Tutorial 1 - Answers

February 2014

Problem 1
Consider the market for apple juice. In this market, the supply curve is given by
QSJ = 10PJ − 5PA and the demand curve is given by QD J = 100 − 15PJ + 10PT ,
where J denotes apple juice,A denotes apples, and T denotes tea.
a.) Assume that PA is fixed at $1 and PT = 5. Calculate the equilibrium price
and quantity in the apple juice market.
To draw a graph of the equilibrium, find intercepts of the demand and the
supply curves.
Demand: QD
J = 100 − 15PJ + 10 × 5 = 150 − 15PJ
x-intercept: solve for PJ = 0 ⇒ QD
J = 150 − 15 × 0 = 150
y-intercept: solve for QD
J = 0 ⇒ 0 = 150 − 15PJ ⇒ 15PJ = 150 ⇒ PJ = 10
Supply: QSJ = 10PJ − 5 × 1 ⇒ QSJ = 10PJ − 5
x-intercept: PJ = 0 ⇒ QSJ = −5
1
y-intercept: QSJ = 0 ⇒ 0 = 10PJ − 5 ⇒ 10PJ = 5 ⇒ PJ =
2
Demand and supply are the black lines in Figure 1
To find the equilibrium price: QSJ = QD
J :

−5 + 10PJ = 150 − 15PJ

25PJ = 155
31
PJ0 = = 6.2
5
To find the equilibrium quantity, substitute the equilibrium price into the
demand or the supply curve. Using supply:
31
QJ0 = −5 + 10 × = 57
5
Using demand:
31
QJ0 = 150 − × 15 = 57
5

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b.) Suppose that a poor harvest season raises the price of apples to PA = 2.
Find the new equilibrium price and quantity of apple juice. Draw a graph to
illustrate your answer.
The change in the price of apples affects the supply curve. As apples, used
in the production of apple juices are more expensive, the cost of production
of juices increases, thus the quantity supplied at any given price is lower:
the supply curve shifts inwards (blue curve in Figure 1).
The new supply curve is:

S1 = 10PJ − 5 × 2 = 10PJ − 10

Thus, to find the equilibrium price:

QD = QS

150 − 15PJ = 10PJ − 10

25PJ = 160 ⇒ PJ1 = 6.4

Now substitute the equilibrium price in demand or supply to find the equi-
librium quantity.
Using demand:
QJ1 = 150 − 15 × 6.4 = 54

Figure 1: Problem 1

c.) Suppose PA = 1 but the price of tea drops to PT = 3. Find the new equilib-
rium price and quantity of apple juice.

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 The change in the price of tea affects the demand curve. As tea is a substi-
tute good for apple juices a decrease in its price will reduce the demand for
apple juices at any price level. Thus, the demand curve shifts inwards (red
line in Figure 1).
The new demand curve is:

D2 : QD
J = 100 − 15PJ + 10 × 3

D2 : QD
J = 130 − 15PJ

To find the equilibrium price, set QS = QD :

−5 + 10PJ = 130 − 15PJ

PJ2 = 5.4

To find the quantity, substitute the price into the demand or in the supply
curve.
Using supply:
QJ2 = −5 + 10 × 5.4 = 49

d.) Suppose PA = 1, PT = 5, and there is a price ceiling on apple juice of

P = 5. What is the excess demand for apple juice as a result? Draw a graph
to illustrate your answer.

Figure 2: Problem 1

At the price of 5, the quantity supplied is:

QS = −5 + 10 × 5 = 45

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 Quantity demanded is:

QD = 150 − 15 × 5 = 75

Thus, the excess demand is 30.

Problem 2
1. Suppose the demand and supply for milk are described by the following equa-
tions:
QD = 600 − 100P
QS = −150 + 150P
where P is price in dollars, QD is quantity demanded in millions of litres per
year, and QS is quantity supplied in millions of litres per year.
a) Graph supply and demand and determine graphically equilibrium price and
quantity
See Figure 3
Demand:
x-intercept
P = 0 ⇒ QD = 600
y-intercept
Q = 0 ⇒ 0 = 600 − 100P ⇒ P = 6

Supply:
x-intercept
P = 0 ⇒ QS = −150

y-intercept
Q = 0 ⇒ 0 = −150 + 150P ⇒ P = 1

b) Calculate the equilibrium

QS = QD
−150 + 150P = 600 − 100P
750
250P = 750 ⇒ P =
250
P0 = 3
To find quantity, substitute the price into the demand or the supply curve.

Q0 = −150 + 150 × 3 = 300

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 Figure 3: Problem 2 - Equilibrium

2. Suppose a growth hormone is introduced that allows dairy farmers to offer

125 million more litres of milk per year at each price.

a) Describe what happened to the supply and the demand curve and graph
the new curves
Supply curve shifts outwards, while the demand curve is not affected.
The new supply curve is (see Figure 4):

S1 : QS = −150 + 150P + 125

S1 : QS = −25 + 150P
x-intercept is:
P = 0 ⇒ QS = −25

y-intercept is:
Q = 0 ⇒ P = 1/6
b) Determine equilibrium price and quantity

QS = QD
−25 + 150P = 600 − 100P
P1 = 2.5

Find equilibrium quantity:

Q1 = −25 + 150 × 2.5 = 350 or Q1 = 600 − 100 × 2.5 = 350

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 Figure 4: Problem 2 - Increased supply

c) Suppose the Government set the price of milk at $3 a litre. Demonstrate

the effect of this regulation on the market for milk. What is quantity
demanded? What is quantity supplied? Discuss.
The Government is imposing a price floor (see Figure 5).
At P = 3 the quantity demanded is:

QD = 600 − 100 × 3 = 300

while the quantity supplied is:

QS = −25 + 150 × 3 = 425

Thus, there is a surplus of milk: QS − QD = 425 − 300 = 125

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 Figure 5: Problem 2: Price floor

Problem 3
By taking an airplane Larry can travel from Denver to Houston in one hour.
The same trip takes 5 hours by bus. Airfare is $90 and the bus fare is $30.
Larry, when he is not travelling, can work and earn $30/hour.
Answer the following questions:
a What is the economic cost for Larry of travelling by bus?
Economic cost = Direct cost + opportunity cost

ECBU S = 30$ + 5 × 30$ = 180$

b What is the economic cost for Larry of travelling by plane?

ECP LAN E = 90$ + 1 × 30$ = 120$

c Which is the cheaper mode of travel for Larry?

By plane! The economic cost is lower.

d How would the answers be different for another person Moe (who can work
and earn $6/hour when he is not travelling)?

ECBU S = 30$ + 5 × 6$ = 60$

ECP LAN E = 90$ + 1 × 6$ = 96$

The best option for Moe is travelling by bus.

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Problem 4
Graph the effect on equilibrium price and quantity in the market for oranges for
each of the following changes.

a) A chemical routinely sprayed on orange orchards is found to cause cancer

Demand shifts inwards (preferences)
b) The wages of farm workers increase
Supply shifts inwards (increase in production costs)

c) A new orange picking machine is invented. For the same cost, it can pick
more oranges, faster, and with less damage than other machines
Supply shifts outwards (improvement in technology)
d) Consumer income falls
If oranges are considered a normal good, demand shifts inwards

e) The price of tangerines falls.

Tangerines are substitute goods for oranges. Thus, a reduction in the price
of tangerines reduces the quantity of oranges demanded.
Then, demand shifts inwards.

Problem 5
The local pub is advertising a special. If you buy one beer, you get the next
one at 25% off, the third one for 50% off and the forth one for 75% off. Your
marginal benefit from drinking beer is shown in the table below. If the price of
a beer is $6, how many should you buy?

#beers MB P

0 0 0
1 7 6
2 4 6 × 0.75 = 4.50
3 2 6 × 0.5 = 3
4 1 6 × 0.25 = 1.50
Marginal benefit is larger than the price only for the first beer. Thus, you
will buy 1 beer.

Problem 6
The demand and supply for a good are respectively:

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 1
D : QD = 5 − P
2
S : QS = −4 + P

a) Determine equilibrium price and quantity and show them on a graph

QS = QD
1 3
−4 + P = 5 − P ⇒ P = 9
2 2
P0 = 6

To find quantity:
6
Q0 = −4 + 6 = 2 or Q0 = 5 − =2
2

Figure 6: Problem 6

See Figure 6

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b) Due to a positive shock to supply, the supply curve shifts outward. The new
curve is:
S 0 : QS = −1 + P
Describe what happens to the equilibrium in the market and calculate the new
equilibrium price and quantity.
The supply curve shifts outwards. Equilibrium quantity increases, while
equilibrium price decreases.

QS = QD
1
−1 + P = 5 − P ⇒ P1 = 4
2
Find quantity:
Q1 = −1 + 4 = 3

c) Now suppose that, given a negative shock, the quantity demanded declines
by 20%. What happens to the demand curve? Graph the new curve and
calculate the new equilibrium.
The slope of the demand curve changes. The demand curve becomes steeper.

D2 : QD2 = 0.8 × QD
1
D2 : QD2 = 0.8 × (5 − P )
2
2
D2 : QD2 = 4 − P
5
Considering the supply curve described at point a), the equilibrium price is:
2
−4 + P = 4 − P
5
P2 = 5.71

and quantity
2
Q2 = −4 + 5.71 = 1.71 or Q2 = 4 − × 5.71 = 1.71
5

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