EC 101.

01&03 Problem Session: Chapter 4 Fall 2021

1. Sketch generic supply and demand curves for the housing market and label the equilibrium price
and quantity.

a. A booming economy increases the demand for housing. Show the shift in the demand curve on
your graph. What does this do to the price and quantity in the market?

b. You and a friend both notice that more houses are built in response to this change. Your friend
says, “this is a sign that the supply curve is shifting as well.” You respond, “no, this is actually
just a shift along the supply curve.” To help your friend understand, demonstrate what you mean
on your graph.

c. As it turns out, there actually is a shift in the supply curve due to an unrelated breakthrough in
construction that lowers the cost of building houses. In what direction does the supply curve
shift? Show this on your graph.

d. Relative to the original price and quantity, what is the overall effect of both shifts on price and
quantity?
Answers:
a. The price increases and the quantity increases. See first diagram.

b. See the two red arrows on the supply curve; this represents a shift along the supply curve, which
is different from a shift of the supply curve.

c. A reduction in cost lowers the supply curve vertically, which is the same as a shift to the right, or
an increase in the supply. See second diagram below.

d. Quantity increases unambiguously. The overall effect on price is ambiguous as it depends on the
size of the supply shift relative to the demand shift. As drawn, there is a slight increase in price,
but with a slightly larger supply shift, price could remain the same or be even lower.

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 2. For each of the following situations, sketch the demand curve as accurately as possible.

a. Appendectomy is a life-saving operation that some people need. Regardless of the price, the
quantity demand is 300,000 every year.

b. For any price above $5 absolutely nobody will buy your lemonade, but for any price below $5
you find that you are able to sell as much lemonade as you like.

c. There is only one buyer. For any price above $100 this buyer wants nothing. For any price at or
below $100 this buyer wants exactly 20 units.
Answers:
a. A vertical (“perfectly inelastic”) demand curve.

b. A horizontal (“perfectly elastic”) demand curve. Note that above $5 the quantity demanded is
zero (drawn explicitly in the graph, but often only implied in other graphs).

c. This is a step “function” that jumps at the price of $100. At a price of exactly $100 the buyer is
willing to buy any number of units, so it is actually preferable -- not just permissible -- to fill in
this region with a horizontal line. (Also, technically speaking, the demand is not a “function” in
the mathematical sense because the price of $5 maps into multiple quantities demanded.)

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3. The demand for ice cream is QD = 70 − 4P, and the supply of ice cream is QS = 10 + 2P, where P
is the price of ice cream.
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 a. Find the equilibrium price and quantity of ice cream.

b. Suppose consumers’ income increases and ice cream is considered as a normal good. As a result,
the demand curve for ice cream becomes QD = 100 − 4P. Find the new equilibrium price and
quantity of ice cream.

Answers:
a. At equilibrium, the quantity demanded must be equal to the quantity supplied. Thus, we have 70
− 4P = 10 + 2P. Solving for P, we have 60 = 6P and hence, P = 10. Substituting P = 10 into the
demand or supply equation, we have Q = 70 – 4 (10) or 10 + 2 (10) = 30. The equilibrium price is
$10, and the equilibrium quantity is 30 units.

b. Equating the new QD with QS, we have 100 − 4P = 10 + 2P. Solving for P, we have 90 = 6P and
hence, P = 15. Substituting P = 15 into the demand or supply equation, we have Q = 100 – 4 (15)
or 10 + 2 (15) = 40. The new equilibrium price of ice cream is $15 and the equilibrium quantity is
40 units.

4. The equilibrium price of coffee in an economy, measured in dollars, is about $2,000 per ton. To
help the coffee farmers earn a higher income, the government set the price to $2,500 per ton.

a. How will this affect the demand and supply of coffee in the coffee market?

b. Construct a diagram for coffee to show the effect of the government action. Will the coffee
farmers be better off?
Answers:
a. The price set above the market equilibrium level will lead to an increase in the quantity of coffee
supplied but a decrease in the quantity of coffee demanded in the coffee market.
b. At a market price of $2,500 per ton, the quantity supplied will exceed quantity demanded. There
will be an excess supply of coffee in the market. Only those farmers who are able to sell their
product at the higher price of $2,500 will be better off. Those who are unable to do so will be
worse off.

5. A freshwater aqua farm in Singapore can breed tiger prawns and tilapia. Recently, it was found
that there may be a risk of contracting a type of disease from the consumption of tiger prawns—
this discovery has led to fear among its consumers. How will this affect the equilibrium price and
quantity of tilapia in Singapore?
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Answer: The fear of contracting a disease from the consumption of tiger prawns decreases their demand.
This will lead to a lower equilibrium price, thereby reducing profit in breeding tiger prawns. This, in turn,
will decrease the demand for breeding tiger prawns at the freshwater aqua farm in Singapore. The
consequent fall in the equilibrium price of conducting aquaculture, leads to an increase in the supply of
tilapia. Thus, the supply curve for tilapia will shift to the right. In the diagram below, the equilibrium
price falls from P1 to P2 and the equilibrium quantity increases from Q1 to Q2.

Market for Tilapia

See http://www.nytimes.com/2011/09/02/us/02apples.html

6. As part of U.S. sugar policy (in 2013), the government offered to buy raw sugar from domestic
sugarcane mills at an average price of 18.75 cents per pound. The government offer was made for
as much raw sugar as sugar mills produced. Any raw sugar purchased by the government was not
sold in the domestic market, as this might have caused raw sugar prices to fall. The price of 18.75
cents per pound was above the equilibrium price.

a. Under this policy, what do you think the government’s demand curve for sugar looks like?

b. What impact does this policy likely have on domestic sugar prices?

Answers:

a. Since the government is willing to buy any quantity of raw sugar at the 18.75 cents per pound, the
demand curve is horizontal at that price. The government’s demand curve is shown in the
following figure:

b. Since the government guarantees that mills will get 18.75 cents per pound of raw sugar, they do
not have an incentive to sell sugar to any buyer who offers less than that price. In effect, the
government is raising the price of raw sugar to 18.75 cents per pounds. Also note that when the
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price falls below 18.75 cents, the millers sell the sugar to the government. Since the government
does not re-sell this sugar in the open market, the domestic market price is very likely to increase.

See http://www.npr.org/2013/03/28/175569499/farm-bills-sugar-subsidy-more-taxing-than-
sweet-critics-say