ASSIGNMENT 1

Course: Microeconomics/Economics for Managers

Code: ECON 508/512

Prepared For:
Prof. Dr. Shoaib Ahmed
Adjunct Faculty
School of Business and Economics (SOBE)
MBA & EMBA Program
United International University

Prepared By:
Ridwan Abir
ID: 112212034
School of Business and Economics (SOBE)
MBA Program
United International University

Date of Submission: 11/08/2021

1. In past decades, the price of coffee in the United States rose significantly as a result
of bad weather in coffee-producing regions. Use the income effect and the substitution
effect concepts to explain why the quantity of coffee demanded in the United States
significantly decreased.

Ans: The income effect states the change in demand or the purchasing power on consumption. It
expresses the relationship between the change in relative market prices and incomes spent on
consumer goods or services, whereas the substitution effect states the changes in prices for which
a consumer can switch to a cheaper alternatives of goods or services. Now here, the demand of
coffee in the United States decreased, impacting with the income effect because, since the prices
of coffee rose, consumers are buying less as they might not be able to afford spending high price
in it. Thus, the quantity of coffee demand decreased gradually. In terms of the substitution effect
concept, people or consumers will switch to a lower price coffee or any alternatives like tea, which
they can afford with their income. And this substitution of product impacted the quantity demand
of coffee to fall down.

2. What are the factors that cause a change in demand? Use supply and demand
graphs to illustrate what happens to price and quantity when demand increases.

Ans: A change in demand can be caused initially by the increase or decrease in price of a goods
or services. But there are other factors which also impacts a change in demand. They are also
known as the basic determinants of demand and they are as followed:

1. Consumer’s taste and preferences.

2. The number of consumer in the market.
3. Consumer’s income.
4. The prices of related goods.
5. Consumer’s expectations about future prices and incomes.

When demand increases, the quantity of a product consumption increases at every given prices.
As demand increases, the demand curve, D0 is shifted to the right side, forming a new demand
curve, D1. The following fig. below illustrates the changes when demand increases:

Fig: Demand Curve shifts rightward from D0 to D1 when Demand Increases

3. Given the demand for and the supply of a commodity, what price will be the
equilibrium price of this commodity? Explain why this price will tend to prevail in
the market and why higher (lower) prices, if they do exist temporarily, will tend to
fall (rise).

Ans: When a demand curve (D), and a supply curve (S) of a commodity intersects each other at a
specific point, then it is known as the equilibrium price (EP) or the equilibrium quantity (EQ) of the
commodity and it is mostly address as the market is in an equilibrium position. Now, this
equilibrium price will tend to prevail in the market because when the market price is above the
equilibrium price then it means that the quantity supplied is greater than the quantity demanded
which will create a surplus for the commodity. Therefore, market price will fall. Again, when the
market price is below the equilibrium price then it means that the quantity supplied is less than the
quantity demanded which will create a shortage for the commodity. Therefore, market price will
rise as the market is not clear due to the shortage of commodity. The government regulations plays
an important factor by setting price floor and price ceiling to make the market in an equilibrium
position.

4. Suppose an industry sells 2000 units of a product at $10 per unit one year, 3000
units at $12 the next year and 4000 units at $14 the third year. Is this evidence that
the law of demand is violated? Explain.

Ans: According to the Law of Demand, it states that the quantity demanded will decrease with
increase in prices and vice versa. In this scenario, we can say that the law of demand is violated as
both the quantity and prices are increasing every year. But there are some goods which are an
exception to the violation for law of demand. These goods are known as Inferior goods and Luxury
goods. Inferior goods includes rice, breads, and eggs etc. which are said that consumers will buy
these goods even if the prices increase. Luxury goods are goods such as diamonds, cars etc. which
are said to have demands even if they are expensive. Therefore, these two categories of goods
doesn’t fall in the violation of Law of Demand.

5. What are the major determinants of price elasticity of demand? Use those
determinants and your own reasoning in judging whether demand for each of the
following products is probably elastic or inelastic: (a) bottled water; (b) toothpaste;
(c) Crest toothpaste; (d) ketchup; (e) diamond bracelets; (f) Microsoft Windows
operating system.

Ans: There are four major determinants of price elasticity of demand and they are as followed:
1. Availability of Substitute products.
2. Proportion of Income
3. Luxury goods vs Necessity goods
4. Time
Basically, these are the common or general determinants for price elasticity of demand.
According to my opinion and judgement about the determinants discussed above, the demand for
each of the following products, whether it falls in elastic or inelastic, are given below:
a) Bottled Water: We know that water is an available resource and there are many substitutes
available for water. For example: we can boil and filter tap water, which is free to use for
drinking. Customer can shift to substitutes if there is a change in price for bottled water
and therefore it falls under elastic demand.
b) Toothpaste: This is a necessity product which means it is used every day. Therefore, it
falls under inelastic demand as a small changes in price would not cause a lot impact to
buy toothpaste.
c) Crest Toothpaste: Since this specifies a brand name of toothpaste, the product is price
elastic or falls under the elastic demand. There are other brands which can be used as a
substitution for Crest toothpaste if the price changes.
d) Ketchup: Due to the low substitution of this product, ketchup falls under inelastic demand.
Therefore, a few changes in price would not affect the demand for purchasing it.
e) Diamond Bracelets: Since diamond is a luxury and expensive product, it depends on the
proportion of income one is willing to spend. Therefore, in my opinion, it falls under the
elastic demand.
f) Microsoft Windows Operating System: This has an inelastic demand as this product is
necessary and widely used in every computer systems in home or offices.