NOTE: 1. 2.

These are revision and preparatory mid-term test questions; Students are encouraged to draw and understand their own diagrams in cases where the solution does not show them. This is to encourage you to research and think through the issues rather than rote learn.

Question 1: Assume that a country is presently located on its production possibilities rontier. !"plain what impact #i any$ the ollowing events will have on its production possibilities rontier. #a$ The general level o work orce training increases;

This represents an increase in the quality of a resource such as labour, and will cause the frontier to shift outwards. (2. !ar"s# #b$ An economic downturn results in underutilisation o capital equipment; This will result in production bein$ located inside the frontier. The position of the frontier will be unchan$ed. (2. !ar"s# #c$ The marketing skills o the managers are improved through special training programs; One way to accelerate econo!ic $rowth is to $ain additional resources. %ny increase in resources will shift the production possibilities frontier outward. &i!ilar to part (a#, the frontier will shift outwards. (2. !ar"s# #d$ %anu acturing irms are made to pay or cleaning up the pollution that they cause. This represents a decrease or redirection of resources towards the cleanin$ up the pollution. %s fir!s are forced to pay this cost they will internalise it resultin$ in increased production costs and their own outputs will decrease with a leftward shift in the supply cur'es. On the a$$re$ate le'el this would transpose of an inward shift of the production possibility frontier. (2. !ar"s# Question 2: The marketing department o your business have in ormed you that the price o one o your products should be reduced so you meet with them to discuss the implications o this. &hat are these implications #i.e. what matters should the meeting discuss$' This question deals with the relationship between price elasticity of de!and and total re'enue. (t does !atter whether de!and is elastic or not. (f you raise prices, total re'enue will increase if de!and is price inelastic but decreases if de!and is price elastic. (t is possible for de!and to be price inelastic in the short)run but price elastic when a lon$er ti!e period is considered.

(llustrate this usin$ a dia$ra! and table relatin$ price elasticity of de!and to re'enue raised by the fir! (or consu!er e*penditure# si!ilar to e*hibit .+ p.12+ of ,ayton or section -.2 of &lo!an and Norris. (1. !ar"s# Question -: (se a sin$le dia$ra! to e"plain and show the combined e ect o the ollowing two events on the market equilibrium price and quantity or train travel) #a$ A large increase in the price o petrol; #b$ An increase in motor vehicle engine price parts. %ssu!in$ that auto!obile tra'el and train tra'el are substitutes and that trains do not run on petrol/ than an increase in the price of petrol will cause people to use cars less and rail tra'el !ore. 0onsequently the de!and cur'e for rail tra'el will shift to the ri$ht fro! 1. to 11 on dia$ra! 1 as tra'ellers switch to the less e*pensi'e rail tra'el. (2 !ar"s#. %n increase in the price of auto!obile en$ine parts will cause the !anufacturin$ costs and hence the price of auto!obiles to increase and their supply cur'e to shift to the left. 0onsequently the de!and cur'e for rail tra'el will shift to the ri$ht fro! 11 to 12 on dia$ra! 1 as tra'ellers switch to the less e*pensi'e rail tra'el. (2 !ar"s#. (n each ri$htward shift of the de!and cur'e the equilibriu! price and quantity will increase and the substitution will $o on as lon$ as train tra'el is percei'ed by consu!ers to be the cheaper alternati'e. (2 !ar"s# Question 2: *llustrate and e"plain with diagrams using an e"ample+ the actor#s$ which result in) #a$ An increase in quantity demanded)

%n increase in the quantity de!anded co!prises of !o'e!ent down and alon$ a downward slopin$ de!and cur'e fro! point % to point 3 on dia$ra! 2, assu!in$ that all other influences ha'e been held constant. This is reflected in a decrease in the price fro! 4. to 41 which corresponds to an increase in the quantity de!anded fro! Q. to Q1. (2 !ar"s# #b$ A decrease in demand.

% decrease in de!and fro! 1. to 11 on dia$ra! - is a leftward shift of the whole de!and cur'e and this will result fro!: 1. 2. -. 1ecrease in the price of a substitute/ (ncrease in the price of a co!ple!ent/ % decrease in inco!es and the $ood is a nor!al $ood/

2. . +.

%n increase in inco!es and the $ood is an inferior $ood/ 0han$e in tastes 5 a decrease in the desire to purchase/ E*pectations of lower prices in the future.

Question : Suppose the income elasticity o demand or urniture is ,-.. and the income elasticity o demand or doctors/ services is , ..-. 0ompare the impact on urniture and doctors/ services o a recession that reduces consumer income by 1. per cent. 6urniture is a nor!al $ood and inco!e elastic since 78 9 : 2.., which is ; 1../ (- !ar"s# 1octor<s ser'ices is a nor!al $ood and inco!e inelastic since 78 9 : ..2, which is = 1../ (- !ar"s# (n a recession the de!and for furniture will fall by 2. > and the de!and for doctor<s ser'ices will fall by 2>. The i!pact on furniture is $reater than that of doctor<s ser'ices as furniture would be considered a lu*ury $ood, whereas doctor<s ser'ices are still considered a necessity e'en durin$ a recession. (2 !ar"s# Question +: *llustrate and e"plain with diagrams using an e"ample+ the di erence between #a$ a decrease in the quantity supplied and #b$ a decrease in supply. (a# % decrease in the quantity supplied co!prises a !o'e!ent down an upward slopin$ supply cur'e fro! point % to point 3 on dia$ra! 2, which corresponds to a decrease in quantity fro! Q. to Q1 on the hori?ontal a*is and a decrease in price fro! 4. to 41 on the 'ertical a*is, with all other influences bein$ held constant (2 !ar"s for the dia$ra! and !ar"s for the written e*planation#/ (b# % decrease in supply constitutes a leftward shift of the upward slopin$ supply cur'e on dia$ra! . This results when production and supply costs ha'e increased or another $ood appears !ore profitable in supply (2 !ar"s for the dia$ra! and - !ar"s for the written e*planation#. Question @: *llustrate and e"plain with diagrams using an e"ample+ the di erence between a decrease in the quantity supplied and a decrease in supply. (a# On the upward slopin$ supply cur'e a fall in the price fro! 4. to 41 will result in a decrease in the quantity supplied fro! Q. to Q1 all other thin$s bein$ held constant.

There will be !o'e!ent bac"wards A downwards alon$ the supply cur'e fro! point % to point 3 (b# % decrease in supply fro! !eans a co!plete leftward shift in the supply cur'e fro! &. to &1. This occurs because of: %n increase in the $oods production costs: % substitute $ood beco!es !ore profitable in supply. Question B: #a$ *nterpret the ollowing *ncome !lasticities o 1emand #2!1$ values or the ollowing and state i the good is normal or in erior; 2!13 ,..4 The de!and response as inco!e chan$es (i.e. the proportionate chan$e in de!and di'ided by the proportionate chan$e in inco!e#/ (nelastic because = 1../ This is a nor!al $ood because the de!and increases with inco!e as indicated by the positi'e si$n. (2. !ar"s# 2!13 -2.4 The de!and response as inco!e chan$es (i.e. the proportionate chan$e in de!and di'ided by the proportionate chan$e in inco!e#/ Elastic because ; 1../ This is an inferior $ood because the de!and decreases with inco!e as indicated by the ne$ati'e si$n. (2. !ar"s# #b$ *nterpret the ollowing 0ross-5rice !lasticities o 1emand #6!1$ and state i the goods are substitutes or compliments. 6!13 , ..7 The de!and response of this $ood as the price of the other $ood chan$es (i.e. the proportionate chan$e in de!and di'ided by the proportionate chan$e in price of the other $ood#/ This $ood is inelastic because the real absolute 'alue is = 1../ and a &ubstitute $ood because the de!and increases as the price of the other $ood increases. (2. !ar"s# 6!13 -2.2 The de!and response as inco!e chan$es (i.e. the proportionate chan$e in de!and di'ided by the proportionate chan$e in inco!e#/ Elastic because the real absolute 'alue is ; 1../

0o!ple!entary $ood because the de!and for the $ood decreases as the price of the other $ood increases. (2. !ar"s# Question C: &ith the 8global recession/ in current times+ should governments continue with law o 8minimum wages'/ &hy 9&hy :ot' !"plain and illustrate with diagrams in the light o economic concepts o a 8price ceiling/ or 8 loor/. 0onsider the labour !ar"et equilibriu! dia$ra! below with upward slopin$ supply and downward slopin$ de!and cur'es. (2. !ar"s#

The !ar"et equilibriu! wa$e rate and correspondin$ e!ploy!ent le'els can be found where the de!and and supply cur'es intersect. This can only occur if the !ar"et is allowed to clear 'ia !ar"et forces. (2. !ar"s# (f a !ini!u! wa$e is i!posed which is ; the equilibriu! wa$e rate say at D1 then the supply of labour will e*ceed the de!and for labour causin$ an o'ersupply and consequently une!ploy!ent. (2. !ar"s# (f a !ini!u! wa$e is i!posed which is = the equilibriu! wa$e rate say at D1 then the de!and for labour will be e*ceed the supply de!and for labour causin$ a s"ills shorta$e and proble!s fillin$ 'acancies. (2. !ar"s# Question 1.: ;There is no such thing as ree <unch.= !"plain with the aid o a suitable diagram. (n an econo!y of scarce resources choices !ust be !ade as to what to produce usin$ the li!ited a'ailable resources. The cost of !a"in$ a choice is the opportunity cost, otherwise "nown as the ne*t best alternati'e choice or in'est!ent. Esin$ the si!ple 4roduction 4ossibility 6rontier or (ndifference 0ur'e approach it can be shown that the opportunity cost of increasin$ the use or production of $ood or co!!odity % is what we for$o in the use or production of co!!odity 3.

Question 11: Fe'ision Questions 5 0ross 4rice and (nco!e Elasticity of 1e!and: Assume that portable ear phone model 5!>1> is sold by <aing/s electrical and your business sells the %5> player that uses these ear phones. (n ortunately+ you have had to increase the price o the %5> players rom ?74 to ?@4 and as a result+ the quantity demanded or the portable ear phones has decreased rom 2>. to 1A.. At a latter stage your sales sta tell you that the price o <aing/s portable ear phones has increased rom ?14 to ?2. per set and as a result the %5> player demand has allen rom 24. to 2.4. #a$ 0alculate the cross-price elasticity o demand or the ear phones+ and is it elastic or inelastic' 4roportionate chan$e in ear phone de!and A 4roportionate chan$e in G4- player price 9 H(1C. 5 2-.# A 2-.I A H(@ 5 + # A + I 9 ) ..1@-C1-.2- A ..1 -B2+1 - 9 )1.1-/ This is ; ) 1... and therefore elastic/ #b$ 0alculate the cross-price elasticity o demand or the %5> players+ and is it elastic or inelastic' 4roportionate chan$e in G4- de!and A 4roportionate chan$e in portable ear phone price 9 H(2. 5 2 .# A 2 .I A H(2. 5 1 # A 1 I 9 ) ..1B A ..-- 9 ).. / This is = ) 1... and therefore inelastic. #c$ *nterpret the values calculated in #a$ and #b$ i.e. are the ) 3oth cross)price elasticity of de!and 'alues are ne$ati'e !eanin$ that this pair of $oods are co!ple!ents. (f the si$n of the cross)price elasticity of de!and coefficient is positi'e the pair of $oods are substitutes. The bi$$er the positi'e coefficient, then the !ore they are substitutes. (f the si$n of the cross)price elasticity coefficients are ?ero then there is no relationship between the $oods. #d$ Are these cross price elasticities elastic or inelastic measures' 6or portable ear phones it is elastic because it is $reater than )1... which !eans that you $et a !ore than proportionate chan$e (decrease# in the de!and for portable ear phones in response to the proportionate increase in the price of the G4- players.

6or G4- players it is inelastic because it is = ).. which !eans that you $et a less than proportionate chan$e (decrease# in the de!and for portable ear phones in response to the proportionate increase in the price of the G4- players. #e$ Assuming that a 1.B increase in income will cause a 4B increase in sales o %5> players+ what is the income elasticity o demand or the %5> players and is this good a necessity or lu"ury good' 4roportionate increase in G4- player de!and A 4roportionate increase in inco!e 9 ( > A 1.># 9 .. / This inco!e elasticity of de!and is inelastic (i.e. = 1..# #$ *s this income elasticity o demand elastic or inelastic and interpret its value' (nelastic because it is less than 1... and this !eans that there is a less than proportionate increase in G4- player de!and for the proportionate inco!e increase. (f the si$n is positi'e and the 'alue is = 1.. but $reater than ?ero the $ood is a nor!al $ood and is a necessity. This !eans that it has a downward slopin$ de!and cur'e and is not a lu*ury ite!. (f the coefficient is ; 1.. the $ood is a nor!al $ood and also a lu*ury $ood. (f the 'alue is ne$ati'e then the $ood is an inferior $ood !eanin$ that its de!and decreases with an increase in inco!e. (n this case it is li"ely to be replaced by a better quality $ood. #g$ Cow will the above 1.B increase in income a ect portable ear phone sales commencing with an initial equilibrium quantity demanded o 2>.' 6ro! question (e# we ha'e calculated that a 1. per cent inco!e increase will cause a per cent increase in the de!and for G4- players. (f we assu!e that there is one set of ear phones only for e'ery G4- player the sale of portable ear phones will increase by per cent (fro! 2-. to 222 rounded#. #h$ Cow will the 1.B increase in income a ect the price o the %5> players' De "now fro! (f# that a 1.> increase in inco!e causes a > increase in de!and for ear phones fro! 2-. plus 11. 9 to 222 rounded/ De "now fro! (a# that the cross price elasticity of de!and is )1.1-/ Jence, )1.1- 9 (proportionate chan$e in ear phone de!and A proportionate chan$e in G4player price#/ so that )1.1- 9 ( > A K># Jence K> 9 ( > A )1.1-# 9 )2.222@@B@+1 9 )2.22, or a fall in the price of G4players by 2.22> (fro! L+ ... to L+2.1- rounded#.

Question 12: Through appropriate diagrams+ show the e ect o each on the equilibrium price o laptops or each o the ollowing) #a$ Dall in income level due to Elobal Fecession G 1emand curve will shi t to the le t #b$ Scientists develop cheaper so twares and hard wares G Supply curve will shi t to the right Question 1-: @$ 5ublishing house 6 has a price elasticity o demand or its publications #maHority core te"t books at schools$ as ..@ B. 5ublishing house 6 intends to revise its prices o the books. * you were the irm manager what pricing strategy #increase or decrease o price$ would you advise and why' !"plain with the help o suitable diagrams. The important concept here is the relationship between price elasticity o demand and revenue raised G you should revise and thoroughly understand these concepts Iuestion 1) Suppose the income elasticity o demand or urniture is ,-.. and the income elasticity o demand or doctors/ services is , ..-. 0ompare the impact on urniture and doctors/ services o a recession that reduces consumer income by 1. per cent. 6urniture is a nor!al $ood and inco!e elastic since 78 9 : 2.., which is ; 1../ (- !ar"s# 1octor<s ser'ices is a nor!al $ood and inco!e inelastic since 78 9 : ..2, which is = 1../ (- !ar"s# The i!pact on furniture is $reater than that of doctor<s ser'ices as furniture as furniture would be considered a lu*ury $ood, whereas doctor<s ser'ices are still considered a necessity e'en durin$ a recession. (2 !ar"s# Iuestion 2) #a$ *nterpret the ollowing *ncome !lasticities o 1emand #2!1$ values or the ollowing and state i the good is normal or in erior; 2!13 ,..4 The de!and response as inco!e chan$es (i.e. the proportionate chan$e in de!and di'ided by the proportionate chan$e in inco!e#/ (nelastic because = 1../ Nor!al $ood because the de!and increases with inco!e as indicated by the positi'e si$n. (2. !ar"s#

2!13 -2.4 The de!and response as inco!e chan$es (i.e. the proportionate chan$e in de!and di'ided by the proportionate chan$e in inco!e#/ Elastic because ; 1../ (nferior $ood because the de!and decreases with inco!e as indicated by the ne$ati'e si$n. (2. !ar"s# #b$ *nterpret the ollowing 0ross-5rice !lasticities o 1emand #6!1$ and state i the goods are substitutes or compliments. 6!13 , ..7 The de!and response of this $ood as the price of the other $ood chan$es (i.e. the proportionate chan$e in de!and di'ided by the proportionate chan$e in price of the other $ood#/ (nelastic because the real absolute 'alue is = 1../ &ubstitute $ood because the de!and increases as the price of the other $ood increases. (2. !ar"s# 6!13 -2.2 The de!and response as inco!e chan$es (i.e. the proportionate chan$e in de!and di'ided by the proportionate chan$e in inco!e#/ Elastic because the real absolute 'alue is ; 1../ 0o!ple!entary $ood because the de!and for the $ood decreases as the price of the other $ood increases. (2. !ar"s# 4rice 0eilin$s and 6loors: &tudenst are ad'sied to draw the dia$ra!s and thin" throu$h the issue: Dhat is the effect of the followin$ on the !a"et if the followin$ are i!posed: #a$ * a price ceiling is placed below the equilibrium price+ what is the e ect #i.e. will the market clear$' :o because we cannot charge a price above the ceiling so we will not reach the equilibrium price. #b$ * a price ceiling is placed only above the equilibrium price+ what is the the market clear' 2es because we can charge only below the ceiling and the equilibrium price is in this range #c$ * a price loor is placed below the equilibrium price+ will the market clear' 2es+ because we can charge only above the loor and the equilibrium price is in this range. #d$ * a loor is placed above the equilibrium price+ will the market clear' :o+ because we cannot charge a price below the loor where the equilibrium price is.

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