PAF Karachi Institute of Economics and Technology City Campus

Course: Micro & Macroeconomics

Faculty: Iftikhar Mubbashir
Class ID: (Solution)
Assignment Date: Sep 21, 2013
Project Part(-II)
Submission Date: Oct 05, 2013

1. What is a competitive market? Briefly describe the types of markets other than perfectly competitive
markets.

2. Colddrinksandpizzaarecomplementsbecausetheyareoftenenjoyedtogether.Whenthepriceofcold
drinksrises,whathappenstothesupply,demand,quantitysupplied,quantitydemanded,andthepricein
themarketforpizza?
Solution)

PPizz

P0

P1

Qpizz
Q1
Q0

Whenthepriceofthecomplementgoodincreases,resultsintheleftwardshiftofthedemandcurveforpizza
fromDtoDwhichresults:
Demand
DecreasesfromDtoD
Quantitydemanded
DecreasesfromQ0toQ1
Quantitysupply
DecreasesfromQ0toQ1
Supply
Nochange
Price
DecreasesfromP0toP1

3. Definetheequilibriumofamarket.Describetheforcesthatmoveamarkettowarditsequilibrium.
Solution)
Equilibrium refers to a situation in which the price has reached the level where quantity supplied equals
quantitydemanded.
EquilibriumPrice:Thepricethatbalancesquantitysuppliedandquantitydemanded.
Onagraph,itisthepriceatwhichthesupplyanddemandcurvesintersect.
EquilibriumQuantity:Thequantitysuppliedandthequantitydemandedattheequilibriumprice.
Onagraphitisthequantityatwhichthesupplyanddemandcurvesintersect.
Lawofsupplyanddemandclaimthatthepriceofanygoodadjuststobringthequantitysupplied
andthequantitydemandedforthatgoodintobalance.

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Price of

Supply
Cone

Equilibrium
Equilibrium price

$2.00

Demand

Equilibrium

quantity

0 1 2 3 4 5 6 7 8 9 10 11 12 13

Quantity of Ice-Cream Cones

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

Thecoldsnapwilldestroyorangesandthatwillreducethequantityoforangesproducedwhichwillreduce
thesupplyofthequantityoforanges.So,therewillbefewerorangeswhichwillshiftthesupplycurveleft
side.Asthefigureshowsthisdecreaseinsupplyraisestheequilibriumprice.

b. WhentheweatherturnswarminNewEnglandeverysummer,thepricesofhotelroomsinCaribbean
resortsplummet.
Solution)
When the weather turns warm, there will be fewer people who will be eager to visit warm places like
Caribbean.So,attheexistingpricesthehotelroomswillbeemptyinCaribbean.Inotherwordstherewillbe
adecreaseindemandforhotelrooms.Thedemandcurvewillshifttotheleft.Thehotelownerswillreduce
thepricetokeeptheroomsbooked.Asthefiguresuggests,thiswillreduceequilibriumprice.
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c. WhenawarbreaksoutintheMiddleEast,thepriceofgasolinerises,whilethepriceofausedCadillac
falls.
Solution)

Wardestroysoilfields,oiltankerswhichreducethesupplyofoil,thesupplycurveforoilmovesleftside.Thus
thepriceofgasolineincreasesasisevidentfromthefigure.

5. During the 1990s, technological advance reduced the cost of computer chips. How do you think this
affectedthemarketforcomputers?Forcomputersoftware?Fortypewriters?
Solution)
Psoftwares

P1

P0

D
Q0

Q1

Q softwares

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Whenthepriceofthecomplementgoodincreases,resultsintherightwardshiftofthedemandcurveforsoft
waresfromDtoDwhichresults:
Demand
IncreasesfromDtoD
Quantitydemanded
IncreasesfromQ0toQ1
Quantitysupply
IncreasesfromQ0toQ1
Supply
Nochange
Price
IncreasesfromP0toP1

Ptypewriter

P0

P1

Qtypewriter
Q1
Q0

When the price of the substitute good decreases, results in the leftward shift of the demand curve for
typewritersfromDtoDwhichresults:
Demand
DecreasesfromDtoD
Quantitydemanded
DecreasesfromQ0toQ1
Quantitysupply
DecreasesfromQ0toQ1
Supply
Nochange
Price
DecreasesfromP0toP1

Pcomputers

S
P0

P1

Qcomputers
Q0
Q1
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Whentheinputpriceofproductiondecreases,resultsintherightwardshiftofthesupplycurveforcomputers
fromStoSwhichresults:
Supply
IncreasesfromStoS
Quantitydemanded
IncreasesfromQ0toQ1
Quantitysupply
IncreasesfromQ0toQ1
Demand
Nochange
Price
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)

Ifwarningoncigarettepackagesconvincesmokerstosmokeless,thedemandcurveforcigarettesshiftsto
theleftasshowninabovefigure.ThedemandcurveshiftfromD1toD2ataprice$2andthequantitydemand
fallsfrom50to20cigarettes.

c. Ifpolicymakerswantedtoreducetotaltobaccoconsumption,whatpoliciescouldtheycombinewith
thecigarettetax?
Solution)
Ifataxraisesthepriceofcigarettesthedemandcurvewouldnotshiftbutincreaseinpricewouldreducethe
quantity demanded as shown in above figure that tax increase the price of cigarette from $ 2 to $ 4 and
quantitydemandedreducedfrom20to12.

7. Themarketforpizzahasthefollowingdemandandsupplyschedules:
PRICE($) QUANTITY
QUANTITY
DEMANDED
SUPPLIED
4
135
26
5
104
53
6
81
81
7
68
98
8
53
110
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39
121
Graphthedemandandsupplycurves.Whatistheequilibriumpriceandquantityinthismarket?Iftheactual
priceinthismarketwereabovetheequilibriumprice,whatwoulddrivethemarkettowardtheequilibrium?If
the actual price in this market were below the equilibrium price, what would drive the market toward the
equilibrium?
Solution)
TheequilibriumpriceofPizzawouldbe$6andtheequilibriumquantityofPizzawouldbe81asshown
intersectionpointonabovefigure.
Ifpriceofpizzaincreasesfromtheequilibriumpriceitwouldbesurplussupplycreatedandsupplierwould
notabletosaleastheywant.
If price of pizza decreases from the equilibrium price it would be shortage supply created and buyers
wouldnotabletobuyasthewant.
Tomakemarketequilibriumsuppliermusthavetodecreasethepriceinordertoremovesurplus.
Tomakemarketsequilibriumsuppliermusthavetoincreasethepriceinordertoremoveshortage.

8. Supposethatthepriceofbasketballticketsatyourcollegeisdeterminedbymarketforces.Currently,the
demandandsupplyschedulesareasfollows:
PRICE
QUANTITY
QUANTITY
($)
DEMANDED
SUPPLIED
4
10,000
8,000
8
8,000
8,000
12
6,000
8,000
16
4,000
8,000
20
2,000
8,000
a. Draw the demand and supply curves. What is unusual about this supply curve? Why might this be
true?
Solution)

PB Ball

8000
Q B ball

Theunusualaboutthissupplycurveisconstantsupplyduetoavailabilityconstantseatsatbasketballground.
Thesuppliercouldnotsupplymorethan8000seats.

b. Whataretheequilibriumpriceandquantityoftickets?
Solution)

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The Equilibrium quantity would be 8000 seats and the Equilibrium price would be
$8.00.
c. Yourcollegeplanstoincreasetotalenrollmentnextyearby5,000students.Theadditionalstudents
willhavethefollowingdemandschedule:
PRICE($) QUANTITY
DEMANDED
4
4,000
8
3,000
12
2,000
16
1,000
20
0
Nowaddtheolddemandscheduleandthedemandscheduleforthenewstudentstocalculatethenew
demandschedulefortheentirecollege.Whatwillbethenewequilibriumpriceandquantity?
Solution)
PRICE($)
QUANTITYDEMANDED
QUANTITYSUPPLIED
4
14,000
8,000
8
11,000
8,000
12
8,000
8,000
16
5,000
8,000
20
2,000
8,000

PB Ball

12

8000
Q B ball

The Equilibrium quantity would be 8000 seats and the Equilibrium price would be
$12.00.

11. Definethepriceelasticityofdemandandtheincomeelasticityofdemand.
Solution)Priceelasticityofdemandisameasureofhowmuchthequantitydemandedofagoodrespondstoa
changeinthepriceofthatgood.
Priceelasticityofdemandisthepercentagechangeinquantitydemandedgivenapercentchangeinthe
price.
Thepriceelasticityofdemandiscomputedasthepercentagechangeinthequantitydemandeddividedby
thepercentagechangeinprice.
Incomeelasticityofdemandmeasureshowmuchthequantitydemandedofagoodrespondstoachange
inconsumersincome.
Itiscomputedasthepercentagechangeinthequantitydemandeddividedbythepercentagechangein
income.
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Higherincomeraisesthequantitydemandedfornormalgoodsbutlowersthequantitydemandedforinferior
goods.

12. Listandexplainsomeofthedeterminantsofthepriceelasticityofdemand.
Solution)
AvailabilityofCloseSubstitutes:Goodswhichhaveclosedsubstitutearemoreelastic.Asmallincreasein
pricemayguidepeopletoswitchforsubstitute.Examplecouldbebutterandmargarine.
Necessities versus Luxuries: Necessities which have no substitute could be inelastic. Increasing in price
wouldnoteffectonquantitydemanded.Examplevisittothedoctor.WhereaspriceofLuxuriesrises,the
quantitydemandedfalls.
DefinitionoftheMarket:Theelasticityofdemandinanymarketdependshowwedefineanymarket.If
we define market narrowly, that will be easy to find substitute mean more elastic. If we define market
broadly,thatwillbedifficulttofindsubstitutemeanlesselastic.
TimeHorizon:Somegoodsmoreelasticoverthelongtimewhicheffectquantitydemandedafteralong
time.Example,peopletaketimetoswitchfromfuelinefficientcarstoefficientcarsduetoincreaseinfuel
price.

13. On a supplyanddemand diagram, show equilibrium price, equilibrium quantity, and the total revenue
receivedbyproducers.
Solution)
EquilibriumPrice
P0
EquilibriumQuantity
Q0
TR = P0 Q0
TotalRevenue

P0

Q
Q0

14. Howisthepriceelasticityofsupplycalculated?Explainwhatthismeasures.
Solution)
Priceelasticityofsupplyisameasureofhowmuchthequantitysuppliedofagoodrespondstoachange
inthepriceofthatgood.
Priceelasticityofsupplyisthepercentagechangeinquantitysuppliedresultingfromapercentchangein
price.

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15. Foreachofthefollowingpairsofgoods,whichgoodwouldyouexpecttohavemoreelasticdemandand
why?
a. requiredtextbooksormysterynovels
Solution)Mysterynovelshavepossiblesubstitute,moreelasticbutrequiredtextbookhasnotsubstituteless
elastic.
b. Beethovenrecordingsorclassicalmusicrecordingsingeneral
Solution) Classical music recording have possible substitute, more elastic but Beethoven recording has not
substitute,lesselastic.
c. heatingoilduringthenextsixmonthsorheatingoilduringthenextfiveyears
Solution)Heatingoilduringthenextfiveyearscouldbepossiblesubstituteinfuture,moreelasticbutheating
oilduringthenextsixmonthshavenoimmediatesubstitute,lesselastic.
d. rootbeerorwater
Solution)Rootbeerhasnosubstitute,lesselasticbutwaterhavepossiblesubstitute,moreelastic.

16. SupposethatbusinesstravelersandvacationershavethefollowingdemandforairlineticketsfromNew
YorktoBoston:
a.Asthepriceofticketsrisesfrom$200to$250,whatisthepriceelasticityofdemandfor(i)business
travelersand(ii)vacationers?(Usethemidpointmethodinyourcalculations.)
Solution)
Usingmidpointformula:
(1,900 2,000) [(1,900 + 2,000) 2]
= 0.23
E D (B.T ) =
(200 250) [(200 + 250) 2]
(800 600) [(800 + 600) 2]
= 1.29
E D (V ) =
(200 250) [(200 + 250) 2]

b.Whymightvacationershaveadifferentelasticitythanbusinesstravelers?
Solution)Forvacationers,travelisoflessnecessitycomparedtobusinesstravelers.Vacationershavelonger
time horizon for travel while the business travelers have a very short time to travel. Vacationers also have
severalothersubstitutesliketravellingbycar.Thatsubstituteisnotappropriateforbusinesstravelersasthey
need to reach faster to their place of destination. This is why vacationers will have a higher elasticity of
demandforairticketscomparedtothebusinesstravelers.

17. Supposethatyourdemandscheduleforcompactdiscsisasfollows:
PRICE($)
QUANTITY
DEMANDED
(INCOME QUANTITY Demanded (INCOME =
=$10,000)
$12,000)
8
40
50
10
32
45
12
24
30
14
16
20
16
08
12
a. Use the midpoint method to calculate your price elasticity of demand as the price of compact discs
increasesfrom$8to$10if(i)yourincomeis$10,000,and(ii)yourincomeis$12,000.
Solution)
(40 32) [(40 + 32) 2]
i)Whenincomeis$10,000: E D =
= 0.50
(8 10 ) [(8 + 10 ) 2]

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ii)Whenincomeis$12,000: E D =

(50 45) [(50 + 45) 2]

= 0.47
(8 10 ) [(8 + 10 ) 2]

b. Calculateyourincomeelasticityofdemandasyourincomeincreasesfrom$10,000to$12,000if(i)the
priceis$12,and(ii)thepriceis$16.
Solution)
(30 24 ) [(30 + 24 ) 2]
i)Incomeelasticityatprice$12: E Y =
= 1.22
(12,000 10,000) [(12,000 + 10,000) 2]

(12 8 ) [(12 + 8 ) 2]
ii)Incomeelasticityatprice$16: E Y =
= 2.20
(12,000 10,000) [(12,000 + 10,000) 2]

18. TwodriversTomandJerryeachdriveuptoagasstation.Beforelookingattheprice,eachplacesan
order.Tomsays,Idlike10gallonsofgas.Jerrysays,Idlike$10worthofgas.Whatiseachdrivers
priceelasticityofdemand?
Solution: For Tom the price elasticity of demand is inelastic, as he does demand the amount of the gas
withoutinquiringtheprice,meanshisdemandisindependentoftheprice.Whereas,thedemandforjerryis
highlyelastic;ashedemandedthequantityofthegasoffixedamount.

19. Considerpublicpolicyaimedatsmoking.
a. Studiesindicatethatthepriceelasticityofdemandforcigarettesisabout0.4.Ifapackofcigarettes
currentlycosts$2andthegovernmentwantstoreducesmokingby20percent,byhowmuchshouldit
increasetheprice?
Solution)
(Q Q1 ) [(Q2 + Q1 ) 2]
0.2
0 .2
P =
= 0.5 = 50%
ED = 2
= 0.4 0.4 =
(P2 P1 ) [(P2 + P1 ) 2]
(P2 P1 ) [(P2 + P1 ) 2]
0.4
b. Ifthegovernmentpermanentlyincreasesthepriceofcigarettes,willthepolicyhavealargereffecton
smokingoneyearfromnoworfiveyearsfromnow?
Solution)5yearsfromnowaswithtimethemoresubstitutesthesmokerswouldhaveavailable.
c. Studiesalsofindthatteenagershavehigherpriceelasticitythandoadults.Whymightthisbetrue?
Solution)Astheyarenotthatmuchaddictedtothehabitastheeldersareandtheincomeaffectislargeron
teenagersthatitisonelders.

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