MICROECONOMICS

Problem Set 1
1.You are deciding to buy a new air conditioner for your home, and you have narrowed down
your search two models – one an energy efficient model, and the other the standard model. The
energy efficient model sells for Rs. 25,000 and will save you Rs. 1,250 at the end of each of the
next five years in electricity costs. The standard model has features similar to the energy efficient
model but provides no future saving in electricity costs. It is priced at Rs. 20,000. Assuming your
opportunity cost of funds is 5 percent, which air conditioner should you purchase?

2. Suppose the demand function for corn is Qd =10 − 2p, and supply function is Qs =3p −5 . The
government is concerned that the market equilibrium price of corn is too low and would like to
implement a price support policy to protect the farmers. By implementing the price support
policy, the government sets a support price and purchases the extra supply at the support price.
In this case, the government sets the support price ps = 4.
(a) At the support price ps = 4 find the quantity supplied by the farmers, the quantity demanded
by the market, and the quantity purchased by the government.
(b) Calculate the cost to the government to implement the price support policy. Draw a graph to
show the government cost.
(c) Suppose now the government switches from price support policy to subsidy policy. For each
unit of corn produced, the government subsidizes the farmer s = 5/3. Find the new equilibrium
price under this subsidy policy. How much money will the government have to spend in order to
implement this subsidy policy?

3. You are presented with two business opportunities. The first might generate $40,000 after Year
1, $30,000 after Year 2, and $20,000 after Year 3. The second might generate $20,000 after Year
1, $30,000 after Year 2, and $40,000 after Year 3. Which proposition should you choose if the
prevalent interest rate is 8 percent?

4. In the market for televisions, Samsung estimates that the price elasticity of demand for its 9000
Series LED TVs’ is -12.64 and the cross-price elasticity of demand is 7.35. The company now
reduces the price of this series by 9 percent of its present price level. Explain what would happen
to (a) sales of Samsung’s 9000 Series LED TVs and (b) the demand for this Series if its close
competitor Sony also reduced price for comparable Bravia series by 11 percent.

5. Over the past 25 years, technological advances have reduced the cost of computer chips. How
do you think this affected the market for computers? For computer software? For typewriters?
Explain.

4. A travel company has hired a management consulting company to analyze demand in 26

regional markets for one of its major products: a guided tour to a particular country. The
consultant uses data to estimate the following equation:
Q = 1,500 – 4P + 5A + 10I + 3PX
where Q = amount of the product demanded; P = price of the product in dollars; A = advertising
expenditures in thousands of dollars; I = income in thousands of dollars; PX = price of some other
travel products offered by a competing travel company
a) Calculate the amount demanded for this product using the following data: P = $ 400; A =
$20,000; I = $15,000; PX = $ 500
b) Suppose the competitor reduced the price of its travel product to $400 to match the price of
this firm’s product. How much would this firm have to increase its advertising in order to
counteract the drop in its competitor’s price? Would it be worth for them to do so? Explain.
c) What other variables might be important in helping estimate the demand for this travel
product?

6. Kajal’s utility function is U(x, y) = x2y. She has income M = 240 and faces prices Px = $8 and Py =
$2.
(a) Determine her optimal basket given these prices and her income.
(b) If the price of y increases to $8 and Kajal’s income is unchanged, what must the price of x fall
to in order for her to be exactly as well off as before the change in y’s price?