BITS PILANI, K.K.

BIRLA GOA CAMPUS

II SEMESTER 2016-17 COMPREHENSIVE EXAM
Course No. ECON F211 Course Title: Principles of Economics
08/5/2017 Time: 3 Hours Total Marks: 40

NAME_____________________________ID____________________________Section______

MARKS OBTAINED______________

Instructions:
1. Write down your answers for PART A on the question paper and submit with main
answer booklet.
2. Answer PART B in the main answer booklet.
3. Assume fractional answers are feasible, wherever applicable.
4. Write your answers legibly. Overwritten answers will not be rechecked.

PART A

1. Consider a uniform/single price charging monopolist with Total Cost TC = cQ + F ,

where Q denotes output and F denotes fixed cost. It faces an inverse market demand P(Q)
dP
where < 0 . Derive a condition in terms of the price charged by the monopolist so that
dQ
it will
a) obtain positive profit [1]
b) obtain positive producer surplus [1]
c) shut down in the short run. [2]

Solution
cQ + F F
a) π = PQ − (cQ + F ) > 0 ⇒ P > = c + = ATC
Q Q
b) Pr oducerSurplus = PQ − cQ > 0 ⇒ P > c

Shut Down if π (Q > 0) = PQ − cQ − F ≤ π (Q = 0) = − F

c)
⇒P≤c

Note
The question was asked in terms of price charged. Hence it is necessary that you
have isolated & written the condition in terms of price. Any other condition has
been considered as an incomplete answer.

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 2. Suppose Tata Sky is the only service provider in Andaman. It faces demand function P =
50-0.1Q and its total cost of providing service is TC = 500 + Q. Assume that the company
is not able to discriminate among the customers.
a) If the regulator (Telecom Regulatory Authority of India, TRAI) wants to ensure that
there is no deadweight loss in this market, then calculate the regulated price it should
enforce on Tata Sky: _________ [1]
and consequently the profit/loss of Tata Sky:___________ [2]
b) If TRAI wants to ensure that Tata Sky does not incur any loss (i.e. earns zero profit),
then calculate the lowest price it should enforce on Tata Sky: ____________ [2]

Solution

a)
DWL = 0 ⇒ P = MC ⇒ 50 − 0.1Q = 1 ⇒ Q = 490
⇒ π = 1 * 490 − (500 + 490) = −500

b)
π = 0 ⇒ PQ − TC = 0 ⇒ P = AC
500 + Q
⇒ 50 − 0.1Q = ⇒ 0.1Q 2 − 49Q + 500 = 0 ⇒ Q = 479.6,10.4
Q
Q = 479.6 ⇒ Lowest Pr ice = 2.04

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 3. A firm with patented product has Total Cost function TC = 20Q and faces demand
P=100-Q. Assume that the firm is not able to discriminate among the consumers.

a) Calculate the deadweight loss resulting from monopoly equilibrium:_________[2]

b) Now consider two alternative scenarios for the monopolist.

Scenario1: The government enforces a ceiling price = 40 in which case the

monopolist does not invest in R&D since it is worried about future government
regulation. Thus the Marginal cost of production is 20. In this scenario, calculate
Consumer Surplus______________ [1]
Producer Surplus_______________and [1]
Social welfare_____________ [1]

Scenario2: There is no government regulation. Hence the monopolist invests in R&D

which involves a Fixed cost=50. Due to the R&D (you may consider this as a process
innovation) the Marginal cost of production becomes very low. For the sake of
simplifying the analysis, assume that the Marginal cost of production becomes
zero. In this scenario, calculate Consumer Surplus______________ [2]
Producer Surplus_______________and [2]
Social welfare_____________ [1]

Solution
a)
Monopoly : MR = MC ⇒ 100 − 2Q = 20 ⇒ Q = 40, P = 60
Social Optimal : P = MC ⇒ 100 − Q = 20 ⇒ Q = 80, P = 20
DWL = 0.5 * 40 * 40 = 800

b) Scenario1
Ceiling = 40 ⇒ Q = 100 − 40 = 60
CS = 0.5 * (100 − 40) * 60 = 1800
PS = 40 * 60 − 20 * 60 = 1200
SW = 3000

Scenario2
MR = MC = 0 ⇒ 100 − 2Q = 0 ⇒ Q = 50, P = 50
CS = 0.5 * 50 * 50 = 1250
PS = 2500
SW = 3750

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 4. Consider a consumer allocating her fixed income on two commodities X and Y. The
consumer likes to consume more of both goods. Suppose there are three alternative
commodity bundles A, B and C. Based on this information, state whether the following
statements are TRUE or FALSE:

a) The indifference curves of this consumer are negatively sloped: __________

b) If utility from bundle A is greater than utility from bundle B then bundle A must
contain more of both goods X and Y: __________
c) Suppose the preference pattern of a consumer can be represented by convex
indifference curves. Then the expenditure associated with different points on a typical
indifference curve is same:__________ [3]

Solution

a) True: MUX >0 and MUY >0 implies dY/dX= - MUX / MUY <0

b) False:

c) False:

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 5. Consider a hypothetical, economically “Developed Nation” that consumes the following
4 products. The first three products are produced within its geographic boundary and the
fourth product is produced in an “Underdeveloped Nation”.

Quantity Unit Price in Quantity Unit Price in

produced in 2015 2015 produced in 2016 2016
Nutella 15 300 20 350
Rayban sunglass 20 3000 25 5000
Pasta 30 150 20 100
Nike shoes 20 3000 30 3500

a) Taking the Base year =2015, compute: [1X5=5]

i. Nominal GDP in 2015=_________
ii. Nominal GDP in 2016= ___________
iii. Real GDP in 2015=___________
iv. Real GDP in 2016=___________
v. GDP Deflator in 2016=___________

b) Suppose the “Typical basket” of a consumer in the Developed Nation comprises of 1

unit of Nutella, 1 Rayban sunglass, 2 units of Pasta and 1 pair of Nike shoes. Taking
2015 as the Base year, calculate the Consumer Price Index in 2016:____________[3]

Solution
a)
i. Nominal GDP in 2015=_________69000
ii. Nominal GDP in 2016= ___________134000
iii. Real GDP in 2015=___________69000
iv. Real GDP in 2016=___________84000
v. GDP Deflator in 2016=___________159.5

b) CPI=137

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 PART B

6. Consider a perfectly competitive market for an essential commodity, where the demand
curve is highly inelastic and supply curve has positive slope and elastic. Suppose the
government enforces a price ceiling in this market. Using a properly constructed
diagram, examine the change in Consumer Surplus due to the ceiling policy when
compared to initial unregulated market equilibrium. [3]

Solution

Initial Equilibrium: E
@ Enforced Ceiling price PC, quantity transacted in the market = QC
∆CS = (1 + 3) − (1 + 2) = 3 − 2 >=< 0
There is ambiguous effect on the consumers

Note
A ceiling price is effective (i.e. binding) only when it is less than the equilibrium
price. If you have considered a ceiling price above the equilibrium price, then it is
an ineffective policy- hence marks have been deducted.

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 7. Consider a perfectly competitive market for a commodity, where the supply curve is
completely inelastic and demand curve has negative slope and elastic. Suppose the
government enforces a price ceiling in this market. Using a properly constructed
diagram, examine the change in Consumer Surplus due to the ceiling policy when
compared to initial unregulated market equilibrium. [2]

Solution

Initial Equilibrium: E
@ Enforced Ceiling price PC, quantity transacted in the market is still = Q0
∆CS = (1 + 2) − 1 = 2 > 0
Consumers are unambiguously better off.

Note
A ceiling price is effective (i.e. binding) only when it is less than the equilibrium
price. If you have considered a ceiling price above the equilibrium price, then it is
an ineffective policy- hence marks have been deducted.

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 8. Recently, the Kerala government has proposed a “fat tax” on consumption of burgers,
pizzas and other junk food served in branded restaurants. Using a properly constructed
diagram, explain a scenario where the consumers would have to bear most of the burden
of this “fat-tax”. [2]

Solution

Consider inelastic demand curve and relatively elastic supply curve.

In this case, the tax burden on the consumers = (PB – Po )Q1

> tax burden on the producers = (Po – PS )Q1

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 9. Countries around the globe are debating whether to permit agricultural farms to produce
genetically modified (GM) crops, which have their DNA altered through genetic
engineering. The introduction of GM techniques can affect both the quantity of a crop
supplied by the farmers and whether consumers want to buy that crop. Using GM
techniques, farmers can produce more output at a given cost. However, several scientists
and consumer groups have raised safety concerns about GM crops. The objective of this
exercise is to analyze the impact of GM technology on equilibrium price and quantity of
brinjal (a vegetable) produced in India and the USA.

Observation1: In India when compared to the old equilibrium (before GM introduction),

both the price and quantity of brinjal has decreased post GM introduction.

Observation2: During the same time period of analysis in the USA, it has been found
that while price has decreased, the quantity of brinjal transacted in the market has
increased substantially.

Using properly constructed diagram(s) for the two separate markets in the USA and
India, provide economic explanation of these 2 observation(s). [3]

Solution

Indian market:

Given the statement “Using GM techniques, farmers can produce more output at a given
cost”, supply curve shifts outward to the right (more quantity is being supplied at a given
price)

However, “Several scientists and consumer groups have raised safety concerns about GM
crops”. Consequently, demand curve would shift inward (less quantity would be
demanded at a given price).

Observation 1 can be explained when Demand curve shifted MORE than the supply
curve.

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 USA Market

Given the statement “Using GM techniques, farmers can produce more output at a given
cost”, supply curve shifts outward to the right (more quantity is being supplied at a given
price)

However, “Several scientists and consumer groups have raised safety concerns about GM
crops”. Consequently, demand curve would shift inward (less quantity would be
demanded at a given price).

Observation 2 can be explained when Supply curve shifted MORE than the demand
curve.

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