Question 1 10 marks

Part A
Australia produces ethanol from sugar cane, and the land
used to grow sugar cane is used to grow food crops.
Suppose that Australias production possibilities for
ethanol and food crops are as in the table.
Solution:
The PPF graph of Australia is


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5
6
0 10 20 30 40 50 60 70 80
F
O
O
D

C
R
O
P
S

I
N

T
O
N
S
/
D
A
Y
ETHANOL IN BARRELS/DAY
PPF
Ethanol
(barrels
per day)
Food
crops
(tonnes
per day)
70 0
64 1
54 2
40 3
22 4
0 5


a) If Australia increases its production of ethanol from 40 barrels per day to 54
barrels per day, what is the opportunity cost of an additional barrel of ethanol?
(1 mark)
If Australia increases its production of ethanol from 40 barrels to 54 barrels, the opportunity
cost in the terms of tons of food crops is 1, because if Australia increases the production fro 40
to 54 barrels then Australia have to forgo the 1 ton of food crops.

b) Does Australia face an increasing opportunity cost of ethanol? What feature of
Australias PPF illustrates increasing opportunity cost? (1 mark)
Answer
The convexity of the PPF illustrates increasing opportunity cost. As from the graph of PPF it
is clear that the graph is convex in nature i.e. flat at the top and steep at the bottom. According
to PPF, Australia is facing an increasing opportunity cost of ethanol. For example If Australia
increases its production of food crops from 1 tons to 2 tons, the opportunity cost is 10 barrels
of ethanol but If Brazil increases its production of food crops from 2 tons to 3 tons, the
opportunity cost is 14 barrels of ethanol and so on.


The table sets out the demand and supply schedules for banana.








(c) Draw a graph of the market for banana. What are the equilibrium price and
quantity? Explain why. (1 mark)

The equilibrium price 2.50 and the equilibrium quantity is 2250 boxes of banana a week. This
is the equilibrium price and quantity because at this point both the supply and demand are
equal.
0
1
2
3
4
5
6
7
0 500 1000 1500 2000 2500 3000 3500 4000 4500
P
r
i
c
e
Quantity
QD QS
Price
(dollars
per box)
Quantity
demanded
Quantity
supplied
(boxes a week)
6 500 4000
5 1000 3500
4 1500 3000
3 2000 2500
2 2500 2000
1 3000 800

(d) If the price of banana was $1.50 a box. What would be the situation in the banana
market (shortage or surplus)? Explain why and how the price and quantity
would adjust?
If the price of banana was $1.50 a box then it would create a shortage in the market because at
this point the demand of banana increases but suppliers dont want to sell bananas at this price
so supply decreases which creates the shortage in the market. As the shortage exist price of
bananas automatically adjust i.e. the price increases due to this the demand decreases and
supply increases and a point come at which the price and quantity will again come at
equilibrium.

(e) Suppose a cyclone destroyed some banana farms in QLD and the quantity of
banana supplied decreased by 500 boxes a week at each price. Explain what
would happen to the market supply and demand and how would the equilibrium
price and quantity adjust? Illustrate the changes on your graph.
If the supply of Bananas decreases by 500 boxes a week then the new quantity supplied
would be
Price
(dollars
per box)
Quantity
demanded
Quantity
supplied
Quantity
supplied
New
(boxes a week)
6 500 4000 3500
5 1000 3500 3000
4 1500 3000 2500
3 2000 2500 2000
2 2500 2000 1500
1 3000 800 300

As from the graph it is clear that as the supply decreases because of cyclone the supply curve
shifts towards left and it increases the price to $3 and decreases the quantity to 2000 boxes a
week. So at this point the market again is at equilibrium.
(f) Suppose a cyclone decreased banana supply by 500 boxes a week at each price.
But at the same time the demand for banana increased by 500 boxes a week at each
price. Explain what would happen to the market equilibrium price and quantity?
Illustrate the changes on your graph. (3 marks)
If the supply of Bananas decreases by 500 boxes a week and at the same time the demand of
bananas increases by 500 boxes a week then

Price
(dollars
per box)
Quantity
demanded
Quantity
Demanded
New
Quantity
supplied
Quantity
supplied New
(boxes a week)
6 500 1000 4000 3500
5 1000 1500 3500 3000
4 1500 2000 3000 2500
3 2000 2500 2500 2000
2 2500 3000 2000 1500
1 3000 3500 800 300
0
1
2
3
4
5
6
7
0 500 1000 1500 2000 2500 3000 3500 4000 4500
P
r
i
c
e
Quantity
QD QS QsN



As the supply decreases by 500 units it shifts the supply curve inwards but if the demand
increases by 500 boxes also then it would increases the demand at the demand curve will shift
outward thus increasing the price to $3. As from the graph if this happens then only the price
will increase in the market but the equilibrium quantity remains constant.

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1
2
3
4
5
6
7
0 500 1000 1500 2000 2500 3000 3500 4000 4500
P
r
i
c
e
Quantity
QD QS QsN QdN
Question 2 10 marks
Part A
A tour agencys demand schedule for hotel rooms is
given in the table.
(a) What happens to total expenditure of the tour
agency if the price falls from $400 to $350 per
night per room? Is the demand for hotel room
elastic, inelastic, or unit elastic? (1 mark)
Solution:
Criteria:
i. If fall in price of a commodity causes total expenditure (or total revenue) to increase,
demand for the good is elastic (E > 1).
ii. If fall in price of a commodity causes total expenditure (or total revenue) on a
commodity to decrease, demand for the commodity is inelastic (E < 1).
iii. If changes in price of a good do not bring about any change in total expenditure, (i.e.
total revenue) demand for it is unitary elastic. (E=1)
When the price of a room is $400, 4 rooms per night are demanded and total expenditure of
the tour agency would equals to $1600. As the price of a chip falls to $350 per night, the
number of rooms demanded increases to 6 rooms and the agency bears the cost of $2100. The
total expenditure increases when the price falls.
As the decrease in the price of a hotel rooms causes the total expenditure to increase, so
demand for the hotel room is elastic, if the price falls from $400 to $350.
(b) What happens to total expenditure of the tour agency if the price falls from $300 to
$250 per night? Is the demand for hotel room elastic, inelastic, or unit elastic? (1
mark)
When the price of a room is $300, 8 rooms per night are demanded and total expenditure of
the tour agency would equals to $2400. As the price of a chip falls to $250 per night, the
number of rooms demanded increases to 9 rooms and the agency bears the cost of $2250. The
total expenditure decreases when the price falls from $300 to $250. The demand is inelastic
in nature because as the price falls total expenditure decreases so the demand for the hotel
room is inelastic
Price
(dollars
per night per
room)
Quantity
demanded
(no. of
rooms
per night)
200 10
250 9
300 8
350
400
6
4
(c) Calculate the demand elasticity of the hotel room, when the price falls from $400 to
$350 per night per room and when the price falls from $300 to $250, respectively
Demand elasticity of demand when the price falls from $400 to to $350.
Elasticity of Demand =
%
%

Elasticity of Demand =
(64)/4
(350400)/400

=0.5/- 0.125
= - 4
Elasticity of Demand =
%
%

Elasticity of Demand =
(98)/8
(250300)/300

= 0.125/ - 0.167
= - 0.74
PART B) When Hanas income was $3,300, she bought 5kgs of rice and 2kgs of beef a
month. Now her income is $4,400 and she buys 4.5kgs of rice and 2.75kgs of beef a
month.
(d) Calculate Hanas income elasticity of demand for beef. Show your calculation. (1
marks)
We know that
Income Elasticity of Demand =
%
%

Income Elasticity of Demand =
(
2.752
2
)100
(
44003300
3300
)100

Income Elasticity of Demand =
.%
.%

=1.13
(e) Calculate Hanas income elasticity of demand for rice. Is rice normal good or
inferior good? Show your calculation. (2 marks)
According to given data
Income Elasticity of Demand =
(
4.55
5
)100
(
44003300
3300
)100

=
10%
33.3%

= - 0.30
Rice is inferior good for Hana because negative income elasticity of demand is associated
with inferior goods also Income elasticity of demand is less than zero i.e. an increase in
income will lead to a fall in the demand.
Suppose a flood cuts the quantity of sugar cane grown by 4 per cent.
(f) If the price elasticity of demand for sugar cane is 0.5, by how much will the price
of sugar cane rise? Show your calculation. (1 marks)
As the flood cuts the quantity of sugar can by 4 % which means that the price of wheat will
rise by 8%.
Price Elasticity of Demand =
%
%

0.5 =
4%
%

% change in Price =
4%
0.5

% change in Price= 8%

(g) If sugar makers estimate that this change in the price of sugar cane will increase
the price of sugar by 15 per cent and decrease the quantity demanded for sugar by
3 per cent, what is the price elasticity of demand for sugar? Show your calculation.
(1 marks)
If 8% of change in price of sugarcane will increase the price of sugar by 15 per cent and
decrease the quantity demanded for sugar by 3 per cent then the price elasticity of demand
would be 0.2.
As we know that
Price Elasticity of Demand =
%
%

Price Elasticity of Demand =
%
%

= 0.2
(h) If coffee makers estimate that, with the change in the price of sugar, the quantity
of coffee demanded will decrease by 6 per cent, what is the cross elasticity of
demand for coffee with respect to the price of sugar? (1 marks)
If by 15% of the change in the price of sugar, the quantity of coffee demanded decreases by
6 per cent then the cross elasticity of demand for coffee with respect to the price of sugar
would be 0.4.
Cross Price Elasticity of Demand =
%
%

=
%
%

= 0.4
Question 3 10 marks
Part A
The table shows the demand and supply schedules
for low-cost housing.
(a) If the government puts a rent ceiling of $650
a month, what is the rent paid and how
many rooms are rented? Explain why? (1
mark)
The maximum price a seller is allowed to charge for a product or service. If the government
puts a rent ceiling of $650 a month (above market equilibrium rate) then the outcome is the
market equilibrium rent of $600 a month with 2,000 apartments. The reason is that this the
rent at which the demand and supply is same so if they charge high prices then it would
create a surplus.



400
450
500
550
600
650
700
750
0 500 1000 1500 2000 2500 3000
R
e
n
t
No of Rooms
demand
supply
Rent
(dollar per
room)
Quantity
demanded
(rooms)
Quantity
supplied
(rooms)
500 2,500 1,500
550 2,250 1,750
600 2,000 2,000
650 1,750 2,250
700 1,500 2,500

(b) Now the government strictly enforces a rent ceiling of $550 a month. How many
rooms are rented? Is the low-cost housing market efficient? Explain why.
If the government strictly enforces the rent ceiling of $550 a month then the number of
apartments rented is 1,750 and the rent is $550 a month because that is the maximum rent
that suppliers have to charge. Low cost housing market is not efficient because it would
create a shortage in the market i.e. people demand is more but at low price the supplier will
supply less in the market. The resulting shortage of goods can lead to consumers having to
queue up in line to get the goods, government rationing, and even the development of a
black market dealing with the scarce goods.
(c) If the government strictly enforces a rent ceiling of $550 a month, what happens to
consumer surplus and producer surplus? Using the table information, draw a
diagram to explain. Also, calculate total housing search costs and deadweight loss.
Show your calculation. (3 marks)


Without a rent ceiling, the market produces an efficient 2000 units of housing at a rent of
$600 a month. A rent ceiling of $550 a month decreases the quantity of housing supplied to
1750 units. Producer surplus and consumer surplus shrink and a deadweight loss arises. The
orange rectangle represents the cost of resources used in increased search activity. The full
loss from the rent ceiling equals the sum of the red rectangle and blue triangle. The highest
rent that someone would offer is $650 a month. The shaded region in the graph shows the
400
450
500
550
600
650
700
750
1500 1750 2000 2250 2500 2750
R
e
n
t
No of Rooms
demand
supply
Rent Ceiling
Consumer
surplus
Producer
surplus
Housing
Search Cost
Deadweight
Loss
dead weight loss. No the low cost housing is not efficient because it would create a surplus
in the market.
The deadweight loss equals the area of the blue triangle:
Deadweight loss = x base x height
Deadweight loss = (2000 1750) x (650 550).
= (250)(100)
=$12500.
Housing search cost equals to the area of the orange rectangle
= Length x width
= (650-550) x (1750-1500)
=100 x 250
= $25000
Part B
The US Farm Bill 2012 indicates that the domestic price of wheat will be maintained
at $350 per tonne, which is above the market equilibrium level of $300 per tonne, in
order to support for domestic wheat growers. At the market equilibrium, 100 tonnes
are supplied.
(a) Is the wheat price control in the US a price floor or a price ceiling? (1 mark)
The wheat price control in US is an example of price floor i.e. the market equilibrium price is
$300 but government as imposed a price floor of $350 which supports the suppliers so that
suppliers produces more and provide more in the economy.
(b) On a graph, show and explain if the price control in the US creates a shortage or
a surplus in the market for wheat. Assume that the US does not trade wheat
internationally. (2 marks)
If the US does not trade wheat internationally then by setting a price floor of $350, it would
create a surplus in the economy i.e. the supply will be greater than the demand. As the more
prices attracts producers attention to increase the profit they will produce more but at high
prices people demand less so it would create a surplus in the economy.


(c) Show on a graph and explain how the price control in the US changes consumer
surplus, producer surplus, and deadweight loss in the domestic wheat market. (2
marks)


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100
150
200
250
300
350
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40 60 80 100 120 140 160 180
P
r
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c
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Quantity
QS
Qd
Price Floor
Surplus
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50
100
150
200
250
300
350
400
450
500
40 60 80 100 120 140 160 180
P
r
i
c
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Quantity
QS
Qd
Price Floor
Consumer Surplus
Producer Surplus