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Managerial Economics: Marginal Rate and Price Elasticity

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I need help with the following topics: What is the marginal rate of substitution (MRS) and why does it diminish as the consumer substitutes one product for another? Use examples to illustrate.

Guided Response:
In 300 words or more, please provide your response to the above discussion question. Find two goods from your own consumption basket and explain how the MRS changes for the two products as you substitute one for the other

The tobacco industry is a prime example to consider when talking about price elasticity of demand. While nicotine use can be addictive for many users, it is not addictive for the so-called "social smokers".

Hainer, R. (2010). Social smokers aren't hooked on nicotine, just smoking. Cable News Network. Retrieved from Weather, Entertainment & Video News. Retrieved November 13, 2012, from ttp://www.cnn.com/2010/HEALTH/04/24/social.smokers/index.html

What can we say about the price elasticity of demand for nicotine products (such as cigarettes, pipes, tobacco) in the group of nicotine addicted users, versus the group of "social smokers"? Can we say whose demand is likely to be more elastic? Why?

Guided Response:
Provide your response to the discussion question in 300 words or more. Further, comment on the effectiveness of government policy aimed at reducing the negative effects of smoking on health. For example, consider high taxation on producers? - is that effective?

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Managerial Economics

When looking at the Marginal Rate of Substitution (MRS), it is important to understand the basic principle that drives the idea. If a person is presented with two products, both acceptable, but one more prized; how much of one will they give up for the other. The Formula for MRS can be determined as follows. MRSxy = Good Y / Good X (Marginal rate of substitution, 2010). Note that the marginal rate of substitution (MRS) is the personal exchange rate of the consumer in contrast to the market exchange rate. The idea of MRS can be exampled in the world of consumer and producer. That is to say, consumers may have two similar products that they like, but one particularly more than the other. On the other hand, a company may have two similar products, but one is cheaper than the other to produce. The trade off between these choices comes at the expense of what must be sacrificed to obtain the other. The optimal solution would be gaining one without being any worse off from losing the other.

As an example, I like Ice Cream. There are many different products on the market, but I have two particular brands that I eat more than any of the others. Breyers is a good brand, and can be purchased at most any supermarket where I live. The other brand that is particularly ...

Solution Summary

This 901 word solution provides three references to tie Managerial Economic concepts together in an understandable fashion. Within the text Marginal Rate of Substitution and Price Elasticity of Demand is covered thoroughly. Examples are given to help make the concepts more understandable.

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Concepts in Managerial Economics

1. In a competitive market, the market-determined price is $60. For a typical firm producing 100 units of output, short-run marginal cost is constant at $65, average total cost is $95, and average fixed cost is $30. Is this firm making the profit-maximizing decision? If not, what should it do?
a) No, it is not making the profit maximizing decision. In the short run, it should reduce its rate of production until its marginal cost is equal to $60.
b) Yes, it is making the profit-maximizing decision.
c) No, it is not making the profit maximizing decision. In the short run, it should increase its rate of production until its marginal cost is equal to $60.
d) No, the firm is not making the profit maximizing decision. It should shut down in the short run to minimize losses.

2. When price is greater than average variable cost but less than average total cost at the profit-maximizing level of output, a firm should
a) continue to produce the level of output at which marginal revenue equals marginal cost.
b) increase output to minimize its losses.
c) reduce output to the level at which price equals average variable cost to minimize its losses.
d) shut down to minimize its losses.

3. In a competitive market, the market-determined price is $25. For a typical firm producing 10,000 units of output, the firm's average cost reaches its minimum value of $25. Is this firm making the profit-maximizing decision? If not, what should the firm do?
a) No, it is not making the profit-maximizing decision. In the short run, it should reduce its rate of production because its marginal cost is not equal to $25.
b) Yes, it is making the profit-maximizing decision.
c) No, it is not making the profit-maximizing decision. In the short run, it should increase its rate of production because its marginal cost is not equal to $25.
d) No, it is not making the profit-maximizing decision. In the short run, it should reduce its rate of production until its average variable cost is equal to $12.

4. In the purely competitive case, marginal revenue (MR) is equal to
a) cost.
b) profit.
c) price.
d) total revenue.

5. If price exceeds average costs for a typical firm in a perfectly competitive industry, ____ firms will enter the industry, supply will ____, and price will be driven ____.
a) no new; remain the same; up
b) more; decrease; down
c) more; decrease; up
d) more; increase; down

6. Which of the following statements is not a characteristic of a perfectly competitive market?
a) Large number of firms in the industry
b) Outputs of the firms are perfect substitutes for one another
c) Limited information is available to all market participants
d) Ease of entry into the market

7. The perfectly competitive firm
a) faces a downward-sloping demand function.
b) can influence market price only in a downward direction.
c) cannot earn any economic profits in the short run because it faces a horizontal demand curve.
d) makes its profit-maximizing decision only on the basis of output.

8. The following are the inverse demand curve and MR curves for a monopolistically competitive firm. P = 1000 - 2Q MR = 1000 - 4Q Where P is the price of the product and Q is the level of production. For the 200th unit of Q, MR is equal to _______ and demand is price ____________.

a) 200, elastic
b) -200, inelastic
c) 600, elastic
d) -600, inelastic

9. In the long run, firms in a monopolistically competitive industry will
a) earn substantial economic profits.
b) tend to just cover costs, including normal profits.
c) seek to increase the scale of operations.
d) seek to reduce the scale of operations.

10. Assume a monopoly has the following demand schedule: Price........Quantity $20.............200 $15.............300 $10.............500 $5...............700 What can you say about the price elasticity of demand along the demand curve between $15 and $20?
a) Demand is price elastic.
b) Demand is price inelastic.
c) Demand is unitary elastic.
d) There is not enough information to tell.

11. Which of the following statements is correct?
a) Barriers to entry do not affect the industry structure.
b) Barriers to entry affect the competitiveness of an industry because they determine whether or not typical firms in an industry will face new competition if they are earning above normal returns on investment.
c) Barriers to entry are highest for monopolistic competition.
d) Barriers to entry can be achieved only through government mandate.

12. Which of the statements below concerning barriers to entry is FALSE?
a) They restrict entry into industries in which positive economic profits are being made.
b) They are somewhat lessened by the existence of patents.
c) They may be due to legal impediments such as licenses.
d) They may be due to a single firm controlling access to a natural resource or production process.

13. In comparing monopoly to a competitive market, which of the following is FALSE?
a) Market price will be higher under monopoly.
b) Equilibrium quantity will be higher under perfect competition.
c) Consumers will be worse off with the monopoly.
d) Employment will be higher under monopoly.

14. All of the following are possible characteristics of a monopoly except
a) there is a single firm.
b) the firm is a price taker.
c) the firm produces a unique product.
d) the existence of some advertising.

15. ZZZ, Inc. operates in a monopolistically competitive industry. Its demand curve can be written as P = 160 - Q and its short run total cost curve is equal to TC = 1000 + Q^2. What is the rate of output that maximizes ZZZ, Inc.'s short run profits?
a) 40
b) 0
c) 53
d) 20

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