Assignment

(The purpose of this assignment is to give you an idea about the type of questions that you can
expect in the exam. No marking/evaluation will be done on this assignment. You just solve it on
your own to understand. No need to submit after solving it. I will discuss the questions tomorrow.)

Part A

Underline the most appropriate answer:-

1) When output is doubled if inputs are doubled, the returns to scale is

b) constant

c) decreasing

d) none of the above

2) In a short run perfectly competitive market, the firm will shut down production when the price
of the product is less than

a) average variable cost

b) average fixed cost

c) average total cost

d) marginal cost

3) Producer surplus is defined as

a) Total Revenue minus average total cost

b) Total Revenue minus total variable cost

c) Total Revenue minus average fixed cost

d) Total Revenue

4) Product Homogeneity is related to

b) Monopolistically competitive market

c) Oligopoly market

5) If the demand curve is a horizontal line (given that the price is in the vertical axis and quantity
is in the horizontal axis), then own price elasticity of demand is

a) perfectly inelastic

b) unit elastic

c) perfectly elastic

6) If the two goods are substitutes, the cross price elasticity of demand is expected to be

a) positive

b) negative

c) indeterminate

d) none of the above

7) If the Government imposes a price ceiling (restricts the market price of a particular commodity
at a level which is below the market clearing/ equilibrium price)

a) producer surplus increases

b) producer surplus decreases

c) producer surplus does not change.

8) For an inferior good

a) demand increases as income increases

b) demand falls as income increases

c) demand does not change as income increases

d) none of the above is true

a) necessarily linear

b) necessarily non-linear

c) may or may not be linear.

10) When there are increasing returns to scale

a) the isoquants move closer together as inputs are increased proportionately

b) the isoquants move farther as inputs are increased proportionately

c) the isoquants remain equally spaced as output increases proportionately

d) none of the above is true

11) The short run average cost curve is U shaped because of

a) law of diminishing returns

b) return to scale

c) economies of scale

d) economies of scope

12) Consider the following linear demand function: Q=8-2P (Q and P stands for quantity and price
respectively). The price elasticity of demand will be unity at

a) P=3, Q=2

b) P=2, Q=4

c) P=4, Q=0

d) P=0, Q=8
13) If two inputs used in the production are complement to each other, then isoquants are

a) linear

b) convex

c) concave

d) none of the above is true (Ans: L-Shaped isoquant)

14) Think of a perfectly competitive labor market. Government imposes a minimum wage rate for
the laborers. This minimum wage rate turns out to be higher than the market clearing/equilibrium
wage rate. This government intervention is likely to result

a) excess demand in the labor market

b) unemployment

c) no changes in the labor market compared to the market equilibrium.

d) none of the above is true

15) Suppose the fixed cost of production for a competitive firm in the short run is Rs. 10000. As
it starts production it faces a loss of 12000. The firm should

a) stop production

b) continue production

c) remain indifferent between producing or not producing.

d) none of the above is true

16) Profit maximizing output level is determined where

a) price equals marginal cost

b) average revenue equals marginal cost

c) marginal revenue equals average cost

d) none of the above is true (Ans: marginal revenue equals marginal cost)
17) Price elasticity of supply for a commodity with respect to the price of raw materials is expected
to be

a) positive

b) negative

c) nothing can’t be said about the sign

18) Consider the following Cobb-Douglas production function: Q=K0.5L0.3 (Q,K and L are output,
capital and labor respectively). This production function exhibits

a) Constant return to scale

b) Increasing return to scale

c) Decreasing return to scale (If Sum of power = 1 it’s CRS; less than 1 it’s DRS; greater than 1
then it’s IRS

19) A technological progress causes the output of a firm to

a) increase for each level of inputs

b) decrease for each level of inputs

c) output does not change

d) nothing can be said

20) Under Economies of scale, doubling of output requires

a) more than a doubling of cost

b) exact doubling of cost

c) less than a doubling of cost

d) none of the above is true

22) For a perfectly competitive firm, the following relation holds

23) For which of the following commodities, geographic boundary of the market is most restricted
a) Gold
b) Petrol
c) Housing

24) Consider the supply curve of labor. Suppose the labor supply increases initially as wage rate
increases. But after a certain level of wage rate, labor supply starts declining with the increase in
wage rate. The slope of the labor supply curve is
a) positive throughout
b) negative through
c) initially negative and positive afterwards
d) none of the above is true (As the supply curve is initially increasing [+ve slope] and then
decreasing [- ve slope])
Part B
Answer the following questions:-
1) Are the following statements true or false? Explain your answers. False
a) The elasticity of demand is same as the slope of the demand curve.
 As Slope = -(Delta P / Delta Q) which is an absolute change where as Elasticity = (Delta
Q*P/Delta P*Q) which is percentage change.

b) The cross-price elasticity of demand will always be positive. False (Eg: Car and Petrol)

c) The supply curve of apartments/ housing is more inelastic in the shorter duration of
time as compared to longer duration of time. True

2) Use supply and demand curves to illustrate how each of the following events would affect
the price of butter and the quantity of butter bought and sold: a) an increase in the price of
ghee; b) an increase in the price of milk; c) a decrease in the average income levels.

SB
C = wL + rK

MC = w
P** DB’

P*
DB

Q* Q**

Supply Curve Demand Curve

3) Draw the demand curve for a life saving drug. Using the diagram, try to explain that
consumer surplus is very large for the life saving drug given the market price.

Ans. When we have a perfectly elastic demand the consumer surplus is too large
4) A firm has a fixed production cost of Rs. 5000 and a constant marginal cost of production
of Rs. 500 per unit of output produced.

a) What is the firm’s total cost function? What is the average variable cost and average
cost?

MC, AVC
Ans: TC = TVC + (TFC/5000)

Q; TVC = 500 Q
500 MC = AVC

TC = (500 Q/TVC) = (5000/TFC)

Avarage Total Cost = AVC + AFC

b) What happens to the average cost if the firm continuously increases production?
Ans: As Q goes up AFC starts falling. As Q becomes very large the AC converge towards
the AVC
5) Suppose you are the manager of a watchmaking firm operating in competitive market. Your
cost of production is given by : C=200+2Q2[Q is the level of output and C is the total cost.
The marginal cost of production is 4Q; the fixed cost is Rs. 200.)
a) If the price of watches is Rs. 100, how many watches should you produce to maximize
profit?

C = 200 + 2Q2

FC = 200; MC = 4Q

100 = 4Q
Therefore Q = 25

b) What will be the profit level?

6) Suppose the demand curve for a product is given by Q=300-2P+4I, where I is the average
income measured in thousand of rupees. The supply curve is Q=3P-50
a) If I=25,find the market clearing price and quantity for the product
Ans: QD = 300 – 2P + 4I
I = 25; QD = 300 – 2P + 100
= 400 – 2P
Equilibrium price will be determined from QD = QS
Therefore,
400 – 2P = 3P – 50
5P – 450
Therefore,
P = 90; Q = 400 – 180 = 220
b) If I=50, find the market clearing price and quantity for the product

Similar as above

c) Draw a graph to illustrate your answers.

7) Using a diagram to show that producer surplus increases as market price increases. Explain
carefully the source of the increase in producer surplus.
8) Suppose in the hot summer, demand for ice cream suddenly goes up. Does it imply a higher
equilibrium/market clearing price for ice cream. Explain your answer carefully using a
diagram.

9) Using a diagram, clearly illustrate the cost minimizing input choices of a firm in the long
run? Using the same diagram, show that because of input flexibility in the long run, cost
of production in the long run is less than the cost in the short run.
10) Suppose total revenue of Producer A is Rs. 10000 and the total variable cost he incurs is
Rs. 5000. Apart from that he needs to pay a fixed cost of Rs. 3000. What is the profit and
producer surplus for Producer A? Now we consider Producer B with the same total revenue
and total variable cost. But Producer B incurs a fixed cost of Rs. 4000. Does the profit
earned by Producer B is less than Producer A? What about producer surplus? Explain your
answer.

Producer Surplus = Total Revenue – Variable Cost