IBS553 ME/ SET – I(KEY)/0906

Part – A: Basic Concepts

TOTAL MARKS: 30 MAXIMUM TIME: 30 MINUTES

1. According to the kinked demand curve 5. Charging of different prices from

theory, when one firm raises its price, different consumers is possible under
other firms will which of the market conditions?

a. also raise their prices a. Perfect competition

b. refuse to follow b. Monopoly
c. increase their advertising c. Oligopoly
expenditure d. Monopolistic competition
d. exit the industry e. Duopoly
e. raise barriers to entry
6. Which of the following is not true of a
perfectly competitive market?
2. Which of the following might not be a
reason for emergence of monopoly?
a. if supernormal profits are earned,
then the price will fall over time
a. Sole producer in the market b. in long-run equilibrium, P = MR =
b. The firm big enough to satisfy the SRMC = SRATC = LRAC
entire market demand produced at c. a constant-cost industry exists when
minimum average cost the entry of new firms has no effect
c. A company having patent for the on their cost curves
product d. homogeneous product
d. Government has awarded license e. In long run all firms earn super
for the firm normal profits
e. Free entry of firms into the
industry. 7. Suppose a car wash has 2 washing
stations and 5 workers and is able to
3. One possible effect of advertising on a wash 100 cars per day. When it adds a
firm’s long-run average cost curve is to third station, but no more workers, it is
able to wash 150 cars per day. The
marginal productivity of the third
a. raise the curve washing station is
b. lower the curve
c. shift the curve rightward a. 100 cars per day
d. shift the curve leftward b. 150 cars per day
e. no effect on average cost c. 5 cars per day
d. 50 cars per day
4. What is the likely impact on price in a e. 15 cars per day
perfectly competitive market when the
demand curve shifts to the right slowly 8. Assuming that the marginal cost curve
and the supply curve shifts to the right at for a firm is a smooth U-shaped, the
a faster rate? corresponding total cost curve has a
(an)
a. Price would increase
a. linear shape
b. Price would fall
b. S-shape
c. The price remains same
c. U-shape
d. The cost of production would
d. Reverse S shape
determine the increase in price
e. Reverse U shape
e. Price is dependent on given factors.

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9. What is likely to be the shape of supply d. marginal utility

curve of an increasing cost industry in e. average utility
the long run?
13. If the government wanted to raise tax
revenue and shift most of the tax burden
a. Negative sloped to the sellers, it would impose a tax on a
good with a
b. Positive sloped
c. Parallel to X axis
a. steep (inelastic) demand curve and
d. Parallel to Y axis
a steep (inelastic) supply curve
e. U shaped b. steep (inelastic) demand curve and
a flat (elastic) supply curve
10. The change in quantity demanded c. flat (perfectly elastic) demand
resulting from change in purchasing curve and a steep (inelastic)
power is known as supply curve
d. flat (perfectly elastic) demand curve
and a flat (elastic) supply curve
a. income effect
e. perfectly inelastic demand and
b. substitution effect elastic supply
c. law of demand
d. consumer equilibrium effect 14. A manufacturer of Addidas hires an
e. law of supply economist to study the price elasticity of
demand for his product. The economist
estimates that the price elasticity of
11. What does the perfectly elastic demand demand coefficient for a range of prices
curve under the perfect competition close to the selling price is greater than
mean to the producer? 1. The relationship between changes in
price and quantity demanded for this
segment of the demand curve is
a. The demand is sensitive to
price
a. elastic
b. The demand is less
sensitive to price b. inelastic
c. There is no constraint on c. perfectly elastic
supply d. perfectly inelastic
d. Different prices exist in the e. unitary elastic
market
e. The producer can sell as
15. Which of the following will result in an
many goods as he wants at the
increase in total revenue?
existing price.

a. price increases when demand is

12. The amount of utility that a consumer
elastic
gains from the consumption of one more
unit of a good is called b. price decreases when demand is
elastic
c. price increases when demand is
a. incremental utility unitary elastic
b. total utility d. price decrease when demand is
c. diminishing utility inelastic

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e. price increases when demand is d. Decrease in demand

perfectly elastic
16. An increase in consumer’s incomes
increases the demand for Pepe Jeans.
As a result of the adjustment to a new
equilibrium, there is a (an)
e. Unlimited amount being
available for customers distribution
20. The gap between the short run total cost
and the short run variable cost is
dependent on

a. leftward shift of the supply curve a. Fixed cost

b. downward movement along the b. Average fixed cost
supply curve
c. Average variable cost
c. rightward shift of the supply curve
d. Average cost
d. upward movement along the
supply curve e. Marginal cost.
e. no shift in demand curve
21. An economic theory claims that a rise in
17. Suppose autoworkers receive a gasoline prices will cause gasoline
substantial wage increase. Other things purchases to fall, ceteris paribus. The
being equal, the price of autos will rise phrase ‘ceteris paribus’ means that
because of a (an)
a. other relevant factors like
a. increase in the demand for autos consumer incomes must be held
b. rightward shift of the supply curve constant
for autos b. gasoline prices must first be
c. leftward shift of the supply curve adjusted for inflation
of autos c. the theory is widely accepted but
d. reduction in the demand for autos cannot be accurately tested
e. upward shift in demand for autos d. consumers need for gasoline
remains the same regardless of
18. What is the likely impact on the supply price
curve and the price when there is e. all factors are subject to change in
technological progress in an industry? short run

a. The supply curve would

shift upwards and the prices would 22. A review of the performance of the
increase Indian economy during the 1990’s is
primarily the concern of
b. The supply curve will
remain the same and the price
would decline a. macroeconomics
c. The supply curve would b. microeconomics
shift to the left and the prices
c. both macro and micro economic
would decline
d. The supply will decrease d. neither micro nor macro economics
and the price would not change e. welfare economics
e. The supply and price will
increase. 23. Economics is the study of

a. how to make money

19. Price ceiling is likely to result in
b. how to operate a business
a. Increase in supply c. people making choices because
of the problem of scarcity
b. Surplus production
c. Black marketing

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d. the government decision making
process
e. money
24. An increase in the distance between the
isoquants as the output is increased
would indicate
a. Diminishing returns to a
variable factor
b. Increasing returns to a
variable factor
c. Increasing returns
scale
d. Decreasing returns to scale
e. Constant returns to scale.
25 The point beyond which no rational firm
would employ labor is
a. when the average product of labor is
equal to marginal product of labor
b. when the marginal product of labor
is maximum
c. when the marginal product of
labor is zero
d. when total product of labor is zero
e. when the average product of labor is
zero
26. On a production possibilities curve, a
change from economics inefficiency to
economic efficiency is obtained by
a. movement along the curve
b. movement from a point outside
curve to a point on the curve
c. movement from a point inside
curve to a point on the curve
d. a change in the slope of the curve
e. movement from outside the curve to
another point outside the curve
27. The difference between the price an
individual is willing to pay and the price
he or she actually pays is
a. producer cost
b. monopolist profit
c. economic profit
IBS553 ME/ SET – I(KEY)/0906
d. producer surplus
e. consumer surplus
END OF PART - A
28. General equilibrium analysis is
concerned with the analysis of the
a. effect of changes in an individual
market holding other things equal
to b. equilibrium state for the economy
as a whole in which the markets
for all goods and services are
simultaneously in equilibrium
c. effect of change in the equilibrium
point when the demand is kept
constant and supply is changed
d. effect of change in the equilibrium
point when the supply is kept
constant and demand is changed
e. effect of change in equilibrium when
demand and supply are kept
constant while all other things are
varying
29. Given that the elasticity of demand for
the high end cell phones is inelastic,
what is the likely impact on the high end
cell phone producing firm’s revenue in
case there is reduction in the prices of
these cell phones?
a. The revenue would be the
same
b. Revenue would increase
c. Revenue would fall
d. Given a small price change
revenue would increase
e. The impact cannot be
calculated.
30. Which of the following has the lowest
elasticity of supply?
a. luxury items
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b. necessities d. items that have the least budgetary

allocation
c. perishable goods
e. normal goods

PART – B&C

TOTAL MARKS: 70 MAXIMUM TIME: 2½ HOURS

INSTRUCTIONS TO CANDIDATES
Answer Part B & Part C in SINGLE ANSWER BOOKLET.
Write your enrollment number on the first page of the answer book at the space provided
only.
All rough work may be done on any blank page in the answer book
Pencil should not be used for answering
The unused portion of the answer book must be boldly crossed prior to submitting
Attempt all questions
Marks are indicated against each question.

Part–B: (40 Marks)

Problems testing, Conceptual Understanding and Application
Analytical Ability, Case lets, Situational Analysis

1. The Dolan Corporation, a maker of small engines, determines that in 2006 the demand curve
for its product is
P = 2,000 – 50Q
where P is the price (in dollars) of an engine, and Q is the number of engines sold per
month.

a. To sell 20 engines per month, what price would Dolan have to charge?
b. If it sets a price of $500, how many engines will Dolan sell per month?
c. What is the price elasticity of demand if price equals $500?
d. At what price, if any, will the Demand for Dolan’s engines be unitary elastic?

(2 + 2 + 3 + 3 = 10 marks)

Answer:
(a) If Q = 20, P, = 2000 – 50(20) = 1,000
Thus price would have to equal $1000

(b) Since 500 = 2,000 – 50Q, Q = 1,500/50 = 30. Thus, it will sell 30 per month

(c) Because Q = (2,000-P)/50 = 40 – 0.02P,

dQ/dP = -0.02,
Thus, (P/Q)*(∂Q/∂P) = -0.02*500/30 = -0.33

(d) If -0.02*P/(2,000 – P)/50 = -1

-0.02*50P/2,000 – P = -1
P = 2,000 – P
= 2,000/2 = 1,000
Thus, if price equals $1000, the demand is unitary elastic.

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2. The Sun Pharmaceutical Company’s total variable cost function is estimated as follows:
TVC = 50 Q – 10 Q2 + Q3
where Q is the number of output produced.
a. What is the output where marginal cost of production is minimum?
b. What is the output level where average variable cost is a minimum?
c. What are the values of average variable cost and marginal cost at the output specified in
the answer to part (b)?
(4 + 3 + 3 = 10 marks)
Answer:

(a) Since MC is first derivative of total variable cost and equals dTVC/dQ
MC = 50 – 20 Q + 3 Q2
It is a minimum when
dMC/dQ = - 20 + 6 Q = 0
or
Q = 20/6

(b) Average variable cost equals

AVC = TVC/Q = 50 – 10Q + Q2
It is minimum when
d AVC/dQ = - 10 + 2Q = 0
or
Q=5

(c) if q = 5, average variable cost equals

50 – 10 (5) + 5 (5) = 25
MC equals 50 - 20 (5) + 3 (5) (5) = 25
Thus, MC equals average variable cost at this output level .
3. Suppose that the market demand function of a perfectly competitive industry is given
by QD = 4,750 – 50P and the market supply function is given by
QS = 1,750 + 50P, and P is expressed in dollars.

a. Find the market equilibrium price

b. Find the quantity demanded and supplied in the market at P = $50, $40, $30, $20
and $10.
c. Draw the market demand curve, the market supply curve and the demand for one of
100 identical perfectly competitive firms in this industry and explain.
d. Write the equation of the demand curve of the firm.
(2.5 + 2.5 + 4 + 1 = 10 marks)
Answer:

(a) QD = QS
4,750 – 50P = 1,750 + 50P
P = $30 (equilibrium price)

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(b) Market Demand and Supply Schedule

Price ($) QD QS
50 2,250 4,250
40 2,750 3,750
30 3,250 3,250
20 3,750 2,750
10 4,250 2,250

(c) Draw the figure showing how you determine price for a perfectly competitive industry
and firm

(d) P = $30

4. Deep Shawak is hired as a consultant to a firm producing ball bearings. This firm sells in
two distinct markets, one of which is completely sealed off from the other. The demand
curve for the firm’s output in the one market is P 1 = 160 – 16Q1, where P1 is price of the
product, and Q1 is the amount sold in the first market. The demand curve for the firm’s
output in second market is P 2 = 80 – 4Q2, where P is the price of the product, and Q is the
amount sold in second market.
The firms marginal cost curve is 5 + Q, where Q is the firm’s entire output (destined for
either market). The firm asks Deep Shawak to suggest what its pricing policy should be.

a. How many units of output should the firm sell in the second market?
b. How many units of output should the firm sell in the first market?
c. What price should it establish in each market?
(3.5 + 3.5 + 3 = 10 marks)
Answer:

(a) MR1 = 160 – 16Q1

MR2 = 80 – 4Q2
MC = 5 + (Q1 + Q2)
Therefore,
160 – 16Q1 = 5 + Q1 + Q2
80 – 4Q2 = 5 + Q1 + Q2
Or
155 – 17Q1 = Q2
75 – 5Q2 = Q1
Thus
1550- 17(75 – 5Q2) = Q2
155 – 1,275 + 85Q2 = Q2
84Q2 = 1,120
Q2 = 1,120/84 = 13.33
It should sell 13.33 units in the second market

(b) Q1 = 75 – 5Q2
= 75 – 5(1,120/84)
= 75 – 66.66 = 8.33
It should sell 8.33 units in the first market

(c) P1 = 160 – 8(8.66) = 93.66

P2 = 80 – 2(13.33) = 53.33

END OF9 PART - B

 IBS553 ME/ SET – I(KEY)/0906

Part – C: (30 Marks)

Case Analysis / Applications of concepts

5. (a) Professor Rahul Gupta is a University professor working in US. He is considering leaving
the university job and opening a consulting business. For his service as a consultant, he
would be paid $75,000 a year. To open this business, Professor Gupta must convert a
house from which he collects rent of $ 11,000 per year into an office and hire a secretary at
a salary of $15,000 per year. University pays professor Gupta $ 50,000 a year. Based only
on economic decision making, do you predict the professor will leave the university to start
a new consulting business?
(5 Marks)
Answer:
There is difference between accounting profit and economic profit. Accounting profit is the
difference between total revenue and total explicit cost. Explicit cost implies payments to
nonowners of a firm for their resources. Economic profit is total revenue minus explicit and
implicit costs. Implicit cost implies the opportunity costs of using resources owned by the
firm. In the consulting business, the accounting profit is $ 60,000. An account would
calculate profit as the annual revenue of $ 75,000 less the explicit cost of $ 15,000 per
year. However, the accountant would neglect implicit costs. Professor Gupta’s business
venture would have implicit costs of $ 11,000 in forgone rent and $ 50,000 in forgone salary
earnings. His economic profit is -$1000, calculated as the accounting profit of $60,000 less
the total implicit costs of $61,000. So the professor will stay with the university to avoid an
economic loss.

5. (b) Suppose the total cost equation for a monopolist is given by

TC = 500 +20Q2
Let the demand equation be given by
P = 400 – 20 Q
where P is the product/service price and Q is company output/service.
what are the profit –maximizing price and quantity?
(5 marks)
Answer:

Profit maximization condition in monopoly market is MR = MC

The equation for marginal revenue is the derivative of the total revenue equation with
respect to Q. Similarly, marginal cost is the derivative of total cost with respect to quantity.
That is
Because total revenue is price time’s quantity, the total revenue is
TR = 400Q – 20 Q2
MR = dTR/dQ = 400 – 40Q
and
MC = dTC/dQ = 40Q
Profits are maximized by choosing the quantity where marginal revenue equals marginal
cost. Thus
400 - 40Q = 40Q
Solving for Q gives 5 Units as the profit maximizing quantity. Substituting Q = 5 into the
demand equation gives P = 300

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6. Market researchers have studied the market for milk, and their estimates for the supply of
and the demand for the milk per month are as follows

Price per gallon Quantity demanded Quantity supplied

($) (millions of gallons) (millions of gallons)
2.50 100 500
2.00 200 400
1.50 300 300
1.00 400 200
0.50 500 100

(a) Using above data, graph the demand for and the supply of milk. Identify the
equilibrium point. What happens to equilibrium if price rises or falls in the given case
up or below than the equilibrium price respectively?
(b) Suppose the government enacts a milk support price of $2 per gallon. Indicate this
action on your graph, and explain the effect on the milk market. Why would the
government establish such a support price?
(c) Now assume the government decides to set a price ceiling of $1 per gallon. Show
and explain how this legal price affects your graph of the milk market. What objective
would government is trying to achieve by establishing such a price ceiling?

(4 + 3 + 3 = 10 marks)
Answer:

Draw the graph w.r.t. data given in the table and show the equilibrium point, equilibrium
price and quantity at that point on the respective axis.

(a) The equilibrium prie is $1.50 per gallon, and the equilibrium quantity is 300 million
gallons per month. The price system will restore the market’s $1.50 per gallon price
because in either a surplus will drive prices down or a shortage will drive the prices
up.

(b) The support price results in a persistent surplus of 200 million gallons of milk per
month, which the government purchases with taxpayers money. Consequently,
taxpayers who do not drink milk are still paying for milk. The purpose of the support
price is to bolster the incomes of dairy farmers.

(c) The ceiling price will result in a persistent shortage of 200 million gallons of milk per
month, but 200 million gallons are purchased by consumers at price $1 per gallon.
The shortage places a burden on the government to ration milk in order to be fair and
to prevent black markets. The government’s goal is to keep the price of milk below
the equilibrium price of $1.50 pr gallon, which would be set by a free market.

7. Suppose IBM raised the price of its printers, but Hewlett-Packard (the largest seller)
refused to follow. Two years later IBM cut its price, and H-P retaliated with an even deeper
price cut, which IBM was forced to match. For the next five years, H-P raised its prices five
times, and each time IBM followed suit within 24 hours. Does the pricing behavior of these

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computer industry firms follow the Cartel or price leadership model? Why? Explain the
features of both the models giving some examples.
10 marks

Answer:

The pricing behavior follows the price leadership model. The price leader is H-P, which is
the largest and most dominant firm in the computer printer industry. After a price war, IBM
followed each of H-P’s price hikes. Price leadership is a pricing strategy in which a
dominant firm sets the price for an industry and the other firms follow. A cartel is a group of
firms that formally agree to control the price and the output of a product. The goal of the
cartel is to reap monopoly profits by replacing competition with cooperation. OPEC is one
of the most successful cartels in the world.

END OF QUESTION PAPER

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