ASSIGNMENT 1

Question 41.
A retail bank's sources of funds include savings, time, and checking (current) deposits. In June 2011,
Hang Seng Bank, a leading Hong Kong bank, quoted interest rates of 0.01% on savings accounts,
0.15% on a 12-month time deposit, and nothing on checking accounts.
a. Suppose that the bank incurs an additional 0.2% cost to administer checking accounts, and 0.1%
cost for savings accounts and time deposits. List the three sources of funds in ascending order of
annual cost per dollar of funds.

SAVING ACCOUNT
CHECKING ACCOUNT
TIME ACCOUNT

b. Suppose that the bank has $2 billion of savings deposits, $5 billion of time deposits, and $3 billion
of checking deposits. On a diagram with amount of funds in billions of dollars (from 0 to 10 billion) as
the horizontal axis and cost in millions of dollars as the vertical axis, illustrate the (i) average variable
cost of funds, and (ii) marginal cost of funds.






Average Variable cost and marginal cost graph line will overlap each other because fixed cost is zero.



Problem 42.
Between 2008 and 2009, the average circulation of U.S. newspapers fell by 7%. The New York Times
suffered a relatively smaller decline, with weekday circulation falling 3.6% to 1,039,031. The Times
announced a quarterly loss of $74 million with a slight increase in circulation revenue due to a price
increase in 2008 from $1.25 to $1.50. In early May 2009, it was reported that the Times would raise
its weekday price from $1.50 to $2 and that the price increase would raise revenue by $40 million.
a) Using the 2008 price and circulation information, calculate the price-elasticity of demand for
the New York Times weekday edition.
Demand Elasticity = % change in quantity demanded
0
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10
12
14
2 3 5
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Amount of Funds (in billions of dollors)
Chart Title
AVERAGE VARIABLE COST MARGINAL COST
%change in its price

% change in quantity demanded = - 3.6%
% change in the price = 1.5 1.25 = 20%
1.25
Price elasticity = - 0.18

b) At the current circulation of say 1.04 million and price of $1.50, and assuming 300 weekdays
a year, what is the New York Times current annual revenue from weekday sales?

Annual revenue from weekly sales = 1.04 * 1.5 * 300
= $468 million

c) Consider the expected 2009 price increase from $1.50 to $2. What is the percentage change
in price?

% change in the price = 2 1.5 = 33.33%
1.5

d) Suppose that the expected 2009 price increase from $1.50 to $2 does indeed yield $40
million in incremental revenue. What is the percentage change in revenue over your answer
in (b)?

% change in revenue above $468 million = 40/468 = 8.547 %

e) Substitute the percentage changes from (c) and (d) into the following rule: percentage
change in revenue = percentage change in price + (price-elasticity of demand x percentage
change in price). Calculate the price-elasticity of demand which would imply the $40 million
increase in revenue.

% change in revenue = % change in price (1 + price elasticity of demand)
8.547 = 33.33 * (1+ price elasticity of demand)
Price elasticity = - 0.74

f) Compare the elasticity from (e) at a price of $1.50 with the elasticity from (a) at a price of
$1.25. Does the difference in elasticitys seem reasonable?

There is a reasonable difference in price elasticitys (-0.18 and 0.74) however both being inelastic.



Question 44.
The market demand curve for Potato chips has been estimated to have the equation
Q = 1000 0.2P + 3Y 10B + 5R
Where Q is the quantity demanded of potato chips (in 000 cartons per week),
P = 250 is the price of potato chips (in rupees per carton),
Y = 500 is the per capita income of consumers (in rupees per week)
B = 50 is the price of beer (in rupees per bottle)
And R = 10 is the price of roast peanuts (in rupees per packet).
a. Calculate the demand elasticities for potato chips with respect to (i) own price, (ii) income,
(iii) the price of beer and (iv) the price of roast peanuts.
b. Is demand for potato chips price elastic or inelastic?
c. Is demand for potato chips normal or inferior?
d. Are potato chips and beer complements or substitutes? What of chips and peanuts?
e. If the price of peanuts increases by 50% by what percent will demand for chips change?


Solution.
Q = 1000 0.2P + 3Y 10B + 5R
Q=1000-0.2(250)+3(500)-10(50)+5(10)
=2000 cartons per week.
a) i) Demand elasticity for potato chips with respect to own price =
= -0.2(250/2000)
= -0.025.
ii) Demand elasticity for potato chips with respect to income =
= 3(500/2000)
= 0.75
iii) Demand elasticity for potato chips with respect to the price of beer =
= -10(50/2000)
= -0.25
iv) Demand elasticity for potato chips with respect to price of roast peanuts =
= 5(10/2000)
= .025
b) The demand for potato chips is inelastic as demand elasticity for potato chips with respect to
its own price is more than -1.

c) Potatoes are normal goods as co-efficient of Y(income) is +ve. So, the demand for potato
chips is normal.

d) Potato chips and beer are complements. Potato chips and peanuts are substitutes.

e) Q = 1000 -0.2(250)+3(500)-10(50)+5(15)
=2025.
If the price of roast peanuts increases by 50%,i.e., from 10 to 15, demand for potato chips
increases from 2000 to 2025.
% change in the demand of potato chips = (Final-initial)/Initial *100
= (2025-2000)/2000 *100
= (25/2000)*100
= 1.25% increase.