Answer key for sample mid-term

Problem 1
Explain how each of the following events would influence the market in the short run. Assume standard
demand and supply curves, i.e., a downward sloping demand curve and an upward sloping supply curve.
The market that needs to be analyzed is indicated in parentheses against each event.

For each event, you have to indicate the direction of movement of the demand curve (outward, inward, or
no change; alternatively, rightward, leftward, or no change), the supply curve (outward, inward, or no
change; alternatively, rightward, leftward, or no change), equilibrium price (up, down, or no change), and
equilibrium quantity (up, down, or no change)

For all the parts below, assume that the markets are competitive and that only the event being described has
changed i.e. do not make any additional assumptions than what is mentioned in the question.

Note: For demand and supply curves, allow all types of terms: increase/outward/rightward and analogously
for decrease

a. A major war breaks out due to which several civilians join the army and are deployed at the front.
What is the effect on the labour market?

Demand curve
Increases
Decreases
No change
Ambiguous

Supply curve
Increases
Decreases
No change
Ambiguous

Equilibrium price
Increases
Decreases
No change
Ambiguous

Equilibrium quantity
Increases
Decreases
No change

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 Ambiguous

b. In August 2019, thousands of restaurants delisted themselves from Zomato’s platform as part of a
#logout campaign What is the effect on market for food deliveries on Zomato’s platform? (Zomato
is an Indian restaurant aggregator and food delivery service provider.)

Demand curve
Increases
Decreases
No change
Ambiguous

Supply curve
Increases
Decreases
No change
Ambiguous

Equilibrium price
Increases
Decreases
No change
Ambiguous

Equilibrium quantity
Increases
Decreases
No change
Ambiguous

c. An increase in the price of movie tickets. What is the effect on the market for movie theatre
popcorn?

Demand curve
Increases
Decreases
No change
Ambiguous
Supply curve
Increases
Decreases
No change
Ambiguous

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 Equilibrium price
Increases
Decreases
No change
Ambiguous
Equilibrium quantity
Increases
Decreases
No change
Ambiguous

d. A new technology that makes it cheaper to extract juice from oranges. What is the effect in the
market for orange juice?

Demand curve
Increases
Decreases
No change
Ambiguous

Supply curve
Increases
Decreases
No change
Ambiguous
Equilibrium price
Increases
Decreases
No change
Ambiguous
Equilibrium quantity
Increases
Decreases
No change
Ambiguous
e. An increase in the proportion of twins relative to singletons among newborns. What is the effect
on the market for baby clothes?

Demand curve
Increases
Decreases
No change

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 Ambiguous

Supply curve
Increases
Decreases
No change
Ambiguous

Equilibrium price
Increases
Decreases
No change
Ambiguous
Equilibrium quantity
Increases
Decreases
No change
Ambiguous

f. A prediction by the Indian Meteorological Department that the monsoon is going to be “below
normal”. What is the effect in the market for food grains?

Demand curve
Increases
Decreases
No change
Ambiguous
Supply curve
Increases
Decreases
No change
Ambiguous

Equilibrium price
Increases
Decreases
No change
Ambiguous

Equilibrium quantity
Increases
Decreases
No change
Ambiguous

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Problem 2
JustPizza! is a profit maximizing firm in a perfectly competitive market, where a pizza sells for Rs.
500. JustPizza!’s cost curves are:
TC = 75,000 + q^2 (Note: q^2 should be read and written as q square)
MC = 2q
where q is the number of pizzas sold every day by JustPizza!

a. Calculate JustPizza! profit maximizing quantity. Is the firm earning a profit?

a.
JustPizza! profit maximizing quantity is

100
250
500
50

Profit maximizing condition for perfectly competitive firms is P = MC

Profits = TR – TC
TR = P.q = 500 * 250 = 125,000
TC = 75,000 + 250*250 = 75,000 + 62,500 = 137,500
Profits = 125,000 – 137,500 = -12,500 Or,
No, the firm is making is loss.
b.
To analyze the firms short run decision, we need to compare AVC at q = 250 units with the price.
AVC = TVC/q
AVC = (TC – FC)/q = (137,500-75,000)/250 = 62,500/250 = 250
The firm should not shut down because the price (Rs. 500) is greater than the AVC (Rs. 250) and it is able
to cover its variable costs.

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If the firm shuts down it will lose 75,000 and since the current looses are lower than that it should continue
to operate.

Note: if answer just says “do not shut down because VC are being covered” then the answer is incomplete
as it doesn’t provide the calculation that was asked.
Problem 3

The market for supplying flowers outside the Jagannath temple in Puri is perfectly competitive. All
firms (a firm is a stall) sell flowers in small bamboo baskets. Each existing firm and every potential
entrant are identical and they face the same long run average cost and long run marginal cost curves.
The minimum level of long run average cost is Rs. 5 per bamboo basket, and occurs when a firm sells
200 bamboo baskets of flowers each day. The market demand curve for a basket of flowers is Q =
28,005 – P, where P is the market price in Rupees per basket.

a. What is the long run equilibrium price per basket of flowers in the market?
b. How many baskets does each firm sell at this price?
c. How many firms will be in the market at the long-run equilibrium?
d. What are the economic profits in the long run in this market? Would a competitive firm stay in
business at this level of profit? Explain your answer in no more than 2-3 sentences.
Answer:

a. What is the long run equilibrium price per basket of flowers in the market?

Rs 10
Rs. 5
Rs. 20
Rs. 15
In the long run equilibrium in a perfectly competitive market, the demand/AR curve is tangent to the AC
curve (at its minimum point). Therefore, the long run equilibrium price is the same as the minimum level
of LAC:
P = Rs. 5
b. How many baskets does each firm sell at this price?
100
200
50
500

We are given that the minimum LAC for a firm corresponds to a quantity of 200 baskets. Therefore, in the
long run equilibrium quantity for a firm is q = 200 baskets
c. How many firms will be in the market at the long-run equilibrium?
100
120
140
160

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We can figure out the market demand at the LR equilibrium price by plugging in the value of P into the
demand curve:
Q = 28005 – 5
Q = 28000

Since, each firm produces 200 baskets, the number of firms N is given by N = Qd/q

28,000
𝑁=
200

𝑁 = 140
There are 140 firms in the market.

d.
In the long run, firms make zero economic profits (economic profit equals total revenue minus total cost,
and total cost includes all the opportunity costs of the firm).
In particular, total cost includes the opportunity cost of the time and money that the firm owners devote to
the business. In the zero-profit equilibrium, the firm’s revenue must compensate the owners for the time
and money that they expend to keep their business going.
Note: Firm is indifferent is also OK.

Problem 4
A firm operating in the perfectly competitive market of spectacles has hired you to estimate the
supply and demand curves for spectacles. You have been informed that the price elasticity of supply
is 1.7 and the price elasticity of demand is -0.85. The current equilibrium quantity is 1206 units and
current price of spectacles is $41. Given this:

a. Estimate the linear demand curve at the current price and quantity. Assume that the demand curve
takes the form Qd = a – bP. You may round off the parameters (a and b) of the demand curve to the
nearest whole number.
Qd=2231+25P
Qd= 2231-25P
Qd= 1205-5P
Qd= 1205+5P

b. Estimate the linear supply curve at the current price and quantity. Assume that the supply curve
takes the form Qs = c + dP. You may round off the parameters (c and d) of the supply curve to the
nearest whole number
Qs=-844+50P
Qs=-844-50P
Qs=-1206+41P
Qs=1206+41P

c. The government is considering imposing a $1 tax per unit on spectacle sellers to raise revenue to

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fund a vision correction program for low-income families. Some sellers are upset that the tax is levied
on them and they argue that under the current market conditions they would have a pay a larger
percentage of the burden of tax? Based on the information provided in the question above, do you agree
with this assessment? Calculate the economic incidence of the tax on buyers and sellers.
Incidence of the tax on buyers is 0.33, seller 0.66
Incidence of the tax on buyers is 0.66, seller 0.33
Equal incidence on both
Whole incidence on the buyer

d. What is the demand curve facing an individual firm this competitive market (assume we are
referring to the short run)? Explain your answer in no more than 1-2 sentences.
Descriptive answer

Answer:

a.
First, we estimate the demand curve.
Q = a - bP

Elasticity of demand = b ×

.85 = b ×

-1025.1 = b × 41
b = 25 (or the precise number)
Qd = a - bP
1206 = a - 25(41)
1206 = a - 1025
a = 2231 (or the precise number)
Qd = 2231 - 25P

Or, P in terms of Q
b.
Next, we estimate the supply curve.
Qs = c + dP

Elasticity of Supply = d ×

1.7 = d ×

2050.2x = d × 41
d = 50 (or the precise number)
Q = c + dP

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 1206 = c + 50(41)
c = -844 (or the precise number)
Qs = -844 + 50P
Or, P in terms of Q
c.
The economic incidence of the tax on buyers is Es/(Es + |Ed|) = 1.7/2.55 = 0.66 and the economic incidence
of the tax on sellers is |Ed|/(Es+Ed) = 0.85/2.55 = 0.33.
The sellers’ argument is wrong. Since the demand curve is inelastic and the supply curve is (relatively)
elastic, the sellers are able to pass on a larger proportion of the tax on the buyers. They pay only 33% of the
tax burden but the buyers will pay 66% of the tax.

d.
The demand curve facing an individual firm in perfect competition is perfectly elastic.
Note: saying p = 41 and firm being "price taker" is also fine.

Problem 5
Asian News International (ANI), an Indian news agency, has monopoly in the market of syndicated
news video feeds, especially archival footage. ANI has hired you to assist them in setting the price
that they should charge television channels for their archival footage. The managers recognize that
there are two distinct demand curves for archival footage. One demand curve applies to national
media TV channels and the other applies to regional media TV channels. The two demand curves
are:
P1= 9.6 - 0.08Q1
P2 = 4 - 0.05Q2

where P1 = price charged to national TV channels, P2 = price charged to regional media channels,
Q1 = duration of archival footage for national TV channels, and Q2 = duration of archival footage
for regional TV channels. Assume that the archives require only a fixed cost to be maintained, so that
the managers consider marginal cost to be zero.

a. If ANI decides to price discriminate, what should the profit maximizing price and quantity be in
each market?
Q1=40, P1=4.8, Q2=60, P2=2
Q1=60, P1=2, Q2=40, P2=4.8
Q1=60, P1=4.8, Q2=40, P2=2
Q1=60, P1=4.8, Q2=60, P2=2

b. What is the elasticity of demand at the quantities and prices calculated in part (a) of this question
for each market?
E1=E2=1
E1=E2=-1
E1=E2=0
E1=E2=-0.5

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c. Are these elasticities consistent with your understanding of profit maximization and the
relationship between marginal revenue and elasticity? Explain your answer in no more than 1-2
sentences.
Yes, it is consistent
No, not consistent
Can't ascertain

d. Would your answer to part (a) change if the marginal cost was not zero and instead you were
informed that marginal cost of ‘producing’ archival footage was Rs 4? Why or why not? Explain
your answer in no more than 1-2 sentences.
Yes, answer would change
No, answer would not change

e. Compared to the case of the monopolist charging an uniform price, what would be the effect of a
price discriminating monopolist on total welfare/social surplus? Would it increase, decrease or not
change? No further calculations are required. Explain your answer in no more than 1-2 sentences.
Decrease
Increase
No change

Answer:

a.
Optimal price discrimination requires that ANI sets MR1 = MR2 = MC.

MR1 = MC = 0
Setting MR1 = 0
9.6 - 0.16Q1 = 0
9.6 = 0.16Q1
Q1 = 60

P1 = 9.6 - 0.08(60)
P1 = 4.8

MR2 = MC = 0
Setting MR2 = 0
MR2 = 4 - 0.10Q2 = 0
4 = 0.10Q2
Q2 = 40

P2 = 4 - 0.05(40) = $2
P2 = Rs 2

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b.
To calculate elasticities, solve for Q.
P1 = 9.6 - 0.08Q1
P1 - 9.6 = -0.08Q1
Q1 = 120 - 12.50P1

Q1 = 120 - 12.5P1

E1 = ∙

E1 = -12.50 ∙

E1 = = -1.0

P2 = 4 - 0.05Q2
P2 = 4 - 0.05Q2
P2 - 4 = -0.05Q2
Q2 = 80 - 20P2

E2 = -20 ∙

E2 = -1
Or,
The elasticities for both segments are -1 (unitary elastic)

Or,
E1 = E2 = -1

Or,
|E1| = |E2| = 1

c.
Yes, it is consistent.
When MC = 0, profit maximization requires that MR = 0 (which in turn implies that there should be no
change in TR when price/quantity changes, as firms are on the portion of the demand curve which is unitary
elastic)
d.
Yes, the answer would change.

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ANI shouldn’t supply video to the second market (regional media TV channels) because it is too small. The
maximum willingness to pay in that market is Rs 4 (P2 = 4 – 0.05*0 = 4) which is the same as the marginal
cost. Formally, we can see this by setting MR2 = 4 - 0.10Q2 = MC = 4. This implies that Q2 = 0.
e.
Increase
The total surplus would increase in case monopolist practices price discrimination (because the deadweight
loss is minimized).

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