Week 3 Chapter 2: Market Forces: Demand and Supply

For this week read Chapter 2, pages 48-68

Answer the following questions:

Question 1.

The structure of an industry includes the number of participants, technology, and the ease of entry and exist. When the number of sellers is many, a single seller is said to operate under condition of perfect competition. Suppose the company ABC produces pizza (Good X) and operates in a competitive market and uses cheese as its main input. What would happen to the supply of good X in each of the following situations.

a. The price of cheese increases.

Hint:

1. Draw the demand and supply curves for a typical competitive market. Label each curve and identify the initial points (D⁰, S^o , E⁰ , P⁰and Q⁰ ).

2. Now, show which curve (demand or supply) will be affected if the input cost of cheese increases and why? Label the affected curve (D¹, or S¹ ).

3. What is the new equilibrium? Label as P¹, Q¹ and E¹

4. Give an interpretation as to the new price (higher or lower) and the new equilibrium quantity (higher or lower).Review the topic on Comparativestatistics.

b. What is an excise tax. Suppose an excise tax of $2 is imposed on Good X. Explain how this excise tax will affect the market for Pizza.

Hint: Here, again begin your analysis from the initial values of equilibrium as given under comparative statics. Numbers are not relevant. Simply show the impact of the tax on the equilibrium price and quantity.

c. What is an “ad valorem” tax? Suppose an ad valorem tax of 3 percent is imposed on good X.

Hint: Use comparative statics, show how the supply curve will be affected under this situation. Simply show the impact of the tax on equilibrium Price and Quantity

d. A technological change reduces the cost of producing additional units of good X.

Hint: Use theapproach given under part (a)of this question.

Question 2

The question below is about market equilibrium and how to compute equilibrium values. Suppose demand and supply are given by Qd = 15-2P and Qs = -3+P.

a. What are the equilibrium quantity and price in this market? Show your work?

Hint:

1. Draw the demand and supply graph and label all initial points ( D⁰, S⁰, P⁰, E⁰), following the use of comparative statics given your text on pages 62-65)

2. Set demand equal to Supply and solve the values. See page 62 for a practice problem

3. Next, insert the values in the graph.

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