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)
(ii)

Sketch the demand and supply curves.

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)
(ii)

2.

What is the new equilibrium price and what quantities are bought and
sold in equilibrium?
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?

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.

4.

(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.

Assume the number of bicycles demanded and supplied in Victoria, at various

prices, is as follows:
Price of Bicycle
($)
120
160
200
240

Quantity Demanded
per year (000)
24
20
17
15

Quantity Supplied
per year (000)
9
16
21
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
stores DVD hire.

(b)

Explain why the stores 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 Bookworms price affect their total revenue?
(b) When the price of Easyread novels increased from $20 to $23, Bookworms
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
Bookworms sales to increase from 120,000 to 130,000 novels.
Calculate and interpret the income elasticity.
(d) When the average price of womens magazines increased by 6%, the
demand for novels increased by 2% per month. Do these figures suggest
that novels and womens 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

2.

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?

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?
Explain your answers fully and use diagrams in your analysis.

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 Bills
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
0
1
2
3
4
5
6
7
8

5.

TP
0
80
200
310
400
450
480
490
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.

Given the following data for a firm:

Q

TFC ($)

0
1
2
3
4
5
6
7
8
9
10

200
200
200
200
200
200
200
200
200
200
200

TVC ($)
0
50
90
120
160
220
300
400
520
670
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)
1
2
3
4
5
6
7
8

Total Product (Q)

8
24
39
50
56
59
61
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 firms 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)
100
700
1300
1900
2500
3100
3700

Total Cost (LRTC)

5,000
29,400
46,800
60,800
75,000
93,000
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?
(Make sure your answer includes a definition of the underlined term.)

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 cost is $
.

(f)

Total variable cost is $ _

; thus the firms total revenue covers
all variable cost, leaving approximately $
to apply to fixed
costs.

(g)

If price falls to $2 the firm will produce

, total revenue less

units. Why?

$
MC

ATC

AVC

6
5

4
3

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
60
70
80
90
100
110
120

100
110
130
160
200
250
310
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 growers 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)
0
1
2
3
4
5
6
7
8
9
10

Total Cost (TC)

90
110
126
139
150
163
178
196
219
249
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 firms 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 firms short run supply curve, indicating the relevant numerical

values for price and output.

(d)

5.

Suppose this firms 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.

A perfectly competitive firm producing X has the following monthly cost data
(Q = total output, MC = marginal cost):
Q (units)
1
2
3
4
5
6
7
8
9
10

6.

MC ($)
40
37
32
28
30
32
35
40
46
56

(a)

For each of the following prices determine this firms 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
markets 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.

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 $300.
P ($)
500
450
400
350
300
250
200
150
100

Q (units)
0
1
2
3
4
5
6
7
8

TVC ($)
230
440
690
990
1410
1960
2710
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.

Tigers 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

Tigers marginal cost is $4 a bottle - ie, marginal cost is constant for this firm.
Assume fixed costs of $4000.

5.

(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 Tigers profit-maximising output and

price, and the associated level of profit or loss.

A monopoly has the following monthly demand and cost data.

(Q = output or quantity demanded, P = price, MC = marginal cost):
P ($)
148
146
144
142
140
138
136
134
132

Q (units)

6.

4
8
12
16
20
24
28
32
36

MC ($)
100
95
90
94
101
110
121
134
149

(a)

What is this monopolys 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.

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
P = $700
P = $700

Chill

P = $1500

8.

35
29

P = $1500
30

41

35

39

27
38

(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.

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
P = $50,000
Alpha

P = $50,000
P = $80,000

35
40

40
35

P = $80,000
30
45

45
30

(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.

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 firms 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 firms 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

D
a
D

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) societys 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
1
1

10
9
8
7
6
5

4
3
4

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) societys 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.