Q1. Refer to the information on the daily consumption and corresponding utility for Ms.
Ruby given in the table
below to answer the question(s) that follow. Both the goods are normal goods.
Number of
Total Utility Marginal Utility
Pastry per Day
1 80
2 150
3 200
4 230
5 10
Number of
Total Utility Marginal Utility
Sandwich per Day
1 60
2 110
3 144
4 168
5 12
Ms. Ruby currently earns Rs 1,200 per day. The slope of her budget constraint is -0.5 and pastry is on the X-
axis. The market price of sandwich is Rs 400 per unit.
a. Assuming that law of diminishing marginal utility holds, calculate the maximum total utility Ms. Ruby will
receive if she spends all her money on pastry and the consumption of the last unit of pastry does not provide
any additional satisfaction.
Ans: Price of Sandwich (Y-axis) is Rs 400, Px/Py = -0.5; Hence, Px (Pastry) = Rs 200. Maximum possible
consumption of X (Pastry) with given budget = 1200/200 = 6 units. Hence, maximum total utility after
consuming 6 units of pastry = 230+10+0 = 240. [2 / 0 marks for Price of Pastry + 3 / 0 marks for TU]
b. Calculate the utility maximizing level of consumption bundle for Ms. Ruby. Justify your answer with
appropriate calculations.
Ans: Initial consumption bundle: 4 pastries &1 sandwich. MUx/Px = 0.15 = MUy/Py [8 / 4 / 0 marks]
Sandwiches
4 5 Pastries
200
80
Pastry
4 5
c. Suppose the price for pastry falls to Rs 80 per unit, use utility maximizing principle to derive the demand
curve from indifferences curve and budget constraints for the individual for Pastry. Give appropriate labeling
by specifying how much quantity of pastry will be demanded by the individual at different prices.
Ans: New optimal consumption: 5 Pastry and 2 sandwiches as the price of pastry fall to Rs 80.
[4 marks + 6 marks for graph of demand curve]
Q2. This part is not related to data given above. Suppose an individual is currently spending her entire budget
on utility maximizing consumption bundle and the slope of budget constraint is -0.50. If the market price
of the commodity on the X-axis increases by hundred percent ceteris paribus, how will that change the
individual’s demand for that commodity due to income effect and substitution effect? Demonstrate
graphically (not to scale) and clearly indicate the total change in the quantity demanded after price
increase due to income effect component and due to substitution effect component in the same graph. No
calculations/numbers are required, label the graph clearly.
Ans: Refer to the graph below. [7 marks or 3 or 0]
Q3. Refer to the information provided below to answer the question(s) that follow.
The above figure represents the market for pumpkins both before and after the imposition of a sales tax by the
government, which is represented by the shift of the supply curve. The pumpkins are sold by a number of
storeowners and it is a perfectly competitive market.
a. Use the midpoint formula to calculate the price elasticity of demand for pumpkins from the equilibrium
point before the imposition of the tax to the equilibrium point after the imposition of the tax.
Ans: -1.9 [8 marks or 0]
b. Calculate the total dollar tax collection of the government from the imposition of this tax.
Ans: 3*700 = $ 2100 [4 marks / 0]
c. What would have been the total tax collection of the government if the price elasticity of demand for
pumpkins were zero?
Ans: Perfectly inelastic: Hence, Qd = 1200 and Total tax to govt. is $3*1200 = $3,600 [4 marks / 0]
d. By how much do storeowners increase the price of pumpkins following the imposition of the tax?
e. Ans: $(7.25-5.5) = $1.75 [4 marks / 0]
Q3. You are given the following information pertaining to the coefficients of different variables related to
commodity A.
Constant N PA T PB PC M F PI
600 1.5 4 15 12 2 0.03 10 12
N: number of buyers for good A, PA: market price of good A. Good A is an Inferior good, T:
consumer taste index for good A, P B: price of complementary good in consumption, P C: price of a
substitute good in the production, M: average household income, F: number of firms producing the
commodity, PI: price of a key factor of production
a. Identify and mention all relevant variables to the market demand function for commodity A.
Ans: N, PA, T, PB, M [6 or 3 or 0]
b. Specify the general demand function for commodity A.
Ans: QA = 600 – 4PA – 0.03M – 12PB + 15T + 1.5N [6 or 3 or 0]
c. If PA=$5, M=$25,000, PB=$40, PI=$1.5, F=50, N=2000, PC=$3.5, T=6.5 calculate the aggregate
quantity demanded.
Ans: 2,447.5 units or 2,448 units [3 marks / 0]
Q5. Assume that the number of units of capital (K) is being held constant as 5 while the number of units of
Labor (L) required for different levels of output is given below in the following table. Assume that wage
rate is Rs.1000 per unit of labour, the rental rate is Rs. 5000 per unit of capital and the output of the firm is
sold for Rs. 20 in the competitive market.
Labour (L) 0 4 6 9 14 22 34
Output (Q) 0 100 200 300 400 500 600
a) Calculate the value of AVC and MC at each of the different levels of output.
Labor Output AVC = TVC / QL MC= ∆TVC / ∆Q MP MRPL at P = MRPL at P =
(L) (Q) 4 / 3 /2/ 0 marks 4 / 3 /2/0 marks 20 40
0 0 -- -- -- - -
4 100 40 40 25 500 1250
6 200 30 20 50 1000 2500
9 300 30 30 33.33 660 1666.5
14 400 35 50 20 400 1000
22 500 44 80 12.5 250 625
34 600 56.67 120 8.33 166.6 416.5
b) Identify and clearly mention the value of AVC and MC when the stage of diminishing returns starts.
Ans: AVC= 30 and MC = 20 when the stage of diminishing returns starts [4 / 2 / 0 marks]
c) Identify and clearly mention the value of MC when AVC is at its minimum.
Ans: AVC is min at Q = 300 and value of MC = AVC = 30 [2 / 0 marks]
d) Calculate and show the necessary calculations to find out the number of units of variable input, which will
be demanded by the perfectly competitive firm if the firm is trying to maximize profits.
Ans: Equilibrium condition in the input market: MRPL = wage rate so when P = 20, L = 6.
[Based on table above 8 / 4 / 2 marks]
e) If the output of the firm is sold for Rs. 50 in the competitive market, ceteris paribus, calculate and show the
necessary calculations to find out how many units of variable input will be demanded by the perfectly
competitive firm if it trying to maximize profits.
Ans: Equilibrium condition in the input market: MRPL = wage rate so when P = 20, L = 14.
[Based on table above 8 / 4/ 2 marks]
Q6. Consider the perfectly competitive firm with the following cost and revenue situation. Based on the
information provided answer the question that follows:
a) Calculate the amount of amount of total profit/loss of this firm in the given situation.
Ans: At P = MC = MR. P = MR = $16 and quantity = 17. At this output, TC = 23 x 17 = 391. And TR = 16
x 17 = 272. Loss = - 119 [4 or 0 marks]
b) Calculate the amount of total operating profit at the equilibrium level of output.
Ans: Operating profit = TR – TVC = 68 [4 or 0 marks]
c) What will the firm choose to do in the short-run and why?
As operating profit is positive, (or loss = 119 is < TFC) this indicates it will continue to operate.
[4 or 0 marks]
d) Mention the price below which the output the firm will not produce anything. Calculate the amount of
profit / loss of the firm at that price
Ans: P = min of AVC = $11 is the shut down price. [2 / 0 marks]
Loss = TFC = 187 (or 186.998) [5 / 0 marks]
e) What is the long run equilibrium price and quantity? And calculate the amount of TC and profit in the long
run.
Ans: P = MC = min of ATC = $22. And quantity = 19.
TC =TR = 22 x 19 =418. Hence profits = 0. [2 + 2+ 1 + 1marks]
*******END*******
