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ABBE4024
ECONOMICS FOR MARKETING

September 2008/2009

Suggested Answers

Source: CEL TARC

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Question 1
a) - Monopolistically competitive market.
- Key conditions:
i. There are many buyers and sellers.
ii. Each firm in the industry produces a differentiated product.
iii. Free entry and exit.

b) Niche Marketing. Introduce many varieties of toothpaste into the market to further differentiate
their products from other firms like Procter&Gamble. These include not only “improved”
products, such as Colgate Herbal White, but new product, such as Looney Tunes Bubble Fruit.
Colgate has tailored their toothpaste to meet the needs of different segment of the toothpaste
market.

c) No, Colgate is likely to earn zero economic profit in long run from its Looney Tunes Bubble
Fruit toothpaste. This is because Colgate is in the environment where toothpaste makers of other
brand can easily enter the same market segment to steal some market share from Colgate until
firms in the same market segment earns zero economic profit and there is no incentive for
additional firms to enter this market. As shown in the diagram, entry continues until the demand
curve for Looney Tunes Bubble Fruit toothpaste decrease to D1, where it is just tangent to
Colgate’s average cost curve. (Refer to diagram in chapter 8, Baye.)

d) i) A/R = EQ,A/-EQ,P = 0.6/12 = 0.05

Colgate should spend 5% of its revenue earned from Looney Tunes Bubble Fruit on the
advertising.
ii) The greater the advertising elasticity the greater the optimal level of advertising - direct
relationship.

Question 2
a) PV = (12000/1.07) + (12000/1.072) + (12000/1.073) + (12000/1.074)
= RM40,646.54
The maximum amount I would be willing to pay is RM40,646.54.

b) i) Optimal transfer price = MCu

= RM7,000

ii) Transfer pricing is a pricing strategy which a firm optimally sets the internal price at which an
upstream division sells an input to a downstream division. It is important because most division
managers are provided an incentive to maximize their own division’s profits. If the upstream
mark up prices in excess of true MC of the input, the downstream also ends up charging the price
of the final output higher than MC, double marginalization occurs and the price of the final
output is charged higher than the optimal price, therefore results in lower overall profits for the
firm.

c) NPV = [(14000/1.08) + (14000/1.082) + (14000/1.083) + (10000/1.084) + (7000/1.085)] − 40000

= RM8193.74

Should purchase the machine since the NPV is positive, it means the return rate is higher than
8%.

d) 95 percent confidence interval for the true value of a

= 700±2(4.5)
= 691, 709
95 percent confidence interval for the true value of b
= −12.5±2(0.5)
= −13.5, −11.5
Source: CEL TARC
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d) Eco profit = TR − Explicit cost − Implicit cost

= 100,000−50,000−24,000
= RM26,000

Question 3
a) i) Substitute, cross price elasticity is positive.
ii) Change in TR = RM127,500
iii) Expected TR = RM827,500

b) i) Qd = Qs, P = RM8.78, Q = 632.44 units

ii) CS = RM99,995.09; PS = RM2,498.14
iii) Qs = 330
650−2P = 330
PF = RM160
iv) The maximum price consumers are willing to pay for the available output in market. (Refer
to diagram in chapter 3, Baye.)

c) 15% / % change in advertising = 0.25

% change in advertising = 60% (should increase advertising by 60%)

Question 4
a) i) PxX + PyY = M
Y = −2/3X + 100
ii) Refer to Tutorial 4.
iii) Refer to Tutorial 4.

b) i) MR = MC, Q = 13.5 units, P = RM28

ii) MR = 0, Q = 13.75 units, P = RM27.50
iii) Max Profit = PQ − C
= (28x13.5) − (5+13.5)
= RM359.50
iv) MC = P, Q = 27 units, P = RM1

c) Non-rival: A good which when consumed by one person does not preclude other people from
also consuming the good. Example: Radio signals, national defense.

Non-exclusion: No one is excluded from consuming the good once it is provided. Example:
Clean air

Question 5
a) i) −0.3 (3000/6750) = −0.13, inferior good, higher income leads to lower demand.
ii) −65 (20/6750) = −0.19, inelastic demand, increase price to earn higher revenue.

iii) Q = 8050−65P
P = 123.85−0.02Q
MR = 123.85−0.04Q
Set MR = 0, 123.85−0.04Q = 0, solve for Q = 3096.25,
thus P = 123.85−0.02 (3096.25)
= RM61.93

iv) −25 (18/6750) = −0.07, negative value, X and Z are complements.

b) P = (E/1+E) MC
= RM10
Source: CEL TARC
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c) i) The practice of bundling several different products together and selling them at a single
bundle price.

ii) If charge 368 per bundle, TR = 368 x 6000 = 2,208,000

If charge 288 per bundle, TR = 288 x 7000 = 2,016,000

So, should charge RM368 per bundle.

Source: CEL TARC