Microeconomics (EWMBA 201A)

Problem Set 2
(100 points)

Note: these exercises are more difficult than the typical exercises from the exam. These
problem sets are designed to be solved in groups and with plenty of time. In contrast, the exam
will include short multiple-choice questions that are meant to be solved quickly and
individually. Some of the exercises in the problem sets can be challenging. The goal is to
challenge you to think critically instead of asking you to apply formulas like a robot. If your
group gets stuck with a question, just email the GSI for help.

Submission instructions: Please submit this problem set by the due date in the appropriate
assignment in bCourses. Problem sets and all pages must be submitted as one PDF file. You can
either fill in your answers digitally on the PDF, or print out the problem set, write your answers,
and then scan it for submission.

Problem 1. Pharmaceutical company pricing (40 points)

A pharmaceutical company faces the following demand function for one of its products in the
American market:
QA = 2,000,000 − 20,000PA
where QA is the number of prescriptions sold in the American market annually and PA is the
price per prescription. The firm's annual total cost function is:
TC A = $40,000,000 + $5QA
The company is considering also entering the Brazilian market where the demand for the
pharmaceutical is:
QB = 200,000 − 3,000PB
The cost function for the Brazilian market is:
TC B = $1,000,000 + $5QB

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 Microeconomics (EWMBA 201A)

a. Calculate the firm's optimal price in the US. Show your work.

Q = 2,000,000 – 20,000P
P = 100 – 0.00005Q

TR = P x Q

TR = (100 – 0.00005Q)*Q

TR = 100Q – 0.00005Q^2

MR = ∂TR / ∂Q = 100 – 0.0001Q

TC = 40,000,000 = 5Q
MC = ∂TC / ∂Q = 5

MR = MC

5 = 100 – 0.0001Q

-95 = -0.0001Q

950,000 = Q
Substitute Q back into demand function:

P = 100 – 0.00005(950,000) P = 100 – 47.5

P = $52.5

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b. What is the optimal price to charge in the Brazilian market? Show your work.

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c. Explain why the problem of parallel imports, a form of arbitrage, may result from the
pricing structure you have calculated in the previous questions.

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d. To address the problem of parallel imports, the company is considering two options: 1)
implementing uniform pricing, or 2) paying $1,500,000 annually to implement a
program to monitor US clinics to ensure its products imported from Brazil are not sold in
the US. What should it do to maximize profits? Explain.

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Problem 2. Super Computer Pricing (20 points)

You are an executive for Super Computer, Inc. (SC), which rents out super computers. SC
receives a fixed rental payment per time period in exchange for the right to unlimited
computing at a rate of P cents per second. SC has two types of potential customers of equal
number—10 businesses and 10 academic institutions. Each business customer has the demand
function Q=10 - P, where Q is in millions of seconds per month; each academic institution has
the demand Q=8-P. The marginal cost to SC of additional computing is 2 cents per second,
regardless of volume.

a. Suppose that you could separate business and academic customers. What rental fee and
usage fee would you charge each group? What would be your profits?

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 Microeconomics (EWMBA 201A)

b. Suppose you were unable to keep the two types of customers separate and charged a
zero rental fee. What usage fee would maximize your profits? What would be your
profits?

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Problem 3. Mrs. Smyth’s Demand (40 points)

In early 2002, Mrs. Smyth’s, a Chicago-based food company, initiated an empirical estimation of
demand for its gourmet frozen fruit pies. The firm wants to formulate pricing and promotional
plans for the future on the basis of historical data, and management is interested in learning
how pricing and promotional decisions might affect sales. Mrs. Smyth’s has been marketing
frozen fruit pies for several years, and its market research department has collected quarterly
data over two years for six important marketing areas, including unit sales quantity, the retail
price charged for the pies, local advertising and promotional expenditures, and the price
charged by a major competing brand of frozen pies. Statistical data published by the U.S.
Census Bureau on population and disposable income in each of the six market areas were also
available for analysis. It was therefore possible to include a wide range of hypothesized
demand determinants in an empirical estimation of fruit pie demand. These data appear in the
table below.

1. Run one linear regression of the following form using all these data (also available in Excel
format on the course website) and report the equation with the estimated coefficients.
Qit = b0 + b1Pit + b2Ait + b3PXit + b4Yit + b5Popit + b6Tit
The subscript i indicates the regional market from which the observation was taken, whereas
the subscript t represents the quarter during which the observation occurred.

Where:
Q is the quantity of pies sold during the t th quarter
P is the retail price in dollars of Mrs. Smyth’s frozen pies
A represents the dollars spent for advertising;
PX is the price, measured in dollars, charged for competing fruit pies
Y is dollars of disposable income per capita
Pop is the population of the market area
T is the trend factor (2000-1 = 1,…, 2001-4 = 8)

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2. Please interpret each of the coefficients in the regressions results. For each coefficient,
discuss both the sign as well as its magnitude (e.g., if we were to increase X by Z units, the
variable Y would increase/decrease by …).

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3. Can you explain intuitively the meaning of the coefficient of determination (R2) for the Mrs.
Smyth’s frozen fruit pie demand equation. Does it suggest that demand is mostly
predictable or unpredictable?

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4. Use the results from question 1 to estimate 2002-1 unit sales in the Washington, DC-
Baltimore, MD, market under the following assumptions:
a. P = $7.20
b. A = $30,000
c. PX = $6.00
d. Y = $43,000
e. Pop: Same as in prior period

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5. Using the regression output, please estimate the demand elasticity under the above
conditions (e.g., P = $7.20, A = $30,000, …). Use whatever elasticity formula you prefer (for
most people, it’s easier to use the point elasticity).

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6. Use the formula for marginal revenues as a function of the price elasticity. Calculate
marginal revenue under the above conditions (price of $7.20, …).

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7. Based on the answer to the previous item (i.e., marginal revenues), can you say whether the
price of $7.20 is profit-maximizing? If more information is needed, explain why.

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Advertising Time
Year- Unit Price Expenditures Competitors' Income Variable
Quarter Sales (Q) ($) ($) Price ($) ($) Population (T)
Atlanta, GA 2000-1 193,334 6.39 15,827 6.92 33,337 4,116,250 1
2000-2 170,041 7.21 20,819 4.84 33,390 4,140,338 2
2000-3 247,709 5.75 14,062 5.28 33,599 4,218,965 3
2000-4 183,259 6.75 16,973 6.17 33,797 4,226,070 4
2001-1 282,118 6.36 18,815 6.36 33,879 4,278,912 5
2001-2 203,396 5.98 14,176 4.88 34,186 4,359,442 6
2001-3 167,447 6.64 17,030 5.22 35,691 4,363,494 7
2001-4 361,667 5.30 14,456 5.80 35,950 4,380,084 8

Chicago, IL, 2000-1 401,805 6.08 27,183 4.99 34,983 9,184,926 1

Gary, IN, 2000-2 412,312 6.13 27,572 6.13 35,804 9,237,683 2
Kenosha, WI 2000-3 321,972 7.24 34,367 5.82 35,898 9,254,182 3
2000-4 445,236 6.08 26,895 6.05 36,113 9,272,758 4
2001-1 479,713 6.40 30,539 5.37 36,252 9,300,401 5
2001-2 459,379 6.00 26,679 4.86 36,449 9,322,168 6
2001-3 444,040 5.96 26,607 5.29 37,327 9,323,331 7
2001-4 376,046 7.21 32,760 4.89 37,841 9,348,725 8

Dallas-Fort 2000-1 255,203 6.55 19,880 6.97 34,870 5,294,645 1

Worth, TX 2000-2 270,881 6.11 19,151 6.25 35,464 5,335,816 2
2000-3 330,271 5.62 15,743 6.03 35,972 5,386,134 3
2000-4 313,485 6.06 17,512 5.08 36,843 5,409,350 4
2001-1 311,500 5.83 16,984 5.29 37,573 5,409,358 5
2001-2 370,780 5.38 15,698 6.19 37,781 5,425,001 6
2001-3 152,338 7.41 22,057 6.94 37,854 5,429,300 7
2001-4 320,804 6.19 17,460 6.38 39,231 5,442,595 8

Los Angeles- 2000-1 738,760 5.75 42,925 5.54 28,579 16,381,600 1

Long Beach, CA 2000-2 707,015 6.61 50,299 6.73 28,593 16,544,289 2
2000-3 699,051 5.03 37,364 5.04 28,633 16,547,258 3
2000-4 628,838 6.76 50,602 4.61 28,833 16,553,958 4
2001-1 631,934 7.04 53,562 5.85 29,242 16,587,432 5
2001-2 651,162 6.70 48,911 5.63 29,876 16,680,782 6
2001-3 765,124 6.54 49,422 6.94 30,327 16,716,936 7
2001-4 741,364 5.73 44,061 6.37 30,411 16,717,938 8

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(Continued)
Minneapolis- 2000-1 291,773 5.35 13,896 5.78 29,778 2,972,443 1
St. Paul, MN 2000-2 153,018 6.33 27,429 4.73 30,079 2,974,275 2
2000-3 574,486 5.94 31,631 6.70 30,598 2,989,720 3
2000-4 75,396 7.00 39,176 4.58 30,718 3,020,244 4
2001-1 590,190 5.19 33,538 5.17 30,922 3,021,618 5
2001-2 288,112 7.02 53,643 5.15 31,199 3,025,298 6
2001-3 276,619 7.02 60,284 5.46 31,354 3,042,834 7
2001-4 522,446 5.23 53,595 6.06 31,422 3,063,011 8

Washington, DC, 2000-1 395,314 5.80 22,626 6.56 38,892 7,611,304 1

Baltimore, MD 2000-2 436,103 5.32 22,697 6.38 39,080 7,615,783 2
2000-3 336,338 6.35 25,475 4.53 39,510 7,666,220 3
2000-4 451,321 5.95 25,734 6.31 39,552 7,710,368 4
2001-1 352,181 6.01 23,777 6.24 39,776 7,713,007 5
2001-2 317,322 7.02 27,544 4.86 41,068 7,752,393 6
2001-3 422,455 5.71 23,852 4.86 47,471 7,754,204 7
2001-4 290,963 7.36 30,487 5.32 41,989 7,782,654 8

Average 391,917 6.24 29,204 5.70 34,625 7,706,365

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