Subject: Economics    / General Economics

Question

MICROECONOMICS

Topic Two: Demand, Supply and Elasticity

1. (a) Suppose the demand and supply curves for good X are as follows: QD = 200 – 5P
QS = -25 + 4P where P is in dollars per unit of X.

(i) Sketch the demand and supply curves.
(ii) What does "ceteris paribus" mean in relation to the demand curve above?
(iii) In this example, what is the equilibrium price of X, quantity supplied and demanded, total purchasers' expenditure on X and total revenue received by sellers?

(b) At a later period it is found that the supply function for X is: QS = -7 + 4P
(i) What is the new equilibrium price and what quantities are bought and
sold in equilibrium?
(ii) Does the fall in the equilibrium price, which follows this shift of the supply curve, shift the demand curve and hence raise the consumption of X?

2. Suppose the demand and supply curves for good Y are as follows: QD = 600 – 7.5P
QS = -100 + 10P where P is price per kg measured in dollars
and Q is quantity measured in ‘000kgs

(a) Sketch the demand and supply curves for good Y. (b) Determine the equilibrium price and quantity.
(c) If the price of a substitute good for Y were to increase, outline the effect that this would have on the demand and supply curves you have drawn. What effect would it have on the equilibrium price and quantity?

(d) Assume that at the same time as (c) the price of labour used to produce good Y increased. Outline the combined effect that these would have on the demand and supply curves you have drawn. What effect would this have on the equilibrium price and quantity?

3. Suppose the demand and supply curves for good Z are as follows: QD = 15 – 1.5P
QS = 0 + 1.0P where P is the price per litre measured in dollars

and Q is the quantity measured in ‘00litres

(a) Sketch the demand and supply curves.

(b) Determine the equilibrium price and quantity.

(c) Explain the meaning of a consumer surplus, and calculate the value at the equilibrium price.

(d) Explain the meaning of a producer surplus, and calculate the value at the equilibrium price.

4. Assume the number of bicycles demanded and supplied in Victoria, at various prices, is as follows:

Price of Bicycle Quantity Demanded Quantity Supplied
(\$) per year (‘000) per year (‘000)
120 24 9
160 20 16
200 17 21
240 15 24

(a) Sketch the demand and supply curves. From your sketch determine the equilibrium price and quantity.

(b) Calculate the arc elasticity of demand between the prices of \$160 and \$200, and interpret your answer. Is the demand for bicycles elastic or inelastic over this price range?

(c) Calculate the arc elasticity of supply between these same two prices and interpret your answer.

5. Explain precisely why it is not possible to estimate the magnitude of an own price elasticity of demand, simply by looking at the slope of the demand curve.

6. The local movie rental store had been hiring out DVDs at \$4 each. On average,
1800 DVDs were hired per week. In response to an increase in running costs, the store increased their DVD hire to \$5, resulting in the typical number of DVDs hired per week falling to 1250.

(a) Calculate and interpret the arc own price elasticity of demand for this store’s DVD hire.

(b) Explain why the store’s revenue from DVD rentals has fallen despite increasing their price.

7. “Demand curves are always negatively sloped.” Discuss.

8. State whether you would expect demand for the following products to be relatively elastic or inelastic. In each case outline the factors likely to be important in determining the product's price elasticity.
(a) cigarettes
(b) a well-known brand of soap

9. Explain the likely cross elasticity of demand between the following products: (a) rice and noodles
(b) electricity and electric stoves
(c) paper bags, aluminium foil, plastic wrap

10. Bookworm and Easyread are both publishers of popular novels. (a) Assume that demand for Bookworm novels is elastic.
(i) Explain the meaning of the underlined term.
(ii) Outline one important factor that you feel has helped to determine the size of this own price elasticity.
(iii) How would a fall in Bookworm’s price affect their total revenue?

(b) When the price of Easyread novels increased from \$20 to \$23, Bookworm’s sales increased from 105,000 to 120,000 novels. Calculate the arc cross price elasticity. Are the two brands of novels close substitutes? Explain.

(c) An increase in average weekly earnings from \$290 to \$310 caused Bookworm’s sales to increase from 120,000 to 130,000 novels. Calculate and interpret the income elasticity.

(d) When the average price of women’s magazines increased by 6%, the demand for novels increased by 2% per month. Do these figures suggest that novels and women’s magazines belong to the same market? Explain.

Topic Three: Applications of Demand and Supply

1. Suppose the demand and supply curves for good M are as follows: QD = 70 – 2P
QS = -10 + 2P where P is price per kg measured in dollars
and Q is quantity measured in ‘000kgs

(a) Sketch the demand and supply curves.

(b) Determine the equilibrium price and quantity.

(c) Calculate the value of the consumer and producer surplus at the equilibrium price.

(d) Explain why governments may introduce a price ceiling

(e) Suppose a price ceiling of \$15 were to be introduced. Calculate the consumer and producer surplus after its introduction.

(f) Who has benefited from the introduction of the price ceiling?

2. Suppose the demand and supply curves for good W are as follows: QD = 100 – 2P
QS = -20 + 4P where P is price per kg measured in dollars
and Q is quantity measured in ‘00kgs

(a) Sketch the demand and supply curves.

(b) Determine the equilibrium price and quantity.

(c) Calculate the value of the consumer and producer surplus at the equilibrium price.

(d) Explain why governments may introduce a price floor.

(e) Suppose a price floor of \$30 were to be introduced. Calculate the consumer and producer surplus after its introduction.

(f) Who has benefited from the introduction of the price floor?

3. With the introduction of a unit tax, to be paid by producers, the supply curve shifts upwards. Explain why, when the same tax is levied directly on consumers, the demand curve shifts downwards.

4. Suppose the government is considering the imposition of a unit tax to be levied on beer producers. The view of companies is that this is just one more cost for them to bear. Consumers disagree saying that the companies pass the taxes on to them in terms of higher prices.
(a) Given that the demand for beer is inelastic, which viewpoint is correct? (b) Would the burden of the tax be any different if the government levied the
tax on consumers (over the counter) rather than on beer producers?

Topic Four: Production and Costs

1. Explain the difference between explicit and implicit costs, giving examples.

2. “Economic profit can never be greater than accounting profit.”
Discuss this statement, making sure your answer includes an explanation of how the two measures of profit are calculated.

3. Bill own and runs a computer shop. The following data are about his financial matters in his first year of business:
\$
190,000 Total revenue
65,000 Salary that Bill could have earned if he had worked for another firm
90,000 Loan from a bank
9,000 Interest paid to the bank
70,000 Purchase of durable assets with his own money
4,200 Dividend that he could have earned by investing his \$70,000 in shares
14,000 Depreciation of the durable assets
30,000 Salary for an assistant
67,000 Raw materials purchased and used

Using the relevant figures (some figure/s is/are irrelevant), calculate Bill’s accounting profit and economic profit for his first year of business. Show your calculations.

4. The table below shows the total production of a firm as the quantity of labour employed increases, with all other factors of production remaining constant.

L TP
0 0
1 80
2 200
3 310
4 400
5 450
6 480
7 490
8 480
(a) Calculate the marginal product (MPL) and the average product of labour
(APL).

(b) Define the law of diminishing returns. Is the marginal product calculated in part (a) consistent with the law of diminishing returns?

(c) Draw a sketch graph showing the relationship between the three curves:
total product, marginal product, and average product.

5. Given the following data for a firm:
Q TFC (\$) TVC (\$)

0 200 0
1 200 50
2 200 90
3 200 120
4 200 160
5 200 220
6 200 300
7 200 400
8 200 520
9 200 670
10 200 900
(a) For each of the levels of output shown above, calculate the following:
• total cost (TC)
• average fixed cost (AFC)
• average variable cost (AVC)
• average total cost (ATC)
• marginal cost (MC).
(b) Why is MC the same when computed from either TVC or from TC? (c) Sketch a graph showing AVC, ATC and MC.

(d) Explain how we can determine the value of AFC from this graph, without sketching the AFC curve.
(e) Explain why the MC curve cuts AVC and ATC at their minimum points. (f) If TFC were \$300 rather than \$200, explain how this would affect the
AFC, AVC, ATC, and MC curves.

6. The following production function relates to a small firm that incurs fixed costs of \$100 and labour costs of \$10 per hour.

Labour Hours (L) Total Product (Q)
1 8
2 24
3 39
4 50
5 56
6 59
7 61
8 62

(a) For each of the output levels shown above calculate:
• average and marginal product
• total variable and total cost
• average variable, average total and marginal cost

(b) Explain the relationship between
• average product and average variable cost
• marginal product and marginal cost

(c) For the above data, over which output range do we observe diminishing returns?

7. As a firm expands its scale of output, it enjoys economies of scale. Hence the larger is a firm’s scale of output, the lower will be its long run average cost. Discuss.

8. The long run cost function for a firm is given below.

Output (Q) Total Cost (LRTC)
100 5,000
700 29,400
1300 46,800
1900 60,800
2500 75,000
3100 93,000
3700 122,100
(a) Using the cost and output figures given above, calculate the long run average cost (LRAC).
(b) Over what range of output would the firm experience economies of scale? (c) Which output(s) represent minimum efficient scale (MES) for this firm?

9. Why is it that in some markets large and small firms can coexist and are equally viable? Discuss with reference to the concept of minimum efficient scale.

10. Discuss how economies of scale are related to the structure of a market.

Topic Five: Perfect Competition

1. Use the figure below, representing a perfectly competitive firm, to complete the following statements.

(a) If price is \$7, the firm should produce _ units.

(b) Since average total cost of this profit maximising output is \$
total cost is \$ .
(c) Therefore the firm makes a total profit of \$ . (d) Price then falls to \$3. The firm will produce approximately
units.

(e) Since average total cost at this output is \$ , total revenue less total cost is \$ .

(f) Total variable cost is \$ _ ; thus the firm’s total revenue covers all variable cost, leaving approximately \$ to apply to fixed costs.

(g) If price falls to \$2 the firm will produce units. Why?

\$

MC

8 ATC

7 •
AVC
6

5
• •
4

3 •
• •
2 •

1

100 300 500 700 900

output

2. A small scale grower supplies tomatoes to local fruit shops. Fixed costs facing the grower are \$100, and the variable cost data is given in the table below:

Output (Q) Total Variable Cost (TVC)
50 100
60 110
70 130
80 160
90 200
100 250
110 310
120 380

(a) For the output and cost figures given above, calculate the average variable cost (AVC) and marginal cost (MC).

(b) Assume the grower operates under perfectly competitive conditions, and the price he receives is currently \$6 per kilogram. Determine the output level that would maximise the grower’s profits. What are profits at this output level?

(c) If, due to an influx of new competition, the price of tomatoes falls to \$3 per kilogram, explain whether the grower should continue to produce in the short run and in the long run.

3. Using a perfectly competitive firm operating in the short run as a basis for your diagram, show and explain the prices associated with the break even and shut down points, and explain the output ranges over which the firm produces to make a positive economic profit and to minimise economic losses.

4. A perfectly competitive firm has the following cost data:

Q (units per day) Total Cost (TC)
0 90
1 110
2 126
3 139
4 150
5 163
6 178
7 196
8 219
9 249
10 289

(a) For the output and cost figures given above, calculate the average total cost (ATC), average variable cost (AVC) and marginal cost (MC).

(b) For each of the following prices determine this firm’s profit-maximising (or loss-minimising) output per day, in the short run, and calculate the daily profit or loss.
(i) \$13.20 (ii) \$16.50 (iii) \$39.00

(c) Draw this firm’s short run supply curve, indicating the relevant numerical values for price and output.

(d) Suppose this firm’s costs are the same as those of other firms in the perfectly competitive market. Indicate, together with a brief explanation, the numerical value of the critical price level below which this firm will leave the market in the long run, and above which new firms will enter that market in the long run.

5. A perfectly competitive firm producing X has the following monthly cost data
(Q = total output, MC = marginal cost):

Q (units) MC (\$)
1 40
2 37
3 32
4 28
5 30
6 32
7 35
8 40
9 46
10 56
(a) For each of the following prices determine this firm’s optimal output per month in the short run. Show your calculations.
(i) \$30.50 (ii) \$32.40 (iii) \$42.00

(b) Suppose the market price of X is \$49.00. Calculate the total fixed cost that would result in zero economic profit for this firm. Show your calculations.

(c) Suppose there are 400 firms in the perfectly competitive market for X, each with the same monthly cost data as the above firm. Draw this market’s short run supply curve, indicating the specific prices and quantities of output, on the assumption that the cost data are not affected by the summation of the firms’ outputs.

(d) Suppose the market price of X is \$60.00 and the total fixed cost of the above firm is \$140 per month.
(i) Initially, how would this firm react to the situation in the long run?
Explain with the aid of your calculations.

(ii) With the aid of diagrams (sketches will be sufficient – there is no need to plot the exact data) showing both the firm and the market, explain how this market adjusts to long run equilibrium.

6. In long-run equilibrium, P = AC = MC. Of what significance for the allocation of resources is the equality of MC and AC? Of what significance for the allocation of resources is the equality of P and MC?

Topic Six: Monopoly

1. Discuss the major barriers to entry into a market. Explain how each barrier can foster monopoly. Which barriers, if any, do you feel give rise to monopoly power that is socially justifiable? (From Jackson Review question 1, page 339)

2. A firm has the following demand schedule for its product: Price (\$) Quantity
55 0
50 1
45 2
40 3
35 4
30 5
25 6
20 7
Derive the marginal revenue schedule. Why does marginal revenue fall faster than price?

3. A monopoly has the following demand and cost data as shown below
Assume fixed costs of \$300.
P (\$) Q (units) TVC (\$)
500 0
450 1 230
400 2 440
350 3 690
300 4 990
250 5 1410
200 6 1960
150 7 2710
100 8 3710
(a) For the output and cost figures given above, calculate the average variable cost
(AVC), average total cost (ATC) and marginal cost (MC).

(b) For the price and quantity figures given above, calculate total revenue (TR) and marginal revenue (MR).

(c) Based on the figures above, determine the short run profit maximising (loss minimising) output and total profit or loss for this monopoly.

(d) Suppose the government were to impose a price ceiling at the allocative efficient price. What is the value of this price and resulting level of output?

(e) Would the monopolist remain in business in the long run if the price ceiling remained in place? Explain your answer.

(f) Define productive efficiency. At which output level would this firm achieve productive efficiency?

4. Tiger’s Mineral Springs, a monopoly, faces the following demand schedule for bottled mineral water:

QD = 20 – 2P
where P is the price per bottle measured in dollars, and
Q is the quantity measured in ‘000 bottles
Tiger’s marginal cost is \$4 a bottle – ie, marginal cost is constant for this firm. Assume fixed costs of \$4000.

(a) Sketch the demand, marginal revenue (MR), average variable cost (AVC)
and marginal cost (MC) curves for the firm.

(b) Based on your diagram, determine Tiger’s profit-maximising output and price, and the associated level of profit or loss.

5. A monopoly has the following monthly demand and cost data.
(Q = output or quantity demanded, P = price, MC = marginal cost):

P (\$) Q (units) MC (\$)

148 4 100
146 8 95
144 12 90
142 16 94
140 20 101
138 24 110
136 28 121
134 32 134
132 36 149
(a) What is this monopoly’s profit maximising output and price in the short run? Explain with the aid of your calculations.

(b) Suppose the total fixed cost of this monopoly was \$500 per month. What would be the monthly profit or loss of this monopoly at the output determined at (a)? Show your calculations.

(c) Suppose the government were to impose a price ceiling on this monopoly at the allocatively efficient price. Determine the value of this price and the associated level of output and profit (or loss) for the firm.

6. With the aid of a diagram, explain how the misallocation of resources that results from monopoly can be eliminated by means of price regulation.

Topic Seven: Monopolistic Competition and Oligopoly

1. What is (are) the main difference(s) between a monopolistically competitive market and a monopoly market?

2. Explain how the presence of product differentiation influences the way in which firms in a monopolistically competitive market set their prices, as compared to firms operating in a perfectly competitive market.

3. Explain why firms in both perfectly competitive and monopolistically competitive markets earn zero economic profits in the long run. Contrast the long run adjustment process for the two market structures.

4. Firms in monopolistically competitive markets provide consumers with the benefit of product variety. Discuss.

5. What role does advertising play in oligopolistic and monopolistically competitive markets? Is advertising socially desirable? Discuss.

6. Mutual interdependence is a characteristic of the oligopoly market structure, but not the other three market structures. Explain.

7. Suppose Chill and Freeze are the only two firms in the air conditioning market.
Each firm is considering two possible pricing strategies – either P = \$700 or P = \$1500 – for their goods. The following payoff matrix gives the profit outcomes (in \$m).

Freeze

Chill

(a) What price will each of the firms choose if they make their decisions independently, following a maximin strategy? Explain how you determined your answer.

(b) What is meant by the term collusion? In general, what is the incentive for firms in an oligopoly market to collude? Explain.

(c) Based on the payoffs for Chill and Freeze (shown above) and your solution in (a), could these firms benefit by colluding? Explain.

(d) Discuss factors that deter firms operating in an oligopoly market structure from colluding, and explain how they act as a deterrent.

8. Suppose Alpha and Delta are the only two firms in the speedboat market. Each firm plans to put only one model onto the market. They are considering two possible choices – a standard model at P = \$50,000 or a luxury model at
P = \$80,000. The following payoff matrix gives the profit outcomes (in \$m).

Delta

Alpha

(a) What price will each of the firms choose if they make their decisions independently, following a maximin strategy? Explain how you determined your answer.

(b) Based on the payoffs for Alpha and Delta (shown above) and your solution in (a), could these firms benefit by colluding? Explain.

9 Explain why firms may prefer non-price competition to price competition.

10. In the diagram below, both demand curves are relevant to one particular firm in an oligopolistoc market structure. One curve indicates the quantity of its product demanded at each price level when rival firms do not respond to price changes initiated by this firm. The other curve represents the firm’s demand curve drawn upon the assumption that rival oligopolists do respond to price changes initiated by this firm.

price

D2
D1 quantity

(a) Explain which curve is which and justify your choice.

(b) Under what assumptions would a “kinked” demand curve result from the diagram above?

(c) Using the kinked demand curve, explain how a firm’s profit maximising price and output may not change even when the firm experiences an increase in costs.

Topic Eight: Market Failure

1. (a) Explain the meaning of external economies (or benefits) and external diseconomies (or costs), giving an example of each.

(b) Why does the presence of an external economy or diseconomy lead to market failure? Explain.

(c) The following diagram shows the demand and supply curves for a good.
Demand curve D is based on marginal private benefit only, while demand curve Da is based on marginal social benefit.

P
S

Da

D
Q
On the basis of the diagram and information above, draw a diagram to indicate
(i) the socially optimal output and price of the good, and
(ii) society’s loss if there is no government intervention in the demand or supply of this good.

(d) The following diagram shows the demand and supply curves for good Z. The supply curve is based only on marginal private costs. But each unit of Z produced incurs an external cost of \$4 in the form of pollution.

P (\$)

12

11

10

9

8
7

6

5

4

3

4 5 6 7 8 9 10
Million units of Z per month

(d) On the basis of the diagram and information above, draw a sketch diagram to indicate

(i) the socially optimal output and price of Z when the marginal social costs are taken into account by suppliers; and
(ii) society’s loss due to the external costs if production of Z is entirely determined by the private market. Also calculate the amount of this loss; show your calculations.

(e) Discuss measures the government could take to eliminate the loss to society shown in part (d).

2. Suppose the demand and supply curves for leather shoes are as follows: QD = 60 – 5P
QS = 0 + 10P

where P is price measured in dollars, and
Q is quantity measured in '000s of pairs

(a) Draw the demand and supply curves for leather shoes and determine the equilibrium price and quantity.

(b) Suppose the production of the leather shoes generates an external cost (or external diseconomy) due to chemical pollution. With the aid of a demand and supply diagram, explain how society suffers a loss due to this external cost.

(c) With the aid of a diagram, explain how the imposition of a tax on producers could bring about the socially optimal level of output in the market. Will producers bear the full burden of this tax? Explain.

3. “Education is not a public good.” Discuss.

4. Explain why there is little incentive for firms to become involved in the supply of public goods.