### Class 6 notes

```EC102: CLASS 6
Christina Ammon
Overview
 Will go through one question today as an example of what to
do + common mistakes
 Will go through one more next week
 Moodle Quiz 6
Common Mistakes/Tips
 Expected to write half a page for each 5 point sub-question
 Makes sure you answer the question!
• It might seem an obvious conclusion to what you said before but still
need to write it!
 Graphs
• Include them whenever possible
• Use one for every subquestion
 Don’t just describe what happens but why things happen!
• i.e. the equilibrium changes is not enough
• Why does the equilibrium change? Why is the old allocation no longer
an equilibrium
Common Mistakes/Tips II
 Make sure your writing is legible
 Try to use more “technical” language
• E.g. when relative prices change the budget constraint pivots or rotates
 Try to be very exact with your descriptions
 E.g. demand increases is not the same as the demand curve
shifts
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The equivalent would be: demand increases for every price level
Point out when it’s a shift and when we move along the demand curve.
 Market clearing is not the same as an equilibrium in general!
Example question: 2f
 Use a diagram to show the new equilibrium in the
coffee market after the increase in the price of tea and
compare it with the equilibrium before the increase in
the price of tea.
 Graph:
 As coffee and tea are substitutes, the increase in the price of
tea increases the demand of coffee
 As a result, prices go up and quantities demanded increase.
 At the new equilibrium, prices are higher and quantities have
increased.
 As coffee and tea are substitutes, the increase in the price of tea
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means that consumers substitute away from tea and towards coffee.
This increases the demand for coffee for any given price.
Thus the demand curve shifts out.
Now, e1, the equilibrium in the market before the change in the
price of tea, is no longer an equilibrium, as at p1 there is excess
demand.
The excess demand creates a competition for coffee among
consumers, which pushes up prices.
The increase in prices decreases demand and simultaneously
increases supply as producers are willing to supply a larger quantity
for a higher price and we move along the supply curve
This continues until supply equals demand again
At the new equilibrium, of P2 and Q2, prices are higher and
quantities consumed have increased compared to the old equilibrium
Perfect Competition
 Assumptions
• Many, small sellers
• Output is homogeneous
• Perfect information
• There are no barriers to entry
 What does that imply about the equilibrium
• Sellers are price takers
• Profits are zero in the long run
• Sellers do not behave strategically
Perfect Competition
 Price taking
• Sellers or buyers have no market power
• i.e. sellers cannot influence the price at which they are able to sell their
output and buyers cannot influence the price at which they buy the goods
 Strategic Behaviour
• A supplier does not behave “strategically” when it does not anticipate
any reaction by rival suppliers when it chooses its own actions
Question 1
The can industry does not fit the conditions of a perfectly
competitive market structure because:
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Products are homogeneous
There are a lot of producers
Producers are price-takers
Producers behave strategically
Question 2
 The demand of a good is said to be perfectly elastic if its
demand curve:
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Slopes downwards
Slopes upwards
Is vertical
Is horizontal
tion&3
Question 3
 sM is supply by Mash Farm,
sS is supply by Spuds
Suppliers and SSR is market
supply. When the price of
potatoes is 300, the
quantities supplied by Mash
Farm, Spuds Suppliers and
the market are respectively:
 50, 100 and 150
 40, 75 and 150
 40, 75 and 115
 40, 75 and 100
tion&3
Question 4
 When the price of potatoes
rises from 300 to 400, the
elasticity of market supply
is:
• 105/115
• 115/105
• 35/100
• 300/115
Question 4
 Similar to demand elasticity, the elasticity of supply is
 ε = (ΔX/Δp)•(p/X)
 ΔX = 35; Δp = 100; p = 300 and X = 115.
 => ε = (35/100)•(300/115) = 105/115
 <1 => The market supply of potatoes is inelastic
Question&5
Question 5
 The combination of price p1, firm quantity x1 and market
quantity X1 does not identify a long-run equilibrium because:
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Marginal revenue is below marginal cost
Average revenue is above average cost
Explanation
Average revenue is below average cost
Marginal revenue is above marginal cost
The market does not clear
Taxes
 Statutory Incidence
 Economic Incidence
 => In competitive market: Does not matter who carries the
statutory incidence
Question 6
 Assume that the supply of land in London is perfectly inelastic
because the total amount is fixed. If the demand for land in
London is, instead, neither perfectly inelastic nor perfectly
elastic, the burden of a tax on land would be:
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Borne by sellers
Question 6
Question&7
Question 7
 Assume that the supply of houses in Detroit is perfectly elastic
because the is no shortage of houses. If the demand for houses
in Detroit is, instead, neither perfectly inelastic nor perfectly
elastic, the burden of a tax on houses would be:
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