Managerial Economics: Handout

Heman Lohano

Q1: In Pakistan, the domestic demand and supply functions for vegetable oil are given by:

Qd = 900 2 P

Qs = 4 P

where Qd is quantity demanded (in kilograms) per year, Qs is quantity supplied (in kilograms)
per year, P is the price in rupees per kilogram.

(a) Find the market equilibrium price and quantity.

(b) Compute the consumer surplus (in rupees) at the equilibrium price and quantity
computed in part (a).

(c) Compute the producer surplus (in rupees) at the equilibrium price and quantity computed
in part (a).

(d) How much is the total surplus at the equilibrium price and quantity?

Key:
(a) The given demand and supply functions for vegetable oil are:
Qd 900 2P (1)
Qs 4P (2)
Market clearing condition of the equilibrium is:
Qd Qs (3)
Substituting equations (1) and (2) into equation (3) yields:
900 2P 4P
P 150 (4)
Now we substitute equation (4) for P in equation (1), and let Q be the equilibrium quantity in
equation (3), Qd Qs Q . This yields the following:
Q 900 2 *150
Q 600 (5)
Therefore, the equilibrium price and quantity of vegetable oil are:

P* = Rs.150 per kg
Q* = 600 units per year

(450 150)600
(b) CS = Rs.90,000
2

(150)600
(c) PS = Rs.45,000
2

(d) TS = 90,000 + 45,000 = Rs.135,000

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Q2:
In Pakistan, the domestic demand and supply functions for vegetable oil are given by:

Qd = 900 2 P

Qs = 4 P

where Qd is quantity demanded (in kilograms) per year, Qs is quantity supplied (in kilograms)
per year, P is the price in rupees per kilogram.

(a) Assume an open market with international trade. The vegetable oil is traded in a
competitive world market, and the world price is Rs. 100 per kilogram. Unlimited
quantities are available for import into Pakistan at this price. Under free trade, what will
be (i) the price of vegetable oil in Pakistan, (ii) total quantity demanded, (iii) quantity
supplied domestically, and (iv) quantity of vegetable oil imports?

(b) With free international trade, compute: (i) consumer surplus, (ii) producer surplus, and
(iii) total surplus (in rupees).

Solution:
(a)
Domestic price: P* = Rs.100

Quantity demanded: QD 900 2 *100 = 700 units

Quantity supplied: QS 4 *100 = 400 units

Import: Import = QD QS = 700 400 = 300 units

(b)

(450 100)700
CS = Rs.122,500
2

(100 0)400
PS = Rs.20,000
2

TS = 122,500 + 20,000 = Rs.142,500

Q3: Compare the results of Q2 with those of Q1 on: price, CS, PS and TS.

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Q4:
In Pakistan, the domestic demand and supply functions for cars are given by:

where is the quantity demanded (in thousand cars), is quantity supplied (in thousand
cars), and P is the price (in lacs of rupees per car).

(a) Compute the equilibrium price and quantity.

(b) Now assume an open market with international trade. The cars are traded in a
competitive world market, and the world price is 9 (in lacs of rupees per car). Unlimited
quantities are available for import into Pakistan at this price. Under free trade, what will
be the:

(i) price of car in Pakistan,

(ii) total quantity demanded,
(iii) quantity supplied domestically, and
(iv) quantity of imported cars?

Key:
(a) The given demand and supply functions for cars are:

(1)

(2)

Market clearing condition of the equilibrium is:

(3)
Substituting equations (1) and (2) into equation (3) yields:

(4)

Now we substitute equation (4) for P in equation (1), and let Q be the equilibrium quantity in
equation (3), . This yields the following:

(5)

Therefore, the equilibrium price and quantity of vegetable oil are:

P* = Rs.10 lacs per car

Q* = 200 thousand cars

(b)

(i) price of car in Pakistan: Rs.9 lacs per car

(ii) total quantity demanded: 230 thousand cars
(iii) quantity supplied domestically: 170 thousand cars
(iv) quantity of imported cars: 60 thousand cars

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Q5:
Suppose a market for petrol is described by the following demand and supply functions:

Qd 80 P

Qs 40 P

where Qd is the quantity demanded in thousand liters, Qs is quantity supplied in thousand

liters, and P is the price in rupees per liter.

(a) What is the equilibrium price and quantity? (Note: Q is in thousand liters)

(b) Now suppose that the government imposes a tax of Rs.10 per liter to raise the
government revenue. What will be the new equilibrium price for buyers and sellers, and
the new equilibrium quantity?

(c) How much will be the burden of the tax on buyers and sellers each?

(d) How much will be the government revenue (in rupees)?

Key:

(a) Q* = 20 thousand liters, P* = Rs.60 per liter

(b) Q* = 15 thousand liters, Pb* = Rs.65 per liter, Ps* = Rs.55 per liter

(c) Tax burden on buyers: Rs.5 per liter (50 percent)

Tax burden on sellers: Rs.5 per liter (50 percent)

(d) GR = 10*15 thousand = Rs.150 thousand

Q6:
Suppose the government imposes a tax on a good. If demand is relatively inelastic and supply
is relatively elastic, the burden of the tax will fall mostly on whom: Producers or Consumers?
Show graphically or explain briefly.

Key:

If demand is relatively inelastic and supply is relatively elastic, the burden of the tax will fall
mostly on consumers.

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Q7:
The demand function for a good is:

where is quantity demanded, P is the price of the good, and M is consumers income.

(a) Suppose M = 100. Write the demand function for M = 100.

(b) Compute the price elasticity of demand at P = 50.

(c) Interpret the elasticity computed in part (b).

Key:

(a)

(b) Ep = 2*50/200 = 0.5

(c) If price increases by 1 percent, the quantity demanded decreases by 0.5 percent.

Q8:
The price elasticity of demand for cars in Pakistan is estimated to be 2, and the income
elasticity of demand is 3. The quantity demanded for cars is 200 thousand cars per year given
the current price and national income. If the price of cars increases by 5 percent and the
national income in Pakistan also increases by 5 percent, how many cars will be demanded?
Show your work.

Key:
Price effect: 20 thousand cars
Income effect: + 30 thousand cars

Quantity demanded = 200 20 + 30 = 210 thousand cars

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Q9:
Determine the effect upon equilibrium price and quantity if the following change occurs in a
particular market: The price of inputs used to produce the good increases. Illustrate
graphically and explain briefly.

Q10:
(a) If the cross-price elasticity of demand for two goods is positive, then are the goods:
Substitutes or Complements? Explain briefly.

(b) What is the range of the income elasticity of demand for a necessity? Explain with its
interpretation.

Key:

(a) Substitutes

(b) between 0 and 1 (positive and less than 1)

Q11:
(a) When price rises from Rs. 8 to Rs. 10, the producers' quantity supplied rises from 200 to
210. Compute the price elasticity of supply.

(b) Is the supply elastic or inelastic? Explain briefly.

Key:

(a) E = 5/20 = 0.25

(b) Inelastic

MCQs

A good is normal if:

A) income and the demand are unrelated.

B) when income increases, the demand remains unchanged.
C) when income increases, the demand decreases.
*D) when income increases, the demand increases.

On a linear demand curve:

A) price elasticity is the same at all points on the demand curve.

*B) demand is elastic at high prices.
C) demand is elastic at low prices.
D) demand is inelastic at high prices.

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The burden of a sales tax will fall mostly on buyers when demand is relatively ___________
and supply is relatively __________.

A) elastic; elastic
B) inelastic; inelastic
*C) inelastic; elastic
D) None of the above

To say that two goods are complements, their cross-price elasticities of demand should be:

A) greater than 0.
*B) less than 0.
C) equal to 0.

The long-run price elasticity of supply of crude oil is ________ the short-run price elasticity
of supply of crude oil.

A) equal to
B) not comparable to
*C) greater than
D) less than

The demand function for a product is given by: QD = 160 2P, where QD is quantity
demanded and P is the price. What is the price elasticity of demand at P = 30?

A) 0.33
B) 0.45
*C) 0.6
D) 2

Moving along a demand curve, the quantity demanded decreases by 8 percent when the price
increases by 10 percent. The price elasticity of demand is:

*A) 0.8
B) 1.25
C) 8.0
D) 10

The price elasticity of demand for cars in Pakistan is estimated to be 1, and the income
elasticity of demand is 2. The quantity demanded for cars is 200 (thousand) cars per year in
Pakistan given the current price and national income.

If the price of car increases by 1 percent and the national income in Pakistan also increases by
1 percent, what will be the quantity demanded for cars?

A) 199 (thousand) cars per year

B) 201 (thousand) cars per year
*C) 202 (thousand) cars per year
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When price rises from Rs.8 to Rs. 12, producers' quantity supplied rises from 180,000 to
198,000. The price elasticity of supply is:

A) 5.0: elastic
B) 0.2: elastic.
C) 5.0: inelastic.
*D) 0.2: inelastic.

The demand function for a product is given by: QD = 160 2P, where QD is quantity
demanded and P is the price. What is the arc price elasticity of demand between P = 20 and
P = 30?

A) 0.33
*B) 0.45
C) 0.6
D) 2.2

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