ECS1501. Tutorial letter 202/2/2017. Economics I. Semester 2. Department of Economics ECS1501/202/2/2017

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1 ECS1501/202/2/2017 Tutorial letter 202/2/2017 Economics I ECS1501 Semester 2 Department of Economics IMPORTANT INFORMATION: This tutorial letter contains important information about your module.

2 Dear Student The purpose of this tutorial letter is to provide you with the correct answers to Assignment 02, which was included in Tutorial Letter 101/3/2017. Note the same line of argument was followed in answering and explaining the questions as the one suggested in tutorial letter 201/2/2017: Step 1: Read the stem of the question carefully (it usually contains the answer). Step 2: Try to answer the question without looking at the alternatives (this is usually possible) Step 3: Only now do you look at the alternatives. Select the one which matches/corresponds/is the same as your answer in step 2. Step 4: Proceed to the next question. Remember we said the other alternatives (the incorrect ones) are called distractors their function is to distract your attention from the correct option and to mislead you. Stay focused on what is correct. In our explanations we might refer to some of the distractors to indicate where the catch in the statement is. Make sure if your answers were correct or incorrect. If you had an incorrect answer, use it as a valuable learning opportunity by finding out why you were wrong and what the correct answer is. Even if you had an answer correct, make sure that you understood it and not merely guessed the correct answer. This work is important and it will be covered in the examinations as well. Remember, only with hard work can we be successful. Regards Your lecturers ECS S2@unisa.ac.za SOLUTIONS TO ASSIGNMENT The correct alternative is [3]. There are 3 key factors to remember in the definition of demand. First, the what question. It is the amount of goods and services. Second, the who question: that an individual or a consumer is willing and able to buy or purchase at a given market price. Third, the when question: at a given time period. There has to be an element of willingness to buy and the ability to buy. 2

3 ECS1501/ The correct alternative is [3]. The market demand aggregates the total quantity demanded by all individuals at each particular price level. Individual demand is concerned about the quantity demanded by each individual at each particular price level. 2.3 The correct alternative is [2]. Recall that according to the law of demand, there is a negative relationship between quantity demanded and price. Therefore, as the price of a kg of potatoes increases, Themba is forced to reduce the quantity of potatoes she buys. 2.4 The correct alternative is [3]. This question deals with shifts of versus movements along curves. The easiest way to deal with the distinction between the two is to remember that if there is a change in price (and only if there is a change in price), we have a change in quantity demanded. A change in quantity demanded is shown by a movement along the demand curve. If any of the other determinants of demand change (income, taste, fashion ) there is a change in demand, which is illustrated by a shift of the demand curve. Sarah s salary (income) increases. In other words, we deal with a change in one of the non-price determinants of demand. Statements [1] and [2] refer to an increase in quantity demanded and can thus be ignored. Statement [4] refers to a movement along a demand curve (from A to E) and is therefore also not correct. As Sarah s salary increased by R , her demand for socks will increase. This is represented by a shift of the demand curve from D 2 to D 3 (point s b to d). 2.5 The correct alternative is [1]. The law of supply posits a positive relationship between price and quantity supplied. 2.6 The correct alternative is [2]. The price factor impacts on the quantity supplied. A change in price will result in either an increase or a decrease in quantity supplied. In this case, a 10% increase in the price of beef will result in an increase in the quantities of beef supplied by Beef R Us. 3

4 2.7 The correct alternative is [2]. The emergence of the mad cow disease forced farmers to look for healthier grazing areas and also safe drinking water. This represents an increase in cost to the farmers. The increased production cost (which is a determinant of supply) will result in a decrease in the supply of cattle products. Hence one would expect an inward (leftward) shift of the supply curve from S to S The correct alternative is [4]. The decrease in water tariff implies a reduction in production costs to the grape farmers. This will enhance the farmers ability to produce and supply more grapes. The outcomes of the first three alternatives are the same a decrease in supply: Statement [1], an increase in the wage rate constitutes an increase in production costs and thus a decrease in supply. Statement [2], a decrease in labour productivity reduces supply and, statement [3], the planting of non-drought resistant crops during a drought season will reduce supply. 2.9 The correct alternative is [3]. Recall that at equilibrium quantity demanded equals quantity supplied. Thus first equate Qd=Qs Qd = Qs P = = 120P 900 = 150P 150P = P = 150 = P 30P To obtain the equilibrium quantity, substitute the P=6 into either the Qd or Qs equations Qd = P = 600 = 600 = (6) 180 4

5 ECS1501/202 or Qs = P = = = (6) The correct alternative is [4]. You will need to calculate the quantity demanded and quantity supplied at a price of R8, thus you have to substitute P = 8 into the Qd or Qs equations. Qd = P = 600 = 600 = (8) 240 and Qs = P = = = (8) 960 Quantity supplied is more than quantity demanded, thus we have excess supply or a surplus (and statements [1] and [2] can be ignored). How big is the surplus? Surplus = = The correct alternative is [3]. Any price above the equilibrium price results in an excess of supply. 5

6 2.12 The correct alternative is [2]. Consumer surplus is the difference between the price a consumer pays for a good and the price he/she is willing to pay for the good The correct alternative is [2]. This question asks what will happen to the equilibrium quantity if demand and/or supply changes. More specifically, it asks under which circumstances can the effect on the equilibrium quantity not be determined (indeterminate). The easiest way to determine the effect on equilibrium quantity is to draw diagrams depicting each of the scenarios. For example, statement [1] refers to an increase in demand and an increase in supply: The increase in demand is shown by a rightward shift in the demand curve and it leads to an increase in the equilibrium quantity. 6

7 ECS1501/202 The increase in supply is shown by a rightward shift of the supply curve. This shift also leads to an increase in equilibrium quantity. Both the increase in demand and the increase in supply lead to an increase in equilibrium quantity. We can thus conclude that the equilibrium quantity will definitively increase (we can determine what will happen to the equilibrium quantity). Alternative [1] is therefore not correct. Alternative [2]: The decrease in demand is illustrated by a leftward shift of the demand curve leading to a decrease in the equilibrium quantity. 7

8 From statement [1] we know that an increase in supply increases the equilibrium quantity. What is the net effect of a decrease in demand and an increase in supply on the equilibrium quantity? If we show the two shifts on the same diagram we see that the equilibrium quantity decreases. Yes, we find that the equilibrium quantity decreased. But is this always true? What would have happened if the increase in supply is greater than the decrease in demand? The net result is an increase in the equilibrium quantity. 8

9 ECS1501/202 The decrease in demand could also be equal to the increase in supply. In this instance the equilibrium quantity stayed the same. In all three scenarios we saw the effect on equilibrium quantity depend on the relative sizes of the shifts of the supply and demand curves. Thus, the equilibrium quantity could increase, decrease or stay the same. That is, the effect on the equilibrium quantity is indeterminate. You can test whether alternatives [3] and [4] are indeed incorrect by drawing diagrams The correct alternative is [2]. Passenger planes and jet fuel are complements. Thus as the prices of passenger planes increase, the quantity demanded of passenger planes will decrease. If fewer planes fly, less jet fuel is required, the demand for jet fuel will also decrease shown by a leftward shift of the demand curve It is impossible to answer this question with the given information. All students were credited with the marks for this question. 9

10 2.16 The correct alternative is [4]. ee pp = QQ PP PP QQ ( ) = (19 17) = = 7, With price elasticity of demand, we always use absolute values, this means we ignore the negative sign. Therefore, the price elasticity of demand is 7, The correct alternative is [4]. The income elasticity coefficient of 2 indicates that Samsung TV is considered a normal good (e y is positive and >1). Thus as income decreases, one would expect that the quantity demanded will also decrease. In this case, there will be a 20% decrease in the quantity of Samsung flat screens purchased: IIIIIIIIIIII eeeeeeeeeeeeeeeeeeee ee yy = % QQQQ % YY Substitute the given information into the equation and solve % QQQQ 2 = % QQQQ 10% 2 10% = % QQQQ % QQQQ = 20% (Note with income elasticity of demand (and cross elasticity), we never disregard the negative sign as it tell us something about the nature of the product(s).) 10

11 ECS1501/ The correct alternative is [3]. Tea and milk are complements. Thus if the price of one rises, the quantity demanded of the other decreases and vice-a- versa. Cross elasticity of demand is calculated as follows: CCCCCCCCCC eeeeeeeeeeeeeeeeeeee (ee cc ) = % QQQQ oooo pppppppppppppp BB (mmmmmmmm iiii tthiiii iiiiiiiiiiiiiiii) % PP oooo pppppppppppppp AA (tttttt) = 12% 6% = 2 Remember the negative sign is important when we deal with cross elasticity as it tells us that the two products (tea and milk) are complements The correct alternative is [2]. Recall that when demand is inelastic, price and total revenue move in the same direction, and when demand is elastic, price and total revenue move in opposite directions. Therefore, given that the demand for air travel is elastic during the off peak season, increasing price during this period will result in a decrease in the total revenue. However increasing the price during the peak travel season, when the demand is inelastic will result in an increase in the total revenue The correct alternative is [3]. From our discussion of elasticity we know that the broader the definition of a product, the smaller the price elasticity of demand tends to be. I think most South Africans will agree there are no substitutes for maize meal. The price elasticity of maize meal is therefore small. However, if we divide the demand for maize meal into all the different brands (Iwasa, Sun, Impala, Ace and so on) we find that the price elasticity of the individual brands tend to be more elastic because of the availability of substitutes. **** ***** **** 11