JOMO KENYATTA UNIVERSITY OF AGRICULTURE AND TECHNOLOGY

MASTERS IN BUSINESS ADMINSTRATION (MBA)

COURSE MANAGERIAL ECONOMICS

COURSE CODE HCBA 3106

STUDENT STANSLAUS M. MUSAU

ADM. NO HDB311-C005-0177/2021

LECTURER DR. JOSHUA MATANDA

QUESTION ONE (20 MARKS)
(a) Using regression equation estimate the demand function for meals served in ordinary
hotels in Nairobi. The data regarding price charged and number of meals served are as
follows:

HOTEL 1 2 3 4 5 6 7 8
Price 30 36 38 281 26 38 32 28
per
meal in
shs.
Meals 200 180 170 220 240 180 210 200
served
per day

Interpret the value of intercept term a and b-coefficient of the estimated regression equation
Y= a + bx

Hotels Price (X) Meals served (Y) XY X2

1 30 200 6000 900
2 36 180 6480 1296
3 38 170 6460 1444
4 281 220 61820 78961
5 26 240 6240 676
6 38 180 6840 1444
7 32 210 6720 1024
8 28 200 5600 784
N=8 ∑X=509 ∑y=1600 ∑Xy=106160 ∑X2 =86529

Y=a+bx
∑ x y=a ∑ x +b ∑ x 2 ………. (i)
Σy =Na+ b ∑ x ……………… (ii)
1,600 = 8a + 509b
106,160 = 509a + 86,529b
to find value b;
= 509/8 = 63.625

Substitute b by 63.63
(l600*63.625) = (8a*63.625) + (509*63.625)
101,800 = 509a + 32385.125b
Therefore;
106,160 = 509a + 86,529b………………. (i)
101,800 = 509a + 32,385b ……………... (ii)
4,360 = 0 + 54,144b
4360
b= =0.080526005
54144
Substituting the values of b in equation
106,160 = 509a + 86,529 x 0.080526005
106,610 = 509a + 6,967.834663
106,600 – 6,967.834663 = 509a
99,192.16534= 509a
99192.16534
a= =194.8765527
509
Thus, the demand function will be:
y =a + bx …. Substitute the values of a and b
y = 194.8765527 + 0.080526005x
The above equation can be interpreted as; at price 0(X) 195 meals are served with a 0.08 rise at
the increase of price by 1 unit.

b) Discuss the factors that are likely to limit the quality of the demand forecast
 The nature/type of market - For a less competitive market or say a monopoly, it is
easier to predict sales but becomes difficult in a market where new firms can freely enter.
In a situation where firms dictate their own prices, the quality of demand maybe affected
since other firms can sell at relatively lower prices.
 Technological advancement – this can happen in a case where a new or an existing
competitor firm offering the same quality of commodities or services goes a notch
higher to offer online services or online mode of transacting capturing the generation Y
may greatly affect the quality of demand.
 Lack of past data - This applies for new products where it’s very difficult to estimate the
correct production sales figures because of lack of past sales data. In this case,
management / an organization has to rely on guesswork and other techniques which
might not be effective.
 Psychological factors - Forecasting the psychological factors of customers is difficult.
They may change suddenly from one that of confidence to apprehensiveness about the
future. For example, a rumor of an impending war, for instance, would create a great
demand for consumable items.
 Choice of appropriate demand forecasting method - The ability to select the
appropriate demand forecasting method is really important because there isn’t a
generally accepted demand forecasting method for all products. This means that different
 techniques should be used for different products. So, selecting the right technique for the
right product will assist in getting the right results.
 Ease of understanding / interpreting the results - This could be a make or break point
for any organization. It is very important for organizations to have people who
understand and can interpret the information generated by the forecaster. It would be of
no help to have information but there being no one to interpret thus making the whole
process futile.

c) Examine the practical importance of demand forecasting

Demand forecasting is a fundamental task that is very important in running a business smoothly
and making sound operational decisions. It assists a business in several ways including;
Budgeting preparing
Demand forecasting helps reduce risks and make efficient financial decisions that impact profit
margins, cash flow, allocation of resources, opportunities for expansion, inventory accounting,
operating costs, staffing, and overall spend. All strategic and operational plans are formulated
around forecasting demand.

Production scheduling and planning

Demand forecasting lets you provide the products your customers want, when they want them.
Proper demand forecasting and inventory control can help ensure a business doesn’t buy
insufficient or excessive inventory.

Storing inventory
Demand forecasting helps firms spend less money on both inventory purchase orders and
warehousing as the more inventory you carry, the more expensive it is to store. Good inventory
management involves having enough product on hand but not too much. Closely tracking
inventory levels lets firms easily restock and forecast inventory over time.
Developing a pricing strategy
Demand forecasting isn’t just about perfecting a business’s production schedule to supply
demand, but it should also help price products based on the demand. Understanding the market
and potential opportunities, businesses can grow, formulate competitive pricing, employ the right
marketing strategies, and invest in their growth. If a business chooses to slash prices or put an
item on promotion, demand may temporarily increase for that product. Without that sale, it may
not have experienced the boost. If there is limited supply of a high-demand product, you can use
the scarcity principle to increase the price as an exclusive offer. However, firms must keep an
eye on new entrants though as supply may increase.
Determining the scale of operations
Demand forecasting helps in determining the level at which a firm is going to operate. For
instance, a high demand forecast that implies increased demand informs on the number of staff
required and vice versa.
Determining the expansion or exit strategy
Demand forecasting informs the measures which can be taken to either exit or expand the
availability of a product in a particular market. From the demand forecasting, a firm is able to tell
whether a particular product is going to be sustainable be available in the market based on the
demand.

d) A seller of textile cloth wants to lower the price of its cloth from shs. 150 per metre to
shs. 142.50 Per metre. If it’s present, sales are 2000 metres per month and further it is
estimated that its price elasticity of demand for the product is equal to 0.7. Show
i. Whether or not his total revenue will increase as a result of his decision to lower
the price
Price elasticity of demand = ∆in quantity demanded = (Q2-Q1)/Q1
∆ in price (P2 – P1)/P1
PED=0.7
Q1=2000 Q2=?
P1=150 P2=142.50
0.7= (Q2-2000)/2000 0.7= (Q2-2000)/2000 -0.035= (Q2-2000) Q2-2000=-0.035*2000
(142.5-150)/150 -0.05 2000
Q2-2000=-70 Q2=-70+2000 = 1930metres
Revenue under initial price/quantity – 150*2000 = 300,000
Revenue under new price/quantity – 142.50*1930 = 275,025
Thus His revenue will reduce to from Shs.300, 000 to Shs.275, 025

ii. Calculate the exact magnitude of its new total revenue

Revenue under new price/quantity – 142.50*1930 = 275,025

QUESTION THREE (20 MARKS)

a) Explain the necessary conditions of price discrimination and point out clearly the
justification for price discrimination

Price discrimination is a pricing strategy that charges different prices from customers for the
same good or service. In perfect price discrimination, the seller charges each customer the
maximum price he is willing to pay. It is most valuable when the profit from separating the
markets is greater than the profit from keeping the markets combined.
Conditions for price discrimination are:
 There must be difference in elasticity of demand: Price discrimination is possible
only when elasticity of demand will be different in different markets. Monopolist
 will fix lower price where the demand will be elastic and higher price where the
demand will be inelastic.
 Differentiated product: Price discrimination is possible when buyers need the
same service in connection with differentiated goods.
 Market imperfections: Price discrimination is possible only when there is some
degree of market imperfections. The seller is able to divide his market into
separate parts only if it is imperfect.
 The firm must be able to identify different market segments, such as domestic
users and industrial users.
 Markets must be kept separate, either by time, physical distance and nature of use,
such as Microsoft Office ‘Schools’ edition which is only available to educational
institutions, at a lower price. Time based pricing – also called dynamic pricing –
is increasingly common in goods and services sold online. In this case, prices can
vary by the second, based on real-time demand related to consumers’ online
activity.
 There must be no seepage between the two markets, which means that a consumer
cannot purchase at the low price in the elastic sub-market, and then re-sell to other
consumers in the inelastic sub-market, at a higher price.
 The firm must have some degree of monopoly power.

b) A cartel includes large and small companies each with different long run average and
marginal cost curves. A cartel requires each member to reduce output by 15% in the short
run from the total output produced while behaving competitively for it to maximize
profits. The authority assigns a quota to each firm that is 15% less than the output
produced by the firm

i. Explain why the 15% reduction rule will or will not maximize total profits of
the cartel
In the short run, the cartel would make profits through charging monopoly prices, market curving
up, and the restricting the output which creates shortage.
On the flip side, the 15% reduction will not maximize profits for the cartel. This is because the
assigned quota is less than the actual production and it is common knowledge that profits are
maximized when the level of output corresponds to the level of Marginal revenue; MR=MC.

ii. How would you assign the quota of each firm to maximize total cartel profits
I would assign the quotas to match the average of the output of the entire cartel. This would
ensure the marginal revenue equals the marginal cost hence maximizing profits.
 iii. Explain why the cartel would adopt the 15% rule
The cartel would adopt the 15% rule because it limits output thus creating artificial shortage
under which it forms the basis for charging exorbitantly high thus maximizing profits.

c) The theory of third degree of price discrimination predicts that a monopolist will
charge a lower price in the market where demand is price elastic and a higher price
in the market where demand is price inelastic. Explain your position on this
statement.
Third degree of price discrimination occurs when a company charges a different price to
different consumer groups. For example, a theatre may segment the customers into seniors,
adults, and children, each paying a different price when seeing the same movie. To validate the
above statement, we can see that even though there is no difference in the cost to the theatre in
supplying these consumers with the products (movies), a slight decrease in price for children
attracts more children to the movie since they do not have much cash at their disposal. This may
not be the case for the seniors who have more cash at their disposal and thus are charged a higher
price compared to the one charged for children without a significant negative effect of the
number of seniors going to the movies.