Solutions to Moodle Quiz 1 (Microeconomics)

Problem 1
Correct Answer: e References Lecture notes: Frank: pp.39

Supply & Demand, p.10, Factors that shift supply curves (4).

Generally, the more firms there are that can supply any product, the greater will be the quantity supplied of that product at any given price. Accordingly, an increase in the number of suppliers in the microcomputer industry shifts the supply curve to the right, while the demand curve is unaffected. This is displayed in the diagram below. At the original price (P0), supply exceeds demand. In order to clear the excess supply, firms reduce their price to P1. This increases the quantity demanded (a movement along the demand curve), resulting in an increase in the quantity traded in the market from Q0 to Q1. Consequently, the new market equilibrium (the intersection of supply and demand) occurs at a higher quantity and a lower price. Problem 1: The microcomputer market
P S0 S1 P0 P1

D Q0 Q1 Microcomputers

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Solutions to Moodle Quiz 1 (Microeconomics)

Problem 2
Correct Answer: b References Lecture notes: Supply & Demand, p.4, Factors that shift demand curves (2). Frank: pp.38, Bacon and Eggs. Draw two separate supply and demand diagrams, one for the oil market and one for the automobile tyre market. In the oil market, a reduction in the supply of oil shifts the supply curve to the left, leading to a rise in the price of oil as stated. Oil and automobile tyres are complements since both are essential for running a car. Generally, with complements, an increase in the price of one good decreases the demand for the other good: As the price of oil increases, driving becomes a more expensive way to travel. Consequently, people want to drive less. They thus require fewer tyres, as they do not wear out as often. Therefore, in the automobile tyre market, the demand curve shifts in, lowering both quantity traded and price. Problem 2: The oil market
P
o

S1o S0o

P1o P0o

Do Q1o Q0o Oil

Problem 2: The automobile tyre market

Pt St

P0t P1t D0t D1t Tyres

Q1t

Q0t

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Solutions to Moodle Quiz 1 (Microeconomics)

Problem 3
Correct Answer: a References Lecture notes: Frank: pp.38-9 (1) For some products, particularly agricultural ones, nature has a great deal to say about the placement of the supply curve. In the case of a good harvest, the supply curve shifts to the right, leaving the demand curve unaffected. There is excess supply at the current market price which will be pushed down until supply and demand equate again. We observe a mere movement along the demand curve. In the new equlibrium, price is lower and quantity is higher. Problem 3: The grapes market (1)
P S0 S1 P0 P1

Supply & Demand, p.8, Factors that shift demand curves (6). Supply & Demand, p.11, Factors that shift supply curves (5).

D Q0 Q1 Grapes

(2) Information on medical research revealing that eating grapes prevents cancer may be passed on to consumers through news on TV or radio, reports in magazines, advice by health experts, etc. As a result, the demand for grapes increases, hence the demand curve shifts out. In the new equilibrium, both price and quantity are higher. Problem 3: The grapes market (2)
P S

P1 P0 D1 D0 Q0 Q1 Grapes

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Solutions to Moodle Quiz 1 (Microeconomics)

Problem 4
Correct Answer: b References Lecture notes: N/A Frank: pp. 41-2 In equilibrium, quantity supplied and quantity demanded must be the same. Therefore the two equations given in the question (supply and demand) must both hold in equilibrium. In the below diagram, this is where the curves intersect. This allows us to substitute P=Q into P=10-Q, so that we have P=10P. Rearranging, we get 2P=10, which yields an equilibrium price of P=5.

Problem 5
Correct Answer: b References Lecture notes: N/A Frank: pp. 41-2 From Problem 4, we know that the equlibrium price is 5. Substituting this value for P into the expression for supply (or alternatively demand), this immediately gives an equilibrium quantity of Q=5.

Problems 4 & 5: Supply and demand curves

P 10 S: P=Q

D: P=10-Q 5 10 Q

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Solutions to Moodle Quiz 1 (Microeconomics)

Problem 6
Correct Answer: b References Lecture notes: Frank: pp.38 In this problem, there are two forces which might affect the demand curve for good X: the rise in income and the rise in the price of good Y. Obviously, income will influence the amount of most goods and services people will purchase at any given price. From Problem 2, we know that prices of substitutes and complements also affect demand. Consequently, the shift in the demand curve for X will be the net result of these two effects. Only if both changes individually imply a rightward shift, we can be sure that the demand curve for X will always shift out. If the two changes had opposite effects on demand, the shift in the demand curve would depend on the relative sizes of the two forces. The result would therefore be ambiguous without further information. Let us consider these two effects in turn: The rise in income: For the demand curve to shift to the right with an increase in income, we require that the quantity of good X demanded at any price rise with income. Hence, by definition X must be a normal good. A rise in the price of good Y: This will only increases the demand for good X if the two goods are substitutes. When the price of Y increases, consumers will switch their consumption to good X. Thus the quantity demanded of X increases at every possible price of X.

Supply & Demand, p.4 & p.7, Factors that shift demand curves (1)-(4).

In summary, the demand curve for good X shifts unambiguously to the right for X being a normal good and Y being a substitute for X. Problem 6: Normal good and substitute
P Income P2 P1 P0 D2 D1 Q2 X PY S

D0 Q0 Q1

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Solutions to Moodle Quiz 1 (Microeconomics)

Problem 7
Correct Answer: b References Lecture notes: Frank: pp.37-41 A drop in factor prices due to a new discovery raises the supply of inkjet printers, as they are now cheaper to produce. The fall in the price of laser printers, clearly a substitute for inkjet printers, reduces the demand for inkjet printers. In the inkjet printer market, a rightward shift in the supply curve and a simultaneous inwardshift in the demand curve will unambiguously decrease equilibrium price but will leave the effect on equilibrium quantity undetermined. The increase in supply tends to increase the quantity traded, whereas the decrease in demand tends to reduce it. Whether quantity goes up (Case (a)) or down (Case (b)) will consequently depend on the relative sizes of the two shifts1. Problem 7: Case (a) a larger shift in supply
P S0

Supply & Demand, p.4, Factors that shift demand curves (1). Supply & Demand, p.9, Factors that shift supply curves (1).

P0

S1

P1 D1 Q0 Q1

D0

Inkjet Printers

Problem 7: Case (b) a larger shift in demand

P S0 S1 P0

P1 D1 Q1 Q0

D0

Inkjet Printers

It will also depend on the relative price elasticities of supply and demand. Dont worry about this yet, as we will be covering elasticities later in the term.

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Solutions to Moodle Quiz 1 (Microeconomics)

Problem 8 Discussion Question

References Lecture notes: Supply & Demand, p.3, Excess supply, excess demand and equilibrium. Supply & Demand, p.4, Factors that shift demand curves (1)(2). Supply & Demand, p.15-16, Lines at the petrol pumps (1)(3).

Frank: pp. 34-6 Normally, a lower price of tea would lead to a higher demand for lemons and thus a higher price. Such an analysis would be analogous to the one in Problem 2. In this case, however, with an effective price ceiling on tea of PCt, the quantity consumers demand, QDt, exceeds the quantity firms are willing to supply, QSt. There is therefore excess demand or shortage of size QDt-QSt in the tea market. In an unregulated market the immediate response to such a high level of excess demand would be for the price of tea to rise sharply to PEt. This would reduce the quantity demanded and increase the quantity supplied so that they are both QEt, and an equilibrium has been reached. However, here the law prevents it from rising above the price ceiling. Note that at the price ceiling, PCt, producers are only willing to supply QSt, which therefore also equals the quantity transacted. Consumers cannot get hold of as much tea as they would like. In fact, with an offering of only QSt tea, consumers would be willing to pay as much as PIMPt for tea. This pressure usually finds ways of expressing itself, e. g. by waiting in line or fighting for tea, so that PIMPt is the implicit price consumers pay for tea. Problem 8: Price ceiling in the tea market
Pt St PIMPt PEt Price ceiling Dt QSt QEt Q Dt Tea

PCt

Clearly, this implicit price PIMPt is well above the market equlibrium price PEt. Turning to the the market for lemons, we can now apply standard analysis. Due to the complementarity between tea and lemons, the higher price of tea will result in a fall in demand for lemons. Consequently, there will be a drop in the price of lemons from P0L to P1L. Finally, we are left to discuss the effects on the market for coffee. Since coffee and tea are substitutes, consumers will react to
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Solutions to Moodle Quiz 1 (Microeconomics)

the increased price of tea by demanding more coffee. There is thus an increase in the demand for coffee, and therefore an increase in its price from P0c to P1c. Problem 8: Effect on the lemon market
PL SL

P0L P1L D0L D1L Lemons

Q1L

Q0L

Problem 8: Effect on the coffee market

Pc Sc

P1c P0c D1c D0c Coffee

Q0c

Q1c

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