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Prices and Markets

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TUTORIAL 2

The market: Demand, supply and elasticities

Practice questions/exercises:

The purpose of this exercise is for you to familiarise yourself with the model of the

competitive market and how it works in practice.

Download the Excel file Tutorial 2 Worksheet from Blackboard under lecture topic 2

and answer Qs 1 and 2 below.

Q1: Market demand

Suppose a product has a demand function given by P=80-2Qd.

(a) Let Q represent the amount of the product consumers are willing and able to buy

at different price levels. What is this concept called? Create a new column of

data to enter the price levels associated with each of these quantities in your

data set.

(b) What is the price level at or above which consumers are unwilling to buy any

quantity of the product? Which part of the demand function above reveals this?

(c) Plot these data as a demand curve on a graph. Does this demand curve follow

the law of demand? Which part of the demand function above reveals the law

of demand? How is this reflected in the graph? What are the possible reasons

behind the law of demand?

(d) Now examine how responsive consumers are to price changes in the product.

What is the appropriate concept called? Using the midpoint method, calculate an

appropriate value to reflect this responsiveness for every time that price falls in

your data set.

(e) Now classify each of these values in terms of responsiveness and interpret them.

What happens to these values for lower and lower prices? Why?

Q2: Market supply

Now assume this product has a supply function given by P=20+2Qs.

Assume further than the first column Q now reflects the quantities firms are willing

and able to supply at different price levels.

(a) What are the price levels associated with these quantities? Enter a new column

of data to show these for every quantity.

(b) Display the resulting supply curve by adding it to the graph which already shows

your demand function. Does the supply curve follow the law of supply?

Please save the answers to your worksheet above, as you will need it again for

Tutorial 3.

Q3: When Anna was studying at university, she had a monthly income of $900 and

bought 4 items of second-hand clothing. Now, she is working full-time with a monthly

income of $3000. She now buys 20 items of second-hand clothing a month.

Compute Annas income elasticity of demand using the midpoint method. What type

of goods are second-hand clothes for Anna?

Q4: Recently, the price of a Kit Kat fell from $1.80 to $1.50. As a result, the quantity

demanded of Mars Bars decreased from 1200 to 1000. What would be the

appropriate elasticity to compute? What does your answer tell you? (use the

midpoint method to compute).

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