Microeconomics, Term I, AY 2014-15

PGDM 2014-16
Problem Set #1

1. You are presented with two business opportunities. The first might generate $40,000 after Year 1, $30,000
after Year 2, and $20,000 after Year 3. The second might generate $20,000 after Year 1, $30,000 after Year 2,
and $40,000 after Year 3. Which proposition should you choose if the prevalent interest rate is 8 percent?
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2. You are deciding to buy a new air conditioner for your home, and you have narrowed down your search two
models one an energy efficient model, and the other the standard model. The energy efficient model sells for
Rs. 25,000 and will save you Rs. 1,250 at the end of each of the next five years in electricity costs. The standard
model has features similar to the energy efficient model but provides no future saving in electricity costs. It is
priced at Rs. 20,000. Assuming your opportunity cost of funds is 5 percent, which air conditioner should you
purchase?
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3. Suppose the demand function for corn is Q
d
= 10 2p, and supply function is Q
s
=3p 5. The government is
concerned that the market equilibrium price of corn is too low and would like to implement a price support
policy to protect the farmers. By implementing the price support policy, the government sets a support price
and purchases the extra supply at the support price. In this case, the government sets the support price p
s
= 4.
(a) At the support price p
s
= 4 find the quantity supplied by the farmers, the quantity demanded by the market,
and the quantity purchased by the government.
(b) Calculate the cost to the government to implement the price support policy. Draw a graph to show the
government cost.
(c) Suppose now the government switches from price support policy to subsidy policy. For each unit of corn
produced, the government subsidizes the farmer s = 5/3. Find the new equilibrium price under this subsidy
policy. How much money will the government have to spend in order to implement this subsidy policy?
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4. In the market for televisions, Samsung estimates that the price elasticity of demand for its 9000 Series LED
TVs is -12.64 and the cross-price elasticity of demand is 7.35. The company now reduces the price of this
series by 9 percent of its present price level. Explain what would happen to (a) sales of Samsungs 9000 Series
LED TVs and (b) the demand for this Series if its close competitor Sony also reduced price for comparable
Bravia series by 11 percent.
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5. Over the past 25 years, technological advances have reduced the cost of computer chips. How do you think
this affected the market for computers? For computer software? For typewriters? Explain.
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6. Suppose that you have estimated the following demand curve: Q = 125 4.5P + 0.01M, where Q represents
quantity, M represents average income, and P is price. Suppose that average income is equal to Rs. 25,000.
Calculate the price elasticity of demand at P = Rs. 65. If you were a revenue-maximizing firm, would it be
optimal to charge a price of Rs. 65? Explain.
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7. Vivek produces pens, using as inputs only labour (L) and machines (K). His production function is given by
the following equation, q = 10(K)
2/3
+ (L)
1/2

(a) What type of returns to scale does Viveks production function exhibit?
At the end of last year, Vivek bought his only machine for Rs. 1000. He will use this machine for next 5 years,
after which the machine will have no value. Vivek will calculate depreciation linearly at 20% of the total value of
the machine per year. This machine has no other use besides Viveks production of pens, and, at this moment
Vivek cannot buy any more machines.
(b) What is Viveks annual fixed cost of production? Is the fixed cost sunk or not? Explain.
(c) What is Viveks demand for labour as a function of the quantity he wants to produce annually?
(d) Assuming that wage equals 1, what is Viveks annual total cost function?
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8. A recent newspaper circular advertised the following special on tires:

If a consumer has $500 to spend on tires and other goods and each tire usually sells for $50, how does this deal
impact the consumers opportunity set? Please ignore the statement Tax and shop supplies are not included
and are an additional charge of the advertisement.