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PART 1.
Q1.
Water is inexpensive to produce in most parts of the world while diamonds require
difficult search and discovery, expensive mining, and extensive transportation and
security expenses. In other words, diamonds cost more than water, so minimum asking
prices of suppliers dictate the higher market value observed for diamonds.
(McGuigan, Moyer, Harris 2014)
According to demand and supply theory, market price equilibrium is related to use value,
production cost and scarcity results from simultaneous interaction of buyers and sellers.
However, the concept of marginal use suggestsadditional to total use value, production
cost and scarcity, the price may also be determined by its marginal use value. The
marginal use value is resulting from its most important use to a person.When someone
possesses a good, he will use it to satisfy the highest priority need. Once the highest
priority need is satisfy, he will use it to less important uses as long as the more urgent
uses have been satisfied.
Eugen von, Bhm-Bawerk (1891) exemplifies a farmer with five sack of grain. From the
first grain, he will make bread as sustenance to survive. From the second sackof grain, he
will make another bread to be strong to work. Then, the third sackof grain he will feed his
farm animal. The forthsackof grain, he will used it to make whisky, and the fifthof grain
he will feed to the pigeons. If one of those sack of grain gone, he will not reduce each of
those activities proportionately, but he will stop feeding the pigeons. Therefore the value
of the fifth sackof grain equal to the satisfaction feeding the pigeons. If he sells the fifth
sack of grain and not feeding the pigeons, his least productive use of the forthsackof grain
is to make whisky. Hence, the value of forth sackof grain is the value of whisky. But if he
loses four sacks of grain, only then that he will start eating less. The last sack of grain is
worth of his life.
In other words, it is not the total usefulness of that matter, but the usefulness of each
additional unit to a person that govern the price. The total usefulness of water isvital to
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sustaining life. But the water is abundant in supply and inexpensive to produce in most
part of the world. Once the highest priority need for water is satisfied,the usefulness of
each additional unit of water becomes low.
Therefore, additional unit of water becomes less value as the supply of water increases.
Oppositely, diamonds are very low in supply. Such low supply that makes the usefulness
of one additional unit of diamond is greater than one additional unit of water that
abundant in supply. This makes diamond worth more than water. Therefore, people who
want diamond are willing to pay a higher price for one diamond and seller of diamonds
will sell one diamond higher than water.

Extracted from James R. McGuigan, R. Charles Moyer, FrederickH.deB. Harris,.(2014).

Managerial Economics.Cengage Learning. Singapore.

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Thediagram shows marginal cost of producing water is cheap up to 90 gallons which is a
typical households daily consumption. While marginal cost of producing diamond are
very steep even small quantity (two carat). However, buyer still regards the cosmetic
diamond as highly valuable uses. Therefore, THE equilibrium market price of diamond
should be traded exceed equilibrium market price of water.
Q2.
Event: 1. Firm plan to increase the price of its product next period.
2. The firm also anticipates that consumers disposal incomes will also increase.
From price elasticity of demand, ED = %QD/(%P), the effect of price increase on
quantity demanded is equal to %QD = ED(%P).
From income elasticity formula, Ey =%QD/(%Y), the effect of income increase on
quantity demanded is equal to %QD =EY(%Y)
Assumption:priceand income effects are independent and additive, the quantity
demanded next period, Q2 equal to current period demand, Q1 plus changes caused by
the price and income increases
Each of price elasticity of demand, EDandincome elasticity formula, Ey, percentage
changesmultiplied by current period demand, Q1 to get the changes inquantity demanded
caused by the price and income increases.
Q2 = Q1 + Q1ED(%P) + Q1EY(%Y)] or
Q2 = Q1[1 + ED(%P)+ EY(%Y)]
Example:
ABCplan to increase price of its product 6 percent next period and anticipates that
disposable income will also increase 5 percent next period. The price elasticity of demand
estimated 1.2 and the income elasticity estimated at 2.0. ABC currently sells 3 million
units per year.
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Assumption:
1. Both elasticities constant over the range of price and income changes anticipated.
2.Otherfactors that influence demandunchanged.
Using this formula:
Q2 = Q1[1 + ED(%P)+ EY(%Y)]
The quantity demanded next period,
Q2 = 3,000,000 [1+ (- 1.2)(0.1) + (2.0)(0.05)]
=3,084,000 units
Therefore the estimate demand for next period is 3,084,000 units. It display that the
anticipated income increaseoffsetthe decline in quantity demanded related to price
increase.

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PART 2
a

Quadratic Production Function

Using quadratic model: Q = 0 + 1K + 2L + 3L2 + 4LK

We tabulate production data as follows:

By substituting the respective values of independent variable into the estimated quadratic
production function:
Q = 997.728155 + 0.026213K 3.022041L +0.002814L2 0.000013LK
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The equation indicates that:
b

Every 1%increase in capital will increase production by 0.026213 tons.

Every 1% increase in labor will reduce production hours by 3.02241 hours.

Is the estimated production function good? Why or why not?

Standard error of estimation is 71.47. The prediction error is too large.

Using t-test at the k = 5% level of significant with degree of freedom 12, t.025,12 = 2.179.
Because each of independent variables t-ratiosnot less than -2.160 or greater than
+2.160. Therefore, all of the coefficients are statistically in significant at the 5% level
ofsignificance.
Correlation coefficient, r = 0.9643
The regression model has 96.43% degree of association between variables.
Coefficient of determination, r2 = 0.9299
The regression model, explain approximately 92.99% of the variation in the sample.
Use F-test to test the hypothesis that all the regression coefficients are zero.
The decision is to reject the null hypothesis of no relationship between X and Y at the
k=5% level of significance if F-ratio is greater than the F0.05,1,13 = 4.67
From the summary output, F-ratio = 33.1907 is greater than critical value of 4.67.
Therefore, we reject the null hypothesis that there is no relationship between X and Y at
the 5% level of significance. We can conclude that the regression model does explain a
significant proportion of the variation in the sample.
Conclusion:
The regression model is good but has a large prediction error.
b. Cobb-Douglas Production Function
1. Estimate the Cobb-Douglas production function Q = L1K2, where Q = output; L =
labor input; K = capital input; and , 1, and 2 are the parameters to be estimated.
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Transform Cobb-Douglas production function Q= L 1K2 into logarithm turn equation

into the following equation:
Ln(Y) = + 1ln(L) + 2ln(K)
= - 4.7547; 1= 1.0780 and 2 = 0.4152
Y = - 4.7547 + 1.0780ln(L) + 0.4152ln(K)
The antilog is: Q = 0.0086L1.0780K0.4152
2. Use t-test at the 5 percent level ofsignificance with degree of freedom 12,
t.025,12 = 2.179.From the summary output, each independent variable t-ratios exceed
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2.179. Therefore,both of the coefficients are statistically significant at the 5% level of
significant.
3. The percentage of the variation in output that is explained by the capital (K) and labor
(L) variables is R2 = 94.81%
4. EK = 1 = 0.4152;1% increase in K yields a 0.4152% increase in Q
EL = 2 = 1.0780;1% increase in L yields a 1.0780% increase in Q
5. 1 + 2= 1.0780 + 0.4152 = 1.4932
Since the sum of the exponent of the L and K is greater than 1, the production
function exhibits increasing return to scale.
PART 3
a. Impact of price cut of model A from $30 to $27.
i). ED = Q/PA
= {(Q2 Q1)/ [(Q2 + Q1)/2]}/{(P2 P1)/[(P2 + P1)/2]}
= [(Q2 Q1)/ (Q2 + Q1)] [(P2 + P1)/ (P2 P1)]
2.5 = [(Q2 15,000)/ (Q2 + 15,000)] [(27 + 30)/ (27 30)]
Q2 =19,545 units, therefore model A new total revenue,
TR2 = P2xQ2 =27x19,545 = $527,715, and
TR = $527,715 $450,000 = +$77,715
ii). Margin per unit, M2 = P2 Variable Cost/unit = $27 $15 = $12
Contributing Margin, CM2 = M2xQ2 = 12 x 19,545 = $234,540
CM = $234,540 $225,000 = +$9,540
The change in the contribution margin is positive,price cut for model A would be good.
b. Impact of price cut of model A from $30 to $27 to other model.
i). EAxB= 0.5 = QB/PA
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= [(QB2 Q B1)/(QB2 + Q B1)] [(PA2 + PA1)/(PA2 PA1)]
= [(QB2 5,000)/ (QB2 + 5,000)] [(27 + 30)/(27 30)] = 0.5
QB2 = 4,744 units
EAxC = 0.2 = QC/PA
= [(QC2 - QC1)/(QC2 + QC1)] [(PA2 + PA1)/(PA2 PA1)]
= [(QC2 10,000)/ (QC2 + 10,000)] [(27 + 30)/(27 30)] = 0.2
QC2 = 9,792 units
Total Revenue:
A: 27 x 19,545

= $527,715

B: 35 x 4,744

= $166,040

C: 45 x 9,792

= $440,640

Total Revenue

= $1,134,395

R = $1,134,395$1,075,000=+$59,395. Revenue firmrises, ignorecosts.

ii). Contribution margin:
A: 12 x 19,545

= $234,540

B: 17 x 4,744

= $80,648

C: 25 x 9,792

= $244,800

Total

= $559,988

CM = 559,988 560,000 = $12,

The change in the contribution margin is slightly negative;thereforecompany should not
change the price.

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Part 4.
a. Smart phones from Xiaomi today have imposed upon Apple and Samsung
competitive pressure. Will Xiaomi cause trouble for Apple and Samsung in other
Asian countries including Malaysia and India?
Top Five Smartphone Vendors, Shipments, Market Share and Year-Over-Year
Growth, Q3 2014 Preliminary Data (Units in Millions)

Vendor

2014Q3

2014Q3

2013Q3

2013Q3

Shipment

Market

Shipment

Market

Volumes

Share

Volumes

Share

3Q14/3Q13
Change

1. Samsung

78.1

23.8%

85.0

32.5%

-8.2%

2. Apple

39.3

12.0%

33.8

12.9%

16.1%

3. Xiaomi

17.3

5.3%

5.6

2.1%

211.3%

4. Lenovo*

16.9

5.2%

12.3

4.7%

38.0%

4. LG*

16.8

5.1%

12.0

4.6%

39.8%

Others

159.2

48.6%

113.0

43.2%

40.8%

Total

327.6

100.0%

261.7

100.0%

25.2%

Source: IDC Worldwide Quarterly Mobile Phone Tracker, October 29, 2014
The highest market share from the above IDC table, suggest that Samsung are monopoly
the smartphone market. When look at concentration ratio, we can conclude that both
Samsung and Apple respectively command 23.8% and 12.0% market share, which make

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up an oligopoly market structure. In term of product differentiation, Apple is in
monopolistic competition with its next rival are Samsung and Xiaomi.
Samsung, Apple and Xiaomi in monopolistic market structure.
Apple has product differentiation over its rival Samsung and Xiaomi. Apple create a
premium brand product that preceived luxury. Apple product also come with a slick
design, high quality and durability. Apples strong marketing campaign promote high
image and command loyalty of consumers. The premium brand in turn contribute to high
income elasticity which will increase by a large amound as incomes rises. The lower
income group also will buy Apples product when they can afford it as their incom
increase. Apple iPhone run on iOS compare to it rival, Samsung which running on
Android operating system. All the differentiation has separate iPhone from its close
substitute. If consumers switch to its substitutes, iPhone demand curve will shift leftward
slightly.But most importantly, Apple has always been perceived as the leader in inovation
and Apples fan willing to pay more for its latest product. Some consumers group buy
iPhone as a symbol status. This could imply that, for high income group and Apples
followers, the price elasticity of demand is inelastic. Hence, for profit maximization
purpose, Apple should increase or remain a high price product until its price elasticity
reach unity. For that reason Apple should charge a higher price for its iPhone and make
greater profit margin. However, iPhone has been phenomenal to global market, and there
are always no enough product during the launch period. This because the demand for
latest iPhone always exceeding the quantity supplied. In other words, it means the
quantity supplied remains but the quantity demanded increase dramatically during the
launching period.
P

S1
E2

P2
P1

E1
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Shortage

D1

D2 NEW

Q1 Q2 Q3
Graph 4.1: Quantity demanded increase but quantity supplied remain
From the graph, price equilibrium occur when quantity demanded equal to quantity
supplied at E1. In iPhone case, there is no change in quantity supplied but increase in
quantity demanded. Demand curve shift to the right, from D1 to D2. It means the quantity
demanded increases and cause shortage. The shift in demand causes a temporary shortage
from Q1 to Q3 correspondance to price equilibrium at P1. At this point, Apple will increase
price to P2 and quantity supplied to Q2 to counter the shortage and find new price
equilibrium at E2. Apple production can be consider as underproduction because quantity
demanded is high but the quantity supplied remain the same. Underproduction can cause
market failure, and Apple can be regards as inefficient company.
In monopolistic competition, Apple makes profit in a short-run output. With downward
slope demand curve, At each output, marginal revenue is less than price.
Apple maximization profit by producing the quantity at which marginal revenue equal to
marginal cost.
P

MC

Economic Profit =
(P2 ATC) x QP.MAX

MR =MC
ATC
P2 > ATC
D
P1 = ATC

Profit maximizing quantity

MR
QP.Max

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Graph 4.2: Short run: economic profit
In the long run, eventually its rivals and new entrant enter the market. Technological
improvement expedites the process of imitation or creating substitutes. Thus, demand for
Apple product decrease as more firm join the market. Apples demand curve and
marginal revenue shift to the left. Profit maximizing quantity and price fall. At price
maximization, price equal to average total cost, so economic profit is zero.

MC
P

ATC

Zero Economic Profit =

(P1 ATC) x QP.MAX = 0

MR =MC
P1 = ATC
D Profit maximizing quantity
MR
QP.Max

Graph 4.3: Long run: zero economic profit

In order to regain profit in short-run, Apple has to invent new product that better than its
rival. So Apple has to launch new product to start the cycle again. The short run and long
run cycle of monopolistic also applies to Samsung and Xiaomi. When their product

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reaching zero economic profit, they have to launch new product to pull consumer to
them.
Unlike apple, Samsung pricing its product lower than Apple. This allows Samsung to
been as a substitute for iPhone. When Apple promote its product as a premium luxury
brand product, Samsung promotes a product between normal good and a superior good.
Samsung run its smartphone on android OS and the apps in android market are almost
completely free. Thus Samsung technological advancement promote changing the taste of
consumers which cause Apple demand curve shift to the left. Additional to that, the
income elasticity of demand for Samsung product is slightly elastic compare to Apple.
When Samsung drop price lower that its substitute, Apple, consumer will buy more
Samsung smartphone instead of iPhone. According to law of demand, when price fall,
quantity demanded increase, therefore Samsung can sell more products and have more
profits and eventually dominating the market.
Xiaomi on the othe hand, pricing its product at near cost, in order to gain more consumer
than both Apple and Samsung. Xiaomi are an obvious proof that technology
improvement can expedite immitation or creating substitutes. For consumer who cant
afford neither Samsung nor Apple products, they will opt for Xiaomi. However, as
explain in Apple case, when consumers income increase, Apples income elasticity of
demand will attract the higher income group. Implicitly, it will shift Xiaomi demand
curve to the left and increase quantity demand for iPhone. As long as Xiaomi are
immitating Apple and Samsung innovation, it will not leading the innovation to crack
market power enjoyed by both Samsung and Apple in the short-run. Additional to that,
Xiaomi sell its product online without retail outlet to reduce fixed cost and boost profits.
Apple and Samsung in oligopoly market structure
From IDC Worldwide Quarterly Mobile Phone Tracker, October 29, 2014, we can
presume that both Samsung and Apple being the major vendor for smartphones
worldwide. The rest of the firms including Xiaomi are just fighting what is left of the

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market. Both Samsung and Apple are respectively control 23.8% and 12.0% of the
global market.
Factor that contribute to Samsung domination are:
a. Samsung technology advancement cause change in consumer tastes, lead to leftward
shift of iPhone demand curve. Samsung become a substitutes to iPhone.
b. Android OS offer lots of free apps compare to iPhone apps that has to buy separately.
c. Samsung and adroid OS operate more efficiently compare to Apple.
d. Samsung offer price lower that iPhone.
However, Apple offer superior product only. The demand for Apple product will increase
by large amount as income rises. Furthermore, its product is also scarce and high priced.
To sum up, income elasticity for iPhone is highly elastic for medium income group and
inelastic for high income group and followers.
Samsung in monopoly market
Factor that contribute to Samsung domination are:
e. Samsung technology advancement cause change in consumer tastes, lead to leftward
shift of iPhone demand curve. Samsung become a substitutes to iPhone.
f. Android OS offer lots of free apps compare to iPhone apps that has to buy separately.
g. Samsung and adroid OS operate more efficiently compare to Apple.
h. Samsung offer price lower that iPhone.
From ABI Research, average selling price (ASP) in Q4, 2014 for Samsung, Apple and
Xiaomi respectively are $254, $687 and $220.
P

Apple monopoly superior good

$687

Samsung
Xiaomi

$254
$220
P

Competitive equilibrium

D
Q

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Graph 4.1: Smartphone and iPhone average selling price

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b. As an economic consultant, what would you advise Apple to do in light of the success
of the Xiaomi smart phones? Would you provide similar advice to Samsung?
Apple are better off maintaining what its doing the best. Leading the innovation to create
big differentiation product that difficult to immitate or substitute. Perhaps, its should
strenghten its intellectuall pattern protection to avoid the immitation for certain period.
As for Samsung, the trend of its domination are slowly decrease over time. Perhaps due
to it variety of product has consumed the time for better innovation.

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ATTACHMENT

REFERENCES
James R. McGuigan, R. Charles Moyer, Frederick H.deB. Harris,.(2014). Managerial
Economics.Cengage Learning. Singapore.
Wikipedia. (n.d.). Paradox of value. Retrived from
http://en.wikipedia.org/wiki/Paradox_of_value
Hill. (n.d.). Diamond-water paradox in economic: definition and example. Retrieved from
http://study.com/academy/lesson/diamond-water-paradox-in-economics-definitionexamples.html
International Data Corporation. (2014). Worldwide Smartphone Shipments Increase
25.2% in the Third Quarter with Heightened Competition and Growth Beyond Samsung
and Apple, Says IDC. Retrieved from http://www.idc.com/getdoc.jsp?
containerId=prUS25224914
Hughes. (2015). While Apples average iPhone price surges to $687, Android devices
flounder at $254. Retrieved from
http://appleinsider.com/articles/15/02/02/while-apples-average-iphone-price-surges-to687-android-devices-flounder-at-254

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