Middle East Technical University Spring 2010

Department of Economics
ECON 201
Erol Çakmak
TA: Özlem Tonguç
PROBLEM SET 1
(Questions marked with (*) are to be turned in as homework, due March
5, 2010)
1. Suppose the market for grass seed can be expressed as:
Demand: QD = 100 - 2p
Supply: QS = 3p
a. At the market equilibrium, calculate the price elasticities of supply and
demand. Use these numbers to predict the change in price resulting from a
specific tax.
b. If government imposes a $5 specific tax to be collected from sellers, what is
the
price consumers will pay? How much tax revenue is collected? What fraction
is paid by sellers?
c. (*) If government imposes a 10% ad valorem tax to be collected from sellers,
what is the price consumers will pay? How much tax revenue is collected?
d. Price elasticity of supply is constant at 1. If the supply curve is changed to Q =
8p, price elasticity of supply is still constant at one. Yet with the new supply
curve, consumers pay a larger share of a specific tax. Why?
2. Suppose that a market has the following supply and demand equations:
Demand: QD = 380 - 10p
Supply: QS = 80 + 5p
If the government imposes a specific tax of τ on suppliers, what will be the price
buyers pay and sellers receive, quantity, and government revenue from the tax
(as
functions of τ). What tax level maximizes the revenue the government collects
from
the tax?
3. (Perloff, p.55 q.30) Calculate the price and cross-price elasticities of demand
for
coconut oil. The coconut oil demand function is _ = 1200 − 9.5 + 16.2 + 0.2_,
where Q is the quantity of coconut oil demanded in thousands of metric tons per
year, p is the price of coconut oil in cents per pound, is the price of palm oil in
cents per pound, and Y is the income of consumers. Assume that p is initially 45
cents
per pound, is 31 cents per pound, and Q is 1275 thousand metric tons per year.
4. You have a regular black ink pen and a red ink pen in your pocket when you
attend
microeconomics class. The demand curve for the black pen is P = 4 – QB and the
price
of the black pen is 3 TL. When the price of the red pen falls from 3 TL to 2.5 TL,
the
demand for the black pen changes to P = 6 – QB. From this information show
whether
the pens are complements or substitutes.
5. (Perloff, p.55 q.40) Use calculus to show that an increase in a specific sales tax
t
reduces quantity by less and tax revenue more, the less elastic the demand
curve
6. (*) The local lemon market has the following supply and demand relationships:
__ = 100 − 5 − _ + 2_
__ = 4
where is the price of lemons (per pound), _ is the quantity of lemons in pounds, _
is
the average consumer income, and _ is the price per pound of oranges. Derive
the
equilibrium price and quantity of lemons as functions of the price of oranges and
average consumer income. Use the calculus method of comparative statics to
compute the effects of income and the price of oranges on the equilibrium price
and
quantity of lemons.
7. (*) In the market for tractors, the government imposes a per unit subsidy of S
TL on
the supply side. After the subsidy the market supply function becomes _ = 10 + 6
and market demand is represented by the equation _ = 260 − 4. If the total
amount
of subsidy paid by the government is 2400 TL, what was the quantity transacted
and
price at the market before the subsidy?