Economics 101-dl Introductory Microeconomics

Professor J. Wissink
Problem Set: Demand and Supply

Demand and Supply

1. Graphically represent the market for apples in New York State under each of the following
conditions (taken one at a time, not all together). Show what happens to the equilibrium price and
quantity. If more than one possibility exists, show them all. (a) The State mandates that fresh fruit
be served in all school lunches. (b) Apple harvesters in the state receive a large wage increase. (c)
The U.S. Agriculture Department imposes a minimum price on apples (called a price support). (d)
The U.S. Agriculture Department imposes a minimum price on oranges, which is higher than the
current equilibrium price on oranges. Analyze all the possible price and quantity outcomes for the
market of apples assuming apples are a normal good.

(a) The demand for apples goes up due to the fact that schools have to serve fresh fruit. The
schools that used to serve fresh apples will not increase their demand for apples but the ones that
didn't serve apples have to serve them now, so overall demand for apples will increase. Therefore,
the equilibrium price and quantity in the apple market goes up.

Apple Market

Price

Supply
Pnew

Pold

Demand (new)
Demand (old)

Qold Q
new

Quantity
(b) Since harvesters are a very important input in the production of apples, an increase in their wages will
cause a decrease in the market supply of apples. A decrease in the supply of apples will increase the
equilibrium price of apples and decrease the equilibrium quantity of apples.

Apple Market

Price
Supply (new)
Supply (old)

Pnew

Pold

Demand (old)

Qnew Qold

Q1
 Qnew

Quantity

Quantity
(c) We need to consider two situations. If the government imposes an effective or binding
minimum price Pfloor which is higher than the natural equilibrium price of apples, P*, then at that
price, the quantity demanded of apples is Q0 which is less than the quantity supplied Q1. There is a
surplus. In this situation, the price is equal to the minimum price and only Q 0 units of apples are
traded in the market. However, if the minimum price is less than the equilibrium price, there is no
effect on the equilibrium price and quantity of apples. It is a non-binding policy.

Price Apples market

Supply
Pfloor
P*

Demand

Quantity
Q0 Q1

(d) An binding minimum price on oranges will increase the price of oranges. Suppose without
minimum price regulation, the equilibrium price of orange is P*. When the government imposes the
minimum price P**, the market price of orange goes up to P**. Since oranges and apples are
substitutes, an increase in the price of oranges will increase the demand for apples and will
increase both the equilibrium price and quantity in the apple market.

Price Apples Market

Price Oranges market

Pnew Dnew(Porange=P**)
P **

Pold
P*

Dold(Porange=P*)

Quantity
Quantity Qold Qnew

Q1
2. Let's model the market for cigarettes. Suppose that the market demand curve for cigarettes (in
billions of packs) is Q = 240-40P and that the market supply curve is Q= -60+60P. (a) Graph the
supply and demand curves, to scale, at prices from $1 to $6 where Q is on the x-axis and P is on
the y-axis. Hint: plug-in the quantities and solve for the price. (b) What are the equilibrium quantity
and price in this market? (c) Suppose the government wants to curb smoking and decides to
impose a $4/pack minimum price on cigarettes. How many packs of cigarettes are traded in the
market now? Calculate any surplus or shortage. (d) Comment on the following statement:
"Removal of the cigarette price support will result in a decrease in price and hence an increase in
demand."

(a) See Graph below.

Quantity Quantity
Price Demanded Supplied
1.0 200.0 0.0
2.0 160.0 60.0
3.0 120.0 120.0
4.0 80.0 180.0
5.0 40.0 240.0
6.0 0.0 300.0

Cigarette Market
6.0
5.0
4.0 Demand Curve
Supply Curve
Price

3.0
2.0
1.0
0.0
0.0 60.0 120.0180.0240.0300.0
Quantity

(b) From the graph, we can see that the equilibrium quantity is 120 billion packs and the equilibrium
price is $3.0 per pack.

(c) At a price of $4, quantity demanded is 80 billion while quantity supplied is 180 billion. A surplus of
100 billion packs is generated.

(d) Only the first half of the sentence is correct. A decrease in price would result in an increase in
quantity demanded. The demand curve remains unchanged.

Q2
3. The embargo imposed on Iraqi and Kuwaiti oil after Iraq's invasion of Kuwait in August, 1990
reduced the supply of oil by 4.3 million barrels a day.

The then President George Bush (not George W.) claimed on September 26 that there was no need for
a surge in oil prices, because additional production by Saudi Arabia and other countries had increased
supply and restored 2/3 of the daily production initially removed by the embargo. He announced he
would investigate.

Was Bush right or wrong? Did he need to investigate? Explain.

Bush is wrong. There is no need to investigate.

Here's how it works: the embargo creates an immediate decrease in supply. That is to say, the supply
curve shifts left, horizontally, by 4.3 million barrels a day.

That creates an oil shortage at the original equilibrium price.

The market price for oil rises in response to this shortage.

The rise in the price of oil induces all the other oil producers to increase the quantity of oil supplied.

We do not end up restoring all the oil, but the higher price for oil does give the incentive for existing oil
producers to move ALONG the new supply curve (S1) restoring 2/3 of the daily production lost by the
embargo.

Without the price increase, we would get no increase in quantity supplied.

See graph.

$
S1
SO

P1
PO 4.3

Q1 QO oil

Q3
4. Consider the market for freshly cut roses. On a normal day, the demand for roses is expressed by
the equation QD=35-P; supply is expressed by the equation QS=2P-20.

a) What is the equilibrium price and quantity on a normal day?

b) On Valentine's Day, demand for roses changes to Q D=37.5-¾P. What is the new equilibrium price
and quantity?

c) Valentines day is in February and suppose that producing roses in the winter costs more than
producing roses in the summer. Suppose the supply curve on Valentine's day changes to
QS=½P-10. Using the demand curve from part B, determine the Valentines Day equilibrium price and
quantity under this set of demand and supply information.

d) Jewelry is also a popular Valentine's Day gift. What do you think will happen to the price of jewelry
around Valentine's Day? Will it exhibit the same kind of price dynamic? Explain. Be sure to state any
assumptions you may have made in reaching your conclusion.

a) To solve set demand equal to supply: 35-P* = 2P*-20 so... 55=3P* so... P* = 55/3 or
P* = 18.33. Now plug P* into either the demand or supply equation to get Q*=16.67 roses.

b) Do the same kind of thing you did for part (A). Set demand equal to supply and solve using the
new demand and original supply. 37.5-3/4P* = 2P*-20 so... 57.5 = 2.75P* so... P*=(57.5)/(2.74) or
P*=20.91 and Q*=21.82 roses.

c) Do the same kind of thing you did for part (A). Set demand equal to supply and solve using the part
(B) demand and new supply. 37.5 - 3/4P* = .5P*-10 so... 47.5 = 1.25P* so... P*=(47.5)/(1.25) or P* =
38 and Q*=9 roses.

d) Roses are perishable, but jewelry is not. People cannot purchase roses for Valentine’s Day far in
advance. Therefore the roses market will be affected by the holiday. Jewelry, however, can be
purchased long in advance, so in all likelihood the price will not rise too much. However it is possible
that those who buy on Valentine’s Day, perhaps because they forgot, have a higher reservation price,
and can be charged more.

Q4
5. Multiple Choice.

1) Which of the following will increase the demand for large automobiles?

a. A fall in the price of small automobiles.

b. A fall in the price of gasoline.
c. A fall in the price of large automobiles.
d. A fall in buyers' incomes.
e. A fall in consumer preferences for driving large automobiles.

2) A supply curve will shift with changes in:

a. technology.
b. income.
c. tastes.
d. number of buyers.
e. market price.
f. none of the above.

3) Which of the following would result in a change in the quantity demanded but not a change in
demand?

a. An increase in population.
b. A change in tastes.
c. An increase or decrease in the price of a substitute or complement.
d. A change in income.
e. A shift in the supply curve.

4) If there is both a decrease in demand and a decrease in supply for a good:

a. the quantity sold will necessarily fall.

b. both quantity sold and price will necessarily fall.
c. the price will necessarily rise.
d. the quantity sold will necessarily rise.
e. neither price nor quantity sold will be affected.

5) The market for roller-blades is unregulated and is presently characterized by excess supply. You
accurately predict that the

a. price of roller-blades will increase, the quantity supplied will fall, and the quantity demanded will
rise.
b. price of roller-blades will increase, the quantity supplied will rise, and the quantity demanded will fall.
c. price of roller-blades will decrease, the quantity supplied will fall, and the quantity demanded
will rise.
d. price of roller-blades will decrease, the quantity supplied will rise, and the quantity demanded will
fall.
e. price of roller-blades will decrease, the supply will fall, and demand will rise.

Q5