Question 1
Companies spend millions of dollars on advertising to create an elastic demand for their
product. Do you agree with this statement? Explain your answer.
(10 marks)
The purpose of advertisements is to make their product relatively inelastic to keep customers buying
their products regardless of price increases.
Question 2
Suppose the market demand curve for a certain good is given by P = 800-2Q (Price is in cents and Q
is in kg) and supply curve is given by P = 200 + Q (Price is in cents and Q is in kg).
a. What is the market equilibrium quantity and price?
[12 marks]
b. Show the supply curve, demand curve and market equilibrium on a graph with the
information given above.
[6 marks]
c. Compute price elasticity of demand when price goes from 600 to 400 [10 marks]
d. At the price of 600, show on the graph whether there is a surplus or shortage
[2 mark]
Question 3
The Formula 1 Grand Prix takes place in Abu Dhabi every November.
Draw a Supply and Demand diagram showing the effect of the F1 Grand Prix on the hotel
market in Abu Dhabi with an explanation. (10 marks)
1. See diagram and explanation.
The Grand Prix increases the Demand for hotel reservations (from D to D’) [give students 4
marks for drawing a higher Demand (with correctly labelling the two axis of their figure) and
another 2 marks for explaining briefly this increase]. With a higher demand, equilibrium
1
prices and quantity both go up [give students 2 marks for saying that the equilibrium price
increases; and another 2 marks for saying that the equilibrium quantity also increases].
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________
Question 4
1. Suppose that in Belize, the opportunity cost of producing a sailboat is 5 hang gliders.
In Honduras, the opportunity cost of producing a sailboat is 8 hang gliders. (10
marks)
a. What is the opportunity cost of producing a hang glider for Belize?
______________________________________________________ (2 marks)
b. What is the opportunity cost of producing a hang glider for Honduras?
______________________________________________________ (2 marks)
c. Which country has a comparative advantage in the production of hang gliders?
______________________________________________________ (2 marks)
d. Which country has a comparative advantage in the production of sailboats?
______________________________________________________ (2 marks)
e. Which country would specialize in the production of sailboats?
______________________________________________________ (2 marks)
2
2. a.
For Belize, the opportunity cost of producing a hang glider is 1/5 of a
sailboat.
b.
For Honduras, the opportunity cost of producing a hang glider is 1/8 of a
sailboat.
c.
Honduras has a comparative advantage in the production of hang gliders.
d.
Belize has a comparative advantage in the production of sailboats.
e.
Belize
Question 5
When the price of a movie ticket rises from $4 to $6, the quantity of tickets demanded decreases
from 500 to 400 a day. Calculate the price elasticity of demand for movie tickets. Based on your
result, comment on whether the demand for movies is elastic or inelastic and why.
Definition of Elasticity with formula
Price increases by 50% (from $4 to $6) and the quantity decreases by 20% (from 500 to 400).
Therefore, the elasticity of demand is -20/+50=-0.4. This is inelastic demand (<1) because the
responsiveness of quantity demanded is less than the responsiveness of the price change.
Question 6
Consider the market for petrol in the UAE as depicted in the diagram below.
3
Price (AED per liter)
1.6
1.4
1.2
1
0.8
0.6
0.4
0.2
0
0
2
4
6
8
10
12
14
16
Quantity of petrol
Quantity demanded (thousands of liters per week)
Quantity supplied (thousands of liters per week)
a) If the UAE government decides to introduce a production quota at 4 thousands of liters
per week, what will the resulting price of petrol be in the market? Explain your
answer.
b) Estimate how much the Consumer surplus is after the introduction of the government
policy.
c) Is this government policy resulting in an efficient outcome? Explain your answer.
a) If the UAE government decides to introduce a production quota at 4 thousands of liters
per week, what will the resulting price of petrol be in the market? Explain briefly your
answer. [8 marks]
The supply curve becomes perfectly inelastic at 4 thousands of liters; therefore, the price of
petrol will rise to 1.2 AED per barrel (this is the point of intersection of the new perfectly
inelastic S curve with the D curve).
b) Estimate how much the Consumer surplus is after the introduction of the government
policy. [6 marks]
It is the triangular area below the D curve for a quantity up to 4 and a price up to 1.2: the area
is (½) (4) (1.4-1.2)=0.4
c) Is this government policy resulting in a efficient outcome? Explain briefly your answer.
[12 marks]
This move is not Efficient, because the production quota will be decreasing the producer’s
surplus and clearly decreases the consumers’ surplus. When at least one party (here, it seems
it seems it is both parties) becomes worse off, then the government policy cannot be Efficient.
Also very important is that a deadweight loss is created, which is a loss to society!
4
Question 7
Your grandmother has asked you to drive her from home, located in the Abu Dhabi downtown
area, to Dubai. Just as you leave from home (and while you are still in the Abu Dhabi downtown
area) you stop at the nearest Baqala store to buy a bottle of water for yourself. You pay 1.5AED
for that bottle of water and you consume all of it immediately.
While driving through the highway on your way to Dubai, your grandmother feels thirsty. You
now stop at the first available ADNOC Oasis and buy her a bottle of water. You, nevertheless,
find that you now have to pay 3AED for exactly the same bottle of water you had purchased
for yourself earlier (at the Baqala store).
Explain briefly, using economic theory, why the ADNOC Oasis store charges a higher price
than the Baqala store for exactly the same bottle of water.
Note: You should use arguments drawn only from economic theory (i.e., do not say, for
instance, that it is your grandmother’s fault that you have to pay 3AED for exactly the same
bottle of water).
The demand for water is inelastic in the middle of the highway, meaning that there are no
substitutes (i.e., other shops) in the middle of the highway. Therefore, the owner of the ADNOC
Oasis shop knows that he can charge more for exactly the same bottle of water (than the stores
in the middle of the city): since the demand is inelastic in the middle of the highway, even if
he increases the price a lot, the quantity demanded will only slightly drop.
5