# Managerial Economics

1. Use the ideas of consumer surplus and producer surplus to explain why economists say competitive markets are efficient. Why are below- or above-equilibrium levels of output inefficient, according to these two sets of ideas?

2. Suppose the cross elasticity of demand for products A and B is +3.6 and for products C and D is 5.4. What can you conclude about how products A and B are related? Products C and D?

3. Columns 1 through 4 in the table below show the marginal utility, measured in utils, that Ricardo would get by purchasing various amounts of products A, B, C, and D. Column 5 shows the marginal utility Ricardo gets from saving. Assume that the prices of A, B, C, and D are $18, $6, $4, and $24, respectively, and that Ricardo has an income of $106.

**see attached excel file for table

a. What quantities of A, B, C, and D will Ricardo purchase in maximizing his utility?

b. How many dollars will Ricardo choose to save?

c. Check your answers by substituting them into the algebraic statement of the utility maximizing rule.

4. Gomez runs a small pottery firm. He hires one helper at $12,000 per year, pays annual rent of $5,000 for his shop, and spends $20,000 per year on materials. He has $40,000 of his own funds invested in equipment (pottery wheels, kilns, and so forth) that could earn him $4,000 per year if alternatively invested. He has been offered $15,000 per year to work as a potter for a competitor. He estimates his entrepreneurial talents are worth $3,000 per year. Total annual revenue from pottery sales is $72,000. Calculate accounting profits and economic profits for Gomez's pottery.

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#### Solution Preview

1. Consumer surplus is created when the value of the good to them is greater than its price, while producer surplus is generated by the excess in price over cost. Consumers are therefore willing to spend up to the point where price is equal to the marginal utility of the next unit, while producers are willing to produce up to the point where the marginal cost of the next unit generated is equal to its price. Thus equilibrium between buyers and sellers is created at the point where marginal cost is equal to marginal benefit. Producing less would mean that surplus is being forfeited, while overproduction means that the resources could have been used for other ...

#### Solution Summary

Solutions to problems involving explicit costs, marginal utility, and cross price elasticity of demand