Microeconomics Answers

Consider the market for cigarettes and assume that it is perfectly competitive. The demand curve in this market is perfectly inelastic ( choose a supply curve of your choice). The government imposes a tax of Rs 10 per quantity on the product. By how much will the price paid by consumers change? Will the quantity traded in the market change? What objective does this tax serve; does it increase or decrease social welfare in the market? Can a similar argument be made for petroleum products?

1. Make up an example of a monthly demand schedule for pizza and graph the implied demand

curve. • Give an example of something that would shift this demand curve, and briefly

explain your reasoning. • Would a change in the price of pizza shift this demand curve?

This week, Super-Save Supermarket lowered the price of apples from $1 to 90 cents per pound. The quantity of apples sold last week was 200 pounds. This week, the quantity sold was 250 pounds. Calculate the price elasticity of demand. Is it elastic, inelastic, or unitary elastic? What happens to total revenue? 

Suppose the demand function is given by Q=13-.5p. Illustrate the curve (draw the curve with correct axes, indicate the intercepts, indicate the slope)

If more time available to the consumer for purchasing the commodity than demand for the commodity is elastic.Why?

1. If the market demand curve is D(p) = 100 − .5p, what is the inverse

demand curve?

2. An addict’s demand function for a drug may be very inelastic, but the

market demand function might be quite elastic. How can this be?

3. If D(p) = 12 − 2p, what price will maximize revenue?

4. Suppose that the demand curve for a good is given by D(p) = 100/p.

What price will maximize revenue?

5. True or false? In a two good model if one good is an inferior good the

other good must be a luxury good

Case Study – Are Diamonds Forever?

How much would you spend on a diamond engagement ring? If you answered around the national average of $4,000 then you too have fallen victim to one of the most incredible marketing campaigns of all time. A diamond is intrinsically worthless, and against popular belief, they really aren’t that rare. Their resale value is next to nothing.

So why are we willing to spend so much on a ring? Well, we can trace that back to the 19th century. Before 1866, diamonds had been rare, but when massive discoveries were found in South Africa, the rock was on the verge of losing its value. Thats when Cecil Rhodes stepped in and founded De Beers Corporation – consolidating the mines and restricting supply, maintaining the fiction that diamonds were scarce and had inherent value.

The real change was in 1938, when the company hired N.W. Ayer to increase sales. By tying their product to love, and specifically to a marriage proposal, by the end of the century, over 80% of all brides had received a diamond wedding ring.

The ad campaign a ‘Diamond is forever’ displayed a diamond as a symbol of love, and suggested that a man should spend up to two month salary on the symbol.

Until 1990, DeBeers had a iron-tight grip on the market, at one point accounting for 90% of all sales, but now this grip is loosening. Using our models for monopoly and monopolistic competition, let’s examine the effects of this changing market.

Below is a representation of the demand curve for diamonds. Assume DeBeers is operating as a monopoly.

1. As a monopolist, what is the total effect of a price change from $2,400 to $1,600 on revenue? Break this change into an increase and a decrease.

If you were to do exercise 1 in for every marginal change in price, you would find the marginal revenue curve. The marginal revenue diagram has been provided for the next exercises, along with the marginal costs for DeBeers.

2. As a monopolist, what quantity does DeBeers produce? What price do they charge?

An ATC curve has been provided for DeBeers. These costs include marketing, mining exploration, and more.

3. What are DeBeers profits? Why are they able to sustain these in the long-run?

From the 1990’s to now, the market has changed considerably, with DeBeer having to adapt to new challenges. The first is the introduction of direct competitors. Russia’s state-owned diamond company ALROSA now produces more diamonds than DeBeers itself. Some new firms even bought mines from DeBeers when the company was trying to support their balance sheet.

Another change is the introduction of substitutes, with synthetic diamonds becoming more appealing to price-conscious young shoppers. Advances on the production of these products are fairly recent, notably, in 2015 New Diamond Technology displayed the potential of synthetics by creating a ten-carat polished diamond. 

This means the market is changing from monopoly to monopolistic competition. We know that entry of other firms will cause the monopolists demand curve to shift.

4. From the 1990s to now, the market is changing from monopoly to monopolistic competition. Explain reasons for this change.

5. Show the effect of the changes on our demand curve. If the new marginal revenue intersects marginal cost at (45, 1,900) draw the new demand curve and new marginal revenue curve.

7. As a monopolistic competitor, what quantity does DeBeers produce? What price do they charge?

8. What are DeBeers profits now?

9. Are these market changes good or bad for consumers? 

A certain firm produces and sells potato chips. Last year it sold 3 million bags of chips at a price of $3 per bag. For last year, the firm's a. accounting profit was $9 million. b. economic profit was $9 million. c. total revenue was $9 million. d. explicit costs was $9 million.

A market has a linear demand schedule with a slope of −0.3. When price is £3, quantity sold is 30 units. Where does this demand schedule hit the price and quantity axes? What is price if quantity sold is 25 units? How much would be sold

at a price of £9?

A perfectly  competitive firm has the following  total cost function.

Total Output     Total Cost

     0              20

     1              30

     2              42

     3              55

     4              69

     5              84

     6              100

     7              117

How much will the firm produce  if the price  of the production  the market  is Rs. 14 per unit? How will it change  its output  if price  if rises  to Rs. 16 per uni5?