Managerial economics principles and applications

Managerial Economics Question Set

The demand function for Good X is defined as Qx = 75-2Px - 1.5Py, where Py is the price of Good Y. Calculate the price elasticity of demand using the point formula for Px = 20 and Py = 10. Determine whether demand is elastic, inelastic, or unit elastic with respect to its own price and whether Good Y is a substitute or a complement with respect to Good X.

Py

Substitute Px = 20 and Py = 10:

To find PED, another variable point is needed:

Increase Px by 15% (23),

6/20 x 100% = -30%

PED = -30/15 = -2

Because PED < -1, the demand is price elastic. (A rise in the price by $1 results in a reduction in Q. Of 2).

Let Py increase by 50% = 15

When Py increase, Qx= 75-2(20) - 1.5(15) = 12.5

The percentage of change in Qx = -(20-12.5)/20 x 100% = -37.5%

To find XED, use the equation (-37.5/12.5) / (50/15) = -0.9

Because XED is negative, Good Y is a complementary good. (Good Y is a complementary good because it has a negative value. If Good Y were a substitute good, any increase in the price of Y would result in an increase in the quantity demanded of X. Alternatively, the amount of X demanded would decrease whenever the price of Y is increased. When the price of a good increases consumers purchase less of the complementary goods associated with it, as demonstrated by the formula above.)

2.) How important is saving for a household and the economy? How much should be saved?

In the wake of the devastating recession which rocked global financial markets during the last few years, the importance of saving and spending within one's means has been heightened for a generation accustomed to the free flow of credit and lending. Even as average incomes in America have risen to their highest historical levels, "U.S. household debt as a share of income has increased steadily during the past quarter of a century ... (and) this debt to income ratio has soared, reaching nearly 135% in 2007" (Gwartney, et al., 2010). The federal government's rampant lending and spending of money borrowed from its own Social Security program, or increasingly the Chinese government, mirrors the average American family's inability to save money on a consistent basis. This has led to a disturbing "paradox of excessive consumption and deficient saving (as) you cannot have a strong, healthy economy if all or most households face financial troubles, because they are spending just about everything they earn (or can borrow) on consumption" (Gwartney, et al., 2010). To address this issue, families with the means to do so should devote at least 10% of their salaries to a savings account of some sort, as a way of ensuring their own future financial security.