MBA_V19 IY2593_ Managerial Economics Hamid Nabati Page | 1

Consumer theory and applications

(Assignment 1: Individual exercises)
Hamid Nabati (19750904-8091)

Part 1: Exercise

1) Which of the following is the best example of how the question of “what goods and services to produce?”
is answered by the command process?

A. Government allowance for the deduction of interest payments on private mortgages

B. Laws regarding equal opportunity in employment
C. Government subsidies for windmill energy production
D. Government regulations concerning the dumping of hazardous waste

I choose the item C as the right answer. The command processes often means that government might
provide material motivations in certain way that motivates firms to produce specific products and earn profit.
Answer item C also means that by providing subsides for windmill energy production, more firms will be
motivated to invest in such a green energy production and also to earn profits from both subsides and
energy production.

2) Business risk involves variation in returns due to the ups and downs of the economy, the industry and
the firm.

A. Fluctuational
B. Structural
C. Business
D. Financial

This is explicitly explained in the chapter 2 in the “Maximizing the Wealth of Stockholder” section.

3) Firms are organized to keep their costs as low as possible by

A. Analyzing supply and demand conditions.

B. Utilizing the latest technology.
C. Comparing external transactions costs with internal operating cost.
D. Minimizing their use of borrowed funds.

As it is explained in chapter 2 (section “The Firm”), a firm allocates its resources between internal operations
and external transactions to keep its total cost at a minimum level.
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4) How long is the “short-run” time period in the economic analysis of the market?

A. Total amount of time it takes original sellers to leave the market

B. Three months or one business quarter
C. Total amount of time it takes new sellers to enter the market
D. Total time in which sellers already in the market respond to changes in demand and
equilibrium price

Based on the definition in the reference book, we can consider the “short-run” as time period in which the
both seller and buyer who are already in the market react to any change in the price. So the D item is the
best choose for right answer.

5) Which of the following will result in a decrease in demand for residential housing in the short run?

A. A decrease in the prices of residential housing

B. An increase in the wages of carpenters
C. A decrease in real household incomes
D. A decrease in the price of lumber

In a short-run time period, any decrease in real household incomes results in less demand for residential
housing. As a result, the price will fall. Item C is the right answer.

6) Which of the following indicates that there is a shortage in the market?

A. Price is falling.
B. Demand is falling.
C. Demand is rising.
D. Price is rising.

When there is a shortage in the market (which means demanded quantity exceeds the supplied quantity),
competitive factors create the pressure for price rising. D is the right answer.

7) Suppose the price of beans rises from €1.00 a kilo to €2.00 a kilo, quantity demanded falls from 10
units to 6 units. In this example, the demand for beans is said to be

A. Perfectly inelastic.
B. Relatively elastic.
C. Relatively inelastic.
D. Perfectly elastic.

EP = (4/10) / (1/1) = 0.4 . So 0 < EP < 1 and the demand is relatively inelastic.
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8) The owner of a produce store found that when the price of a head of lettuce was raised from 50 cents
to €1, the quantity sold per hour fell from 18 to 8. The arc elasticity of demand for lettuce is

A. -1.15.
B. -0.8.
C. -1.57.
D. -0.56.

𝑄2 −𝑄1 𝑃 −𝑃 18−8 0.5−1

𝐸𝑃 = (𝑄1 +𝑄2 ) ⁄ (𝑃21 +𝑃21)  𝐸𝑃 = (18+8) ⁄ (0.5+1) = −1.15
2 2 2 2

9) The t-statistic is computed by

A. Dividing the standard error of the coefficient by the regression coefficient.

B. Dividing the regression coefficient by the standard error of the estimate.
C. Dividing the regression coefficient by the standard error of the coefficient.
2
D. Dividing the R by the F-statistic.

t-statistic is defined by dividing the estimated coefficient to SEC(its standard error of coefficient). So the item
C is the most correct one.

10) Which of the following is the exponential trend equation to forecast sales (S)?

t
A. S = a + b

B. S = a + b(t)
2
C. S = a + b(t) + c(t)

D. None of the above

t
S = a. b is the right form for the exponential trend equation.
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Part 2: Case Study

Netflix is a subscription-based online media streaming service provider that offers movies, tv series and
shows to over 139 million paid subscribers worldwide, generating approximately $16 billion in revenue in
2018. From a start, the company revolutionized the business model of DVD rentals, and later moved on to
make inroads in online media streaming with high-quality contents, both by co-producing with major movie
studios and making its own original production. From successful series such as House of Cards, Orange is
the New Black, Stranger Things, and The Crown, Netflix has become a serious contender at Emmy and
st
Golden Globe Awards with its many nominations. This year, Roma is nominated at the 91 Academy
Awards for Best Picture, the most prestigious honor in the movie industry.

In many ways, we can see that Netflix is a firm with an innovation and a clear strategy. However, due to its
increasing focus to produce and secure distribution rights of new additional contents, especially to cater to
local consumer tastes, Netflix is committed to raise $2 billion in debt over the coming years to finance
these projects.

Answer the following in detail:

1. Drawing from Chapters 1-5, explain the goals of Netflix as a firm, what its products and customers
are.
2. Do you think the demand for its product is elastic or inelastic? Why?
3. What will happen to the supply and demand, both short-run and long-run, if 5G network technology
is quickly gaining widespread adoption in many countries within three years from now? Why?
Remember to take into account the huge investment Netflix will be making.
4. Netflix’s strength has always been its deep knowledge of its customers’ needs and how quick it adapts to
them. This is, in part, due to the vast amount of real-time data it can gather from each viewer.
If you are a consultant for Netflix, and you are given a task to create a new model to estimate
the demand for the sequel of the hit tv series “Breaking Bad,” what variables will you include in
the model? Why?

You can make assumptions; give examples, use graphs, and all relevant information to complement
your answers. Put citations and references, where appropriate.

Q1 (The goals of Netflix as a firm, its products and customers):

Netflix was stablished at 1997 to deliver the movie DVDs using an online rental service.
The Netflix business core model was to send and get back their DVDs to their subscribed
customers by mail and now it is running mainly by offering high quality (even 4K) video
streaming worldwide with a low monthly subscription fee starting at $9 per month. Their
subscribers are located mainly in North America, Latin America, and Europe. Their innovating
model has enabled the possibility to view the high-quality streaming content on any screen at any
desired time (Netflix Media Center, 2019).
Looking to the company history and the business model that they have used so far, the followings
can be considered as the Netflix business goal:
1- Assuming the profit maximization hypothesis, the Netflix also has the primary business
goal to earn profit and maximize it.
2- Dominating the market and maximizing its market share.
3- Providing high quality service for its customers.
4- Creating technological advancement.
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Q2 (Elastic or inelastic demand for its product? Why?):

Elasticity is defined as the ratio between percentage change in the demanded quantity to
the percentage change in the price. It is often used as the rule of thumb that for luxury services
and products demand is elastic. (Keat, et al., 2014) Netflix service cannot be considered as
necessity for many people, so I expect that its demand is probably more elastic. To verify this, I’ll
look to some available data. Netflix has three streaming plan: Basic, standard and premium. The
following graph shows the history of price change of all three plans (Molla, 2019):

Figure 1 History of Netflix price change (Molla, 2019)

And the following picture show the subscribers growth rate from 2012 to 2018 (Bernard, 2018):

Figure 2 Netflix subscriber growth rate (Bernard, 2018)

Considering the changes between April 2014 and April 2018, I calculated the arc price elasticity as
follow:
∆𝑄 ∆𝑃
𝐸𝑝 = ⁄𝑃 Equation 1
𝑄𝑎𝑣𝑔 𝑎𝑣𝑔
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I have calculated an average subscription price of all three plans in 2014 and 2018:
P2014 = ($8 +$9 + $12)/3 = $ 9.67
P2018 = ($8.5 +$12 + $15)/3 = $ 11.83

(130−50) (11.83−9.67)
𝐸𝑝 = (130+50) ⁄ (11.83+9.67) = 4.4 > 1
2 2

Which shows relatively elastic demand and it is consistent with the hypothesis that we had.

Q3 (Future of Netflix supply and demand, both short-run and long-run considering emerging
5G network technology):
5G is more or less same as the current 4G technology; however it provides more
improvements in reliability, coverage, and speed. Easier access to 5G makes it possible for
subscriber to view the streaming content not only on Smart TVs and consoles, but also on tablets
and smartphones anytime and anywhere they are. This will greatly affect the market, but not in
the short-run. The vast investment that Netflix will make, decreases the profit in the short-run, as
the supply and demand won’t grow more than what is has been predicted with current 4G and
network cable lines. Also it must be considered that it takes a while before customers adjust
themselves to the new 5G technology and buy devices that support that. However as time passes
and over a longer period, consumers will finally come up with 5G devices and in much more
areas in the world. This will change the demand and supply curve sharply and long-run will most
probably show a better benefit for Netflix.
However, during the investment period, if Netflix decides to raise the subscription price, it would
affect the short-run demand and number of subscriber will decline.

Q4 (What variables will you include to create a new model to estimate the demand for a TV
series? Why?):
A good forecasting for a TV series must be based on the knowledge of the past viewer
and also should be consistent with other parts of Netflix business line. Netflix as data-driven
company has the possibility to see and report the statistics on how many of the subscribers
completely watched all the parts in the previous series of “Breaking Bad” or in the simple word
“How many subscribers who started watching the first season of “Breaking Bad” continued to
watch it to the end of last season?” This is one of the key variables that I will use in my model.
This is the data that I can use to project for future prediction. Another variable that I will include
in my model is the given ratings to the “Breaking Bad”. This factor also could greatly affect the
decision for series continuation. Also the time period between watching different seasons also is
a variable that I will include in my model, as it is a sign for how much interesting is this series.
The zip code of the subscribers that watched the content will be included in the model as well.
This will show which area has the greatest interest in this TV series. The growing rate of
subscribers in those areas can be included in the model to make a good estimation of demand
quantity.
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Bibliography
Bernard, Z., 2018. netflix-subscription-subscribers-growing-charts-2018-4. [Online]
Available at: https://nordic.businessinsider.com/netflix-subscription-subscribers-growing-charts-
2018-4 [Accessed 10 February 2019].
Keat, P., Young, P. & Erfle, S., 2014. Managerial Economics. 7th ed. Global Edition ed.
s.l.:Pearson.
Molla, R., 2019. The history of Netflix price increases in a single chart. [Online]
Available at: https://www.recode.net/2019/1/16/18185174/netflix-price-increase-subscription-chart-
original-content-streaming [Accessed 10 February 2019].
Netflix Media Center, 2019. About Netflix. [Online] Available at:
https://media.netflix.com/en/about-netflix [Accessed 10 February 2019].