Part A
Answer all the three questions. Maximum of 250 words for each question. Use
diagrams where appropriate to enhance and explain your response. Provide supporting evidence and references where appropriate to justify your arguments. Please note that in answering economics questions it is important to first identify which part of economic theory you should be drawing on in order to respond appropriately.
Your response should always be firstly identifying what part of theory the question relates to and explaining that theory, how the theory helps to answer the question and then presenting the solution to the question poised.
Question 1. Suppose you are in charge of sales at a pharmaceutical company, and your firm has a new drug that causes bald men to grow hair. Assume that the company wants to earn as much revenue as possible from this drug.
If the elasticity of demand for your company’s product at the current price is 1.4, would you advise the company to raise theprice, lower the price, or to keep the price the same? What if the elasticity were 0.6?What if it were 1? Explain your answer.
Question 2. Automobile manufacturing is an industry subject to significant economiesof scale.
Suppose there are four domestic auto manufacturers, but the demand for domestic autos is no more than 2.5 times the quantity produced at the bottom of the long-run average cost curve. What do you expect will happen to the domestic auto industry in the long run?
Question 3. Imagine that the government statisticians who calculate the inflation rate have been updating the basic basket of goods once every 10 years, but now they decide to update it every five years. How will this change affect the amount of substitution bias and quality/new goods bias?
