Microeconomics questions

Demand, supply and elasticity of demand and supply

1) Define the following terms;

 Supply
 Demand
 Elasticity of demand
 Price elasticity demand (PED)
 Demand function
 Ceteris paribus
 Equilibrium
 Total revenue
 Marginal revenue
2. What’s the difference between change in demand and quantity demanded? Use an aid of
diagram.

3. The demand and supply functions of a good are given by P = −2 𝑄𝑑 + 50, P = 0.5𝑄𝑠 + 25
where P, 𝑄𝑑 and 𝑄𝑠 denote the price, quantity demanded and quantity supplied
respectively.
 Sketch the demand and the supply curve
 Determine the value of P when 𝑄𝑑 = 23, 𝑄𝑑 when P = 18
 Determine the equilibrium price and quantity.
 Determine the effect on the market equilibrium if the government decides to impose a
fixed tax of $5 on each good.
4.
  From the graph above answer the following.
 What’s the equilibrium price and quantity?
 At what price will the firm make profit or loss?

5. Income elasticity of demand measures the responsiveness of demand to changes in income.

Explain what is happening to demand and what kind of good is being represented in the
following situations.
a) Income is rising, and income elasticity of demand is positive.
b) Income is rising, and income elasticity of demand is negative.
c) Income is falling, and income elasticity of demand is positive.
d) Income is falling, and income elasticity of demand is negative.

6. For each of the following products, explain whether demand is likely to be elastic or inelastic.
a) Salt,
b) Apple juice
c) Nshima
d) HAART, a type of combination therapy for HIV/AIDS
e) video-game consoles f) Computer mice
Explain your answer….

7. Consider the following demand function: 𝑄𝑑= 25/𝑃2. Show that the point elasticity of demand
for that function is always equal to −2.

8. Where along a straight-line demand curve does consumer spending reach a maximum?
Explain why. What use is this information to the owner of a football club?
9.

Price quantity TR(p.q) %p %q elasticity Description

K0 12
1 10
2 8
3 6
4 4
5 2
6 0

 Calculate the total revenue, %P, %Q and elasticity.

 Give the description
 Draw a graph to show a total revenue
 At which point you the firm be unit, elastic and inelastic

10. Your fruit stall has 100 ripe peaches that must be sold at once. Your supply curve for peaches
is vertical. From past experience, 100 peaches are demanded if the price is £1. The demand
elasticity is −0.5. (a) Draw a supply and demand diagram showing market equilibrium. (b) You
discover 10 of your peaches are rotten and cannot be sold. Draw the new supply curve. What is
the new equilibrium price?

11. Consider the following demand function: QD = 25/P2. Show that the point elasticity of
demand for that function is always equal to −2.

12. Suppose that the market demand for beef is given by QD = 200 −6P + 2Y, where P is the
price of meat per kg and Y is the consumers’ income. Suppose that consumers’ income is £100.
If the price of beef decreases from £10 to £8 per kg, find the corresponding elasticity of demand.
Now suppose that the price is fixed to £8 while consumers’ income increases from £100 to £150;
find the corresponding income elasticity of demand. Is beef a normal good?

13. The market demand for a given good is QD=26 −4P, while the market supply is QS= 2P −4.
Find the equilibrium price and quantity in the market. Now assume that the government
introduces a specific tax t = 3 on the suppliers. Find the new equilibrium price and the new
equilibrium quantity. Compare the pre-tax equilibrium with the after-tax equilibrium. What are
the main differences?
 Exam 1: Study Questions

I. Review of markets

1. Bill and Joe live in Ithaca, New York. At 2 P.M. Bill goes to the local Ticketron outlet and
buys a $30 ticket to a basketball game to be played that night in Syracuse (50 miles north).
Joe plans to attend the same game, but doesn't purchase his ticket in advance because he
knows from experience that it is always possible to buy just as good a seat at the arena. At 4
P.M. a heavy, unexpected snowstorm begins, making the prospect of the drive to Syracuse
much less attractive than before. If both Bill and Joe have the same tastes and are rational, is
one of them more likely to attend the game than the other? Why or why not?
   
2. In the diagram to the right, draw a demand curve for labor in manufacturing and a male labor
supply curve and total (male and female) labor supply curve. Indicate the equilibrium wage
  (W), the total quantity of labor supplied (Lt), and the quantities of men (Lm) and women
(Lw) hired. (Note: men and women are equally qualified for the manufacturing jobs.)
   
3. Suppose the price for haircuts in Eagle Rock increases from $3 to $5. As a consequence, the
number of haircuts demanded falls from 12 to 8 daily.
(1)  What is the value of the arc (midpoint) elasticity of demand for haircuts in Eagle Rock?
(2)  Did the total expenditure on haircuts move in the direction you expected based on the
elasticity value you calculated? Explain briefly.
 
4. (6 minutes) Consider the following demand for scoops of ice cream:
        Qd = 360·P-2
(Note: This is an example of a "constant elasticity" demand equation, which means that the
own-price elasticity of demand remains the same everywhere along the demand curve.)
  a. Is the demand for scoops of ice cream elastic, unit elastic, or inelastic?
  b. How did you decide?
     
5. If your demand for compact discs (CDs) is Qd = 40 - 2P, then if P=$12:
(1) What is the value of your point elasticity of demand for CDs?
(2) Based on your elasticity value, will your total expenditure on CDs rise, fall, or remain the
same if price falls slightly? Explain briefly.
     
6. Which of the demand curves in the diagram to the right illustrate(s)
elastic demand for aspirin as the price varies between $3 and $6 per
bottle? Briefly support your answer.

     
IIA. The rational consumer

1. Home Expo charges a flat $750 fee for interior design services for a remodeling project, but
refunds the fee if the customer buys at least $3,000 of materials for the project. Sketch the
budget line of a Home Expo customer with $8,000 of income available for a reomdeling
project. Put materials (M) on the horizontal axis, income spent on other goods (Io) on the
vertical axis, and assume a constant average price for each unit of materials purchased.
   

2. Virginia and Joe have the same income which they allocate between photocopies (C) and
income spent on other goods (Io). The local photocopy store charges $.05 per copy for the
first 50 copies $.03 per copy for additional copies.
(1) Virginia read the pricing policy correctly and understands what her budget line looks
like. Sketch her budget line in the diagram to the right. Put photocopies on the horizontal
axis.
(2) If Virginia has a smoothly diminishing marginal rate of substitution, will she ever order
exactly 50 photocopies? Explain briefly.
(3) Joe misread the price list at the photocopy store and thought that the price was $.05 per
copy if you make up to 50 copies, or $.03 per copy for all the copies if you make more
than 50 copies. Illustrate in the same diagram what Joe thinks his budget constraint looks
like.
   

3. Suppose that last month you spent all of your monthly snack budget on 6 dark chocolate
candy bars at $1.50 each and 18 cans of Dr. Pepper $.50 each. With this consumption bundle
you were willing to trade 1 can of Dr. Pepper for 3 candy bars. Did you maximize your snack
satisfaction last month? If so, explain why. If not, explain why not, and indicate the direction
of any adjustment you should have made in your consumption bundle.
   

4. Suppose that last month I spent all of my monthly dessert budget on an equal number of
Buster's smoothies ($3 each) and bittersweet hot fudge sundaes from Twohey's ($2 each). I
would have traded two of my smoothies for an extra sundae. Did I maximize my dessert
satisfaction last month? If so, explain why. If not, explain why not, and indicate the direction
of any adjustment I should have made in my dessert bundle. Illustrate my situation last
month in an indifference curve diagram (put hot fudge sundaes on the horizontal axis).
   

5. Suppose you consume only two goods: X=books (B) and Y=rented videos (V). Books cost
$10 apiece and videos rent for $5 apiece. Your utility is given by the function:
      U = B0.2V0.8.
You currently consume 5 books and 10 videos.
(1) What is the current value of your marginal rate of substitution (MRS)?
(2) Could an adjustment in consumption increase your utility? If not, explain why not. If so,
what direction of adjustment should you make, and why?
     
 6. Albert consumes only two goods: X=neutrons (N) and Y=protons (P). The price of neutrons
(PN) is 2 quarks and the price of protons (PP) is 1 quark. Albert's utility is given by the
function:
      U = N0.25P0.75.
Albert currently consumes 4 neutrons and 6 protons.
(1) What is the current value of Albert's marginal rate of substitution (MRS)?
(2) Could an adjustment in consumption increase Albert's utility? If not, explain why not. If
so, what direction of adjustment would you recommend, and why?
     

7. Dan derives utility from potatoes (P) and tomatoes (T) according to the utility function:
            U(P,T) = P1/2T1/2
If the price of potatoes is 50 cents per pound, the price of tomatoes is $1 per pound, and Dan
spends $100 on these two commodities, how many pounds of potatoes will he buy? How
many pounds of tomatoes? Be sure to show appropriate formulas and/or computations.
   

8. Consider an individual who consumes only two goods, donuts (D) and milk (M), for
breakfast, deriving utility according to the following formula:
            U(D,M) = D3/5M2/5
If donuts cost $.50 each and milk costs $2 per gallon, how should the consumer allocate a
monthly breakfast budget of $40? Show appropriate formulas and/or computations.
   

IIB. Extensions and applications of consumer theory

1. "Since 1900 real income has increased tremendously, yet the average number of children per
family has decreased." Consider the following possible explanation and use budget lines and
indifference curves to compare the optimal choice between children (C) and income spend
on all other goods (Io) in 1900 and today (put children on the horizontal axis:
    Despite an increase of both money income and real income (utility), it has become more
expensive to bear and rear children.
     

2. Suppose you have $240 to spend on heavy metal rock concert tickets (T) and other goods
(Ig). Your utility translates into the following market demand for concert tickets:
    Qd = 12 - 0.2·P
  a. Use a budget line and indifference curve diagram to illustrate your optimal consumption
points for each of the following ticket prices (put tickets (T) on the horizontal axis):
    (1) P1 = $60
    (2) P2 = $30
    (3) P3 = $0
  b. Sketch a price-consumption curve (PCC) linking the optimal points you have drawn.
Based on what you know about how elasticity changes as you move down a linear
 demand curve, are you surprised about how your PCC behaves? Why or why not?
     
3. Suppose you consume only chocolate, a normal good, and spy novels, an inferior good. The
income effect is larger than the substitution effect for both goods. Based on this information,
if the price of spy novels decreases:
  (1) Will you consume more or fewer spy novels? Explain.
  (2) Will you consume more or less chocolate? Explain.
     
4. Bill consumes flour and falafel, the only two goods in the economy. When the price of flour
falls, Bill buys more flour and less falafel than before. Which of the following must be true?
(1) If flour is a normal good, the income effect outweighs the substitution effect.
(2) If flour is a normal good, falafel must be an inferior good.
(3) If flour is an inferior good, falafel must be a normal good.
(4) If falafel is a normal good, the income effect outweighs the substitution effect.
(You may use the diagram to the right to help you figure out your answer, but be sure to
provide an explanation).
 
5. (5 minutes) Suppose that the diagram to the right
illustrates your demand curve for amusement park rides.
Your town has 2 amusement parks which offer equally
attractive rides:
    Amusement park 1 has free admission but charges $3
per ride.
    Amusement park 2 charges $25 for admission but the
rides there are free.
Which amusement park would you choose? How did you
decide?

 
     
6. Suppose you have the following demand curve for photocopies:
            Q = 120 - 4P
        where Q = number of copies you make per month, and P = the price per copy (in cents).
Suppose Oxy offers you two options for making photocopies:
        Option 1: Pay 10 cents per copy.
        Option 2: Pay $9 for a copy card that allows you to make as many free copies as you
want for a month. (No one else can use your card--don't ask me how Oxy can enforce this; I
don't know.) Which option will you choose? Carefully explain your answer.
     
7. a. The residents of Owens Valley on the eastern side of California's Sierra Nevada
 Mountains consume water (W) and spend the rest of their income on other goods (Ig). In
the diagram to the right, draw an initial budget line, putting water on the horizontal axis,
and use a (nice smooth) indifference curve to illustrate an initial optimum for a typical
Owens Valley consumer. Label your initial consumption point as point "a."
b. Several years ago, Los Angeles began  shipping water from the Owens Valley to L.A.
Illustrate in your diagram the impact of the resulting increase in the price of water for
your Owens Valley consumer. Label your new consumption point as point "b." Clearly
separate your change in water consumption into a substitution effect and an income
effect.
c. Now suppose that the Owens Valley residents reach an agreement with L.A. to be
compensated with enough income to restore the typical Owens Valley consumers to their
original level of utility. Indicate in your diagram the size of the payment received.
d. Is the amount you have shown larger than, smaller than, or equal to the consumer's
compensating variation for the increase in the price of water? Explain.

e. Now consider the situation of a typical L.A. water consumer receiving Owens Valley
water. In the diagram to the right, draw an initial budget line, putting water on the
horizontal axis, Ig on the vertical axis, and use a (nice smooth) indifference curve to
illustrate an initial optimum. Label your initial consumption point as point "a."
f. Suppose L.A. finances the payments it makes to the Owens Valley by imposing a tax on
water consumed by L.A. residents. Illustrate the new optimum in your diagram, and
clearly label the amount of tax revenue collected from the consumer.
g. Would your consumer have been better off if L.A. had financed the same-sized payment
to the Owens Valley with an income tax instead of a tax on water? Explain briefly, and
use your diagram for support.
   

8. Consider a retired couple, the Gurmans, both aged 64, who consume health insurance (H)
and spend the rest of their income (Ig) on other goods
  a. In the diagram to the right, draw an initial budget line, putting health insurance on the
horizontal axis, and use a (nice smooth) indifference curve to illustrate an initial optimum
for the Gurmans. Label it "A."
  b. The following year, when the Gurmans reach age 65, they qualify for Medicare, which
subsidizes most of their health insurance costs. All they need to pay for is some
supplemental insurance for expenses not covered by Medicare. Illustrate the price
subsidy in the diagram. Label the Gurmans' new optimum as point "B," and clearly
separate their change in health insurance consumption into a substitution effect (S) and
income effect (I).
  c. Use the label "C") to indicate in your diagram how much the government spends on
health insurance coverage for the Gurmans.
  d. When the Gurmans turn 66, two things happen: (1) the price of their supplemental health
insurance rises, and (2) they receive a cost-of-living adjustment (COLA) to their Social
Security income that successfully achieves the government's goal of maintaining retirees'
purchasing power and thereby continues to make bundle B affordable for the Gurmans.
Diagram the Gurmans' new budget line, and use the label "D" to indicate how much the
COLA costs the government.
   e. Is your analysis here consistent or inconsistent with the following assertion about Social
Security's policy for cost-of-living adjustments: "Social Security's COLA's tend to
provide retirees with more income than the minimum they need to maintain their well-
being (utility) over time." Support your answer.
     
9. Suppose you allocate your $400 income between books (B), priced at $10 apiece, and
income spent on other goods (Io).
a. In the top diagram to the right, draw an initial budget line, putting books on the
horizontal axis, and use a (nice smooth) indifference curve to illustrate an initial
optimum. Label your initial consumption point as point "a." Label the amounts for the
endpoints of your budget line.
b. Now suppose the price of books decreases to $5 apiece, and you move to a new optimum
which is directly above or below point "a". Illustrate your new optimum in your diagram,
and label your new consumption point as point "b." Clearly separate your change in book
consumption into a substitution effect and an income effect (you can't provide exact
numbers for this part).
c. Can you classify books as a normal or inferior good for you? Explain how you decided.
d. Plot your demand curve for books in the lower righthand diagram.
e. Suppose the lower price is the result of a book price subsidy offered by the College.
Indicate in the upper righthand diagram the cost to the College of its subsidy.
f. Suppose the College decides to cancel its book price subsidy (so the price of books
returns to $10), but the College just gives you in cash the same amount it spent with the
price subsidy. Draw your new budget line and illustrate a possible new optimum--label it
point "c."
g. Use your new level of book consumption at point "c" to help you draw your new demand
curve for books in the bottom diagram. Assume it is parallel to your original demand
curve. Based on your answer to part c, did your demand curve shift in the direction you
expected when the College increased your income? Explain briefly.
h. Finally, review part b and ignore all the parts in between. Suppose that the lower price
described in part b was the result of a special bookstore sale. But to get into the sale, you
have to pay a cover charge. Indicate in your upper righthand diagram the maximum
cover charge you would be willing to pay to get into the bookstore to take advantage of
the sale price.
     
10. Jean is a poor 18th-century French peasant who consumes only bread and cake.
  a. Depict an initial optimum for Jean in a budget line/indifference curve diagram. Put bread
on the horizontal axis. Leave plenty of space to add lines and notation to your diagram,
and plan ahead for an increase in the price of bread. Label your initial consumption point
'a'.
  b. Now illustrate a possible new optimum for Jean if the price of bread rises. Label your
new optimum as point 'b', and locate it so that you have an upward-sloping price-
consumption curve (PCC) through points a and b.
  c. Would a researcher observing Jean's consumption bundles before and after the change in
the price of bread conclude that cake and bread are substitutes or complements for Jean?
Explain briefly how you decided.
  d. Indicate how the substitution effect and income effect each influences Jean's
 consumption of cake. Which effect helps account for your answer to part c? Explain
briefly.
  Now suppose instead that the vertical axis measures dollars of income spent on goods other
than bread (Ig). (Equivalently, just assume that the price of each piece of cake is 1 franc.)
  e. Suppose that the reason the price of bread rose is because of a tax on bread. Indicate in
your diagram how much tax revenue the government collects from Jean as a result of the
tax.
  f. If the government decides to replace the bread tax with an income tax, illustrate in your
diagram how large the income tax could be without making Jean any worse off than with
the bread tax. Which tax yields more revenue for the government, the bread tax or the
income tax? How can you tell?
     
11. Paula has an income of $960 which she uses to purchase 15 theater tickets (T) priced at $24
each and 30 video games (V) priced at $20 each. Her present consumption bundle is an
optimum for her.
a. Draw Paula's initial budget line and (a nice smooth) indifference curve, putting theater
tickets on the horizontal axis. Label her initial consumption point as point "a." Label the
amounts for her consumption and the endpoints of her budget line.
b. What is the value of Paula's marginal rate of substitution (MRS) at point a, and what does
the value tell you?
c. Now illustrate a possible new optimum for Paula if the price of theater tickets increases,
and separate the change in Paula's consumption of theater tickets into a substitution effect
and an income effect (you can't provide exact numbers for this part).
d. Based on your diagram, are theater tickets a normal or inferior good? How can you tell?
e. Now ignore the price increase of part c and draw Paula's initial optimum again (with
another nice smooth indifference curve) in a new diagram. Now suppose that Paula has
an option to pay a $240 fee to join a discount buying club with PT = $12 and PV = $18.
Draw her new budget line (hint: her new budget line should pass through point a).
f. Will Paula choose to join the club? Why or why not?
g. If Paula does join, will she choose to continue consuming at point a? If so, explain why.
If not, explain why not, and describe the direction of any consumption adjustment she
will make.
h. Indicate in your diagram the maximum fee Paula would be willing to pay to join the
buying club. Is the maximum more or less than $240? How can you tell?
     
12. Oxy faculty spend some of their income on housing (H), and the rest of their income (Ig) on
other goods.
  a. Depict an initial optimum in an indifference curve diagram. Put H on the horizontal axis.
Leave plenty of room to work on the vertical axis. Use an "a" to label your initial
consumption bundle.
b. In response to the relatively high cost of housing in California, Oxy subsidizes the price
of housing purchased by its faculty. Show the consequences of the subsidy for the faculty
member you depicted in part a. Label your new consumption point as "b." Clearly
separate the total change in consumption of housing into a substitution effect and an
income effect.
  c. Based on your diagram, is housing a normal or inferior good? How can you tell?
 d. Oxy is currently looking for ways to reduce its total budget. Would Oxy be able to save
money on the faculty member depicted in your diagram by canceling the housing price
subsidy and offsetting the cancellation by increasing the faculty member's salary just
enough to leave the welfare of the faculty member unchanged? Briefly explain your
answer and use your diagram for support.
     
13. Suppose you spend some of your entertainment budget on cultural events (C), and the rest of
your income (Io) on other goods.
a. Depict an initial optimum in an indifference curve diagram. Put C on the horizontal axis.
Leave plenty of room to work on the vertical axis. Use an "a" to label your initial
consumption bundle.
b. Use your diagram to depict the consequences of a decrease in the price of cultural events.
Label your new consumption point as "b." Clearly separate the total change in your
consumption of cultural events into a substitution effect and an income effect.
  c. Based on your diagram:
    (1) Do you consider cultural events to be a normal or inferior good? How can you tell?
    (2) Is your demand for cultural events elastic or inelastic? How can you tell?
d. Suppose instead that the lower price depicted in part b is the result of a government
subsidy of the price students pay to see cultural events. Indicate in your diagram the cost
to the government of the subsidy it pays on the cultural events you attend.
  e. If the government replaces its price subsidy with an income subsidy of the same dollar
amount, then indicate whether each of the following would rise, fall, remain the same or
change in an uncertain direction compared to its level under the price subsidy policy:
    (1) your utility, and
    (2) your consumption of cultural events.
    Briefly explain both answers.

Compiled by; Samson Mwanza