Microeconomics

Homework-1 Solutions
PGDM Batch 15
Section-C

1. BW Page 86, Problem 9: For solution see HW-1-Solution-2.pdf

2. BW Page 86, Problem 11: For solution see HW-1-Solution-2.pdf
3. (a) Put P = 35 in the two demand equations to obtain Qgp = 325 and Qs = 60.
(b) Let gp and s be the elasticities of Qgp and Qs respectively with respect to price.
gp =
s =

P
P dQgp
=
(5)
Qgp dP
Qgp
P dQs
P
=
(4)
Qs dP
Qs

If P = 35, Qgp = 325 and Qs = 60. Inserting these values into the above equations, we
obtain gp = 0.5385 and s = 2.3333.
(c) The movie theatre is not maximizing revenue by charging each group 35. To maximize
revenue, it needs to charge prices Pgp and Ps such that the elasticity of demand of each
group is 1. Clearly, this condition is not being satisfied at the current price.
(d) To maximize revenue, gp = 1 and s = 1. For gp = 1, we require
Pgp dQgp
Pgp
=
(5) = 1.
Qgp dPgp
500 5Pgp
Solving the above equation, we obtain Pgp = 50 and Qgp = 250. Similarly, for s = 1,
we require
Ps dQs
Ps
=
(4) = 1.
Qs dPs
500 5Ps
This equation gives Ps = 25 and Qs = 100.
Hence, to maximize revenue, the theatre must charge different prices from the general
public and students. As a verification, calculate the total revenue when the theatre is
charging the common price and when it charges different prices. Let T Rgp and T Rs be
the total revenues obtained from the general public and students respectively. Then, if

Pgp = Ps = 35, then

T R = T Rgp + T Rs = (Pgp Qgp ) + (Ps Qs ) = (35 325) + (35 60) = 13475.
On the other hand, if Pgp = 50 and Ps = 25, then
T R = T Rgp + T Rs = (Pgp Qgp ) + (Ps Qs ) = (50 250) + (25 100) = 15000.
Clearly, total revenue is higher under the second scenario.
Additional comments: Profit () is equal to total revenue (T R) minus total cost
(T C). Normally, if total revenue increases, total cost also increases since the associated
output rises. Hence, maximizing total revenue need not necessarily maximize profit.
But for a movie theatre, total cost does not rise with an increase in the audience size.
Whether the audience consists of one person or a hundred people, the total cost of
showing the movie is the same. Total cost is therefore constant. Since
= T R T C,
and T C is constant, maximizing total revenue is equivalent to maximizing profits.
4. BW Page 145, Problem 3:For solution see HW-1-Solution-2.pdf
5. We put food on the X- axis. Let PF = 20 be the price of food and PC = 100 be the price of
clothing.
(a) At the optimum, the marginal rate of substitution (MRS) is equal to the slope of the
budget line. The slope of the budget line is given by

PF
PC

= 15 . Hence, at the optimum

point, M RSF C = 51 .
(b) At the equilibrium, MRS=

C
F

1
5

and we know the the budget line is given by 20F +

100C = 500. So we have two equaltions and two unknowns (C* and F*). Solving them
we get C = 2.5 and F = 12.5. Maximized utility U = 31.25.
(c) Let A be the optimum point and let B be a point with more food and less clothing
than A. As we increase the amount of food, an indifference curve generated by the given
utility function would become flatter. In other words, the slope of the indifference curve
at B (the absolute value of the slope which is all what we need to consider) is less than
at A . Hence, the MRS at B is lower than the MRS at A.