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ECON 211 Assignment 3

Qatar University
Department of Finance and Economics
Intermediate Microeconomics 
ECON 211
Third Assignment
Pricing and Production

Introduction

This assignment seeks to link economic theory with real world. What is required in the first part is to explain the economic theory behind profit maximization for a company operating in perfectly competitive market or in monopolistically competitive market or for a monopolist. The second part requires the use of data and answers to some questions.

Part 1

Explain the theory behind profit maximization with the help of graphs.

Part 2

PoolVac, Inc. manufactures and sells a single product called the “Sting Ray,” which is a patent-protected automatic cleaning device for swimming pools. PoolVac’s Sting Ray accounts for 65 percent of total industry sales of automatic pool cleaners. Its closest competitor, Howard Industries, sells a competing pool cleaner that has captured about 18 percent of the market. Six other vary small firms share the rest of the industry’s sales. Using the last 30 months of production and cost data, PoolVac wishes to estimate its unit variable costs using the following quadratic specification:

The monthly data on average variable cost (AVC), and the quantity of Sting Rays produced and sold each month (Q) are presented in the table below.

PoolVac also wishes to use its sales data for the 26 months to estimate demand for its Sting Ray. Demand for Sting Ray is specified to be a linear function of its price (P), average income for households in the U.S. that have swimming pools (Mavg), and the price of the competing pool cleaner sold by Howard Industries (PH):

The table below presents the last 26 months on the price charged for a Sting Ray (P), average of households with pools (Mavg), and the price Howard Industries charged for its pool cleaner (PH):

obs

Q

AVC

P

MAVG

PH

1

1647

109

275

58000

175

2

1664

118

275

58000

175

3

1295

121

300

58000

200

4

1331

102

300

56300

200

5

1413

121

300

56300

200

6

1378

102

300

56300

200

7

1371

105

300

57850

200

8

1312

101

300

57850

200

9

1301

108

325

57850

250

10

854

113

350

57600

250

11

963

114

350

57600

250

12

1238

105

325

57600

225

13

1076

107

325

58250

225

14

1092

104

325

58250

225

15

1222

104

325

58250

225

16

1308

102

325

58985

250

17

1259

116

325

58985

250

18

711

126

375

58985

250

19

1118

116

350

59600

250

20

91

139

475

59600

375

21

137

152

475

59600

375

22

857

116

375

60800

250

23

1003

127

350

60800

250

24

1328

123

320

60800

220

25

1376

104

320

62350

220

26

1219

114

320

62350

220

27

1120

105

315

55000

200

28

1115

110

310

57000

210

29

1137

114

334

58700

235

30

1150

125

350

63000

240

PoolVac, Inc. incurs total fixed costs of $45,000 per month.

  1. Run the appropriate regression to estimate the average variable cost function (AVC) for Sting Rays. Copy and paste the results from Excel and write down the estimated AVC.
  1. Evaluate the statistical significance of the three estimated parameters using a significance level of 5 percent.
  1. Comment on the algebraic signs of the three parameter estimates.
  1. Write the estimated total variable cost, average variable cost, and marginal cost functions (TVC, AVC, and MC) for PoolVac.
  1. Find the quantity where average variable cost is minimized and compute the minimum average variable cost.
  1. Run the appropriate regression to estimate the demand function for Sting Rays. Copy and paste the results from Excel and write down the estimated demand function.
  1. Evaluate the statistical significance of the three estimated slope parameters using a significance level of 10 percent.
  1. Discuss the appropriateness of the algebraic signs of each of the three slope parameter estimates.
  1. The manager at PoolVac, Inc. believes Howard Industries is going to price its automatic pool cleaner at $250, and average household income in the S. is expected to be $65,000. Using the regression results from part 2 a, write the estimated demand function, inverse demand function (P as a function of Q), and marginal revenue function.
  1. Using your estimated cost and demand function from part 1 and 2, what price would you recommend the manager of PoolVac, Inc. charge for its Sting Ray? Given your recommended price, estimate the number of units PoolVac can expect to sell.
  1. Given your recommended price, estimate the monthly total revenue, total cost, and profit of PoolVac.
  1. For the profit maximizing solution in question 3, compute the point elasticity of demand for Sting Rays.

In the profit maximizing situation in question 3, a 5 percent price cut would be predicted to _______________ (increase, decrease) quantity demanded of Sting Ray by _________ percent, which would cause total revenue to _____________ (rise, fall, stay the same) and profit to _____________ (rise, fall, stay the same).

  1. a. For the profit maximizing solution in question 3, compute the income elasticity of demand for Sting Rays.
  1. Is the algebraic sign of the income elasticity as you expected? Explain.
  1. A 10 percent increase in Mavg would be predicted to ___________ (increase, decrease) quantity demanded of Sting Rays by __________ percent.
  1. a. For the profit maximizing solution in question 3, compute the cross-price elasticity of demand for Sting Rays.
  1. Is the algebraic sign of the income elasticity as you expected? Explain.
  1. A 3 percent decrease in PH would be predicted to ____ (increase, decrease) quantity demanded of Sting Rays by _________ percent.
  1. If total fixed cost increase from $45,000 to $55,000, what price would you now recommend in order to maximize profits at PoolVac? Compute the number of units sold at this price, total revenue, total cost and profit.
  1. If the manager of PoolVac wanted to maximize total revenue instead of profit (a bad idea), the manager would charge a price of ________. At this price, PoolVac’s profit would be ________, which is __________ (higher than, lower than, the same as) the profit in question 3.