PAF Karachi Institute of Economics and Technology City Campus Course: Micro & Macroeconomics Faculty: Iftikhar Mubbashir

r 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. Cold drinks and pizza are complements because they are often enjoyed together. When the price of cold drinksrises,whathappenstothesupply,demand,quantitysupplied,quantitydemanded,andthepricein themarketforpizza? Solution) PPizz a S P0 P1 D D 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)

The cold snap will destroy oranges and that will reduce the quantity of oranges produced which will reduce the supply of the quantity of oranges. So, there will be fewer oranges which will shift the supply curve left side.Asthefigureshowsthisdecreaseinsupplyraisestheequilibriumprice. b. When the weather turns warm in New England every summer, the prices of hotel rooms in Caribbean 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 a decrease in demand for hotel rooms. The demand curve will shift to the left. The hotel owners will reduce 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 S P1 P0 D D Q0 Q1 Q softwares
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 Whenthepriceofthecomplementgoodincreases,resultsintherightwardshiftofthedemandcurveforsoft waresfromDtoDwhichresults: Demand IncreasesfromDtoD Quantitydemanded IncreasesfromQ0toQ1 Quantitysupply IncreasesfromQ0toQ1 Supply Nochange Price IncreasesfromP0toP1 Ptypewriter S P0 P1 D D 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 S P0 P1 D Qcomputers Q0 Q1 Page4of10

 Whentheinputpriceofproductiondecreases,resultsintherightwardshiftofthesupplycurveforcomputers fromStoSwhichresults: Supply IncreasesfromStoS Quantitydemanded IncreasesfromQ0toQ1 Quantitysupply IncreasesfromQ0toQ1 Demand Nochange Price DecreasesfromP0toP1 6. The case study presented in the chapter discussed cigarette taxes as a way to reduce smoking. Now think aboutthemarketsforothertobaccoproductssuchascigarsandchewingtobacco. a. Arethesegoodssubstitutesorcomplementsforcigarettes? Solution) CigarandChewingtobaccoarethecomplementsforcigarettes. b. Using a supplyanddemand diagram, show what happens in the markets for cigars and chewing tobaccoifthetaxoncigarettesisincreased. Solution)

If warning on cigarette packages convince smokers to smoke less, the demand curve for cigarettes shifts to theleftasshowninabovefigure.ThedemandcurveshiftfromD1toD2ataprice$2andthequantitydemand fallsfrom50to20cigarettes. c. If policymakers wanted to reduce total tobacco consumption, what policies could they combine with 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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9 39 121 Graph the demand and supply curves. What is the equilibrium price and quantity in this market? If the actual priceinthismarketwereabovetheequilibriumprice,whatwoulddrivethemarkettowardtheequilibrium?If the actual price in this market were below the equilibrium price, what would drive the market toward the equilibrium? Solution) The equilibrium price of Pizza would be $ 6 and the equilibrium quantity of Pizza would be 81 as shown intersectionpointonabovefigure. Ifpriceofpizzaincreasesfromtheequilibriumpriceitwouldbesurplussupplycreatedandsupplierwould notabletosaleastheywant. If price of pizza decreases from the equilibrium price it would be shortage supply created and buyers wouldnotabletobuyasthewant. Tomakemarketequilibriumsuppliermusthavetodecreasethepriceinordertoremovesurplus. Tomakemarketsequilibriumsuppliermusthavetoincreasethepriceinordertoremoveshortage. 8. Suppose that the price of basketball tickets at your college is determined by market forces. 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 S 8 D 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 $8.00. c. Your college plans to increase total enrollment next year by 5,000 students. The additional students willhavethefollowingdemandschedule: PRICE($) QUANTITY DEMANDED 4 4,000 8 3,000 12 2,000 16 1,000 20 0 Now add the old demand schedule and the demand schedule for the new students to calculate the new 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 S 12 D 8000 Q B ball The Equilibrium quantity would be 8000 seats and the Equilibrium price would be $12.00. 11. Definethepriceelasticityofdemandandtheincomeelasticityofdemand. Solution)Priceelasticityofdemandisameasureofhowmuchthequantitydemandedofagoodrespondstoa changeinthepriceofthatgood. Price elasticity of demand is the percentage change in quantity demanded given a percent change in the price. The price elasticity of demand is computed as the percentage change in the quantity demanded divided by thepercentagechangeinprice. Income elasticity of demand measures how much the quantity demanded of a good responds to a change inconsumersincome. It is computed as the percentage change in the quantity demanded divided by the percentage change in income.
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Higherincomeraisesthequantitydemandedfornormalgoodsbutlowersthequantitydemandedforinferior goods. 12. Listandexplainsomeofthedeterminantsofthepriceelasticityofdemand. Solution) Availability of Close Substitutes: Goods which have closed substitute are more elastic. A small increase in pricemayguidepeopletoswitchforsubstitute.Examplecouldbebutterandmargarine. Necessities versus Luxuries: Necessities which have no substitute could be inelastic. Increasing in price would not effect on quantity demanded. Example visit to the doctor. Whereas price of Luxuries rises, the quantitydemandedfalls. Definition of the Market: The elasticity of demand in any market depends how we define any market. If we define market narrowly, that will be easy to find substitute mean more elastic. If we define market broadly,thatwillbedifficulttofindsubstitutemeanlesselastic. Time Horizon: Some goods more elastic over the long time which effect quantity demanded after a long 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 P S P0 D Q Q0 14. Howisthepriceelasticityofsupplycalculated?Explainwhatthismeasures. Solution) Price elasticity of supply is a measure of how much the quantity supplied of a good responds to a change inthepriceofthatgood. Price elasticity of supply is the percentage change in quantity supplied resulting from a percent change in price.
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15. For each of the following pairs of goods, which good would you expect to have more elastic demand and why? a. requiredtextbooksormysterynovels Solution) Mystery novels have possible substitute, more elastic but required text book has not substitute less 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. Suppose that business travelers and vacationers have the following demand for airline tickets from New YorktoBoston: a. As the price of tickets rises from $200 to $250, what is the price elasticity of demand for (i) business travelersand(ii)vacationers?(Usethemidpointmethodinyourcalculations.) Solution) Usingmidpointformula: (1,900 2,000) [(1,900 + 2,000) 2] = 0.23 E D (B.T ) = (200 250) [(200 + 250) 2] (800 600) [(800 + 600) 2] = 1.29 E D (V ) = (200 250) [(200 + 250) 2] b.Whymightvacationershaveadifferentelasticitythanbusinesstravelers? Solution) For vacationers, travel is of less necessity compared to business travelers. Vacationers have longer time horizon for travel while the business travelers have a very short time to travel. Vacationers also have severalothersubstitutesliketravellingbycar.Thatsubstituteisnotappropriateforbusinesstravelersasthey need to reach faster to their place of destination. This is why vacationers will have a higher elasticity of demandforairticketscomparedtothebusinesstravelers. 17. Supposethatyourdemandscheduleforcompactdiscsisasfollows: PRICE($) 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. Two driversTom and Jerryeach drive up to a gas station. Before looking at the price, each places an order. Tom says, Id like 10 gallons of gas. Jerry says, Id like $10 worth of gas. What is each drivers priceelasticityofdemand? Solution: For Tom the price elasticity of demand is inelastic, as he does demand the amount of the gas without inquiring the price, means his demand is independent of the price. Whereas, the demand for jerry is highlyelastic;ashedemandedthequantityofthegasoffixedamount. 19. Considerpublicpolicyaimedatsmoking. a. Studies indicate that the price elasticity of demand for cigarettes is about 0.4. If a pack of cigarettes 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) As they are not that much addicted to the habit as the elders are and the income affect is larger on teenagersthatitisonelders.

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