(ASSIGNMENT TEMPLATE ENGLISH VERSION)(COVER PAGE)BMME5103PART 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 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.

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)] orQ2 = 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.

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 unitsTherefore 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.

PART 2 1. Quadratic Production FunctionUsing quadratic model: Q = 0 + 1K + 2L + 3L2 + 4LKWe 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 0.000013LKThe equation indicates that:1. Every 1%increase in capital will increase production by 0.026213 tons. 1. Every 1% increase in labor will reduce production hours by 3.02241 hours.

1. 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 = 0.9643The regression model has 96.43% degree of association between variables.

Coefficient of determination, r2 = 0.9299The 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 Function1. 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.

Transform Cobb-Douglas production function Q= L1K2 into logarithm turn equation into the following equation:Ln(Y) = + 1ln(L) + 2ln(K) = - 4.7547; 1= 1.0780 and 2 = 0.4152Y = - 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 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 QEL = 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 3a. 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 = $12Contributing Margin, CM2 = M2xQ2 = 12 x 19,545 = $234,540CM = $234,540 $225,000 = +$9,540The 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= [(QB2 Q B1)/(QB2 + Q B1)] [(PA2 + PA1)/(PA2 PA1)]= [(QB2 5,000)/ (QB2 + 5,000)] [(27 + 30)/(27 30)] = 0.5QB2 = 4,744 unitsEAxC = 0.2 = QC/PA= [(QC2 - QC1)/(QC2 + QC1)] [(PA2 + PA1)/(PA2 PA1)]= [(QC2 10,000)/ (QC2 + 10,000)] [(27 + 30)/(27 30)] = 0.2QC2 = 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= $1,134,395R = $1,134,395$1,075,000=+$59,395. Revenue firmrises, ignorecosts.

ii). Contribution margin:A: 12 x 19,545= $234,540B: 17 x 4,744= $80,648C: 25 x 9,792= $244,800Total= $559,988CM = 559,988 560,000 = $12, The change in the contribution margin is slightly negative;thereforecompany should not change the price.

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)Vendor2014Q3 Shipment Volumes2014Q3 Market Share2013Q3 Shipment Volumes2013Q3 Market Share3Q14/3Q13 Change

1. Samsung78.123.8%85.032.5%-8.2%

2. Apple39.312.0%33.812.9%16.1%

3. Xiaomi17.35.3%5.62.1%211.3%

4. Lenovo*16.95.2%12.34.7%38.0%

4. LG*16.85.1%12.04.6%39.8%

Others159.248.6%113.043.2%40.8%

Total327.6100.0%261.7100.0%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 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.

PQ

S1

P2E2

E1

P1

Shortage

D2 NEWD1

Q2Q3Q1Graph 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.

MCEconomic Profit = (P2 ATC) x QP.MAXPQ

MR =MC

P2 > ATCATC

D

P1 = ATCProfit maximizing quantityMR

QP.Max

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

PQATC

Zero Economic Profit = (P1 ATC) x QP.MAX = 0

MR =MC

P1 = ATC

Profit maximizing quantityD

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 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 structureFrom 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 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 marketFactor 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.

PQ

Apple monopoly superior good

XiaomiSamsung$687

S$254

$220

Competitive equilibriumDP

Graph 4.1: Smartphone and iPhone average selling price

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.

ATTACHMENT

REFERENCESJames 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-definition-examples.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-to-687-android-devices-flounder-at-254

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