DEMAND AND SUPPLY QUESTIONS
Q1. The
City of Accra, is considering two proposals to privatize municipal garbage
collection. First, a leading waste disposal firm has offered to purchase the
city's plant and equipment at an attractive price in return for an exclusive
franchise on residential service. A second proposal would allow several
individual workers and small companies to enter the business without any
exclusive franchise agreement or competitive restrictions. Under this plan,
individual companies would bid for the right to provide service in a given
residential area. The city would then allocate business to the lowest bidder. The
city has conducted a survey of Accra residents to estimate the amount that they
would be willing to pay for various frequencies of service. The city has also
estimated the total cost of service per resident. Service costs are expected to
be the same whether or not an exclusive franchise is granted.
A.
Complete the following
table
Trash Pickups
per Month
|
Price per
Pickup
|
Total Revenue
|
Marginal Revenue
|
Total Cost
|
Marginal cost
|
0
|
$5.00
|
0.00
|
|||
1
|
4.80
|
3.75
|
|||
2
|
4.60
|
7.45
|
|||
3
|
4.40
|
11.10
|
|||
4
|
4.20
|
14.70
|
|||
5
|
4.00
|
18.00
|
|||
6
|
3.80
|
20.90
|
|||
7
|
3.60
|
23.80
|
|||
8
|
3.40
|
27.20
|
|||
9
|
3.20
|
30.70
|
|||
10
|
3.00
|
35.00
|
B. Determine price and the level of service
if competitive bidding results in a perfectly competitive price/output
combination.
C.
Determine price and the level of
service if the city grants a monopoly franchise.
D.
Describe the nature of the marginal
cost and explain why it behaviors like that.
Solution
Trash Pickups
|
Price per
|
Total Revenue
|
Marginal Revenue
|
Total Cost
|
Marginal cost
|
TOTAL PROFIT
|
per Month
|
Pickup
|
|||||
0
|
$5.00
|
0
|
-
|
0
|
-
|
0
|
1
|
4.8
|
4.8
|
4.8
|
3.75
|
3.75
|
1.05
|
2
|
4.6
|
9.2
|
4.4
|
7.45
|
3.7
|
1.75
|
3
|
4.4
|
13.2
|
4
|
11.1
|
3.65
|
2.1
|
4
|
4.2
|
16.8
|
3.6
|
14.7
|
3.6
|
2.1
|
5
|
4
|
20
|
3.2
|
18
|
3.3
|
2
|
6
|
3.8
|
22.8
|
2.8
|
20.9
|
2.9
|
1.9
|
7
|
3.6
|
25.2
|
2.4
|
23.8
|
2.9
|
1.4
|
8
|
3.4
|
27.2
|
2
|
27.2
|
3.4
|
0
|
9
|
3.2
|
28.8
|
1.6
|
30.7
|
3.5
|
-1.9
|
10
|
3
|
30
|
1.2
|
35
|
4.3
|
-5
|
B. In a perfectly competitive industry, P = MR, so the
optimal activity level occurs
where P = MC. Here, P = MC
= $3.40 at Q = 8 pickups per month.
C. The marginal cost initially falls until the 6th
pickups per month then after the 7th pickups per month it begins to
rise. The marginal cost is U- shape becomes of its inverse relationship with
marginal product. Hence, when there is increasing return to marginal factor, MC
will be falling, when MP is at maximum, MC is at minimum and as the law of
diminishing marginal returns set in the MC begins to rise.
D. Refer to the table.
2. Perfectly Competitive Firm Supply. Mankato
Paper, Inc., produces uncoated paper
used in a wide variety
of industrial applications. Newsprint, a major product, is sold
in a perfectly
competitive market. The following relation exists between the firm's
newsprint
output and total production costs:
Total Output
(tons) Total Cost
(per ton)
0
$25
1
75
2
135
3
205
4
285
5
375
6 475
7 600
A. Construct a table showing Mankato's marginal cost of
newsprint production.
B. What is the minimum price necessary for Mankato to
supply one ton of newsprint?
C. How much newsprint would Mankato supply at industry
prices of $75 and $100
per
ton?
Solution
A.
Total Total Marginal
0 $25 --
1 75 $50
2 135 60
3 205 70
4 285 80
5 375 90
6 475 100
7 600 125
B. The minimum marginal cost of newsprint is $50, so this
also represents the minimum price necessary to justify supplying a single unit
of output.
C. In a perfectly competitive market, P = MR. Therefore,
Mankato will supply output so long as price at least covers the marginal cost
of production. At a price of $75, Q = 3 units of output can be justified
because P = $75 > MCQ=3 = $70. However, production of a fourth unit is not
warranted because P = 75 < MCQ=4 = $80. Similarly, Q = 6 could be justified
at a price of $100 because P = $100 = MCQ=6.
D.
No. because MC > MR
Q3. Why are the
perfectly competitive firm and the perfectly competitive industry supply
curves
upward sloping?
Solution:
An individual firm will
supply output so long as it is profitable to do so. Profits are maximized by
setting MR = MC. Because P = MR in a perfectly competitive industry, perfectly
competitive firms will maximize profits by setting P = MR = MC. This means that
the individual firm supply curve in a perfectly competitive industry is given
by the marginal cost curve, so long as marginal cost exceeds average variable
cost, P = MC > AVC.
Given the U-shaped average
cost curve that is typical of firms in perfectly competitive industries, the MC
and firm supply curve will tend to be upward sloping over the range where MC
> AVC. This means that individual firms will increase output as prices rise,
and decrease output as prices fall. From an industry standpoint, total supply
is simply the sum of individual firm supply. Thus, industry output will also
increase as prices rise, and decrease as prices fall.
Q4. Why is the firm
demand curve horizontal in perfectly competitive markets? Does this
mean that the perfectly
competitive industry demand curve is also horizontal?
Explain why in a perfectly competitive market, a
typical firm’s demand curve is horizontal. Moving from the competitive firm to
the industry does this mean that the
perfectly competitive industry demand curve is also horizontal?
ANSWER
Firms are price takers in
perfectly competitive markets. This means that the activity level of each firm
is so small relative to that of the overall industry total that no influence on
industry prices is noted following a change in the firm's production decisions.
All of the firm's output can be sold at the industry's prevailing price. Price
discounts are unnecessary to sell even dramatically higher firm output. Moreover,
the presence of perfect substitutes means that buyers would immediately switch
to alternate suppliers following a price increase. Thus, prices above the
industry norm are not feasible. This gives rise to a horizontal firm demand
curve. Despite the fact that the firm demand curve is horizontal, the perfectly
competitive industry demand curve is downward sloping. Although there are
perfect substitutes for the output of any individual firm (e.g., corn), there
is no perfect substitute for the entire output of a perfectly competitive
industry. This gives rise to a downward sloping industry demand curve. Holding
all else equal, an increase in output for all producers would portend lower
industry prices. Similarly, a fall in industry output would lead to higher industry
prices. In summary, an increase or decrease in output for an individual firm
will have no impact on prices in a perfectly competitive industry. However, a
change in industry output will affect prices. As a result, firm demand curves
are horizontal in perfectly competitive industries; but the industry demand
curve is downward sloping.
Q5)
In Country Faraway, cigarettes are
forbidden, so people trade cigarettes in a black market. The cigarette demand is QD = 12 − P , and the
cigarette supply is Qs = 2P .
(a) Find the equilibrium price and quantity in
the black market.
P=4,
Q=8.
(b)
The government becomes aware of the black market and reinforces the police so that half
of the cigarette supply would be seized and destroyed. Under this circumstance,
what are the demand and supply functions? What is the new equilibrium price and
quantity? Show the change by using a supply and demand diagram.
QD
= 12 − P, QS = P, P=6, Q=6.
(c) How does the consumer surplus change between
(a) and (b)? In (a), the consumer surplus
is 32, and in (b), the consumer surplus is 18. The consumer surplus decreases
by 14.
(d) Suppose that the government changes the
policy and legalizes cigarette dealings. Now cigarettes are traded in an open
market. However, for every unit of the cigarettes bought, the buyer has to pay tax T to the
government. T is equal to the pre-tax price P. What are the demand and supply
functions under this circumstance? What are the equilibrium (pre-tax) price and
quantity? What is the after-tax price paid by buyers?
QD
= 12 − (P + T ) = 12 − 2P,QS = 2P , P=3, Q=6. The after-tax price is 6.
(e)
Compare (b) and (d). Which policy
do consumers prefer? Which policy does the government
prefer? Why?
The
quantities and the (after-tax) prices paid by buyers are the same in both
cases. Therefore, consumers
feel indifferent. For the government, the policy in (b) requires extra expenditure on police and the policy in
(d) brings tax revenue. Therefore, the government prefers (d).
6) Suppose that instead of a supply-demand diagram, you are given the
following information:
Qs = 100 + 3P
Qd = 400 – 2P
From
this information compute equilibrium price and quantity. Now suppose that a tax
is placed on buyers so that
Qd = 400 – (2P + T).
If T =
15, solve for the new equilibrium price and quantity. (Note: P is the price received by sellers and P + T
is the price paid by buyers.) Compare these answers for equilibrium price and
quantity with your first answers. What does this show you?
ANSWER: Prior to the tax, the equilibrium price would be $60 and the
equilibrium quantity would be 280.
Note: 100+3P = 400-2P
5P = 300
P=300/5 = 60
After the tax is imposed, P, the price received by sellers would
be $57. The price paid by buyers would be $72 (57+15). The quantity sold would
be 271. The new answer shows three obvious facts. First, buyers pay more with a
tax and second, sellers receive less with a tax. The third thing is that the
size of the market shrinks when a tax is imposed on a product.
0 comments :
Post a Comment