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 (M_avg), and the price of the competing pool cleaner sold by Howard Industries (P_H):

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

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.

2. 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.

3. 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.

4. 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).

5. 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 M_avg would be predicted to ___________ (increase, decrease) quantity demanded of Sting Rays by __________ percent.

6. 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 P_H would be predicted to ____ (increase, decrease) quantity demanded of Sting Rays by _________ percent.

7. 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.

8. 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.