Professional Documents
Culture Documents
Managerial Economics
Semester 1 2014
Lecture 2A
1
Worked Example - Wine
The supply and demand functions for a quality
wine are given by
Y = Household income
2
Worked Example - Wine
and
Pw = Price of wine
PG = Price of grapes
NW = Number of wineries
3
Worked Example - Wine
Assuming:
P R
= 20 P G
=100
P O
= 24 W e
= 200
Y = 1000 N W
= 41
4
Worked Example - Questions
(a) Calculate the equilibrium price and quantity in this
market.
(b) If the government imposes a price ceiling on wine at
a price of $18.00, calculate the excess demand that will
result.
(c) Calculate the elasticity of demand at this ceiling price.
(d) Using the arc formula, calculate price elasticity of
demand over the price range between the free market
equilibrium price and the ceiling price.
(e) Interpret the results in (c) and (d) above.
5
Solutions
(a) First, substitute the given values for
variables other than own price into the
demand function-
QWD = 1072 - 10 Pw
1072
7
Now, substitute the given values for the
variables other than own price into
the supply function.
S
Q W
= 200 + 20 PW - 0.1(100) - 0.01(200) + 4(41)
= 200 + 20 PW -10 - 2 + 164
= 352 + 20 PW
D S
Q W
=Q
W
1072 - 10 PW = 352 + 20 PW
9
Solutions
So 30PW = 1072 352 = 720
So the equilibrium price in this market is
equal to 24.
We can now solve for the equilibrium
quantity by inserting this price into either
the equation for the demand curve or the
supply curve.
10
Solutions
Demand Curve
D
QW = 1072 - 10 PW
If PW = 24
= 352+ 20(24)
12
Solutions
(b) Now the government imposes a price
ceiling on wine at a price of $18.00 a
bottle.
So, need to calculate, using the equations
for the demand curve and the supply
curve, what will be QWD and QWS at this price.
13
Solutions
Q = 1072 - 10 (18)
D
W
14
Solutions
So, at a price ceiling of $18, demand will
exceed supply by:
892 - 712 = 180
15
Solutions
D
P W
= $18 and Q W
= 892
16
Solutions
Point elasticity formula
dQ P
ED =
dP Q
So differentiate equation for demand curve
with respect to P.
17
Solutions
D
Q
W = 1072 - 10 PW
dQ
= -10
dP
18
ED = -10
892
= - 0.202
18
Solutions
Obviously a negative sign since the
demand curve is downward sloping - price
and quantity demand move in opposite
directions.
Since the elasticity co-efficient, - 0.202, is
less than unity (in absolute terms),
demand for wine is inelastic at this point.
19
Solutions
So if price rises by say 10%, the demand
for wine will fall by 2.02%, and total
revenue will rise.
20
Solutions
(d) Now have to calculate elasticity of demand
over a range of the demand curve between the
points,
D
P W
= $18 and Q W
= 892
D
P W
= $24 and Q = 832
W
21
Solutions
DQ P1 + P2
Arc ED =
DP Q1 + Q2
-60 18 + 24
=
6 892 + 832
-60 42
=
6 1724
= -10 .02436
= -0.2436 22