is Pd = 20 - 5 Q, and the supply curve for
lemons is Ps = 2 + 1 Q (where P is measured in Rs. per unit, and Q stands for
quantity), what is the equilibrium price for lemons?
A) Rs. 3 per unit
B) Rs. 5 per unit
C) Rs. 8 per unit
D) Rs. 10 per unit
-------------------------------------------------------------------------------------------------------Answer (5):
Pd = 20 - 5 Q -------------- 1
Ps = 2 + 1 Q -------------- 2
At equlibrium Pd = Ps,
Therefore, 20-5Q = 2+1Q
6Q = 18
Q=3
Then Pd = Ps = 2+1Q = 5
Therefore equilibrium price for lemon is Rs.5
Same can be derived from the following supply & demand curves

Qty
Supply, Q
(Units)
1
2
3
4

Price/Unit,
Pd
(Rs)
15
10
5
0

Price/Unit,
Ps
(Rs)
3
4
5
6

Page | 11

-------------------------------------------------------------------------------------------------------6) The demand curve for table tennis rackets is Pd = 300 - 6 Q, and the supply curve
for table tennis rackets is Ps = 20 + 10 Q. P is measured in Rs. per racket, and Q in
number of rackets sold per day. If the price of a table tennis racket is set at Rs. 120,
the table tennis racket market will experience:
A) Equilibrium
B) An excess demand of 10 rackets a day
C) An excess demand of 20 rackets a day
D) An excess supply of 20 rackets a day
-------------------------------------------------------------------------------------------------------Answer (6):
Pd = 300 - 6 Q
Ps = 20 + 10 Q
Qty, Q
(Units)
10
20
30
40
50

Price/Unit, Pd
(Rs)
240
180
120
60
0

Price/Unit, Ps
(Rs)
120
220
320
420
520
Page | 12

At Ps = 120,
20+10Qs = 120
Then Qs = 10
Since price is Rs 120 using Pd = 300 - 6 Q, Qd can be calculated.
300 - 6Qd = 120

Qd = 30

Therefore if the tennis racket is set at Rs120, there will be an excess demand of 20 [30
20] rackets a day can be experienced.
-------------------------------------------------------------------------------------------------------7) The cross elasticity of demand for cars with respect to changes in the price of petrol
is -0.5. At an average price per car of $ 5000, the number of cars sold per week is
10,000. If the price of cars remains unchanged but the price of petrol increases from
40 cents to 44 cents per litre, the number of cars sold will fall to
A

5000

7500

8500

9000

9500

Page | 13

-------------------------------------------------------------------------------------------------------Answer (7):

XED =

Percentage Change in Qty demanded of Cars

Percentage Change in Price of Petrol

XED = { QCar / QCar}x {PPetrol / PPetrol}

-0.5 = { QCar /10,000} x {40/(44-40)}
Therefore Q Car = -500
Then number car sold fall by 500 & it is (10000-500) = 9500
-------------------------------------------------------------------------------------------------------8) A business currently selling 10,000 units of its product per month, plans to reduce
the retail price from $ 1 to $ 0.90. It knows from previous experience that the price
elasticity of demand for this product is 1.5
Assuming no other changes, the sales which the business can now expect will be
A. 8500

B 9,000

C 11,000

D 11,500

-------------------------------------------------------------------------------------------------------Answer (8):
PED =

Percentage Change in Qty demanded

Percentage Change in Price

PED = {

Q/ Q}x {P/

-1.5

Q/ 10,000}x {1/(0.9-1)}

= {

P}

Therefore,
Q = 1500
Therefore new sales units = 10000 + 1500 = 11,500
--------------------------------------------------------------------------------------------------------

9) Normal profit is:

A) The profit that the owner can earn from the business in a normal year
B) The average return for the business that the owner is in

Page | 14

C) The highest return for the business that the owner is in

D) The target profit for the year set by the owner
Normal profit is defined as the minimum reward that is just sufficient to keep the
entrepreneur supplying their enterprise. In other words, the reward is just covering
opportunity cost - that is, just better than the next best alternative. (Howarth, n.d.)
Assumed in a normal year, owner can only earn a normal profit.
Normal Profit = Total revenue (Explicit costs + Implicit costs) = 0 (Fonseka, 2013,
p.174)

10) Economic profit is:

A) The difference between total revenue and total explicit costs
B) The difference between total revenue and total opportunity costs
C) Synonymous with normal profit
D) Composed of normal profit plus abnormal profit

Page | 15

References:
Fonseka, A.T. (2013). Economic Theory and Management Practice, Colombo:
Postgraduate Institute of Management Publication.
Howarth, R. (n.d.). Economics
Online. Retrieved from http://www.economicsonline.co.uk/Business_economics/Profit
s.html

Page | 16

Weightage: 25%
Date Due: Group C 14 Feb 2014

Prof. A.T.Fonseka

Page | 17