MGEC: Lecture 3

Practice Problems Answer Key

Problem 1

A survey indicated that chocolate is the most popular ice cream flavor. For each of the following,
indicate the possible effects on demand, supply, or both as well as equilibrium price and quantity of
chocolate ice cream.
a) A severe drought causes dairy farmers to reduce the number of milk-producing cattle in their
herds by a third. These dairy farmers supply cream that is used to manufacture chocolate ice
cream.
Effect on demand: No effect on demand curve
Effect on supply: Supply curve moves inwards; Supply decreases
Equilibrium price and quantity of chocolate ice cream: Equilibrium price increases and
equilibrium quantity decreases

b) Latest research suggests that chocolate does, in fact, have significant health benefits.
Effect on demand: Demand curve moves outwards; Demand increases
Effect on supply: Supply curve also moves inwards as the cost of chocolate will likely go up;
Supply decreases
Equilibrium price and quantity of chocolate ice cream: Equilibrium price increases and
equilibrium quantity is ambiguous. (It may remain the same, increase or decrease depending on
the extent to which the supply curve moves inwards.)

c) The discovery of cheaper synthetic vanilla flavoring lowers the price of vanilla ice cream.
Assuming vanilla ice cream is a substitute good, which has now become cheaper.
Effect on demand: Demand curve moves inwards. Demand decreases
Effect on supply: No effect on supply curve
Equilibrium price and quantity of chocolate ice cream: Equilibrium price decreases and
equilibrium quantity decreases

d) New technology for mixing and freezing ice cream lowers manufacturers' costs of producing
chocolate ice cream.
Effect on demand: No effect on demand curve
Effect on supply: Supply curve moves outwards; Supply increases
Equilibrium price and quantity of chocolate ice cream: Equilibrium price decreases and
equilibrium quantity increases

Problem 2

Consider a market where supply and demand are given as the following:
Demand Curve: QD = 20 - 2P
Supply Curve: QS = 2P
a) Calculate the market equilibrium price and quantity
Market equilibrium price and quantity can be found by equating the demand and supply
functions:
 QD = QS
20-2P = 2P, Solving for P,
P=5
To find Q, plug P = 5 in the demand function; QD = 20-2P; QD = 10
Thus, market equilibrium price = 5 and quantity = 10

b) Calculate the consumer surplus at equilibrium

At equilibrium, consumer surplus is given by the area of the triangle; above equilibrium price
(P=5) and below the demand curve. We can use the formula for area of a triangle = 1/2 × base ×
height, to calculate the consumer surplus. In this case the base of the triangle is 10 and the
height is 5 (10-5), therefore

𝐶𝑜𝑛𝑠𝑢𝑚𝑒𝑟 𝑆𝑢𝑟𝑝𝑙𝑢𝑠 = 1/2 × 10 × 5 = 25

Price

10 Supply
Consumer Surplus

5 Equilibrium

Demand

0 10 20 Quantity

c) Calculate the producer surplus at equilibrium

At equilibrium, producer surplus is given by the area of the inverted triangle; below equilibrium
price (P=5) and above the supply curve. We can use the formula for area of a triangle = 1/2 ×
base × height, to calculate the producer surplus. In this case the base of the triangle is 10 and
the height is 5, therefore

𝑃𝑟𝑜𝑑𝑢𝑐𝑒𝑟 𝑆𝑢𝑟𝑝𝑙𝑢𝑠 = 1/2 × 10 × 5 = 25

Price

10 Supply

5 Equilibrium

Producer
Surplus Demand

0 10 20 Quantity