Student ID Family name First name

896234 Campagnolo Federico

898486 Shojaei Shayan
898230 Sinha Sneh Wayne

Introduction to Economics
Problem set 1
Due date: Thursday, March 2nd at 12:00.
Instructions:
• The problem set can be solved in groups of maximum 3 people. You need to hand in your solutions
through the Moodle platform.
• Make sure to write down the names of all members of the group in your solutions paper. No student can
be added as a participant in the group at a later stage.
• Please upload a unique file PDF file on behalf of all members of the group.
• Once a group has been formed, no further changes will be accepted.

Exercise 1. Consider a competitive market for cars. There are 3 consumers labeled 𝑖 = 1,2,3. Every consumer
wants/needs to buy one single car. In addition, each consumer 𝑖 has a willingness to pay equal to €𝑖k, (e.g.,
consumer 𝑖 = 2 is willing to pay a maximum price of €2k for 1 car). There are two producers of cars. Producer 1
can produce up to 1 car with a marginal cost equal to €1.5k. On the other hand, producer 2 produces the first car
a cost of €1k, the second car at a cost of €1.5k, and the third car at a cost of €3k.

1. Draw in Figure 1 the individual demand curve of each consumer.

Consumer 1 Consumer 2 Consumer 3

Figure 1: Individual Demands

2. Draw in Figure 2 the individual supply curve of each producer.

Producer 1 Producer 2

Figure 2: Individual Supply

3. Draw in Figure 3 both the market demand curve and the market supply curve.

Figure 3: Competitive Market

4. What is the competitive price of this market? €1.5k

5. How many cars will be traded in the competitive equilibrium? 2
6. Identify in Figure 3 the total consumer surplus. ( Blue Area = €2k )
7. Identify in Figure 3 the total producer surplus. ( Orange Area = €0.5k )
8. Suppose that the Government fixes by law the price of cars at €2k.
8.1. How many cars the consumers will be willing to buy at the regulated price? 2
8.2. How many cars the producers are willing to sell at the regulated price? 3
8.3. How many cars will be traded after the Government fixes the price? 2
8.4. Describe the change in surplus experienced by every consumer as compared to the competitive
equilibrium.
Consumer 3: loss of surplus ( from 1.5k to 1k );
Consumer 2: loss of surplus ( from 0.5k to 0 ).
Consumer 1: still doesn’t purchase a car.
 8.5. Describe the change in surplus experienced by every producer as compared to the competitive
equilibrium.
Producer 1: gain of surplus ( from 0 to 0.5k );
Producer 2: loss of surplus ( 1k surplus – 1.5k surplus from unsold car = -0.5k )
8.6. Represent this situation in Figure 4.

Figure 4: Welfare effects of a regulated price

9. Consider again the competitive equilibrium. Suppose that consumer 1 steals the car of consumer 3.
9.1. Draw in the left panel of Figure 5 the gain of surplus to consumer 1 and the loss of surplus to
consumer 3. So basically, C1 did not pay for anything, he stole it. So his total willingness to pay is is his surpluis which is 1K
9.2. Draw in the right panel of Figure 5 the net effect of this reallocation in the total surplus of the market.
9.3. What can you conclude about the goodness or badness of this reallocation.
The blue squares represent the old situation surplus, before consumer 1 steals from consumer 3.
In the new situation customer 3 loses 1.5k, customer 1 gains 1k surplus, therefore the aggregate
surplus decreases by 0.5k, making this a bad allocation if we want to maximize surplus.
For customer 1 this allocation is good.

9.2, In terms of Re-allocation, Now the surplus of C3 is gone, Which was 1.5K, now there is surplus of 1K from C1, overall surplus has decreased by 0.5K
 Figure 5: Reallocation of consumption

isnt producer one irrelevant?

10. Suppose now that a fire starts in producer 1's factory. As a consequence, producer 1 leaves the market.
10.1. Draw in Figure 6 both the market demand and the market supply.
10.2. What is the new competitive price of this market?
Since the two curves intersect from 2 to 1.5, this means the competitive can be any price between
€2k and €1.5k.
10.3. How many cars will be traded in the new competitive equilibrium? 2
10.4. Identify in Figure 6 the total consumer surplus. At least €1k, for competitive price at €2k, and at most
€2k, for competitive price at €1.5k.
10.5. Identify in Figure 6 the total producer surplus. At least 0.5k for competitive price at 1.5k, and at most
1.5k for competitive price at 2k.
10.6. How does the welfare properties of this allocation compare to the welfare properties of the initial
competitive equilibrium? Explain carefully.
In the new situation, the total surplus is equal to the former.
Producer surplus can at the very least be the same as before, which happens at competitive price of
1.5k, otherwise it increases to a maximum of 1.5k.
Consumer surplus can at most be the same as before, which happens at competitive price of 1.5k,
otherwise it decreases to a minimum of 1k.
 Figure 6: Competitive Market

Exercise 2. Consider a competitive market with a demand curve as depicted in Figure 6.

Figure 7: Competitive market

Suppose there is a large number of competitive firms, all identical with constant marginal cost equal to €10.

1. Draw in Figure 7 the market supply curve.

2. What is the competitive equilibrium price? €10 in regard to the intersection of the curves.
3. What is the competitive equilibrium allocation? 40
4. Identify in Figure 7 the total consumer surplus. The area between the demand curve and the competitive
price line is a triangle with the value of €400.
5. Identify in Figure 7 the total producer surplus. There is no producer surplus because there is no area between
the competitive price line and the supply curve.

Exercise 3. Consider the demand curves 𝐷1 and 𝐷2 in Figure 7. Compute the price-elasticity of demand of the
demand curve 𝐷1 when moving from point 𝐴 to point 𝐵. Use both standard percentages changes and midpoint
percentage changes. Repeat the same computations for the demand curve 𝐷 2 when moving from point 𝐴 to point
𝐶. Which demand curve is more elastic? Carefully explain your answer.

D2 is more elastic. If we consider the absolute value of the computed price elasticity of demand values ( both in
the standard and midpoint percentage changes, ) we find that D2’s results are greater than the ones of D1.

This tells us that a variation in the price of the good leads to a greater variation of demand in D2 rather than D1.

It can also be inferred from the graph: from A to B and C the price reduction is the same, but in D2 it results in a
greater increase of demand (C: Q increases from 3/2 to 3 ) compared to D1 ( B: Q increases from 3/2 to 2 ).

Computations in the page below.

Figure 8: Elasticities