# Queen s University Department of Economics ECON 111*S

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1 Queen s University Department of Economics ECON 111*S Take-Home Midterm Examination May 24, 25 Instructor: Sharif F. Khan Suggested Solutions PART A TRUE/FALSE/UNCERTAIN QUESTIONS Explain why each of the following statements is TRUE, FALSE, or Uncertain according to economic principles. Use diagrams where appropriate. Unsupported answers will receive no marks. It is the explanation that is important. [Total 15 marks] A-1. A decrease in the price of coffee and an increase in the wage of workers in the tea industry jointly lead to an increase in both the equilibrium price and quantity of tea. [5 marks] False Coffee is a close substitute of tea. So, a decrease in the price of coffee would lead to a decrease in the demand of tea as people substitute tea for relatively cheaper coffee. The demand curve in the tea market would shift to the left. At the same time, an increase in the wage of workers in the tea industry would increase the cost of production of tea. The profitability of tea industry would decline. The tea industry would respond to this higher production cost by producing less. So, the supply of tea would decrease. This means the supply curve in the tea market would shift to the left. Consequently, the equilibrium quantity of tea would decrease but the effect on equilibrium price of tea is ambiguous. Depending on the magnitudes of the shifts, the equilibrium price can increase, decrease or remain unchanged. In the following figures, I have shown three possible cases. In Figure 1- A, the supply and demand curves shifted in equal size. Consequently, the equilibrium quantity decreased with no change in the equilibrium price. In Figure 1-B, the demand curve shifted to the left relatively more than the supply curve. As a result, both the equilibrium quantity Page 1 of 9 Pages

2 and price decreased. In Figure 1-C, the supply curve shifted to the left relatively more than the demand curve. Consequently, the equilibrium quantity decreased with an increase in the equilibrium price. Since in no case the equilibrium quantity increases, we can conclude that the statement is false. D1 S2 S1 D1 S2 S1 D2 E2 E1 D2 E2 E1 Figure 1-A Figure 1-B D1 S2 D2 S1 E2 E1 A-2. A tax levied on buyers increases the price paid by buyers, while a tax levied on sellers increases the price received by sellers [5 marks]. False Figure 1-C The tax burden is shared by both buyers and sellers depending on the relative elasticity of the demand and supply curves. The inelastic side of the market bears relatively more burden of the tax. It does not matter whether the tax is imposed on buyers or sellers. Consider the standard case where neither of the demand and supply curves is perfectly elastic or perfectly inelastic. Now consider a tax levied on buyers of a good. The initial impact of the tax is on the demand for the good. The supply curve is not affected because, for any given price, sellers have the same incentive to Page 2 of 9 Pages