Intermediate Microeconomics EC202

Lekima Nalaukai Semester II, 2020

Tutorial 13 Suggested Solutions

Chapter 16

Part A: Multiple Choices

1. Let the demand and supply for two linked products, say corn and soy, be the following:
Qcd= 12 – 2pc + ps; Qcs = 4+pc; Qsd = 6-4ps + pc; Qss = 4 + ps. The superscript refers to
“demand” (d) or “supply” (s) and the subscript refers to corn (c) or soy (s). What are the
equilibrium prices of corn and soy?
A. pc = 2; ps = 2
B. pc = 1; ps = 3
C. pc = 3; ps = 1
D. pc = 1; ps = 1

Ans: C

2. According to Walras’ Law, in a general competitive equilibrium with a total of ____

markets, if supply equals demand in the first _____ markets, then supply will equal
demand in the _____ market as well.
A. three; two; first
B. three; three; third
C. three; two; third
D. three; three; first

Ans: C

3. To begin with, John has 6 units of Good X and Jane has 3 units of Good X. If X is
measured horizontally in an Edgeworth box, then how wide should the Edgeworth box
be?
A. 3 units
B. 6 units
C. 9 units
D. 18 units

Ans: C

4. In an Edgeworth box, apples are measured along the horizontal axes, and oranges are
measured along the vertical axes. Player 1 is in the lower left-hand corner; player 2 is in
the upper right-hand corner. Player 1 likes apples but gets no utility from the
consumption of oranges. Player 2 likes oranges but gets no utility from the consumption
of apples. In the initial endowment, Player 1 has 5 apples and 4 oranges. Player 2 also
has 5 apples and 4 oranges. What is the contract curve?
A. All points along the horizontal axis.
B. All points along the vertical axis.
C. All points to the right and below the initial endowment point.
D. The point where Player 1 has 10 apples and 0 oranges, and Player 2 has 8 oranges and 0 apples.

Ans: D
Intermediate Microeconomics EC202
Lekima Nalaukai Semester II, 2020

Tutorial 13 Suggested Solutions

Chapter 16

5. Two individuals, A and B, consume two goods, x and y . Consumer A initially has 3
units of x and 2 units of y . Consumer B initially has 5 units of x and 6 units of y .
Also, for Consumer A the MRS xA, y  5 x 3 y and for Consumer B the MRS xB, y  3 x y . Does
this initial allocation of x and y represent an efficient allocation?
A. Yes
B. No, because both consumers could be made better off by giving A more x and less y .
C. No, because both consumers could be made better off by giving A more y and less x .
D. Cannot be determined from the given information.

Ans: A

6. In a competitive general equilibrium, which of the following relations will not be true?
A. MRSX,Y = MRTX,Y.
B. MRTX,Y = MCX/MCY.
C. MRSX,Y = PX/PY.
D. MRTX,Y = w/r.

Ans: D
Intermediate Microeconomics EC202
Lekima Nalaukai Semester II, 2020

Tutorial 13 Suggested Solutions

Chapter 16

Part B: Conceptual Questions

1. What is the difference between a partial equilibrium analysis and a general equilibrium analysis?
When analyzing the determination of prices in a market, under what circumstances would a
general equilibrium analysis be more appropriate than a partial equilibrium analysis?

A partial equilibrium analysis studies the determination of price and output in a single market,
taking as given the prices in all other markets. In general equilibrium analysis, we study the
determination of price and output in more than one market at the same time.
One would employ a partial equilibrium analysis in situations where the concerns focused on a single
market; for example, how does an increase in rainfall affect the price of corn? One would use general
equilibrium analysis when one was concerned with how changes in price and output in one market affect
the price and output in another market; for example, how does an increase in the price of natural gas
affect the price and output for electric furnaces?

2. What is Walras’ Law? What is its significance?

Walras’ Law implies that a general equilibrium analysis will only be able to determine prices in
N  1 of the markets being studied. This implies that a general equilibrium determines the prices
of all goods and inputs relative to the price of another good or input, rather than determining the
absolute levels of all prices.

3. What is exchange efficiency? In an Edgeworth box diagram, how do efficient allocations and
inefficient allocations differ?

Exchange efficiency occurs when a fixed amount of consumption goods cannot be reallocated
among consumers in an economy without making at least some consumers worse off. Efficient
allocations in an Edgeworth Box occur at points where the indifference curves for different
consumers are tangent. Inefficient allocations occur at points where the indifference curves for
different consumers intersect.
Intermediate Microeconomics EC202
Lekima Nalaukai Semester II, 2020

Tutorial 13 Suggested Solutions

Chapter 16

Part C: Calculations
1. Two consumers, Josh and Mary, together have 10 apples and 4 oranges.
a) Draw the Edgeworth box that shows the set of feasible allocations that are available in this
simple economy.

b) Suppose Josh has 5 apples and 1 orange, while Mary has 5 apples and 3 oranges. Identify this
allocation in the Edgeworth box.

Mary
4
3.5
3
Oranges

2.5
2
1.5
1
0.5
0
0 2 4 6 8 10
Josh
Apples

c) Suppose Josh and Mary have identical utility functions, and assume that this utility function
exhibits positive marginal utilities for both apples and oranges and a diminishing marginal rate of
substitution of apples for oranges. Could the allocation in part (b)—5 apples and 1 orange for
Josh; 5 apples and 3 oranges for Mary—be economically efficient?
To be economically efficient, the two consumers must have identical marginal rates of substitution at the allocation.
While we are not given the MRS for each consumer, we are told that each has an identical utility function. This
implies that at an efficient allocation where the MRS for each consumer is the same, the ratio of apples to oranges
must be the same. Since at the current allocation Josh has a ratio of apples to oranges equal to 5 and Mary has a
ratio of 1.67, this allocation cannot be efficient. The contract curve in this case will be a straight line between the
origins for each consumer.
Intermediate Microeconomics EC202
Lekima Nalaukai Semester II, 2020

Tutorial 13 Suggested Solutions

Chapter 16

2. Suppose that the demand curve for new automobiles is given by QA = 20 – 0.7PA – PG where QA
and PA are the quantity (millions of vehicles) and average price (thousands of dollars per vehicle),
respectively, of automobiles in the United States, and PG is the price of gasoline (dollars per
gallon). The supply of automobiles is given by Q5A = 0.3PA. Suppose that the demand and supply
curves for gasoline are QdG = 3 – PG and QSG = PG.
a) Find the equilibrium prices of gasoline and automobiles.

In equilibrium, the quantity supplied and the quantity demanded for both goods will be equal.
This implies
QAd  QAs
QGd  QGs

Substituting in the given curves implies

20  0.7 PA  PG  0.3PA
3  PG  PG

Here we have two equations and two unknowns. Solving the second equation for PG yields PG  1.5 .
Substituting into the first equation results in

20  0.7 PA  1.5  0.3PA

PA  18.5

At these prices, QA  5.55 and QG  1.5 .

Intermediate Microeconomics EC202
Lekima Nalaukai Semester II, 2020

Tutorial 13 Suggested Solutions

Chapter 16

b) Sketch a graph that shows how an exogenous increase in the supply of gasoline affects the
prices of new cars in the United States.

If the supply of gasoline increases, the supply curve for gasoline will shift to the right lowering the equilibrium price
of gasoline as seen in the graph below.

Market for Gasoline

3.5
3 S
2.5
Price

2
1.5 S'
1
0.5 D
0
0 1 2 3 4

Quantity

Because gasoline is a complement good for autos, the reduction in the price of gasoline will increase the
demand for autos. This will shift the demand curve to the right, increasing the equilibrium price and
quantity for autos as seen in the following graph.

Market for Autos

70
60 S
50
Price

40
30
20
10 D'
D
0
0 5 10 15 20

Quantity
Intermediate Microeconomics EC202
Lekima Nalaukai Semester II, 2020

Tutorial 13 Suggested Solutions

Chapter 16

3. Studies indicate that the supply and demand schedules for ties (t) and jackets (j) in a market are
as follows:

The estimates of the schedules are valid only for prices at which quantities are positive.

a) Find the equilibrium prices and quantities for ties and jackets.

In equilibrium (1) the supply and demand for ties will be equal

410 – 5Pt – 2Pj = –60 + 3Pt , and

(2) the supply and demand for jackets will be equal
295 – Pt – 3Pj = –120 + 2Pj

Solving these two simultaneous equations, we find that P j = 75 and Pt = 40. Also, using either the
demands or supply schedules, we calculate that the equilibrium quantity of jackets is 30, and the
equilibrium quantity of ties is 60.

b) Do the demand schedules indicate that jackets and ties are substitute goods, complementary
goods, or independent goods in consumption? How do you know?

The demand function for ties shows that a higher price of jackets decreases the demand for ties. Similarly
the demand function for jackets shows that a higher price of ties decreases the demand for jackets. Ties
and jackets are therefore complements in consumption.