1

UNIVERSITY OF CAPE TOWN

SCHOOL OF ECONOMICS
ECO2003F
Tutorial 2: Real and Nominal Prices, Supply and Demand, and Rational Consumer Choice
Tutorial compiled by Corne van Walbeek
Homework questions: Due Friday 27 February 2015
Total marks: 71
Question 1
Consider the table in the Excel file Alcohol price data for Tut 2. This shows monthly data for single
340 ml cans and 750 ml bottles of a popular beer brand. You are advised to do the workings in the
Excel file and to write down the answers of the specific questions in the document that you submit
to your tutor. The data are in nominal prices.
1.1
1.2
1.3
1.4

1.5

1.6
1.7
1.8
1.9
1.10

What is the base period of the Consumer Price Index?

[1]
Calculate the real price of beer in both 340 ml cans and 750 ml bottles for each of the
months from January 2009 to May 2013 in Excel.
[3]
Plot the real price of beer in 340 ml cans and the real price of beer in 750 ml bottles (line
graph) for the period January 2009 to May 2013 on the same set of axes.
[3]
Plot the real price of beer in 340 ml cans, but standardised to a per litre price, and the real
price of beer in 750 ml bottles, also standardised to a per litre price, on the same set of
axes, but not the same set of axes as used in question 1.3, for the period January 2009 to
May 2013. (Hint, divide by 0.34 and 0.75 respectively).
[4]
Plot the discount percentage of beer in 750 ml bottles (calculated in question 1.4) relative
to the price of 340 ml cans, for the period January 2009 to May 2013. (Hint, the answer
for January 2009 should be -22.8%)
Discuss possible reasons for the trends in question 1.5.
[2]
By what percentage did the nominal price of 750 ml bottles increase between January
2009 and May 2013?
[2]
By what percentage did the real price of 750 ml bottles increase over the same period? [2]
By what percentage did the Consumer Price Index increase over the same period?
[2]
Repeat question 1.7 and 1.8 for 340 ml cans.
[4]

Question 2
Using appropriate demand and supply curves, explain the impact of the following incidents on the
equilibrium price and quantity of the product/service in question:
2.1
In the guest house accommodation market: Recession in Europe and North America
[2]
2.2
In the market for butter: A decrease in the price of margarine
[2]
2.3
In the market for computers: A factory that produces 40% of the worlds microchip
processors burns down
[2]
2.4
In the market for second-hand furniture: An increase in average income levels
[2]
2.5
In the market for new furniture: An increase in average income levels and an increase in the
wages of workers working in the furniture factories
[2]

2
2.6
2.7

In the market for brandy: The Minister of Finance increases the excise tax on brandy
producers
[2]
In the market for houses: The Minister of Finance increases the transfer duty payable by
buyers of houses
[2]

Question 3
Consider a world with two goods, A and B. The price of A is R50 per unit and the price of B is R30 per
unit.
3.1
With the quantity of A on the vertical axis and the quantity of B on the horizontal axis, draw
the budget lines if total income is R600.
[2]
3.2
Provide an algebraic expression for the budget line.
[1]
3.3
How will the budget line shift if income increases to 900? What is the slope of the curve?
[2]
3.4
How will the budget line shift if income stays at R600 and the price of B increases from R30
to R40 per unit? What is the slope of the curve?
[2]
3.5
How will the budget line shift if income stays at R600 and the price of A decreases from R50
to 40 per unit (the price of B is R30 per unit)? What is the slope of the curve?
[2]
Question 4
With Y being the composite good and the good in question being electricity bought by a household
from the City of Cape Town, draw a budget line if the income of the household is R8000 and
electricity is charged as follows:
First 500 units: R2 per unit
Next 500 units: R4 per unit
Next 500 units: R6 per unit
All subsequent units: R8 per unit
Indicate the coordinates of all points of discontinuity in the budget line and indicate the slope of
each section of the budget line.
[5]
Question 5
Explain the following, using the characteristics of indifference curves (see De Villiers and Frank, page
58-59):
5.1
Why indifference curves cannot cross
[4]
5.2
Why there are an infinite number of indifference curves in an indifference map.
[2]
5.3
Why indifference curves are downward sloping
[2]
Question 6
Consider a world in which people consume only two products, figs and olives. Let figs be represented
on the vertical axis and olives on the horizontal axis. Figs cost R10 per kg and olives cost R10 per kg.
The consumers weekly expenditure on these two products is R50.
6.1
If the consumer really likes figs, but she does not like olives very much (although she does
not dislike them to the extent that she would not eat them at all), what would her
indifference map look like?
[2]
6.2
Draw the budget line for this consumer and show that a scenario like this could easily lead to
a corner solution. How many kilograms of figs and how many kilograms of olives would she
buy?
[3]
6.3
Explain why this is a corner solution by referring to the MRS and the slope of the budget line
and what the latter implies.
[2]
6.4
In an alternative scenario the consumer really likes olives, but she does not like figs very
much (but not to the extent that she would not eat them at all). What would the
indifference map look like in this scenario?
[3]

3
6.5

Explain how this situation could lead to a corner solution. How many kilograms of figs and
how many kilograms of olives would she buy?
[2]

For discussion in the tutorial (not for homework)

Question 7
Consider a household consisting of a woman with two children. The woman earns a monthly income
of R2000 and the children are still too young to work. The price of one unit of food is R5.
7.1
With a composite good (i.e. all non-food products) on the vertical axis and the quantity of
food on the horizontal axis, draw the households budget line.
The woman successfully applies for a child support grant. The value of the child support grant is
R300 per child.
7.2
How does this child support grant change the households budget line? Draw the new line on
the one drawn in 8.1.
7.3
Using some arbitrary indifference curves, show that her receiving the child support grant
improves her position.
Now assume that instead of her getting the child support grant in the form of cash, she receives food
stamps to the value of R300 per child. She can use the food stamps to buy food at the same price as
if she had cash, but she cannot use the food stamps to buy anything else.
7.4
Draw a new budget line, given the information provided above.
7.5
Using carefully selected indifference curves, show that it is possible that this household
would be better off if by getting the food stamps but less well off than had it received the
child support in the form of cash.
Question 8
The following situations refer to special cases of indifference curves where the assumption of moreis-better (non-satiation) is broken. As an exercise in logic and helping you understand the concepts
better, do the following:
8.1
Kamphela likes food but dislikes cigarette smoke. The more food he has, the more he would
be willing to give up to achieve a given reduction in cigarette smoke. If food and cigarette
smoke are the only two goods, draw Kamphelas indifference map.
8.2
Sketch a typical persons indifference curves between garbage and the composite good.
8.3
Eve like apples but does not care about pears. If appleas and pears are the only two goods
available, draw her indifference map.