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HW1 Solutions
HW1 Solutions
HW1 Solutions
HOMEWORK 1
Answer Key
Problem 1
A computer products retailer purchases laser printers from a manufacturer at a price of Rs. 25,000 per printer.
During the year, the retailer will try to sell the printers at a price greater than Rs. 25,000, but may not be able to
sell all the printers. At the end of the year, the manufacturer will buy back any unsold inventory at 40 percent of
the original price. No one other than the manufacturer would be willing to buy these unsold printers at the end
of the year.
a) At the beginning of the year, before the retailer has purchased any printers, what is the opportunity cost
of a laser printer? [2]
Since a printer costs Rs. 25000, before purchasing any printers, the opportunity cost of a laser printer would
be the next best use of Rs. 25000 for the retailer. For example, this money could be invested elsewhere at a
certain rate of return. This return foregone would be the opportunity cost of the laser printer.
b) After the retailer has purchased the laser printers, what is the opportunity cost associated with selling a
laser printer to a customer? (Assume that if this customer does not buy the printer, it will be unsold at
the end of the year.) [3]
Any unsold inventory will be bought back by the manufacturer at 40% of the original price; Rs.10,000
(25000*.40). Therefore, the opportunity cost associated with selling a laser printer to a customer would be
Rs. 10,000 as this is the next best alternative available to the retailer.
Problem 2
Consider the demand curve for the latest wearable fitness device, QD = 40,000 - 4P.
a) Plot the demand curve [2]
Q = 40000-4P
Price
10000
5000
b) Find the price and quantity at which the demand is unit elastic [2]
Given that price elasticity of demand (ϵd ) = -1
Demand curve:
𝑄 = 40000 − 4𝑃
𝑑𝑄
= −4
𝑑𝑃
ϵd = ×
-1 = −4 ×
Given, P = Rs. 2000. We can find the corresponding quantity (Q), by plugging P=Rs. 2000 in the
demand equation Q = 40000-4P; Q = 32000
Use price elasticity formula to find ϵd
ϵd = ×
ϵd = −4 ×
ϵd = − or -0.25
Given, P = Rs. 1000. We can find the corresponding quantity (Q), by plugging P = Rs. 1000 in the
demand equation Q = 40000-4P; Q = 36000
Use price elasticity formula to find ϵd
ϵd = ×
ϵd = −4 ×
ϵd = − or -0.11
Problem 3 [4 marks]
Sandhya: Sandhya is going to spend exactly 600. This means the relationship between quantity demanded by her
(Q) and the price in the market(P) is given by P*Q =600 or Q= 600/P.
Therefore, ϵd = × = − × = − × = −1
Manhar: Demand is completely inelastic i.e. elasticity is equal to 0. This is because Manhar’s demand is not sensitive
to the price. If you plot Manhar’s demand you will find it to be a vertical line at a quantity of 2.
Problem 4
The demand curve for pedicures is given by: QD = 20 - 4P + 0.2I, where P is the price of a pedicure, and I is the
average consumer income.
a) Assume that I is 400. What is the consumer surplus when P is 15? By how much does the consumer surplus
change if P falls to 10? [3]
Q = 100-4P
Price
25 Consumer Surplus
15
0 40 100 Quantity
Consumer surplus is given by the area of the triangle; above market price (P=15) and below the demand
curve. We can use the formula for area of a triangle = × base × height to calculate the consumer surplus.
In this case the base of the triangle is 40 and the height is 10 (25-15), therefore
1
Consumer Surplus = × 40 × 10 = 200
2
When P falls to 10; Q can be found by plugging this value in the demand function; Q = 100-4P
Q = 100 – 4 (10)
Q = 60
In this case, consumer surplus is given by the area of the triangle; above market price (P=10) and below the
demand. In this case, the base is 60 and the height is 15.
1
Consumer Surplus = × 60 × 15 = 450
2
Change in consumer surplus = 450 – 200 = 250
Q = 100-4P
Price
25
10
0 40 60 100 Quantity
b) At a market price of 20, what is the pedicurist’s income? Suppose the pedicurist wants to increase her
income. Should she increase or decrease the price of a pedicure? [2]
To increase her income, the pedicurist should decrease the price of a pedicure, if the demand curve is
relatively elastic; ϵd >1. If demand curve is relatively inelastic; ϵd <1, she should increase the price.
Consumer surplus is given by the area of the triangle; above market price (P=15) and below the demand
curve. We can use the formula for area of a triangle = × base × height to calculate the consumer surplus.
In this case the base of the triangle is 60 and the height is 15 (30-15), therefore
1
Consumer Surplus = × 60 × 15 = 450
2
This can be shown graphically as:
Q = 120-4P
Price
30 Consumer Surplus
15
0 60 120 Quantity
Problem 5 [6 marks]
Suppose you are analyzing the demand for buttermilk at the Goel dining hall. Consider each of the following
scenarios and explain whether it would lead to an increase, decrease, or no change in demand:
a) Term break – Decrease in demand
b) A thunderstorm that brings down the temperature by several degrees – Decrease in demand
c) A decrease in the price of buttermilk – No change in demand, decrease in price of buttermilk will cause
increase in quantity demanded
d) A decrease in the price of watermelon juice – Decrease in demand
e) A decrease in the price of photo copying – No change in demand
f) The latest campus fad – “veganism” – Decrease in demand
Problem 6 [2 marks]
Suppose there are 2 countries, X and Y, capable of producing 2 goods: sense and nonsense. The output per
worker in Country X is 8 units if the worker produces sense and 4 units if he/she produces nonsense. In
Country Y, the output per worker is 6 units of sense or 2 units of nonsense. What is the pattern of absolute
and comparative advantage?
Comparative Advantage: X has a lower opportunity cost in producing nonsense and Y has a lower opportunity cost
in producing sense. Hence X has a comparative advantage in producing nonsense and Y has a comparative advantage
in producing sense.