ECN 303 Practice Problem Solutions for Chapter 3

3. a. Q =400 - (1,200)(1.5) + (.8)(1,000) + (55)(40) + (800)(1) = 2,400.

b. EP = (dQ/dP)(P/Q) = (-1,200)(1.50)/2,400 = -.75.
EA = (dQ/dA)(A/Q) = (.8)(1,000)/2,400 = .333
c. Since demand is inelastic, McPablo’s should raise prices to increase revenues.

Please also determine the weekly sales of tacos per store if McPablo’s raises price by 4%
while cutting its advertising expenditure by 10%.

%∆Q=Ep(%∆P)+EA(%∆A)
=(-0.75)(4%)+(0.333)(-10%)
=(- 3%)+(-3.33%)
= - 6.33%
New Q = 2,400(1 – 6.33%) = 2248

6. a. This means that if the local population increases by 1 percent, ticket sales will increase by 0.7
percent. The actual population increase of 2.5 (1500/60000) percent implies a sales increase of 1.75
percent.
b. The 10 percent increase in ticket price implies a (.6)(10) = 6 percent fall in ticket sales. Because
demand is inelastic, total ticket revenue increases.

9. a. With demand given by P = 30,000 - .1Q and MC = $20,000, we apply the MR = MC rule to
maximize profit. Therefore, MR = 30,000 - .2Q = 20,000 implies Q* = 50,000 vehicles and P* =
$25,000. GM’s annual profit is (25,000 – 20,000)(50,000) – 180,000,000 = $70,000,000.

b. According to the markup rule (with MC = $20,800 and EP = -9), the optimal price is:
P* = [-9/(-9 + 1)][20,800] = $23,400. Because of very elastic demand, GM should discount its
price in the foreign market (not raise it by $800).

Prilosec Pricing Problem

Given the low price elasticity, the very high markup for Prilosec is not at all out of line.
(The tremendous health and pain-relief benefits of the drug account for the low price
elasticity.) We know that MC = $.60 per dose, P = $3.00 per dose and EP is in the range
–1.4 to –1.2. To test whether or not the current price is optimal, apply the markup rule: P =
[EP/(1+ EP)]MC. For EP = -1.4, the optimal price is P* = $2.10. In turn, for EP = -1.2, P* =
$3.60. Although the optimal price is quite sensitive to the precise estimate of elasticity, the
high $3.00 price is consistent with elasticity within the estimated range.

1
 Airline Pricing Problem

1. MRBd=330 – 2QBd=MC=20,
QBd=155
MRTd=250 – 2QTd=MC=20
QTd=115
QBd+QTd=270, the constraint is non-binding.

2. PBd=330 – 155=$175, PTd=250 – 115=$135,

π=175*155+135*115 – 20*155 – 20*115 – 32,000 =$5,250

3. QTotoal=580 – 2P
P=290 – 0.5QTotoal
MR=290 – QTotoal=MC=20
QTotoal=270, P=290 – 0.5*270=$155,
π=P*QTotoal – 20QTotoal– FC=155*270 – 20*270 – 32,000=$4,450

QBd=330 – P=330 – 155=175

QTd=250 – P=250 – 155=95

Compare QBd and QTd in problem 1 and problem 3. How would you comment on the airline’s
decision making on profit maximization?

4. L=(PBdQBd– 20QBd)+(PTdQTd – 20QTd) – 20,000+λ(180 – QBd – QTd)

=[(330 – QBd)QBd– 20QBd]+[(250 – QTd)QTd – 20QTd] –20,000+λ(180 – QBd – QTd)

L
 330  2Q Bd  20    0
Q Bd

L
 250  2Q Td  20    0
Q Td

L
 180  Q Bd  Q Td  0


QBd=110, QTd=70,
PBd=330 – QBd = $220, PTd=250 – QTd = $180,
π=(220*110– 20*110 )+ (180*70 – 20*70)– 20,000=$13,200

Or, M Bd  M Td , i.e., 330 – 2QBd – 20=250 – 2QTd – 20, combined with the constraint QBd+QTd=180.

Or, with same MC, we should have MRBd = MRTd, hence,

330 – 2QBd =250 – 2QTd, combined with the constraint QBd+QTd=180.

2
 Gasoline Pricing Problem
A BP franchisee owns two gas stations in the metro area: one in Detroit, and the other in West Bloomfield.
He faces the following demand conditions: He has estimated that the demand for gasoline at his Detroit
location is QDet = 60 - 20PDet, and QWB = 80 - 20PWB, where Q is in thousands of gallons sold per week, and P
is in dollars/gallon. It costs him $1.50 per gallon to distribute the gas he obtains from BP. Assuming no
fixed costs.

If the BP franchisee charges the same price for gas at both locations, how much profit would he make?

Charging the same price implies treating the two markets as a single market :

Q1 = 60 – 20 P and Q2 = 80 – 20 P => QT = 140 – 40 P

P = 3.50 – .025QT, and MR = 3.50 – 0.05QT =MC= $1.50
=> QT = 2/0.05 = 40 thousand, and P = 3.5 - .025(40) = $2.50

Profit= 2.5*40 – 1.5*40 = $40 k per week.

Q1=10k, Q2=30k.

If the BP franchisee charges different prices for gas at the two locations, how much profit would he
make?
Q1 = 60 – 20 P1 Q2 = 80 – 20 P2
P1 = 3 – .05 Q1 P2 = 4 – .05 Q2
MR1 = 3 – .1 Q1 MR2 = 4 – .1 Q2
MR1 = MC1 MR2 = MC2
MC1 = MC2 = MC

3 – .1Q1 = 1.50 4 – .1 Q2 = 1.50

=> Q1 = 15k => Q2 = 25k
and P1= $2.25 and P2 =$ 2.75

Note that profit is 2.25*15k – 1.5*15k=$11.25 k and 2.75*25k – 1.5*25k=$31.25k in each market with
$42.5 k in total.

In the uniform pricing case, MR1=$2>MC=$1.5 when the franchisee sells 10k gallons in Detroit.
Since MR1>MC, the franchisee should increase Q1 to increase profit in Detroit. Hence, he sets
MR1=MC and sells 15k gallons > 10k gallons when he has the ability to price discriminate.

Similarly, in the uniform pricing case, MR2=$1<MC when he sells 30k in WB. Since MR2<MC, the
franchisee should sell less in WB to increase profit. Hence, he sets MR 2=MC and sells 25k gallons <
30k gallons in the price discrimination case in WB.

Profit is maximized in each market in the price discrimination case.

3
If he can only obtain 20 thousand gallons per week, how should he allocate the gasoline between the two
gas stations?

Max (P1  Q 1  C1 )  (P2  Q 2  C 2 ) subject to Q 1  Q 2  20

L  [(3  .05Q 1 )Q 1  1.5Q1 ]  [(4  .05Q 2 )Q 2  1.5Q 2 ]  ( 20  Q1  Q 2 )

L
 3  .1Q1  1.5    0 (1)
Q 1
L
 4  .1Q 2  1.5    0 (2)
Q 2
L
 20  Q 1  Q 2  0

We have Q 1  5k , Q 2  15k and   1 . Hence, P1  $2.75 and P2  $3.25
Profit is 2.75*5k – 1.5*5k=$6.25 k and 3.25*15k – 1.5*15k=$26.25k in each market with $32.5k in total.

Another way:

From (1) and (2), we know that M1  M 2 .

3 – .1 Q1 – 1.5= 4 – .1 Q2 – 1.5
Q1 + Q2 = 20

Or, with MC1 = MC2, we should have MR1 = MR2, hence,

3 – .1 Q1 = 4 – .1 Q2
.1 Q2 – .1 Q1 = 1

Q2 – Q1 = 10
Q2 + Q1 = 20

Q1 = 5 k, Q2 = 15 k.