APPLICTION POBLEMS IN MICRO ECONOMICS (SOLVED) Q1. Selwyn signed up with an Internet provider for a fixed fee of $ 19.

95 per month. For this fee he gets unlimited access to the World Wide Web. During the average month in 2006 he was logged onto the Web for 17 hours. What is the average cost of an hour of Web time to Selwyn? What is the marginal cost of an additional hour? Ans.1 Ans1. Average cost for the average month in this case will $1.1735.($19.95/17) Marginal cost in this case will be nil as Internet provider is charging fixed fee of $19.95 , so total cost will remain same if he uses it for additional hour in the same month. Q2. For each of the following equations, graph the line and calculate its slope. a. b. c. d. Ans2. a. let us transform these into quantity demanded as a function of price p = 10 2qd qd = 5 0.5 p 10 is the intercept on Y axis. 5 is the intercept on X axis. Joining both you can graph the line. Slope in the above case will be -2 p = 100 4qd qd = 25 0.25 p 100 is intercept on Y axis 25 is intercept on X axis. Joining both by straight line you can graph the line Slope is -4 b) \[P=10-{{2}_{{{q}_{D}}}}(Put\,{{q}_{D}}\,on\,the\,X-axis)\] \[P=100-{{4}_{{{q}_{D}}}}(Put\,{{q}_{D}}\,on\,the\,X-axis)\] \[P=50+{{6}_{{{q}_{S}}}}(Put\,{{q}_{S}}\,on\,the\,X-axis)\] \[I=10,000-500r(Put\,I\,on\,the\,X-axis)\]

i = 10, 000 500r r = 20 1/ 500r Intercept on x axis is 10,000 Intercept on Y axis 20. Join both the points by a straight line . Slope is -1/500= 0.002 d) c) p = 50 + 6qs Intercept on Y axis is 50 . Slope is 6+. This means for every 6 Rs increase in Price Supply will increase by 1 unit. PRICE SUPPLY 50 0 110 10 170 20 230 30 Plot the above table to graph the line. Q3. Kristen and Anna live in the beach town of Santa Monica. They own a small business in which they make wristbands and potholders and sell them to people on the beach. Kristen can make 15 wristbands per hour but only 3 potholders. Anna is a bit slower and can make only 12 wristbands or 2 potholders in an hour. OUTPUT PER HOUR Kristen Anna Wristbands 15 12 Potholders 3 2 For Kristen and for Anna what is the opportunity cost of a potholder? Who has a comparative advantage in the production of potholders? Explain. Who has a comparative advantage in the production of wristbands? Explain. Assume that Kristen works 20 hours per week in the business. If Kristen were in business on her own, graph the possible combinations of potholders and wristbands that she could produce in a week. Do the same for Anna. If Kristen devoted half of her time (10 out of 20 hours) to wristbands and half of her time to potholders, how may of each would she produce in a week? If Anna did the same, how many of each would she produce? How many wristbands and potholders would be produced in total? Suppose that Anna spent all 20 hours of her time on wristbands and Kristen spent 17 hours on potholders and 3 hours on wristbands. How many of each would be produced?

a. b. c. d.

e.

f.

Suppose that Kristen and Anna can sell all their wristbands for $1 each and all their potholders for $5.50 each. If each of them worked 20 hours per week, how should they split their time between wristbands and potholders? What is their maximum joint revenue?

Ans.3 ANS:3 a) OPPORTUNITY COST OF POTHOPLDER Kristen =15/3 =5 Anna= 12/2 =6 b) Kristen for her opportunity cost is lower than Anna. In other words Kristen for every potholder produced will sacrifice 5 wristbands whereas Anna for every potholder produced will sacrifice 6. c) Kristen maximum wristbands she can produce 20*15 = 300 (intercept on y axis) maximum potholders she can produce 20*3= 60. (intercept on x axis) join both the intercepts you will get PPF which will show all the possible combinations. Slope in the above case will be -5. Anna. Similar procedure to be adopted for Anna. d) Kristen wristbands qd = 5 0.5 p =15*10=150 potholders= 10*3=60. Similarly for Anna and (e) part can Be solved. f. If Kirsten produces wrist bands (20*15=300) 300*$1=300 If she produces potholders (20*3=60) 60*5.50= 330 If Anna produces wrist bands (12 *20=240) = 240*$1=240 If Anna produces potholders ( 2*20 = 40) = 40 * $ 5.50=220 Kirsten should produce potholders only as he has comparative advantage in that and Anna should devote all her 20 hours on production of wrist bands in which she has comparative advantage. Their max joint revenue will be 330 + 240 = 570.

Q4.

a. b. c. d. e. f. Ans 4.

Do you agree or disagree with each of the following statements? Briefly explain your answers and illustrate with supply and demand curves. The price of a good rises, causing the demand for another good to fall. The two goods are therefore substitutes. A shift in supply causes the price of a good to fall. The shift must have been an increase in supply. During 2005, incomes rose sharply for most Americans. This change would likely lead to an increase in the prices of both normal and inferior goods. Two normal goods cannot be substitutes for each other. If demand increase and supply increases at the same time, price will clearly rise. The price of good A falls. This causes an increase in the price of good B. Goods A and B are therefore complements.

a) Disagree , they are complementary goods (Price of petrol rises demand for car will fall). b) Agree (demand remaining the same when supply increases equilibrium price falls) c) Disagree demand for normal goods will rise but for inferior will fall with rise in income. d) Disagree they can be as Pizza can be for hamburger. e) Disagree. Depends on the comparative increase in demand and supply. It may rise , fall or remain same. f) Agree if with fall in price of good A Demand for good B rises they are complementary gods. Q5. Suppose the market demand for pizza is given by Qd = 300 20P and the market supply for pizza is given by Qs = 20P 100, where P = price (per pizza). Graph the supply and demand schedules for pizza using $5 through $15 as the value of P. In equilibrium, how many pizzas would be sold and at what price? What would happen if suppliers set the price of pizza at $15? Explain the market adjustment process. Suppose the price of hamburgers, a substitute for pizza (at each price consumers demand twice as much pizza as before). Find the new equilibrium price and quantity of pizza.

a. b. c. d. e.

Ans5. Ans5. b) At. Equilibrium 300 20 p = 20 p 100 40 p = 400 p = 10 Substituting the value in demand function

qd = 300 (20*10) qd = 100 qs = 200 100 qs= 100. So equilibrium quantity in this case will be 100 and price $ 10. c) If price rises to $ 15 Producers will tend o supply 300-100 =200 Where as consumers will demand 300-300 = 0. This will result into excess supply by 200. This will induce competition among the producers and price will start falling till it reaches $10. d) the new market demand in this case will be : qd = 600 40 p 600 40 p = 20 p 100 60 p = 700 p p = 700 / 60 p = $11.67 Substituting value in either qs or qd you will get equilibrium quantity. qd = 600 40*11.67 qd = 133.2 Qd = 133. Q6. Use the diagram below to calculate total consumer surplus at a price of $8 and production of 6 million meals per day. For the same equilibrium, calculate total producer surplus. If price remained at $8 but production were cut to 3 million meals per day, calculate producer surplus and consumer surplus. Calculate the deadweight loss from underproduction.

Ans6. Answer 6. Consumer surplus is the difference between what consumer is ready to pay and what actually he is paying. Consumer surplus in this case is $18. Producer surplus is difference between at what price he is ready to sell and what price he is getting. Producer surplus in this case is again $ 18. If production is cut to 3 million meals per day. Both consumer and producer surplus falls to $ 13.5. Total dead weight loss $9 million.