Download Answer Key 1) The following are the assumed supply and demand

Answer Key
1) The following are the assumed supply and demand schedules for hamburgers in Collegetown:
Quantity
Quantity
Price
Demanded
Supplied
$2.00
6,000
15,000
1.75
8,000
14,000
1.50
10,000
13,000
1.25
12,000
12,000
1.00
14,000
11,000
0.75
16,000
10,000
i) Plot the supply and demand curves and determine the equilibrium price and quantity.
2.0
0
1.7
5
1.5
0
1.2
5
1.0
0
0.7
5
0.5
0
0.2
5
Supply
Demand
2
4
6
8
10
12
14
16
ii) What effect would a decrease in the price of beef (a factor of production) have on the
equilibrium price and quantity of hamburgers, ceteris paribus? Explain referring to the graph.
A decrease in the price of an input shifts the supply curve to the right.
iii) What effect would an increase in the price of pizza (a substitute commodity) have on the
equilibrium price and quantity of hamburgers, again ceteris paribus? Explain referring to the
graph.
A rise in the price of a substitute good increases the demand. This shifts the demand
curve to the right.
2) Suppose that the supply and demand curves for Widgets are given by the equations below:
Demand: QD = 26 - ½ * P and the supply curve is given by
Supply: QS = 6 + 1.5 * P
i) Algebraically find the equilibrium Price and Quantity. Show your work.
General Solution
QD = QS
a - b*P = c + d*P
(b + d)P = c - a
This Problem’s Solution
QD = QS
26 - ½ P = 6 + 1.5 P
2 P = 20
Q = 26 - ½ P
Q = 26 - ½ (10)
Q = 21
P = (c - a)/(b + d)
P = 10
ii) Why, in general, is the supply curve upward sloping?
An upward sloping supply curve reflects increasing cost of production. As more units are produced,
they get marginally more expensive to produce.
3) The city of Whatson Transit Authority runs the only bus company in the city. The current price of a
bus ticket is $1.25 and 800,000 tickets are sold each week. An economic study has found the demand
elasticity of tickets to be d=0.85.
i) Is demand elastic, unit elastic or inelastic?
Since d=0.85 < 1, demand is inelastic.
ii) What is the total revenue for bus ticket sales?
TR  P  Q
 1.25  800,000
 1,000 ,000
iii) Should the Transit Authority increase or decrease ticket prices to increase total revenue?
When demand is inelastic an increase in price increases total revenue. This is because the
reduction in quantity is smaller (in percentage terms) than the increase in price.
iv) Suppose that the city wants to increase bus ridership by 10% for environmental reasons. What
price level will accomplish this increase?
This requires two steps:
Step 1: let x be the percentage decrease in ticket prices required to increase the quantity by 10%.
% change in Q
 0.85
d 
% change in P
.10

 0.85
x
.10
x
 0.1176
 0.85
Step 2: calculate the new price
P new  1  x  Pold
 1  0.1176   1.25
 $1.10
4) The graph below represents the market for bread in Ankara.
S
P
200,000
150,000
100,000
50000
50,000
D
1
2
3
4
5
6
7
Q (millions of units)
i) What is the equilibrium Price and Quantity?
P = 100,000 and Q = 6 (million) units is the equilibrium market price and quantity.
Suppose that to insure that everyone can afford bread, which is a basic necessity, the government sets
a maximum market price of 50,000 TL.
ii) This policy is an example of a Price ( Floor Ceiling ).
iii) The quantity of bread demanded under this policy is 7 (million) units, the quantity supplied is 5
(million) units, resulting in an excess ( supply demand ) of 2 million units.
iv) If a black market for bread were established, what would the likely black market price of bread
be?
In the price ceiling were successfully enforced upon bakers, but the government is
unsuccessful and preventing people from reselling the product and prices above the ceiling,
then the black market sales price would be 150,000 TL given that the quantity supplied is 5
million units.
v) A subsidy is a payment by the government to the producer in addition to the payment that the
consumer makes. How much of a subsidy per unit would the government have to make in order for
there the quantity supplied to equal the quantity demanded with a price of 50,000 TL?
A subsidy is like a tax, but the government gives money for each unit sold, rather than taking
money away. If the price to consumers is 50,000 TL then the quantity demanded is 7 million
units. To get suppliers to produce 7 million units the price that they receive must be 150,000
TL per loaf of bread. Therefore, a subsidy of 100,000 TL is required in order to maintain a
price of 50,000 TL for consumers without having a shortage of bread.
5) Briefly explain why most goods possess diminishing marginal utility. Also explain why this means
that a typical individual’s demand curve for a good is downward sloping.
Diminishing marginal utility of consumption is related to the idea of satiation. That is, people
tend to get satisfied with consuming a good. As more and more of the good is consumed,
consumers get more and more satisfied with that particular good, and they get less benefit
from consuming additional units of the good. Since the benefit is less, consumers are also less
willing to pay for more of the good. This is why the demand curve is typically downward
sloping.
6) The graph below represents the budget line and indifference curve for a consumer with income of
$200 and facing a price of $20 on good X.
Y
20
A
15
10
5
5
i)
What is PY?
10
15
X
I
 20 from looking at the graph (see the Y intercept). Since I = $200,
PY
then PY is $10 per unit.
We know that
ii) Which is true at point A?
At point A the inequality MRS  P X is true. The slope of the indifference curve, MRS, is
PY
steeper than the (absolute value of the) slope of the budget line
7) Suppose that a consumer has selected a combination of goods X and Y such that she is spending her
entire income, but such that MU X  MU Y .
PX
PY
i) Show such a situation on an indifference curve graph.
Good Y
Y1
X1
Good X
ii) To increase the utility of consumption, should the consumer consume (more or less) good X,
and (more or less) good Y.