Fall 2021

METU, Department of Economics

Instructor: Serkan Küçükşenel
T.A.: Rengin M. Ayhan

ECON 201 - Problem Set 1

1. A vegetable fiber is traded in a competitive world market, and the world price is $9 per pound.
Unlimited quantities are available for import into the United States at this price. The U.S. domestic
supply and demand for various price levels are shown as follows:

U.S. Supply U.S. Demand

Price (Million Lbs.) (Million Lbs.)
3 2 34
6 4 28
9 6 22
12 8 16
15 10 10
18 12 4

(a) What is the equation for demand? What is the equation for supply?
(b) At a price of $9, what is the price elasticity of demand? What is it at a price of $12?
(c) What is the price elasticity of supply at $9? At $12?
(d) In a free market, what will be the U.S. price and level of fiber imports?

2. Suppose there are only two goods (X and Y) and only two individuals (numbered 1 and 2) in an
economy. Let PX be the price of good X and PY be the price of good Y. And finally, let I1 represent the
income of individual 1 and I2 the income of individual 2. Suppose the quantity of good X demanded
by individual 1 is given by
X1 = 10 − 2PX + 0.01I1 + 0.4PY

, and the quantity of X demanded by individual 2 is

X2 = 5 − PX + 0.02I2 + 0.2PY

a) Graph the two individual demand curves (with X on the horizontal axis and PX on the vertical
axis) for the case I1 = 1000, I2 = 1000, and PY = 10.

b) Using the individual demand curves obtained in part b, graph the market demand curve for total
X. What is the algebraic equation for this curve?

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3. The following sequence of changes in the demand and supply for hoodies in the ODTUDEN store
occurred. P and Q indicate the price of a per hoodie and total hoodie quantity sold over a month,
respectively.
August: Initial demand and supply are given by the equations Qs = 30P − 30 (when P ≥ 1), and
Qd = 120 − 20P
September: Due to higher cotton prices, the supply of hoodies changed to Qs = 30P − 60 (when
P ≥ 2).
October: Due to the beginning of the new semester, the demand for hoodies was higher, and therefore
demand curve was given by the equation Qd = 140 − 20P .

(a) For each month, find equilibrium price and quantity.

(b) Illustrate your answer with a graph. Illustrate the equilibrium prices and quantities on the graph.

4. There are four individuals, Alice, Bob, Chris and Dale who buy widgets. Their individual demands
are given by the following inverse demand functions:

P (xA ) = 5 − xA

P (xB ) = 10 − 5xB

P (xC ) = 20 − xC

P (xD ) = 10 − 2xD

a) Derive an expression for the market demand for widgets (you can assume that above people are
the only people buying widgets). Graph this market demand with price on the vertical axis and widgets
on the horizontal axis.

b) Along which segment of the market demand curve is demand most elastic? Along which segment
is demand most inelastic?

c) Suppose that the market supply of widgets at a given price is S(P ) = −6 + 23 P . What is the
equilibrium price and quantity? Which consumers are buying positive amounts of the good?

d) As you can observe, individual segments of the demand curve get flatter as we move to the right.
Suppose that we have multiple consumers, all with linear individual demand curves. Is it possible that
the market demand curve for this group of consumers gets steeper as we move to the right? Why or
why not?

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5. Consider the following market demand and supply functions:

QD = D(P, α)
QS = S(P, β)

where α and β denote the variables shifting the demand and supply curves, respectively.

(a) Derive an expression for each of the following elasticity measures (ε):
i. the price elasticity of demand, denoted εQD ,P ,
ii. the price elasticity of supply, denoted εQS ,P ,
iii. the elasticity of the market price with respect to α, denoted εP,α ,
iv. the elasticity of demand with respect to α, denoted εQD ,α .
(b) Could you interpret the type of the good if α was representing income and if εQD ,α > 1?
(c) In equilibrium, QD = QS . Using the market equilibrium condition and assuming that β is held
constant, derive the following expression:

εQD ,α
εP,α =
(εQS ,P − εQD ,P )

[Hint: Use the total differentiation of the market equilibrium condition, where dβ = 0]
(d) Consider the following demand and supply functions where I represents income and W denotes
wages.

QD = 40 − 2P + 0.5I
QS = 20 + 3P − 0.5W

i. Initially, I = 100 and W = 10. Find the equilibrium market price and quantity. Illustrate
your answer on a graph, where the horizontal axis measures the quantity, and the vertical
axis measures the price.
ii. Suppose now that there is a change in income such that I = 110, while wages remain intact
such that W = 10. What is the new equilibrium market price and quantity? Illustrate your
answer on the graph that you have drawn in part (i).
iii. Show whether the expression that you have derived in part (b) gives an accurate prediction
of the change in the equilibrium market price?

6. Suppose that you are concerned about teenage smoking in the US. You are interested in what the
impact would be if a $1 federal tax was added to each pack of cigarettes sold. You have the following
data available:

• Elasticity of demand (General Public): −.45

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• Elasticity of demand (Teenagers): −.7
• Elasticity of supply: 7.0
• Current market price of cigarettes: $5.51
• Current cigarette sales: 17.4B

a) Estimate the supply and demand functions.

b) Using your estimated model, solve for the equilibrium price and quantity. We already know this,
but you should double check to make sure you did part (a) right.

c) Find the supply curve with the tax in effect.

d) Now, use your new supply curve and solve for the new equilibrium price and quantity. By what
percentage do cigarette sales fall?

e) Given the price increase, by what percentage should teenage smoking fall?

7. Suppose that the demand and supply functions in the market for coffee are given as:

QD = 100 − P

QS = 20 + 3P

For each cases below, find the price consumers pay and sellers receive in equilibrium, tax burdens, tax
revenue collected by government, changes in the consumer and producer surplus and the DWL.

a) A unit tax of $16 imposed on the supplier

b) A unit tax of $16 imposed on the buyer

c) A proportional tax of 10% imposed on the supplier

d) A proportional tax of 10% imposed on the buyer

8. The elasticity of demand for domestic heating oil is -0.5, and for gasoline is -1.5. The price of both
sorts of fuel is 60¢ per litre: included in this price is an excise tax of 48¢ per litre. The government
wants to reduce energy consumption in the economy and to increase tax revenue. Can it do this
(a) by taxing domestic heating oil?
(b) by taxing gasoline?

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9. A new chemical cleaning solution is introduced to the market. Initially, demand and supply are
given as:
QD = 1000 − 2P

QS = 100 + P

where QD is the demand and QS is supply.

a) Determine the equilibrium price and quantity.

b) The government then decides that no more than 300 units of this product be sold per period, and
imposes q quota at that level. How does this quota affect the equilibrium price and quantity? Show
the solution using a graph and calculate the numerical answer.

10. True/False

a) The individual quantity demanded is the amount the buyer is allowed to purchase at a given price.

b) For a good with the price elasticity of demand of 0.8, an increase in price will cause total consumer
spending on that good to rise.

c) If we observe that when the price of chocolate increases by 10%, total revenue increases by 10%,
then the demand for chocolate is unit price elastic.

d) Drug interdiction, which reduces the supply of drugs, will likely to be a less effective policy than
education consumers to reduce their demand for drugs because the drug interdiction policy will lower
drug prices and reduce the quantity of drugs demanded.

e) Normal goods have negative income elasticities of demand, while inferior goods have positive
income elasticities of demand.

f) The flatness or steepness of a demand curve is based on absolute changes in price and quantity,
while elasticity is based on relative or percentage changes in price and quantity.