Directions:

Graphs are essential when asked for – write them clearly and label everything!

1. Evaluate this statement: “If I am producing on the elastic portion of demand, then I know that I am maximizing profits because I am producing where MR(marginal revenues) = MC(marginal costs).”

2. Suppose I estimate the following demand function for a dog toy I produce:

Q = 3000 – 40P -2Ppuppy

Where:

Q = quantity demanded in units

P = price in dollars

Ppuppy = average price of a puppy

We are currently operating at the following values:

P = $10

Ppuppy = $500

In addition, suppose MC is $10.

Given all this, please answer the following questions:

a. Derive the firm’s current demand curve and calculate and interpret the firm’s current price elasticity of demand. Be as precise as you can with your elasticity interpretation.

b. Given you answer in b, should the firm increase or decrease output in order to maximize profits (NOT revenues)? Explain and show your work on a well labeled graph. Hint: your graph should indicate the current output level as well as the profit maximizing output level.

c. What is the profit maximizing output and price? Show and explain all your work and match up your answer to your work in part b.

d. When Covid hit there was a large increase in the demand for puppies. In your opinion, what would this do to the intercept (3000) in the demand function above for my dog toy? Given this, would my profit maximizing output increase or decrease? Use the graph in part b to illustrate this answer (Hint: a curve will shift!).

3. Provide a real-world example where you believe a given product’s demand has become more inelastic. Why do you believe this happened?