Solution Set 2

Problem Set 2
Points: 45
Instructions:
Note: You have to provide an explanation for your answer and graphs whenever asked.
The number of points you receive will depend on the clarity and accuracy of your explanation.
Submit a physical copy of your work (1 submission per group, include full names of both the members). Please
write clearly, untidy work is hard to grade and you may lose points.
Q1-Q3: 8 points each (4*2)
1. Using Demand and Supply diagram, explain the effect under each of the following scenario. Make sure to
mention movement/shift.
a. A technological innovation enables ABC Medical Company to produce more blood-sugar meters at every
price (tech innovation implies supply increase. Supply shifts to the right/out)
b. When the price of bagels rises, Bloomington Bagel Company is willing to sell more bagels. (movement
along the supply curve (as price of the product changes) and it is the producers we are talking about, law of
supply)
c. As the temperature rises, consumers purchase more lemonade. (taste/preferences of consumers for
lemonade changes due to a rise in temperature, demand increases, outward shift)
d. When tuition at State U rises, fewer students enroll in courses at State U. (product here is the seat in a
university/enrollment. Price of the good (= the tuition) increases. Since, the chance is due to change in the
price of the product itself, this is a movement along the curve, and we are talking about the
students/consumers, hence, this is a movement along the demand curve, and the quantity demanded
decreases.)
2. Using Demand and Supply diagram, explain the effect under each of the following scenario in the market
for gasoline. Make sure to mention movement/shift
a. a decrease in the price of gasoline (movement..price decrease..quantity demanded increase..no shifts)
b. an increase in consumer income, assuming gasoline is a normal good (shift the demand curve for gas outward)
c. an increase in the price of cars, a complement for gasoline (price of cars go up, qty dded of cars falls,
demand for gas decreases, downward shift of dd curve for gas)
d. an increase in the expected future price of gasoline: there can be different answers..you are given points if
your argument makes sense..future price expectations can affect both demand and supply (increase in
expected future price increase dd today and decrease ss generally).
3. Using Demand and Supply diagram, explain the effect under each of the following scenario in the market
for ice cream. Make sure to mention movement/shift
a. A decrease in income (shifts demand to left as icecream is a normal good)
b. An increase in the price of substitutes for ice cream, such as frozen yogurt (price of frozen yogurt
increases, quantity demanded of frozen yogurt falls due to law of demand, people switch to icecream (the
substitute product), hence the demand for icecream increases, demand shifts to right)
c. A sudden spell of unexpectedly cold weather (demand shifts left, cold weather=decrease in preference
for icecreams)
d. An increase in the price of complements for ice cream, such as cherries and flavored toppings (increase
in price of complements, decrease in demand for icecream, curve shifts left)
4. Using Demand and Supply diagram, show what happens to the equilibrium price and quantity if the supply
curve shifts to the right and the demand curve does not shift? (no need to include explanation, have the
diagram and just mention what happens to the equilibrium price and quantity)..2 points
5. Using Demand and Supply diagram, show what happens to the equilibrium price and quantity if the
demand curve shifts to the left and the supply curve shifts to the left? (no need to include explanation, have
the diagram and just mention what happens to the equilibrium price and quantity)..4 points
6. A price ceiling is not effective if (2 points, show the graph)
Select one:
a. it is set above the equilibrium price.

b. the equilibrium price is above the price ceiling.
c. it is set below the equilibrium price.
d. it creates a shortage.
7. A price floor is effective if: Select one: (2 points, show the graph)
a. it is set above the equilibrium price.

b. the equilibrium price is above the price floor.
c. it is set below the equilibrium price.
d. it creates a shortage.
8. If there is a surplus or an excess of wheat on the market, (2 points, show the graph)
Select one:
a. then some potential consumers looking to buy wheat will not be able to find any to purchase
b. the price of wheat will rise
c. then we know that the price is below equilibrium
d. the price of wheat will fall
P
S
A
P2
B
C
P1
D E
P3
F
Q
9. Refer to the graph above. If the price falls from P2 to P1, area B represents the (2 points, explain why)
a. total increase in consumer surplus.
b. additional consumer surplus to initial consumers.
c. consumer surplus to new consumers.
d. additional producer surplus to initial producers.
10. Producer surplus is the difference between the (1 point)
a. buyer’s willingness to pay and the actual price paid.
b. price and the seller’s opportunity cost.
c. price and the value of unsold inventories.
d. buyer’s willingness to pay and the seller’s willingness to sell.
11. Suppose your sister inherits an antique doll from your Great Aunt Sadie. The doll has a sentimental value of
$500 to you. If your sister sells you the doll for $200, your consumer surplus is equal to? (2 points, show work)
Ans: 300
12. Suppose you inherit an antique doll from your Great Aunt Sadie. The doll has a sentimental value of $100 to
you. Jane is a collector who is willing to pay $800 for your doll. If you sell the doll to Jane for $600, your producer
surplus is equal to? (2 points, show work)
Ans: 500
13. The graph below illustrates the market for fine wine. If the current price is $50 per bottle, we expect the (1 point)
a. price to decrease due to the surplus of wine.
b. price to increase due to the shortage of wine.
c. supply to shift left until the equilibrium price is $50.
d. demand to shift left until the equilibrium price is $50.

14. The graph below illustrates the market for gluten free chocolate cake. If the current price is $30 per cake, we
expect the (1 point)
1. price to decrease due to the surplus of cake.
2. price to increase due to the shortage of cake.
3. supply to shift right until the equilibrium price is $30.
4. demand to shift left until the equilibrium price is $30.

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Problem Set 2

Q1-Q3: 8 points each (4*2)

6. A price ceiling is not effective if (2 points, show the graph)

a. it is set above the equilibrium price.

a. it is set above the equilibrium price.

a. total increase in consumer surplus.

b. additional consumer surplus to initial consumers.

c. consumer surplus to new consumers.

d. additional producer surplus to initial producers.

10. Producer surplus is the difference between the (1 point)

a. buyer’s willingness to pay and the actual price paid.

b. price and the seller’s opportunity cost.

c. price and the value of unsold inventories.

d. buyer’s willingness to pay and the seller’s willingness to sell.

a. price to decrease due to the surplus of wine.

b. price to increase due to the shortage of wine.

c. supply to shift left until the equilibrium price is $50.

d. demand to shift left until the equilibrium price is $50.

1. price to decrease due to the surplus of cake.

2. price to increase due to the shortage of cake.

3. supply to shift right until the equilibrium price is $30.

4. demand to shift left until the equilibrium price is $30.

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