ECON90015

Managerial Economics
Semester 1 2014

Lecture 2A

This example is to accompany

Lectures 2 and 3

1
 Worked Example - Wine
The supply and demand functions for a quality
wine are given by

QWD = 100 - 10 PW - 2.0 PR + 0.5 P0 + 1.0 Y

Where
Pw = Price of wine
PR = Price of restaurant meals

Po = Price of other alcoholic beverages

Y = Household income

2
 Worked Example - Wine
and

QWS = 200 + 20 PW - 0.1 PG - 0.01We + 4 N w

Pw = Price of wine

PG = Price of grapes

We = Wage rate of employees

NW = Number of wineries

3
 Worked Example - Wine
Assuming:

P R
= 20 P G
=100

P O
= 24 W e
= 200
Y = 1000 N W
= 41

4
 Worked Example - Questions
(a) Calculate the equilibrium price and quantity in this
market.
(b) If the government imposes a price ceiling on wine at
a price of $18.00, calculate the excess demand that will
result.
(c) Calculate the elasticity of demand at this ceiling price.
(d) Using the arc formula, calculate price elasticity of
demand over the price range between the free market
equilibrium price and the ceiling price.
(e) Interpret the results in (c) and (d) above.

5
 Solutions
(a) First, substitute the given values for
variables other than own price into the
demand function-

QWD = 100 - 10 Pw - 2.0 ( 20 ) + 0.5 ( 24 ) + 1.0 (1000 )

= 100 - 10 Pw - 40 + 12 + 1000

QWD = 1072 - 10 Pw

This is the equation for the demand curve. 6

 The vertical intercept shows the price at
which quantity
107.2 demanded will be zero

So if price were zero, the horizontal

intercept of 1072 shows the
quantity demanded.

1072
7
Now, substitute the given values for the
variables other than own price into
the supply function.

S
Q W
= 200 + 20 PW - 0.1(100) - 0.01(200) + 4(41)
= 200 + 20 PW -10 - 2 + 164
= 352 + 20 PW

This is the equation for the supply curve.

8
 Solutions
Now in equilibrium, Demand and Supply
are equal, so set the equation for the
demand curve equal to the equation for
the supply curve
i.e.)

D S
Q W
=Q
W

1072 - 10 PW = 352 + 20 PW
9
 Solutions
So 30PW = 1072 352 = 720
So the equilibrium price in this market is
equal to 24.
We can now solve for the equilibrium
quantity by inserting this price into either
the equation for the demand curve or the
supply curve.

10
 Solutions
Demand Curve
D
QW = 1072 - 10 PW
If PW = 24

QWD = 1072 - 10 (24)

= 1072 - 240 = 832

So equilibrium quantity = 832
11
 Solutions
Supply Curve
Q = 352 + 20 PW
S
W

= 352+ 20(24)

= 352 + 480 = 832

So the equilibrium quantity = 832

12
 Solutions
(b) Now the government imposes a price
ceiling on wine at a price of $18.00 a
bottle.
So, need to calculate, using the equations
for the demand curve and the supply
curve, what will be QWD and QWS at this price.

13
 Solutions

Q = 1072 - 10 (18)
D
W

= 1072 - 180 = 892

QWS = 352 + 20 (18 )

= 352 + 360 = 712

14
 Solutions
So, at a price ceiling of $18, demand will
exceed supply by:
892 - 712 = 180

15
 Solutions

(c) Now need to calculate elasticity of

demand at this price ceiling of $18.
This is at a point on the demand curve
where

D
P W
= $18 and Q W
= 892

16
 Solutions
Point elasticity formula

dQ P
ED =
dP Q
So differentiate equation for demand curve
with respect to P.
17
 Solutions
D
Q
W = 1072 - 10 PW
dQ
= -10
dP

18
ED = -10
892
= - 0.202
18
 Solutions
Obviously a negative sign since the
demand curve is downward sloping - price
and quantity demand move in opposite
directions.
Since the elasticity co-efficient, - 0.202, is
less than unity (in absolute terms),
demand for wine is inelastic at this point.

19
 Solutions
So if price rises by say 10%, the demand
for wine will fall by 2.02%, and total
revenue will rise.

20
 Solutions
(d) Now have to calculate elasticity of demand
over a range of the demand curve between the
points,

D
P W
= $18 and Q W
= 892
D
P W
= $24 and Q = 832
W

21
 Solutions

DQ P1 + P2
Arc ED =
DP Q1 + Q2
-60 18 + 24
=
6 892 + 832
-60 42
=
6 1724
= -10 .02436
= -0.2436 22