2nd Assign Micr-macro (Solution)

1. What is a competitivemarket? Briefly describe the types ofmarkets other than perfectly competitive

markets.2. Colddrinksandpizzaarecomplementsbecausetheyareoftenenjoyedtogether.Whenthepriceofcold

drinksrises,whathappenstothesupply,demand,quantitysupplied,quantitydemanded,andthepriceinthemarketforpizza?

Solution) Whenthepriceofthecomplementgoodincreases,resultsintheleftwardshiftofthedemandcurveforpizzafromDtoDwhichresults:

Demand DecreasesfromDtoDQuantitydemanded DecreasesfromQ0toQ1Quantitysupply DecreasesfromQ0toQ1Supply NochangePrice DecreasesfromP0toP1

3. Definetheequilibriumofamarket.Describetheforcesthatmoveamarkettowarditsequilibrium.Solution)Equilibrium refers to a situation inwhich the price has reached the levelwhere quantity supplied equalsquantitydemanded. EquilibriumPrice:Thepricethatbalancesquantitysuppliedandquantitydemanded.

Onagraph,itisthepriceatwhichthesupplyanddemandcurvesintersect. EquilibriumQuantity:Thequantitysuppliedandthequantitydemandedattheequilibriumprice. Onagraphitisthequantityatwhichthesupplyanddemandcurvesintersect. Lawofsupplyanddemandclaimthatthepriceofanygoodadjuststobringthequantitysuppliedandthequantitydemandedforthatgoodintobalance.

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PAF Karachi Institute of Economics and Technology City Campus Course: Micro & Macroeconomics Faculty: Iftikhar Mubbashir Class ID: (Solution)

Project Part(-II) Assignment Date: Sep 21, 2013 Submission Date: Oct 05, 2013

D

Qpizz

PPizza

D

S

Q0Q1

P0

P1

Price of

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Cone

0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of Ice-Cream Cones

13

Equilibriumquantity

Equilibrium price Equilibrium

Supply

$2.00

Demand

4. Explaineachofthefollowingstatementsusingsupplyanddemanddiagrams.a. WhenacoldsnaphitsFlorida,thepriceoforangejuicerisesinsupermarketsthroughoutthecountry.Solution)

Thecoldsnapwilldestroyorangesandthatwillreducethequantityoforangesproducedwhichwillreducethesupplyofthequantityoforanges.So,therewillbe fewerorangeswhichwillshiftthesupplycurve leftside.Asthefigureshowsthisdecreaseinsupplyraisestheequilibriumprice.

b. WhentheweatherturnswarminNewEnglandeverysummer,thepricesofhotelroomsinCaribbean

resortsplummet.Solution)When theweather turnswarm, therewill be fewer peoplewhowill be eager to visitwarm places likeCaribbean.So,attheexistingpricesthehotelroomswillbeemptyinCaribbean.Inotherwordstherewillbeadecreaseindemandforhotelrooms.Thedemandcurvewillshifttotheleft.Thehotelownerswillreducethepricetokeeptheroomsbooked.Asthefiguresuggests,thiswillreduceequilibriumprice.

c. WhenawarbreaksoutintheMiddleEast,thepriceofgasolinerises,whilethepriceofausedCadillac

falls.Solution)

Wardestroysoilfields,oiltankerswhichreducethesupplyofoil,thesupplycurveforoilmovesleftside.Thusthepriceofgasolineincreasesasisevidentfromthefigure.

5. During the 1990s, technological advance reduced the cost of computer chips. How do you think this

affectedthemarketforcomputers?Forcomputersoftware?Fortypewriters?Solution)

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Psoftwares

Q softwares

D

D

S

Q1Q0

P1

P0

Whenthepriceofthecomplementgoodincreases,resultsintherightwardshiftofthedemandcurveforsoftwaresfromDtoDwhichresults:

Demand IncreasesfromDtoDQuantitydemanded IncreasesfromQ0toQ1Quantitysupply IncreasesfromQ0toQ1Supply NochangePrice IncreasesfromP0toP1

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Qtypewriter

Ptypewriter

D

S

D

P0

P1 Q1 Q0When the price of the substitute good decreases, results in the leftward shift of the demand curve fortypewritersfromDtoDwhichresults:

Demand DecreasesfromDtoDQuantitydemanded DecreasesfromQ0toQ1Quantitysupply DecreasesfromQ0toQ1Supply NochangePrice DecreasesfromP0toP1

Q0 Q1

Pcomputers

Qcomputers

D

S

S

P0

P1

Whentheinputpriceofproductiondecreases,resultsintherightwardshiftofthesupplycurveforcomputersfromStoSwhichresults:

Supply IncreasesfromStoSQuantitydemanded IncreasesfromQ0toQ1Quantitysupply IncreasesfromQ0toQ1Demand NochangePrice DecreasesfromP0toP1

6. Thecasestudypresentedinthechapterdiscussedcigarettetaxesasawaytoreducesmoking.Nowthink

aboutthemarketsforothertobaccoproductssuchascigarsandchewingtobacco.a. Arethesegoodssubstitutesorcomplementsforcigarettes?Solution)

CigarandChewingtobaccoarethecomplementsforcigarettes.b. Using a supplyanddemand diagram, show what happens in the markets for cigars and chewing

tobaccoifthetaxoncigarettesisincreased.Solution)

Ifwarningoncigarettepackagesconvincesmokerstosmoke less,thedemandcurve forcigarettesshiftstotheleftasshowninabovefigure.ThedemandcurveshiftfromD1toD2ataprice$2andthequantitydemandfallsfrom50to20cigarettes.

c. Ifpolicymakerswantedtoreducetotaltobaccoconsumption,whatpoliciescouldtheycombinewith

thecigarettetax?Solution)Ifataxraisesthepriceofcigarettesthedemandcurvewouldnotshiftbutincreaseinpricewouldreducethequantitydemandedas shown inabove figure that tax increase thepriceof cigarette from$2 to$4andquantitydemandedreducedfrom20to12.

7. Themarketforpizzahasthefollowingdemandandsupplyschedules:

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PRICE($) QUANTITYDEMANDED

QUANTITYSUPPLIED

4 135 265 104 536 81 817 68 988 53 110

9 39 121Graphthedemandandsupplycurves.Whatistheequilibriumpriceandquantityinthismarket?Iftheactualpriceinthismarketwereabovetheequilibriumprice,whatwoulddrivethemarkettowardtheequilibrium?Iftheactualprice in thismarketwerebelow theequilibriumprice,whatwoulddrive themarket toward theequilibrium?Solution) TheequilibriumpriceofPizzawouldbe$6andtheequilibriumquantityofPizzawouldbe81asshown

intersectionpointonabovefigure. Ifpriceofpizzaincreasesfromtheequilibriumpriceitwouldbesurplussupplycreatedandsupplierwould

notabletosaleastheywant. Ifpriceofpizzadecreases from the equilibriumprice itwouldbe shortage supply created andbuyers

wouldnotabletobuyasthewant. Tomakemarketequilibriumsuppliermusthavetodecreasethepriceinordertoremovesurplus. Tomakemarketsequilibriumsuppliermusthavetoincreasethepriceinordertoremoveshortage.8. Supposethatthepriceofbasketballticketsatyourcollegeisdeterminedbymarketforces.Currently,the

demandandsupplyschedulesareasfollows:PRICE($)

QUANTITYDEMANDED

QUANTITYSUPPLIED

4 10,000 8,0008 8,000 8,00012 6,000 8,00016 4,000 8,00020 2,000 8,000

a. Draw thedemandand supply curves.What isunusualabout this supply curve?Whymight thisbetrue?

Solution)

PB Ball

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8000 Q B ball

D

S 8

Theunusualaboutthissupplycurveisconstantsupplyduetoavailabilityconstantseatsatbasketballground.Thesuppliercouldnotsupplymorethan8000seats.

b. Whataretheequilibriumpriceandquantityoftickets?

Solution)

The Equilibrium quantity would be 8000 seats and the Equilibrium price would be$8.00.

c. Yourcollegeplansto increasetotalenrollmentnextyearby5,000students.Theadditionalstudentswillhavethefollowingdemandschedule:

PRICE($) QUANTITYDEMANDED

4 4,0008 3,00012 2,00016 1,00020 0

Nowaddtheolddemandscheduleandthedemandscheduleforthenewstudentstocalculatethenewdemandschedulefortheentirecollege.Whatwillbethenewequilibriumpriceandquantity?

Solution)PRICE($) QUANTITYDEMANDED QUANTITYSUPPLIED4 14,000 8,0008 11,000 8,00012 8,000 8,00016 5,000 8,00020 2,000 8,000

The Equilibrium quantity would be 8000 seats and the Equilibrium price would be$12.00.11. Definethepriceelasticityofdemandandtheincomeelasticityofdemand.Solution)Priceelasticityofdemandisameasureofhowmuchthequantitydemandedofagoodrespondstoachangeinthepriceofthatgood. Priceelasticityofdemandisthepercentagechangeinquantitydemandedgivenapercentchangeintheprice.Thepriceelasticityofdemand iscomputedasthepercentagechange inthequantitydemandeddividedbythepercentagechangeinprice. Incomeelasticityofdemandmeasureshowmuchthequantitydemandedofagoodrespondstoachangeinconsumersincome. It iscomputedasthepercentagechange inthequantitydemandeddividedbythepercentagechangeinincome.

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8000 Q B ball

PB Ball

D

12

S

Higherincomeraisesthequantitydemandedfornormalgoodsbutlowersthequantitydemandedforinferiorgoods.12. Listandexplainsomeofthedeterminantsofthepriceelasticityofdemand.Solution) AvailabilityofCloseSubstitutes:Goodswhichhaveclosedsubstitutearemoreelastic.Asmallincreasein

pricemayguidepeopletoswitchforsubstitute.Examplecouldbebutterandmargarine. Necessities versus Luxuries:Necessitieswhichhaveno substitute couldbe inelastic. Increasing inprice

wouldnoteffectonquantitydemanded.Examplevisittothedoctor.WhereaspriceofLuxuriesrises,thequantitydemandedfalls.

DefinitionoftheMarket:Theelasticityofdemand inanymarketdependshowwedefineanymarket. Ifwedefinemarketnarrowly, thatwillbeeasy to findsubstitutemeanmoreelastic. Ifwedefinemarketbroadly,thatwillbedifficulttofindsubstitutemeanlesselastic.

TimeHorizon:Somegoodsmoreelasticoverthe longtimewhicheffectquantitydemandedaftera longtime.Example,peopletaketimetoswitchfromfuelinefficientcarstoefficientcarsduetoincreaseinfuelprice.

13. Ona supplyanddemanddiagram, showequilibriumprice,equilibriumquantity,and the total revenue

receivedbyproducers.Solution)

EquilibriumPrice P0EquilibriumQuantity Q0TotalRevenue 00 QPTR =

14. Howisthepriceelasticityofsupplycalculated?Explainwhatthismeasures.Solution) Priceelasticityofsupplyisameasureofhowmuchthequantitysuppliedofagoodrespondstoachangeinthepriceofthatgood. Priceelasticityofsupplyisthepercentagechangeinquantitysuppliedresultingfromapercentchangeinprice.

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Q

P

D

S

Q0

P0

15. Foreachofthefollowingpairsofgoods,whichgoodwouldyouexpecttohavemoreelasticdemandandwhy?a. requiredtextbooksormysterynovels

Solution)Mysterynovelshavepossiblesubstitute,moreelasticbutrequiredtextbookhasnotsubstitutelesselastic.

b. BeethovenrecordingsorclassicalmusicrecordingsingeneralSolution)Classicalmusic recordinghavepossible substitute,moreelasticbutBeethoven recordinghasnotsubstitute,lesselastic.

c. heatingoilduringthenextsixmonthsorheatingoilduringthenextfiveyearsSolution)Heatingoilduringthenextfiveyearscouldbepossiblesubstituteinfuture,moreelasticbutheatingoilduringthenextsixmonthshavenoimmediatesubstitute,lesselastic.

d. rootbeerorwaterSolution)Rootbeerhasnosubstitute,lesselasticbutwaterhavepossiblesubstitute,moreelastic.

16. SupposethatbusinesstravelersandvacationershavethefollowingdemandforairlineticketsfromNew

YorktoBoston:a.Asthepriceofticketsrises from$200to$250,what isthepriceelasticityofdemand for (i)business

travelersand(ii)vacationers?(Usethemidpointmethodinyourcalculations.)Solution)Usingmidpointformula:

( ) ( ) ( )[ ]( ) ( )[ ] 23.022502002502002000,2900,1000,2900,1

. =++=TBED

( ) ( ) ( )[ ]( ) ( )[ ] 29.122502002502002600800600800 =+

+=VED

b.Whymightvacationershaveadifferentelasticitythanbusinesstravelers?Solution)Forvacationers,travel isof lessnecessitycomparedtobusinesstravelers.Vacationershave longer

timehorizon for travelwhile thebusiness travelershaveaveryshort time to travel.Vacationersalsohave

severalothersubstitutesliketravellingbycar.Thatsubstituteisnotappropriateforbusinesstravelersasthey

need to reach faster to their place of destination. This iswhy vacationerswill have a higher elasticity of

demandforairticketscomparedtothebusinesstravelers.

17. Supposethatyourdemandscheduleforcompactdiscsisasfollows:

PRICE($) QUANTITY DEMANDED (INCOME=$10,000)

QUANTITY Demanded (INCOME =$12,000)

8 40 5010 32 4512 24 3014 16 2016 08 12

a. Use themidpointmethod tocalculateyourpriceelasticityofdemandas thepriceofcompactdiscsincreasesfrom$8to$10if(i)yourincomeis$10,000,and(ii)yourincomeis$12,000.

Solution)

i)Whenincomeis$10,000:( ) ( )[ ]( ) ( )[ ] 50.02108108

232403240 =++=DE

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ii)Whenincomeis$12,000:( ) ( )[ ]( ) ( )[ ] 47.02108108

245504550 =++=DE

b. Calculateyourincomeelasticityofdemandasyourincomeincreasesfrom$10,000to$12,000if(i)the

priceis$12,and(ii)thepriceis$16.Solution)

i)Incomeelasticityatprice$12:( ) ( )[ ]

( ) ( )[ ] 22.12000,10000,12000,10000,12224302430 =+

+=YE

ii)Incomeelasticityatprice$16:( ) ( )[ ]

( ) ( )[ ] 20.22000,10000,12000,10000,122812812 =+

+=YE 18. TwodriversTomandJerryeachdriveuptoagasstation.Before lookingattheprice,eachplacesan

order.Tomsays,Id like10gallonsofgas.Jerrysays,Id like$10worthofgas.What iseachdriverspriceelasticityofdemand?

Solution: For Tom the price elasticity of demand is inelastic, as he does demand the amount of the gaswithoutinquiringtheprice,meanshisdemandisindependentoftheprice.Whereas,thedemandforjerryishighlyelastic;ashedemandedthequantityofthegasoffixedamount.19. Considerpublicpolicyaimedatsmoking.

a. Studies indicatethatthepriceelasticityofdemandforcigarettes isabout0.4. Ifapackofcigarettescurrentlycosts$2andthegovernmentwantstoreducesmokingby20percent,byhowmuchshoulditincreasetheprice?

Solution)( ) ( )[ ]( ) ( )[ ] 4.02

2

1212

1212 =++=PPPP

QQQQED ( ) ( )[ ]2

2.04.0

1212 PPPP += %505.0

4.02.0

=== P b. Ifthegovernmentpermanentlyincreasesthepriceofcigarettes,willthepolicyhavealargereffecton

smokingoneyearfromnoworfiveyearsfromnow?Solution)5yearsfromnowaswithtimethemoresubstitutesthesmokerswouldhaveavailable.

c. Studiesalsofindthatteenagershavehigherpriceelasticitythandoadults.Whymightthisbetrue?

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Solution)Astheyarenotthatmuchaddictedtothehabitastheeldersareandtheincomeaffectislargeronteenagersthatitisonelders.