1

1. China mobile offers nine price plans for its “worldwide connect” service in the city of
Nanjing. The cheapest plan provides 350 “free minutes” of calls for 68 yuan per month.
The price of additional call is 0.29 yuan per minute. Jessica’s demand curve for mobile
calling is a straight line. Two points on her demand curve are

i) At a price of 1.29 yuan per minute, quantity is 0

ii) At a price of 0.29 yuan per minute, quantity of 400 minutes.
a) Draw a neat, labelled demand curve for Jessica
b) What would be her total benefit if she purchased the cheapest “worldwide connect”
plan described above.
c) What would be her buyer’s surplus?
a. The Demand curve plots minutes of talk time per month against Yuan per minute. It
joins the points (0, 1.29) with (400, 0.29)
b. Her total benefit would be the area under the demand curve up to 400 minutes. That is
benefit = (1x400)/2 + 0.29x400 =316 Yuan per month.
c. Her buyer surplus would be 316 – 68 – (0.29*50) = 233.5.
2. Sprint is one of the largest mobile service provider in the USA. In march 2011, Sprint had 13.1
million prepaid customers and 33 million post paid customers. Sprint’s prepaid brands
include Virgin Mobile USA, Boost Mobile, and Assurance Wireless. Sprint’s ARPU from
prepaid customers was $ 28 per month as compared with $56 per month from post paid
customers.

a) Explain the meaning of Normal and Inferior products.

b) Apply the concepts of normal and inferior products to prepaid and post –paid mobile
telephone services.
c) Refer to Sprint’s ARPU from prepaid and post paid customers. Are the data consistent
with your answer to (b)?
a, Normal: demand rises as income rises. Inferior: demand decreases as income rises.
b. Post-paid services are a normal product and pre-paid services are an inferior product.
c. Yes since the ARPU from post-paid customers exceeded that from prepaid customers.
3. (a) Explain the meaning of Buyer’s Surplus.
(b) What is two-part pricing? How can a broadband service provider use two–part pricing
to increase profit?
a. Buyer’s surplus is the buyer’s total benefit from a purchased product less the total
expenditure by the buyer on the product. Graphically it is the area under the demand curve
over the number of units purchased less the area under the line drawn at the price paid over
the number of units purchased.
b. Two part pricing is when a seller charges a fixed access or subscription fee and an
additional charge per unit purchased or used. The broadband service provider can set the
access fee or subscription equal to the buyer’s total benefit up to the quantity where the
sellers marginal cost curve intersects the buyer’s demand curve. The usage fee can then be
set equal to the marginal cost of provision.
 2

4. The price elasticity of demand for imported whisky is estimated to be -0.20 over a wide
interval of prices. The Indian Government decides to raise the import tariff on foreign
whiskey, causing its price to rise by 20 percent. Will the sale of whiskey rise or fall, and by
what percentage amount?
Draw a neat, labelled diagram and explain your answer.
The sale of whisky falls by 0.2*20 = 4%. The diagram should be for the annual market for
imported whiskey in India. India can be assumed to be a price taker in the world
market.
5. Qantas operates a fleet of over 100 Boeing passenger jet aircraft. Many jets carry cargo in their
"bellies", under the passenger seating areas. Identify if the following inputs contribute to
fixed or variable costs.
(a) (1). Cockpit personnel: All jets, large and small, require a pilot and co-pilot. Belly cargo
service requires no additional officers in the cockpit.
(2). Airport landing fees: Charged by the weight of the aircraft.
(3). Fuel: Larger aircraft and those carrying heavier loads will consume relatively more fuel.
(b) What is the quantity variable with respect to which costs are classified as fixed or variable?
a.1: Fixed cost: Does not vary with the production rate (passenger miles).
a2. Neither fixed nor variable: Does not vary with distance travelled but varies with number
of passengers
a3: Variable cost: varies with the production rate.
b. Passenger miles.
6. Plastic and steel are substitutes in the production of body panels for certain automobiles. If
the price of plastic increases, with other things remaining the same, we would expect
a. the price of steel to fall.
b. the demand curve for steel to shift to the right.
c. the demand curve for plastic to shift to the left.
d. nothing to happen to steel because it is only a substitute for plastic.
e. the demand curve for steel to shift to the left.
With the help of a neat, labelled diagram explain your answer.
The increase in the price of a substitute good for any good under consideration causes
demand to switch from the expensive substitute to the good in question. The graph will
have two demand curves the one to the right being after the substitute price increase.
The axes will be quantity: tonnes per year (of steel) and price: Rs per tonne.
7. A key component of mobile phones is the microprocessors. Explain with the help of a neat
diagram how changes in consumer income affect Nokia’s demand for microprocessors.
Assume that Nokia mobile phones are a normal good (Assumption about normal/inferior is
essential and worth 25%). Increase in income causes increased mobile phone demand. In turn
this causes increased demand for microprocessors by Nokia and other mobile phone makers.
The graph is of the market for microprocessors. The graph will have two demand curves the
one to the right being after the income increase. The axes will be quantity: numbers per year
(of microprocessors) and price: Rs per unit.
 3

8. Sugar can be refined from sugar beets. When the price of those beets falls,
a. The demand curve for sugar would shift right.
b. The demand curve for sugar would shift left.
c. The supply curve for sugar would shift right.
d. The supply curve for sugar would shift left
With the help of a neat, labelled diagram explain your answer.
A decrease in the price of an input causes supply to increase. The graph is of the market for
sugar measured in tonnes per year with price in $ per tonne. It will have two supply
curves, the one of the right being after the fall in the price of sugar beets.
9. Yachts are produced by a perfectly competitive industry in Dystopia. Industry output (Q) is
currently 30,000 yachts per year. The government, in an attempt to raise revenue, places a
$20,000 tax on each yacht. Demand is highly, but not perfectly, elastic.
a. Q falls from 30,000; P rises by less than $20,000.
b. Q falls from 30,000; P rises by $20,000.
c. Q falls from 30,000; P does not change.
d. Q stays at 30,000; P rises by $20,000.
e Q stays at 30,000; P rises by less than $20,000.
With the help of a neat, labelled diagram explain your answer.
The diagram should be of the market for yachts in units per year with price being $ per unit.
The tax causes an upward shift in the supply curve of yachts (supply decrease). This
causes an excess supply at the initial price plus the tax. Consequently there will be a
movement up the demand curve and down the supply curve to the new equilibrium.
Because of these movements the price rise to the new equilibrium is less than the tax.
Quantity will also fall due to the movement along the demand curve.
10. According to a study of U.S. cigarette sales, when the price of cigarettes was 1% higher,
consumption would be 0.4% lower in the short run and 0.75% lower in the long run.
(Source: Gary Becker, Michael Grossman, and Kevin Murphy, “An Empirical Analysis of
Cigarette Addiction”, American Economic Review, Vol. 84 No. 3, June 1994, 396-418.)
a. Calculate the short- and long-run own-price elasticities of the demand for cigarettes.
b. If the government were to impose a tax that raised the price of cigarettes by 5%, what would
be the effect on consumer expenditure on cigarettes in the (i) short run, and (ii) long run?
a. Short and long run elasticities are -0.4 and -0.75 respectively.
b. The formula linking expenditure to price changes is %∆E = (1+E D)%∆P. So %∆E = 0.6x% =
3% in the short run and 0.25x5 = 1.25% in the long run.
11. Discuss whether horizontal or vertical boundaries of the firm have been changed in the following
situations and whether they were extended and shrunk
The Canadian manufacture of regional jets, Horizontal/vertical
Bombardier, launched the C-series a family Extended/shrunk
of 100-149 seat, long–range jets Bombardier has added a product to
its existing range
The software publisher Microsoft acquired Horizontal/vertical
Skype, a provider of Internet telephony Extended/shrunk
services (answer for Microsoft) Microsoft has added a product to
its existing range (alternate answer
is possible if Skype is a user of
Microsoft software. In this case
extended vertical boundaries can
be the answer).
 4

The conglomerate General Electric divested Horizontal/vertical

its subsidiary, NBC universal , which Extended/shrunk
merged with cable TV provider, Comcast GE has reduced some products
(answer for General Electric) from its existing range.
Explain your answer in each case.
12. This is year a new oil field with substantial reserves has been discovered. Such discoveries
are not made every year. Therefore an increase in the demand for oil will:
a. increase the long run price of oil more than the short run price of oil.
b. increase the long run price of oil less than the short run price of oil.
c. ensure the long run price of oil and short run price of oil increase by the
same amount.
d. ensure that the short run price of oil falls.
e. ensure that the short run price of oil remains unchanged.
With the help of a neat, labelled diagram explain your answer.
The diagram shows the market for crude oil measured in litres per year with price in $ per
litre. Both elastic long run supply and relatively inelastic short run supply pass through
the initial equilibrium point. The more elastic supply is explained by the fact that
additional oil can be drilled for in the new field in the long run. So the demand increase
will cause a smaller price increase in the long run.
13. At a major American food retailer, the own-price elasticities of the demand for various
brands of pasta and biscuits were
Brands Pasta Elasticity Biscuits Elasticity
National brand -1.36 -1.00
Private labels -2.16 -1.14
Low price brands -1.85 -0.50
i) Do national brand or private label or low price brands command more brand
loyalty?
ii) Which is more elastic? The demand for pasta or biscuits?
iii) Based on the own price elasticities, can you make any recommendations on pricing?
i) Brand loyalty makes demand less elastic. In the table above Demand for national brands
are less elastic than demand for private label brand. For pasta national brands have a less
elastic demand compared to low price brands but the opposite is true from biscuits.
ii) For each category of brands the demand for pasta is more elastic.
iii). For Low price biscuits the elasticity is in the inelastic region. So the price should be
increased till it is in the elastic region of demand. For other items incremental margin
percentages from highest to lowest are for a: National brand biscuits; b: Private label
biscuits; c: National brand pasta; d: Low price brand pasta; and e: Private label pasta. To give
more precise pricing advice information on marginal costs is needed.
 5

14. The introduction of refrigerators into American homes:

a. decreased the magnitude of the short run own price elasticity of demand for
raw meat.
b. did not affect the short run own price elasticity of demand for raw meat.
c. increased the magnitude of the short run own price elasticity of demand
for raw meat.
d. decreased the magnitude of the short run own price elasticity of demand for
smoked meats.
With the help of a neat, labelled diagram explain your answer.
The diagram shows the market for raw meat measured in pounds per week with price in $
per pound. Two supply curves are shown passing through the same equilibrium point
that prevailed before the introduction of refrigerators. The greater elasticity of demand
after refrigerators were introduced is because families can buy in bulk when prices are
low and store the meat in the refrigerator to be gradually used up. So demand when
prices are high will be much less than in the pre-refrigerator era.
15. After the September 11, 2001 attacks on the World Trade Center, the supply of downtown
office space in Manhattan was dramatically reduced. Forecasters predicted that the equilibrium
price would rise, but in fact the price fell. What are some factors that could explain the fall in
the equilibrium price, which the forecasters failed to take into account?
a. Demand for office space fell due to quality-of-life concerns.
b. The economic slowdown caused demand for office space to fall.
c. Both (a) and (b).
d. None of the above.
With the help of a neat, labelled diagram explain the impact of 9/11 on downtown office space
in Manhattan.
The diagram shows the market for office space in downtown Manhattan measured in square
feet per year with price in $ per foot. Four equilibria are shown: (a) The equilibrium pre
9/11. (b) The equilibrium immediately post 9/11 with a decreased supply (S 2) due to the
destroying of the World Trade Centre: This will have a higher price and lower quantity
than case (a). (c) An equilibrium with lower demand (Say D 3) than case (b) due to
quality of life concerns. (d) An equilibrium with even lower demand (say D 4) due to the
economic slowdown. The equilibrium price at the intersection of S 2 and D4 should be at
a price lower than the pre-9/11 price as required by the information given.
16. People buy greeting cards and roses throughout the year. As Valentine’s day approaches
however cards and roses become necessities. The demand for both products jumps. The
prices of roses however always increase much more sharply than the price of greeting
Cards.
Explain this disparity by considering the price elasticities of supply in the two markets.
b. With the help of a neat, labelled diagram explain your answer.
a. Since land allotted to growing roses cannot be increased at will merely for Valentine’s day,
the supply of roses will be less elastic than greetings cards which can be stored and used
the following year.
b. The diagram will compare prices and quantities on normal days with those on Valentine’s
day. To be able to compare the markets for greetings cards and roses on the same
diagram, a special diagram is needed. Firstly, this will have quantities as a percentage of
quantities with normal demand & supply (i.e. Index numbers of quantities). Secondly
prices will be percentages of prices with normal demand and supply. Third, the less
elastic rose supply curve and elastic greetings card supply curve will pass through the
 6

normal equilibrium. Fourth, the initial demand curve and rightward demand shift for
Valentine’s day can be assumed to be the same for both roses and greetings cards to
make the price increases depend entirely on the supply response.
17. Any of the following could cause an increase in the demand for a cereal brand except:
a. a decrease in the price of wheat used to produce cereal.
b. a new report from the Surgeon General that wheat helps to cure sunburn.
c. a picture of a popular sports figure, such as Michael Phelps, on the cereal box.
d. an increase in the price of a competing cereal brand.
With the help of a neat, labelled diagram explain your answer.
The three events listed in b., c. and d. could lead to a rightward shift in demand for cereals
because b. and c. could influence buyer’s tastes positively and c. describes an increase in
the price of a substitute. a. leads to a movement along the supply curve.
The diagram is the market for cereals in country X with quantities in boxes per year and
price in rupees per box. There should be two demand curves and one supply curve
drawing showing two equilibria. An arrow should be drawn next to the supply curve
from the higher equilibrium price to the lower equilibrium price and labelled “decrease
in the price of wheat in supply demand analysis”.
18. There are two techniques of anda production: desi (where hens roam around the farm) or
poultry (where hens are fed and watered in wire cages). The poultry technique has a
much less elastic supply curve than the desi technique. When the demand for anda falls:
a. anda production using the poultry technique falls more than with the desi
technique.
b. the production using both techniques falls by the same amount
c. anda production using the poultry technique falls less than with the desi
technique.
d. The poultry anda producers supply curve shifts inward.
e. The desi anda producers supply curve shifts inward.
With the help of a neat, labelled diagram explain your answer.
A supply demand diagram for andas should be drawn with dozens per year on the quantity
axis and Rs per dozen on the vertical axis. An equilibrium intersection should be shown
with a single demand curve and two supply curves. The more inelastic supply curve
should be labelled Spoultry and the more elastic supply curve should be labelled Sdesi. A
second demand curve to the left of the initial demand curve should be drawn and the
new equilibrium quantities identified. The diagram will match choice c. above.
 7

19. From 1970 to 1993, the real price of a college education increased, and total enrollment
increased. Which of the following could have caused this increase in price and enrollment?
a. A shift to the right in the supply curve for college education and a shift to
the left in the demand curve for college education.
b. A shift to the left in the supply curve for college education and a shift to
the right in the demand curve for college education.
c. A shift to the left in the supply curve for college education and a shift to the
left in the demand curve for college education.
d. None of the above.
With the help of a neat, labelled diagram explain your answer.
The diagram should be the market for college education with quantities in annual student
enrollments per year and prices in annual fees per student in Rs. An initial equilibrium
should be shown and a second equilibrium should be shown with a leftward shift in
supply and a rightward shift in demand. The new supply and demand should be drawn
carefully to be sufficiently inelastic so that the price and quantity do increase as
required.
20. Assume that the current market price is below the market clearing level. We would expect
a. a surplus to accumulate.
b. downward pressure on the current market price.
c. upward pressure on the current market price.
d. lower production during the next time period.
With the help of a neat, labelled diagram explain your answer.
The diagram could be for any good with axes, demand and supply curves and equilibrium
carefully labelled. A line should be drawn somewhere below the equilibrium and the
distance between demand and supply curve labelled “shortage” or “excess demand”.
The explanation is that in the supply demand model excess demand causes market
forces to put upward pressure on the price till equilibrium is restored.
21. When an industry's raw material costs increase, other things remaining the same,
a. the supply curve shifts to the left.
b. the supply curve shifts to the right.
c. output increases regardless of the market price and the supply curve shifts
upward.
d. output decreases and the market price also decreases.
With the help of a neat, labelled diagram explain your answer.
The diagram could be for any good with axes, demand and supply curves and equilibrium
carefully labelled. A new supply curve should be drawn to the left of the existing
supply curve and labelled “supply after raw material price increase”.
 8

22. An effective price ceiling causes a loss of

a. seller surplus for certain and possibly buyer surplus as well.
b. buyer surplus only.
c. seller surplus only.
d. buyer surplus for certain and possibly seller surplus as well.
e. neither seller nor buyer surplus.
With the help of a neat, labelled diagram explain your answer.
The diagram could be for any good with axes, demand and supply curves and equilibrium
carefully labelled – it can be found in the slides for chapter 5. A line should be drawn
somewhere below the equilibrium and the distance between demand and supply curve
labelled “price ceiling” The areas of lost sellers surplus and buyer surplus los and gain
should be identified labelling the different perimeters with “a”, “b”, “c”, etc. A legend
should be added:
“Seller’s surplus loss” and buyer’s surplus net gain/loss. In each case the relevant areas
should be identified.
23. Consider the effect of changes in fares on the quantity demanded of taxi services. Do you
expect the demand to be more elastic to fare changes in the short run or in the long run?
With the help of a neat, labelled diagram explain your answer.
In the long run since taxi hirers have more time to adjust their travel choices to substitutes in
the long run (they may also be able to change their locations and reduce/increase their
need for taxi rides).
The diagram should be of the market for taxi services in city X with Q measured in rides per
year and P in Rs per ride. Assume that all taxi rides are of the same length for simplicity.
There should be two demand curves for taxi services passing through the equilibrium
point with the more elastic demand labelled as long run demand.
24. If a price ceiling at a price higher than the initial equilibrium price is imposed, then
a. The market price will decrease and the quantity traded will decrease.
b. The market price will increase and the quantity traded will decrease.
c. The market price will decrease and the quantity traded will increase.
d. The market price will increase and the quantity traded will increase.
e. None of the above.
With the help of a neat, labelled diagram explain your answer.
To have an impact a ceiling should be below the equilibrium price. The diagram could be for
any good with axes, demand and supply curve and equilibrium carefully labelled. A
horizontal line for the price ceiling above the equilibrium price should be added to the
diagram.
 9

25. The market demand and supply functions for Maxwell cricket bats are: QD = 12 – 0.04P and

QS = 0.01P +2, where P is in dollars and Q is in thousands.

(a) Calculate the equilibrium quantity and price and point elasticity of demand in equilibrium.
(b) Suppose the Maxwell bats are taxed $25 per bat. Calculate the revenues generated by the
tax.
(c) What percentage of the tax is paid for by buyers?
(a) Equate the supply and demand equations to get 12 – 0.04P = 0.01P + 2. Solving gives P =
$200. Substituting into either demand or supply equations gives Q = 4 or 4,000 bats.
Price elasticity of demand at equilibrium is given by (ΔQ/ΔP)x(P/Q) = -0.04x(200/4) = -2.
(b) Tax revenue = 25 x 4000 = $1,00,000.
(c) To answer this the post-tax equilibrium price is needed. The post tax supply equation is
now QS = 0.01(P-25) + 2. Equating this with demand and solving for P, gives P = 205. So
post tax buyers pay $205 per bat while sellers receive $205-25 =180 per bat. Thus buyers
pay (205-200)/200 or 20% of the tax.
26. The elected officials in a west coast university town are concerned about the "exploitative"
rents being charged to college students. The town council is contemplating the imposition
of a $350 per month rent ceiling on apartments in the city. An economist at the university
estimates the demand and supply curves as:
QD = 5600 - 8P QS = 500 + 4P,
where P = monthly rent, and Q = number of apartments available for rent. For purposes of
this analysis, apartments can be treated as identical.
a. Calculate the equilibrium price and quantity that would prevail without the
price ceiling. Calculate seller and buyer surplus at this equilibrium.
b. What quantity will eventually be available if the rent ceiling is imposed?
In a neat, labelled diagram illustrate the initial equilibrium, buyer and seller surplus
and also the price and quantity in the market after the rent ceiling is imposed.
a. Equating demand and supply and solving gives P = $425, So Q = 2200 apartments per
month. Buyer surplus is the area below the demand curve up to the equilibrium price. The
demand is zero at a price of 700. So buyer surplus is (700-425)x(2200)x0.5 = $3,02,500. Seller
surplus is the area above the supply curve up to the equilibrium price provided P exceeds
zero. Since P = 0 at Q = 500, seller surplus is the sum of the area below the equilibrium price
up to Q = 500 and the area of the triangle from Q = 500 to Q =2200 up to the price line. Or
seller surplus = (500x425) + (2200-500)x425x0.5 = $5,73,750.
b. Quantity will be the lesser of demand and supply (in this case supply) at the price $350. Or
Q = 1900 apartments per month.
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27. If an ad valorem tax is imposed on sellers and market supply is perfectly elastic. then (Note:
Market price: what buyers pay to sellers)
a. The market price will decrease and the quantity traded will decrease.
b. The market price will increase and the quantity traded will decrease.
c. The market price will decrease and the quantity traded will increase.
d. The market price will increase and the quantity traded will increase.
e. None of the above.
Explain your answer with the help of a neat, labelled diagram.
The supply curve after the ad valorem tax at rate 100t% is imposed is P(1+t) where P is the
pretax supply curve. The diagram can be a market diagram for any good showing a normal,
negatively sloped demand curve and the pre and post tax perfectly elastic supply curves at P
and P(1+t). The post-tax price will increase by the full amount of the tax while quantity
traded will depend on the elasticity of demand.
28. Electric power producers have a choice of several fuels including oil, natural gas, coal, and
uranium. Once an electric power plant has been built, however, the scope to switch fuels
may be very limited. Since power plants last for thirty years or more, producers must
consider the relative prices of the alternative fuels well into the future when choosing
generating plant.
a. Do you expect the cross-price elasticity between the demand for oil-fired power
plants and the price of oil to be positive or negative?
b. Will the cross-price elasticity between the demand for oil-fired power plants and
the price of coal be positive or negative?
c. Compare the short with the long-run own-price elasticity of the demand for oil-
fired power plants.
a. Since oil and oil-fired plants are complementary inputs in electrical power production the
cross price elasticity should be negative.
b. Coal is used in coal based electric power plants which are a substitute for oil-fired power
plants. So coal will also be a substitute for oil-fired plants and have a positive cross-
price elasticity.
c. The short run elasticity will be less than the long run elasticity since existing oil fired
power plants will not be able to immediately exit if the price of oil-fired plants (or its
complements) increases to be replaced by plants based on other fuels. Conversely if
oil-fired plants get cheaper, new plants will have to wait the scrapping dates of
existing plants based on other fuels.
29. Which of the following are possible sources of imperfectly competitive markets?
a. Declining average costs over the range of possible quantities demanded.
b. Legal barriers to entry.
c. Perceived product differentiation.
d. Tariff protection from foreign competition.
e. All of the above.
Explain your answer (if you chose “all the above” explain any one out of a. to d.).
The explanation should focus on how each of the above prevent or hinder competition from
potential rivals as discussed in the text.
 11

37. For a given increase in the price of a product, will the increase in seller surplus be smaller or
larger if the supply is more elastic? Larger
Explain your answer with the help of a neat, labelled diagram.
The diagram should show two supply curves passing through an initial price (say P 0) and the
quantities supplied at another, higher curve P1. (No demand curve should be drawn).
40. Between 2008 and 2009 freight rates for VLCCs collapsed from a record high of $88,400 to
$28,000 a day. The utilization rate of the overall tanker fleet fell from 91% to 84%. Between
2009and 2010 as the world economy recovered VLCC rate rose to $34,800 a day and
utilization of the overall tanker fleet rose to 86%
a. Using relevant demand and supply curves illustrate the shift in the short- run
equilibrium in tanker services between 2008 and 2009.
b. Using the same diagram illustrate the shift in the short- run equilibrium between
2009 and 2010. Explain, using your diagram, the change in fleet utilization from 84%
to 86%.
The diagram should be of the market for tanker services in the short run with quantity
measured in tanker days per year and price measured in $ per tanker-day. The quantity
axis should have a second row of labels with the axis labelled “% utilization of tanker
fleet”. There should be 3 demand curves. D2009 to the left of D2010 in turn to the left of D2008.
There should only be one supply curve. The 2010 equilibrium should be at (Q2010 and 86%
utilization, P = $33,800. The 2009 equilibrium should be at Q2009, 84% and P = $28,000. The
2008 equilibrium should be at Q2008, 91% and P = 88,400.
41. If a specific tax is imposed on sellers and the market supply curve is positively sloped, then
(Note: market price is what buyers pay to sellers)
a. The market price will decrease and the quantity traded will decrease.
b. The market price will increase and the quantity traded will decrease.
c. The market price will decrease and the quantity traded will increase.
d. The market price will increase and the quantity traded will increase.
e. None of the above.
Explain your answer with the help of a neat, labelled diagram.
Sellers will have to recover the tax in addition to their marginal cost so the supply curve will
shift upward by the amount of the tax. The diagram should be a standard market diagram
with 2 parallel supply curves: a post-tax supply curve to the left of a pre-tax supply curve.
 12

42. Tickets to popular sporting events like the FIFA World Cup often sell out. Fans must either
spend long hours waiting in line for a limited supply of tickets or pay a premium price to
scalpers or touts. Scalpers/touts buy tickets to resell.
a. When tickets sell out which condition(s) for economic efficiency might not be
satisfied?
b. Do scalpers improve economic efficiency?
c. If the ticket agencies auctioned the tickets rather than selling them for fixed prices
what would be the impact on scalpers?
a. Marginal benefits of all users will not be equal. Some potential buyers who are not
allotted tickets may have higher benefits than those who have tickets.
b. Scalpers and touts are taking the advantage of the opportunity for making profit resulting
from economic inefficiency. To the extent that they reallocate tickets from low benefit
holders to high benefit fans they improve the total benefits from the sporting event.
However they cannot bring about economic efficiency.
c. The auction would establish the market equilibrium price for the tickets. Consumers
would buy directly from ticket agencies through the auction. They would be no
economic inefficiency. Hence, there would be no business for scalpers.
43. Some online retailers include free shipping while others charge for shipping. In July 2006
bajangles.com offered a Sony 60 inch rear projection TV for $ 2,968.99 with free shipping
while MB superstore offered the same TV for $ 2,692.95 with shipping charges of $ 299.50
to Alaska.
a. Assuming that online retailing and shipping are competitive industries, explain with
the help of a neat, labelled diagram whether it matters for consumers if retailers offer
free shipping or charges for shipping.
b. If consumers view bajangles.com and MB superstore as equivalent (in terms of quality
of service) how should their prices for the same TV compare?
c. Are the actual prices consistent with your answer in (b)?
d. If consumers are biased in decision making by anchoring, how would that affect your
answer in (a)?
a. The diagram is figure 6.2 of the text and the accompanying explanation.
b. The price quoted by bajangles.com should be higher than that of MB by the shipping
charges of $299.50.
c. Prices differ by $276.04 which is 92% of $299.50 or reasonably close.
d. If consumers decisions are biased by anchoring it would benefit sellers to offer free
shipping and charge a price in excess of the retail price plus shipping.
 13

44. The internet has drastically reduced the cost of intermediary services of travel agencies, real-
estate brokers and investment advisors. Assume the market equilibrium price is Rs 15,000
per ticket including Rs 1000 cost of intermediation. The quantity bought is 2 million tickets
a year. With internet bookings however the intermediation cost falls to Rs 300 per ticket
a. Using a neat, labelled diagram, illustrate the original equilibrium for plane tickets
with booking through travel agencies.
b. Illustrate the new equilibrium with online booking in the same diagram and explain
your answer.
a. The diagram will have tickets in millions per year on the Q axis and Rs per ticket on the
price axis. The positively sloped supply and negatively sloped demand will intersect at (2,
15,000).
b. The impact of the internet is to shift the supply curve down by Rs 700 since
intermediation cost falls to Rs 300 from Rs 1000. This will lead to a decrease in the price of
tickets by an amount that depends on the elasticities of demand and supply (but less than Rs
700) and an increase in demand.
45. Mainland China visitors are among the most free spending shoppers at Hermes, Louis
Vuitton, Prada and other luxury stores in Hong Kong. The government of China levies
VAT at 17% on the retail sales of imported goods within China.
Suppose that Chinese tourists can avoid the VAT in China when bringing luxury items back
to China. How would this affect the demand among Chinese for luxury goods (a) in Hong
Kong and (b) within China.
Explain your answer with the help of a neat, labelled diagram.
The demand among Chinese for luxury goods would: (i) increase in Hong Kong, and (ii)
decrease in China. There should be 2 diagrams, one for mainland China and the other for
Hong Kong. The impact of the VAT should be shown as an increase in Hong Kong demand
and a decrease in mainland China supply. The upward shift in the mainland supply curve
should be by 17%. Both diagrams should have items per year on the horizontal axis. But
while the HK diagram should have HK$/item on the vertical axis, the mainland diagram
should have yuan per item on the vertical axis.
46. Travelers can reduce cost for airlines by booking tickets online rather than through travel
agents. How would you assess whether airlines or consumers benefit from the lower cost?
Explain your answer with the help of a neat, labelled diagram.
The diagram for this should be as in Q44(b). The incidence of the move to the internet on
buyers would be greater if supply is more elastic than demand. In proportionate terms the
incidence would be (Rs 15,000 minus the post internet ticket price)/Rs 700. The incidence of
the internet saving would be 1 minus the incidence on buyers.
47. Duty free shops offer tax free sales of liquor and tobacco products at Hong Kong
International Airport. If the demand is completely inelastic what would be the differences
in the pre-tax price of liquor and cigarettes between the airport and the city?
Explain your answer with the help of a neat, labelled diagram.
There would be no price difference at all. However post-tax prices would be higher in the
city by an amount depending on demand and supply elasticities given that the city
supply will shift up by the amount of the tax/duty in the city.
48. A perfectly competitive firm's marginal revenue curve is
a. exactly the same as the marginal cost curve.
b. downward-sloping, at twice the (negative) slope of the market demand curve.
c. vertical.
d. horizontal.
 14

e. upward-sloping.
Explain your answer with the help of a neat, labelled diagram.
A perfectly competitive firm is a price taker. This means it can sell all it wants to at the
going market price so the demand curve it faces is horizontal at that price. So the extra
revenue it gets from an additional unit it sells - its marginal revenue - equals the market
price. This implies that the marginal revenue curve coincides with the demand curve.
The diagram is the standard diagram of a competitive firm showing P = MR and
possibly the MC curve.
49. If the market price for a competitive firm's output doubles then
a. the profit maximizing output will double
b. the marginal revenue doubles
c. at the new profit maximizing output, price has increased more than marginal cost
d. at the new profit maximizing output, price has risen more than marginal revenue
e. the competitive firms will earn an economic profit in the long-run.
Explain your answer with the help of a neat, labelled diagram.
A perfectly competitive firm is a price taker. This means it can sell all it wants to at the going
market price so the demand curve it faces is horizontal at that price. So the extra revenue it
gets from an additional unit it sells - its marginal revenue - equals the market price. This
implies that the marginal revenue curve coincides with the demand curve. The diagram is
the standard diagram of a competitive firm showing the curves P = MR and P 2 = 2P = 2MR =
MR2 and possibly the MC curve.
50. The burden of a tax per unit of output will fall more heavily on buyers when demand is
relatively ______________ and supply is relatively ______________.
a. inelastic; elastic
b. inelastic; inelastic
c. elastic; elastic
d. elastic; inelastic.
Explain your answer with the help of a neat, labelled diagram.
(a) In a standard, properly labelled, demand-supply graph draw two demand and two supply
curves through the initial pre-tax equilibrium point. Call these curves D I, DE, SI, SE. Draw
two more supply curves that are shifted up by the same vertical distance as the amount of the
tax from SI, SE. Call these curves SI1, SE1. Identify the four possible equilibria at the
intersection of a. DI and SI1, b. DI and SE1, c. DE and SI1 and d. DE and SE1. The diagram will
show that the greatest price increase is at b.
 15

58. Which of the following will cause a shift to the left in the supply curve of diesel?
a. A decrease in the price of diesel.
b. An increase in the wage rate of refinery workers.
c. Decrease in the price of crude oil.
d. An improvement in oil refining technology.
e. All of the above.
Explain your answer with the help of a neat, labelled diagram (if your answer is e,
explain how choice d affects diesel supply).
Wages of diesel refinery workers are an input cost. Increase in costs shifts the supply curve
up and to the left. All the other choices are for either a movement along the curve or an
increase in supply. The diagram should have Q in litres per year and P is Rs per litre. There
should be a demand curve and 2 supply curves, an initial curve and a reduced supply after
the wage increase.
59. Other things being equal, the increase in the number of rented homes that occurs after rent
controls are abolished is smaller when
a. own price elasticity of demand for rental homes is price inelastic.
b. own price elasticity of demand for rental homes is price elastic.
c. own price elasticity of demand for rental homes has unitary price elasticity.
d. rented homes and owned homes are complements.
e. rented homes and owned homes are substitutes.
Explain your answer with the help of a neat, labelled diagram.
The diagram should be that of a competitive market with a price ceiling below the
equilibrium price. Q: Units per year. P: Rs per unit. At the quantity supplied/sold given the
price ceiling there should be two demand curves drawn through the demand price (the price
buyers would be willing to pay for the reduced quantity). The equilibria with the two
demand curves if the rent ceiling is removed should be indicated. They will show a smaller
impact of ceiling removal with inelastic demand.
60. Demand for pyjamas (Q) is estimated to be Q = 500 – 0.5P + 2I – 6K. If (per capita) income, I,
is 200 and the average price of kurtas, K, is 50, when the price of pyjamas, P, is 200, the (per
capita) income elasticity of demand is
a. –80%
b. 4.0
c. 0.25
d. 0.8
e. Perfectly elastic
(ii) Would your answer change if the price of Kurtas increased to 60? Explain why or why
not.
i. Substituting the values of I, K, and P into the equation shows that Q = 400. So income
elasticity is (∆Q/∆I)(I/Q) = 2x200/500 = 0.8.
ii. If the price of Kurtas increases to 60, Q will decrease to 440. So the income elasticity
becomes 400/440 = 0.91.
 16

61. Which of the following can cause a shift to the left in the demand curve for train journeys in
India?
a. An increase in bus fares.
b. An increase in the wage rate of railway workers.
c. An increase in the cost of car tyres.
d. An improvement in train catering services.
e. None of the above.
Explain your answer with the help of a neat, labelled diagram (if you choose “none of the
above” explain with respect to choice d).
An improvement in train catering services will cause the marginal benefit from train
journeys to increase. So demand will shift up and to the right.
62. Demand for denim jeans (Q) is estimated to be Q = 900 – 0.5P + 2I – 2S. If (per capita)
income, I, is 400 and the average price of shirts, S, is 200, when the price of denim jeans, P, is
200, the cross price elasticity of demand for jeans with respect to shirts is
a. 1/3
b. 33%
c. -1/3
d. -3
e. Perfectly inelastic
(ii) Would your answer change if per capita income increased to 500? Explain why or why
not.
i. Substituting the values of I, S, and P into the equation shows that Q = 1200. So the cross
price elasticity of demand for jeans with respect to shirts is (∆Q/∆S)(S/Q) = -2x200/1200 =- 0.33
or -1/3.
ii. If the income increases to 500, Q will increase to 1400. So the cross price elasticity becomes
-400/1440 = -0.29.
63. Other things being equal, the increase in the number of 2 star hotel rooms that occurs after
price ceilings on 1 and 2 star hotel rooms are removed is larger when
a. own price elasticity of demand for 2 star hotel rooms is price inelastic.
b. own price elasticity of demand for 2 star hotel rooms is price elastic.
c. own price elasticity of demand for 2 star hotel rooms has unitary price elasticity.
d. 2 star hotel rooms and 1 star hotel rooms serve entirely different market segments.
Explain your answer with the help of a neat, labelled diagram.
The diagram should be that of a competitive market with a price ceiling below the
equilibrium price. Q: Units per year. P: Rs per unit. At the quantity supplied/sold given the
price ceiling there should be two demand curves drawn through the demand price (the price
buyers would be willing to pay for the reduced quantity). The equilibria with the two
demand curves if the rent ceiling is removed should be indicated. They will show a larger
impact of ceiling removal with elastic demand.
 17

64. “Now, Russians take you for a taxi ride”: Russians in Goa’s beach belt have started running
taxis - only for foreigners. Taxi fares by local taxis are exorbitant (e.g. Rs 300 for 0.5 km)
according to Russians and other foreigners. Local taxis have demanded official action against
Russian taxis.
Using a competitive market model and diagram analyse the impact of Russian taxis on the
taxi market in the tourist belt, assuming there is no local taxi association.
There should be two diagrams one Indian supply and demand and one for foreigner tourists
and Russians only. Both diagrams should have Q: rides per season and P: Rs per ride. It may
be assumed that all rides are o.5 km for simplicity. Initially, without Russians the demand
for rides is by both Indians and foreigners and the equilibrium ride price is Rs 300. When
Russians enter, in the foreign tourist diagram Russians supply rides to foreigners at a price
PR below Rs 300. Also since foreigners are no longer being served by Indians, Indians see a
fall in demand leading to a new equilibrium price PI below Rs 300. Now two situations are
possible i. PR ≤ PI. In this case there are 2 separate markets in the new situation. ii. P R > PI. In
this unlikely situation some taxi services will be supplied by Indians to foreigners till prices
for both Indianas and foreigners are equalized at PE, with PR > PE > PI.
65.Suppose that, at the market clearing price of natural gas, the price elasticity of demand is -1.2
and the price elasticity of supply is 0.6. If, initially, the price was 10 percent below the
market clearing price, then at this initial price how large a shortage or surplus would there be
assuming the elasticities stay the same?
Explain your answer with the help of a neat, labelled diagram.
The equations are %∆QS = ES x %∆P and %∆QD = ED x %∆P. So compared to the equilibrium,
%∆QS = 0.6 x -10 = -6% and %∆QD = -1.2 x -10%. Supply would be 6% less than in
equilibrium and demand would be 12% more than in equilibrium if the price was 10%
below equilibrium. So the total shortage would be 18%.
The diagram would be a standard, carefully labelled, supply and demand diagram with the
addition of a price at 0.9P, where P is the equilibrium price. The quantities supplied and
demanded at this price would be 0.94Q and 1.12Q respectively where Q is the equilibrium
price.
66.There are two techniques of egg production: free range (where hens roam around the farm)
or factory (where hens are fed and watered in wire cages). The free range technique has a
much more elastic supply curve than the factory technique. When the demand for eggs falls
for which technique is the production decrease (if any) greater?
Explain your answer with the help of a neat, labelled diagram.
See question 18.
67. An important determinant of the amount of grains harvested next year by Ethiopian farmers
is the amount of seeds planted this year. Western nations have guaranteed to donate three
hundred tons of grain next year. What impact will this have on seed planting this year by the
Ethiopian farmers?
Explain your answer with the help of a neat, labelled diagram.
The increase in the availability of grain next year, other things, equal, will depress the price
of grain. So Ethiopian farmers will plant fewer seeds this year. The diagram will be of
next year’s grain market with tons of grain per year on the x axis and $ per ton on the
vertical axis. There should be one demand curve and three supply curves: The initial
supply curve in the absence of food aid, S0, The supply curve with unchanged Ethiopian
supply plus food aid, S1, to the right of S0. The supply with reduced Ethiopian supply and
food aid, S2, to the left of S1. The relative positions of S0 and S2 is indeterminate – this
should be mentioned.
 18

74. You are a shareholder in Nokai holding shares for which you had paid Rs 10,000. Nokai has
consistently paid dividends of 10% per year to you up to the current year (on December 31).
You expect it to also do so next December 31 and stop paying dividends thereafter. On
January 1 you receive an offer from the CEO of Nokai offering to buy your shares
immediately at a price of Rs 10, 091. You should:
a. Reject the CEO’s offer if the bank interest rate on a one year fixed deposit (FD) is 9%
per annum or less, assuming that the FD is the only other use of funds available to
you.
b. Accept the CEO’s offer since the value of your shares is only Rs 10,000.
c. Accept the CEO’s offer if the bank interest rate on a one year fixed deposit (FD) is 9%
per annum or less, assuming that the FD is the only other use of funds available to you.
d. Reject the CEO’s offer since Rs 91 is much less than the Rs 1,000 dividend you will
receive on December 31.
Explain why your choice is correct.
Rs 10,091 x1.09 = Rs. 10,999.19 which is the principal plus interest you would get if you
accepted the CEO’s offer and put the money in a one year FD. It is less than the Rs 11,000
you will get if you wait to receive your Nokai dividend at the end of the year and sell your
shares.
79. Demand and supply curves for student hostel rooms at Gao University are given by
QD = 6500 - 8P and QS = 500 + 4P respectively. The government levies a tax of Rs 90 per
room on Gao University hostel rooms. The impact of the tax is
a. To increase the equilibrium room price from Rs 500 to Rs 530.
b. To decrease the equilibrium room price from Rs 500 to Rs 410.
c. To increase the equilibrium room price from Rs 500 to Rs 590.
d. To decrease the equilibrium quantity of rooms – it will have no impact on the price of
hostel rooms.
Explain your answer with the help of a neat, labelled diagram.
See the answer to Q81 below. The answer is identical here except that 90 replaces 60.
80. Which of the two statements below is correct?
I. An increase in income tax rates decreases the opportunity cost of attending GIM for
persons who pay income tax.
II. An increase in the rate of unemployment among graduates (having bachelor’s degrees)
decreases, on average, the opportunity cost of attending GIM.
a. I is true, and II is false.
b. I is false, and II is true.
c. I and II are both true.
d. I and II are both false.
Explain why your choice is correct.
I: The opportunity cost of attending GIM is the persons after tax income.
II: The income sacrifice of unemployed graduates if they attend GIM is zero. So if a
greater percentage are unemployed the average opportunity cost will decrease.
 19

81. Demand and supply curves for student hostel rooms at BETS Pilan are given by
QD = 6500 - 8P and QS = 500 + 4P respectively. The government levies a tax of Rs 60 per
room on BETS Pilan. The impact of the tax is
a. To increase the equilibrium room price from Rs 500 to Rs 520.
b. To increase the equilibrium room price from Rs 500 to Rs 560.
c. To decrease the equilibrium room price from Rs 500 to Rs 440.
d. To decrease the equilibrium quantity of rooms – it will have no impact on their price.
Explain your answer with the help of a neat, labelled diagram.
The post tax supply curve (which decreases due to the tax) is given by Q S = 500 + 4(P-60) =
260+4P. Equating this with QD gives P = 520 (also Q will decrease to 2340 from 2500).
The diagram should plot Q in hostel rooms per month against P in Rs per room. As
mentioned with the tax the supply shifts left.
82. The market demand curve for Potato chips has been estimated to have the equation
Q = 1000 – 0.2P + 3Y – 10B + 10R
Where
Q is the quantity demanded of potato chips (in ‘000 cartons per week),
P = 250 is the price of potato chips (in rupees per carton),
Y = 500 is the per capita income of consumers (in rupees per week)
B = 50 is the price of beer (in rupees per bottle), and
R = 10 is the price of roast peanuts (in rupees per packet).
a. Calculate the demand elasticities for potato chips with respect to (i) own price, (ii)
income, (iii) the price of beer and (iv) the price of roast peanuts. In each case first put
down the formula you are using.
b. Is demand for potato chips price elastic or inelastic?
c. Is demand for potato chips normal or inferior?
d. Are potato chips and beer complements or substitutes? What of chips and peanuts?
a. All elasticities are given by slope with respect to the appropriate variable x (independent
variable/Q). From the equation Q = 1000 - 0.2(250) +3(500) -10(50) +10(10) = 2050.
So Own price elasticity = -0.024, income elasticity = 0.732, cross price elasticity with beer =
-0.244 and cross price elasticity with peanuts = 0.049.
b. Price inelastic.
c. Normal.
d. Beer: Complements. Peanuts: Substitutes.
83. The competitive market for wheat flour (atta) in India is initially in long run equilibrium.
Analyse the impact of the following event and the subsequent adjustment back to
equilibrium in the short and the long run. Use an appropriate two panel diagram (panel 1:
typical farm; panel 2: entire market) for your analysis:
Pests destroy a large percentage of the wheat crop in Punjab.
Explain your analysis.
84. The competitive market for wheat flour (atta) in India is initially in long run equilibrium.
Analyse the impact of the following event and the subsequent adjustment back to
equilibrium in the short and the long run. Use an appropriate two panel diagram (panel 1:
typical farm; panel 2: entire market) for your analysis:
Demand for ready-made, packaged frozen wheat flour chapatis increases sharply due to
urbanization and growing numbers of unmarried employees.
Explain your analysis.
 20

85. In 2002, Iraq's Kirkuk region exported 0.5-0.8 million barrels of crude oil per day (mpd) by
pipeline to the Turkish port of Ceyhan. Following the U.S.-led coalition attack against Iraq,
the pipeline was sabotaged. Western Europe refineries switched to buying oil from the Urals
in Russia, shipped by tanker from the Black Sea through the Bosporus and Dardanelles.
However, by early 2004, the surge in European demand and congestion in the Bosporus and
Dardanelles had lifted spot tanker rates to 39,000 Euros per day (Source: “Bosporus Tanker
Congestion Threatens Shortage of Oil”, Financial Times, Jan 12, 2004.)
a. Using a neat, carefully labelled demand and supply diagram, explain the short-run
effects of pipeline disruption on the tanker services market.
b. Using your diagram for (a), also illustrate the long-run effects of pipeline disruption.
c. In which market for transport of oil would prices be relatively more volatile: (i)
pipeline or (ii) tanker? Explain your answer.
a. The diagram should plot Q in billions of ton-miles per year against P in $ per ton-mile.
The disruption should cause demand to increase leading to P and Q both to increase from
(P0,Q0) to (P1,Q1).
b. The long run supply curve should pass through the initial equilibrium and be more elastic
than the short run supply. So the new long run equilibrium price and quantity (P 2,Q2)
should have P0 < P2 < P1 and Q2 > Q1.
c. Pipeline because there supply of pipeline services is less variable than tanker services. So
prices must do more of the adjusting to fluctuations in demand.
86. Own price and income elasticities of demand for petrol are - 0.36 and 0.52 respectively.
Supply elasticities with respect to price and labour wages are 0.54 and - 0.04 respectively. If
the price of petrol is $1 per gallon, and sales are 600 million gallons a year, what will be the
effect on the market price and quantity if (a) income rises by 6% and (b) wages rise by 15%?
Explain your answer with the help of a neat, labelled diagram.
%ΔQD = -0.36%ΔP + 0.52(6). %ΔQS = 0.54%ΔP – 0.04(15).
Equating %ΔQD to %ΔQS and solving for %ΔP gives %ΔP = 4.13 (correct to 2 decimal
places). So %ΔQ = 1.63 (correct to 2 decimal places).
The increase in the price of petrol is by $0.041 (correct to 2 decimal places) or from $1 per
gallon to $1.041 per gallon.
Similarly the increase in sales is from 600 million gallons to 609.78 million gallons a year
(correct to 2 decimal places).
The diagram should plot Q in millions of gallons per year against P in $ per gallon. The
initial equilibrium (supply demand intersection is at (600,1). There after there is a
demand increase (demand shifts right) and a supply decrease (shifts left). The new
equilibrium where the new supply and demand intersect is at (609.78,1.04).
 21

87. (Png – adapted) A bank's sources of funds include savings, time, and checking (current
account) deposits. In June 2011, Hang Seng Bank, a leading Hong Kong bank, quoted
interest rates of 0.01% on savings accounts, 0.15% on a 12-month time deposit, and nothing
on checking accounts.
a. Suppose that the bank incurs an additional 0.2% cost to administer checking accounts, and
0.1% cost for savings accounts and time deposits. List the three sources of funds in
ascending order of annual cost per dollar of funds.
b. Suppose that the bank has $2 billion of savings deposits, $1 billion of time deposits, and $2
billion of checking deposits. Prepare a table with columns for (i) amount of funds in
billions of dollars (from 0 to 5 billion), (ii) average variable cost of funds in millions of
dollars, and (iii) marginal cost of funds in millions of dollars.
(a) Savings accounts: $0.0011, Checking accounts: $0.002, Time deposits: %$0.0025.
(b) There are no fixed costs. The entire costs are variable. AVC is total cost divided by total deposits.
Amount of funds Marginal cost Average variable cost
(in $billion per year) (in $million per year) (in $ million per year)
0 -- --
1 1.1 1.1
2 1.1 1.1
3 2 1.4
4 2 1.55
5 2.5 1.74
88. (Png – adapted) Most Hong Kong residents live across the harbour in Kowloon and the New
Territories, where housing prices are lower than on Hong Kong Island and commute to
work.
Until April 30, 2005, the toll for private cars and taxis with passengers was HK$15 at the
Eastern Tunnel. With effect from May 1, the Eastern Tunnel raised the toll by HK$10 to
HK$25.
In 2003, the Eastern Tunnel carried approximately 26 million for the whole year. On May 9,
traffic resumed after Mainland China’s week-long May Day holiday. During the morning
peak hours, traffic through the Eastern tunnel fell by 17% relative to traffic before the toll
increase.
a. What was the Eastern tunnel’s annual revenue before the fare change?
b. What must be the price elasticity of demand for the Eastern Tunnel’s fare increase not
to change its annual revenue? Explain your answer.
(a) In 2003 Eastern Tunnel’s annual revenue was HK$15 x 26 million = HK$ 390 million.
(b) The price increase from May 1, 2005 was HK$[10/(15+25)/2] or 50% using the arc formula.
The increase in revenue is given by the formula %ΔR = (1+ED)%ΔP. So for there to be no
change in revenue, ED must equal -1. In fact since traffic fell by only 17% rather than 50%,
- that is 18.6% by the arc formula, ED = 0.37 (correct to 2 decimal places).
 22

89. The market for all leather men’s shoes is served by both domestic (U.S.) and foreign (F)
producers. The domestic producers have been complaining that foreign producers are
dumping shoes onto the U.S. market. As a result, the U.S. Congress is very close to enacting
a policy that would completely prohibit sales by foreign manufacturers of leather shoes in
the U.S. market. The demand curve and relevant supply curves for the leather shoe market
are as follows:
QD = 50,000 - 500P
QUS = 6000 + 150P
QF = 2000 + 50P,
where Q = thousands of pairs of shoes per year, and P = price per pair.
a. Currently there are no restrictions covering all leather men's shoes. What are the
current equilibrium values?
b. Calculate the price and quantity that would prevail if the proposed policy is enacted.
With the help of a neat, labelled diagram explain the impact the proposed policy would
have on U.S. buyer and U.S. seller surplus and deadweight loss.
(a) Current supply is QUS+QF = 8000+200P. Equating this with QD gives P = 60. At P = 60, Q
= 20,000. Of this US sellers supply 15,000.
(b) After the ban, supply = QUS. So P rises to 67.69 and Q becomes 16,154. US sales and
seller’s surplus rises because of increase in both price and quantity, but buyer surplus
decreases. The deadweight loss is the triangle bounded by the prices 67.69 and 60 and
quantities 20,000 and 16,154 between the demand curve and the combined supply curve
QUS+QF.
The diagram is for the US leather men’s shoe market (in pairs per year) and the price is in
$ per pair.
90. Your hotel rooms have minibars. Explain how you would price Coca Cola tins and Carlsberg
beer tins to maximize profits.
To maximize profit, the prices should be set according to the rule [p-MC]/p -1/e for each
product. Since elasticities are likely to be similar, the price difference should largely
reflect the difference in MC.

93. Foie gras and butter are exported by France to the United States. Foie gras has no substitutes
but French butter has many perfect substitutes. Analyse the impact of an increase in the US
dollar price of the Euro on the US markets for these products with the help of neat,
carefully labelled diagrams.
One diagram each for the US market for foie gras and butter. Demand for French butter is
perfectly elastic (has many perfect substitutes) and French foie gras demand is
negatively sloped. French supply in both markets is positively sloped. The increase in
the dollar price of the Euro causes French supply to decrease.
94. (Png - adapted) Ford offers a 1 year warranty on its Explorer car. The Auto Club offers an
extended warranty for year 2 for $750. However you must purchase the warranty at the
time you buy the car. You estimate the cost of repairs in year 2 at $800. If your discount rate
is 6% per year, should you purchase the extended warranty? (Note: In your answer present
both your equation and your final result).
You should purchase the extended warranty if the NPV of the cost of repairs [R/(1+i) where i
is the annual discount rate] exceeds the cost of the warranty. Since R = $800, the NPV is
$754.71. The warranty should be purchased. [Note: if the student uses R/(1+i) 2 but the
answer is otherwise correct, give 12 marks].
 23

96. (Png - adapted) Referring to the definition of a market, answer the following questions:
(a) Opponents periodically sabotage the pipelines through which Iraq exports oil to the
rest of the world. Is Iraq part of the world market for oil?
(b)Prisoners cannot freely work outside the jail. How would changes in prisoners' wages
affect the national labor market?
(c) The Australian national electricity transmission grid links its eastern states but not
Western Australia. How would price changes in Western Australia affect the other
states?
“A market consists of buyers and sellers that communicate with each other for voluntary
exchange.”
(a) Yes, partially – to the extent that Iraqi oil reaches buyers.
(b) No impact.
(c) No impact.
97. (Png - adapted) General Motors (GM) produces the gas guzzling Cadillac Escalade SUV and
the fuel efficient Chevrolet Aveo compact. High petrol prices have led to a lower demand
for SUVs and higher demand for compacts. To counter the falling demand, GM reduces its
interest rate on vehicle financing for SUVs to 1.9% per year compared to 3.9% per year for
loans for compacts.
(a) Illustrate the impact of higher petrol prices on the demand for compacts in a neat,
labelled diagram. In the same diagram illustrate the additional impact of the reduced
interest on SUV financing.
(b) Can you predict the combined impact of both these events on the sales of compacts?
If so what is the impact? If not, what is the minimum additional information you
would need?
(a) Higher petrol prices increases demand for SUVs. Lower SUV financing cost reduces
demand for compacts. Net impact is uncertain.
(b) Net impact cannot be predicted. (i) For the petrol price increase the own price elasticity
and the cross price elasticity of compact cars with respect to petrol and (ii) for both events
the cross price elasticity of compacts with respect to SUVs.
98. (Png – adapted) Consider an increase in buyer’s incomes that causes demand for cars to
increase by the same quantity at every price. Supply of cars is positively sloped. Explain
with the help of a neat, labelled diagram why the impact of this on car production
depends on the price elasticity of demand.
Following the demand shift, the quantity adjustment along the new demand curve will be
smaller when demand is inelastic. So car production will increase by more when
demand is inelastic.
99. (Png – adapted) Assume that in the market for shirts there is a negatively sloped demand
and positively sloped supply curve. Under what conditions would an upward shift in
demand have a larger impact on price?
(a) Inelastic demand and inelastic supply.
(b) Inelastic demand and elastic supply.
(c) Elastic demand and inelastic supply.
(d) Elastic demand and elastic supply.
Explain your answer with the help of a neat, labelled diagram.