Microeconomics, supply and demand curves, final exam practice problems
(The attached PDF file has better formatting.)
*Question 1.1: Price Elasticity of Supply
The supply curve of a competitive firm is Q = P – 100. Let η100 be the price elasticity of supply at Q = 100 and let η120 be the price elasticity of supply at Q = 120. Which of the following is true?
0 < η100 < η120
0 < η120 < η100
η
100 < η120 < 0η
120 < η100 < 0η
100 < 0 < η120Answer 1.1: B
The slope MQ/MP = β = 1. The elasticity is 
=
= β X/Y = β P/Q
~ When Q = 100, P = 200, and the elasticity is 2.
~ When Q = 120, P = 220, and the elasticity is 22 / 12 < 2.
Jacob: Does the answer depend on the coefficients of the supply curve?
Rachel: If the supply curve is linear, it does not depend on the coefficients. The supply curve is Q = α + βP. In practice, α must be negative. If α were positive, the firm would produce some quantity even if the price were zero or negative. But the marginal cost is always positive, so the firm would not do this. β must be positive, since a higher price induces a greater quantity. The slope MQ/MP is constant for a linear supply curve.
The ratio P / Q = P / ( α + βP). When P = 0, this ratio is zero. As P increases, this ratio increases, to a maximum of 1/β as P ÿ 4.
Jacob: Can we show that this ratio is monotonically increasing?
Rachel: The derivative of this ratio with respect to P is positive. Taking the derivative requires the quotient rule, which some candidates have forgotten. It is easier to examine the reciprocal of this ratio, which is β + α/P. The derivative with respect to P is –α/P2, which is negative. The reciprocal decreases as P increases, the ratio itself increases as P increases.
*Question 1.2: Price Elasticity of Supply
The price elasticity of supply is positive for most goods. For which good might the price elasticity of supply be negative?
Labor
Water
Food
Commodities
Financial assets
Answer 1.2: A
Labor is the inverse of leisure: labor time + leisure time = 24 hours a day. As labor increases, the worker’s leisure decreases.
A backward bending supply curve is caused by wealth effects that offset the substitution effect and make the consumer desire more leisure time.
A negative price elasticity of supply means that producers supply less of the good as the price increases. This occurs when a higher price for the good makes the producers richer and raises the relative cost of producing the good.
Low paid persons may work 12 hours a day to provide food, clothing, and shelter.
Average paid persons may work 8 hours day, since they desire more leisure time.
Highly paid persons may work 4 hours a day, since they have no use for more pay.
In practice, a higher real wage rate usually increases the labor supply. A person may work on week-ends mowing lawns for $25 an hour but not for $5 an hour.
Labor is different from other goods because it is inversely correlated with leisure.
Other goods have no adverse effect on the supplier when they increase. They increase the supplier’s income when they are sold, but their production causes no loss to the supplier.
Labor adverse affects the supplier. As labor increases, the supplier’s leisure decreases.
*Question 1.3: Supply and Demand of Bread
If the demand for bread decreases (because consumers’ tastes change and they want less bread) and the supply of bread decreases (because a drought ruined the wheat harvest)
The quantity of bread traded increases; the price may increase or decrease.
The quantity of bread traded decreases; the price may increase or decrease
The price of bread decreases; the quantity may increase or decrease.
The price of bread decreases and quantity increases.
By definition, a rise in demand can not occur along with a fall in supply.
Answer 1.3: B
Know the four scenarios:
If demand rises and supply rises, quantity increases but price may rise or fall.
If demand falls and supply falls, quantity decreases but price may rise or fall.
If demand rises and supply falls, price increases but quantity may rise or fall.
If demand falls and supply rises, price decreases but quantity may rise or fall.
We put these scenarios into a two by two matrix:
| Demand Rises | Demand Falls |
Supply Rises | Quantity Increases | Price Decreases |
Supply Falls | Price Increases | Quantity Decreases |
*Question 1.4: Supply and Demand of Wine
If the demand for wine increases (because consumers’ taste for wine changes and they want more wine) and the supply of wine increases (because the grape harvest is good)
The quantity of wine traded decreases; the price may increase or decrease.
The quantity of wine traded increases; the price may increase or decrease
The price of wine increases; the quantity may increase or decrease.
The price of wine increases and quantity decreases.
By definition, a rise in demand can not occur along with a fall in supply.
Answer 1.4: B
Know the four scenarios:
If demand rises and supply rises, quantity increases but price may rise or fall.
If demand falls and supply falls, quantity decreases but price may rise or fall.
If demand rises and supply falls, price increases but quantity may rise or fall.
If demand falls and supply rises, price decreases but quantity may rise or fall.
We put these scenarios into a two by two matrix:
| Demand Rises | Demand Falls |
Supply Rises | Quantity Increases | Price Decreases |
Supply Falls | Price Increases | Quantity Decreases |
*Question 1.5: Supply Curve
The supply curve equals which of the following for competitive firms and monopolists?
| Competitive Firm | Monopolist |
A | marginal revenue curve | marginal revenue curve |
B | marginal cost curve | marginal cost curve |
C | average cost curve | marginal revenue curve |
D | marginal cost curve | does not have a supply curve |
E | marginal cost curve | marginal revenue curve |
Answer 1.5: D
A competitive firm faces a horizontal (flat, perfectly elastic) demand curve. Its supply depends on the price.
A monopoly faces a sloping demand curve. Its supply depends on the marginal revenue, which depends on the price and the slope of the demand curve.
*Question 1.6: Indifference Curves and Demand Curves
Which of the following is not held constant when we use indifference curves to derive the demand curve for good X? Assume that good Y represents all other goods.
The price of good X
The price of good Y
The consumer’s income
The consumer’s tastes
The value to the consumer of good X
Answer 1.6: A