Manage

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econom
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Works
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Economics for Management
Soluti
on -
Suggested solution
Class
2

Teacher: Francisco Labbé

Learning Outcome: Relate how market signals guide the behavior of economic agents and
how to apply them to the operation of companies.

Type of activity
Group workshop
Workshop
Workshop 2: Market forces of supply and demand
Class
Class 2: Market forces of supply and demand
Evaluation
Summative
Estimated delivery time
60 Minutes

Task: In 60 minutes.
1. Answer using the blanks in the statement.
2. Plot using the one on the last page.
This workshop will be graded.

Definition and characterization of the deliverable:

 Length: 60 minutes
 Associated Bibliography: Mankiw, G., (2012) Principles of Economics, 6th Edition. Madrid,
Cengage: Chapter 4: Market forces of supply and demand.
 Concepts used: (1) Demand, (2) Supply, (3) Market equilibrium, (4) Demand shift, (4)
Movement along the supply curve, and (5) Ceteris paribus.
 Structure: (1) Closed questions with calculation results, and (2) Use of graphs.

Part one: initial equilibrium

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Information
Soluti has been collected on potato consumption in several villages of similar
socioeconomic status: (1) Prevailing price in each village and (2) Per capita consumption in
on -
each village. The aggregate consumption of potatoes in the town of interest was estimated by
Class the per capita consumption by the number of people. See the following demand
multiplying
2
table:

Per capita Inhabitants Annual estimated consumption in the

Price
consumption of of the town village of interest with the reference price
(CMg)
each town of interest in each village
$/Kg. Kg/inhabitant/year Quantity Kg/year
(1) (2) (3) (2) x (3)
Town 1 450 53 30.500 1.616.500
Village 2 525 44 30.500 1.342.000
Town 3 675 38 30.500 1.159.000
Village 4 788 29 30.500 884.500

1. (4%) Mark the points of aggregate consumption as a function of price on the graph on the
last page. You will find that they form a roughly linear demand. Just map the points of
consumption.
Precio
1.200

1.000

800

600

400

200

0
0 500.000 1.000.000 1.500.000 2.000.000 2.500.000 3.000.000

Cantidad por año

2. (6%) Project the linear trend of demand and plot the demand line cutting both axes. It is a
straight line passing through the middle of the points already plotted.
Note: In the Statistics course you will learn how to do it in a more precise way.

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Soluti 1.200
on - 1.000
Class 800
2 600

400

200

0
0 500.000 1.000.000 1.500.000 2.000.000 2.500.000 3.000.000

Cantidad por año

3. (10%) Find the mathematical equation of the demand line. Write it down below:

Response:

Since the demand drawn is a straight line, its mathematical equation has the form
Q=a+m∙P, where (1) Q is quantity, and (2) P is price. In addition: (3) the constant or
parameter "a" is a position coefficient or intercept with the Q axis, and (4) the constant
∆Q
or parameter "m" is the slope .
∆P

a) Intercept a: For P=0 ===> Q = 2,500,000 (from the graph), which is why a=2,500,000.

===> Equation: Q = 2,500,000 + Slope m ∙ P

b) Slope m: Must be a change in quantity∆ Q divided by a change in price∆ P . And it is

simple from the graph to conclude that if P changes from P=$1,200 to P=$0 ("end to
end of the curve"), Q changes from 0 to 2,500,000:

∆ Q =2,500,000-0=+2,500,000 and ∆ P =$0-$1,200=$1,200:

∆ Q + 2.500.000
===> m= = =−2.083
∆P −1.200

===> Equation: Q = 2,500,000  2.083 ∙ P

4. (4%) The aggregate supply of potatoes from the town of interest is:
Q = 1,000,000 + 5,000∙Price.
Draw it on the chart on the last page.

Response:

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One way to plot is to construct a bid table and plot. For example:
Soluti
Price Quantity
on -
300 500.000
Class 400 1.000.000
2 500 1.500.000
550 1.750.000
Precio
1.200

1.000

800

600

400

200

0
0 500.000 1.000.000 1.500.000 2.000.000 2.500.000 3.000.000

Cantidad por año

5. Find the market equilibrium in two ways:

5.1. (3%) Graphically. Record your results below.

Response: Quantity: 1,500,000 kg/year (approx.)

Price: 500/kg. (approx.)

5.2. (7%) Mathematically, matching the quantity demanded with the quantity offered. You
must solve a system of equations:

Answer: Q demanded = Q offered

===> 2.500.000 2.083∙P = 1.000.000 + 5.000∙P

Putting like terms together (the terms with P, on the right):

===> +1.000.000 + 2.500.000 = 5.000∙P +

2.083∙P

===> 3.500.000 = 7.083∙P

===> 3.500.000 = 7,083∙P ===> 3,500,000 / 7,083 = P; when dividing by 7,083: P =

.
494

And with P on demand: Q = 2,500,000  2.083∙P =2.500.000  2.083∙494 = 1.470.588

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Soluti
Q = 1.470.588
on -
Class(It can also be P in the offer).
2
(There are differences with the graphical method which is more imprecise).

Part two: Something happens in the economy that changes

the market equilibrium.
We put ourselves in the shoes of a manager of a company that sells potatoes. The task is to
identify the direction of change in the price of what the company sells, when something
happens or will happen in the economy that alters the market equilibrium. Certainly, all
company managers are aware of what is happening or may happen, as it affects their
company. It is also important to determine how the company itself should react.

In the news one reads or hears the announcement of a large project to be installed in the area
and a 50% increase in the number of inhabitants of the town is expected.

Task:
1. Identify the direction of change in the break-even price of potatoes, as it will affect our
company. Use Prof. Mankiw's three-step analysis methodology.

6. Apply Professor Mankiw's methodology to determine the direction of change in price:

a) (3%) Step 1: Indicate: Does the offer change? ___:Yes _X_:No

Does demand change? _X_:Yes ___:No

b) (3%) Step 2: Indicate: The Offer: ___:Increases _X_:No change

___:Decreases

The Demand: _X_:Increases ___:No

change ___:Decreases

c.1) (3%) Step 3: Plot the new situation on the graph on the last page and conclude.

Response:

It is enough to realize that the horizontal quantity increases by 50%, for each price:

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Soluti 1.200

on - 1.000
Class 800
2 600

400

200

0
0 500.000 1.000.000 1.500.000 2.000.000 2.500.000 3.000.000

Cantidad por año

A table of the new demand can also be constructed and plotted, as before:
Quantity
Factor for 50% Quantity with
Price without 50%
increase 50% increase
increase
450 1.616.500 1.5 2.424.750
525 1.342.000 1.5 2.013.000
675 1.159.000 1.5 1.738.500
788 884.500 1.5 1.326.750

c.2) (3%) It is concluded that the equilibrium price:

X_:Increases ___:Remains unchanged ___:Decreases

c.3) (3%) The change in equilibrium is with:

___:A movement along the demand curve (which has not changed).

X_:A shift of the demand curve, which changes position

X_:A movement along the supply curve (which has not changed).

___:A shift of the supply curve, which changes its position.

7. (10%) Obtain the mathematical equation of the new aggregate demand line and write it
down below:

Response:

As demand increases 50%, it is multiplied by 1.5:

Qnew = Qantigua ∙ 1,5 ===> Qnew = [2.500.000  2.083 ∙ P]∙1,5 = 3.750.000 3.125 ∙ P

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Soluti==> Equation: Q = 3.750.000 3.125 ∙ P
on -
8.Class
Find the new market equilibrium, given the expected increase in demand, in two ways:
2 8.1. (5%) Graphically. Record your results below:

Response: Quantity: ___1,950,000___ Kg/year (approx.)

Price: ___595___ $/Kg (approx.)

(the graphic method is not very accurate)

8.2. (10%) Mathematically. Identify the new equilibrium by equating the new quantity
demanded with the quantity offered:

Answer: Q demanded = Q offered

===> 3.750.000 3.125 ∙ P = 1.000.000 + 5.000 ∙

P

Putting like terms together (the terms with P, on the right):

===> 1.000.000 + 3.750.000 = 5,000 ∙ P + 3,125 ∙

P

===> 4.750.000 = 8.125 ∙ P

===> 4,750,000 = 8,125 ∙ P ===> 4,750,000 / 8,125 = P; when dividing by 8,125: P =

585.

And with P in demand: Q = 3.750.000 3.125 ∙ P = 3.750.000 3.125 ∙ 585 =

Q = 1.922.000

(It can also be P in the offer).

9. (6%) Results: You have made a forecast of how the balance will change. Summarize it as
follows.

Due to a 50% increase in the number of inhabitants of the town, in view of a large project
to be installed in the area:

Potato consumption is expected to increase 31%.

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Soluti
And it has been predicted that the price of potatoes will increase by 18%.
on -
ClassNote: It is best to summarize by reporting percentage changes.
2

10. (10%) You should have obtained that the price will increase and the quantity will also
increase. Is this a violation of the Law of Demand, which states that if the price increases,
the quantity demanded must decrease? The answer is NO and indicate why:

The ceteris paribus condition (all else constant) is not met. The number of consumers
increases and this causes demand to shift and change position. It is not a movement
along a single demand curve.

Part three: Company reaction

Now it is important to determine how the company itself should react to what will happen in
the economy and how it will affect it.

Task:
1. Determine how our company should react, based on the prediction of a change in the
price of what it produces and sells: potatoes.

11. (10%) Company response. Identify whether the company should prepare for:

X_:Increase in your quantity sold It will not affect you __:Decrease in quantity sold

If the price increases, the company must prepare for an increase in its quantity sold. This
is what it is in your best interest to do, according to the Law of Supply as applied to the
case of an individual bidder.