Q1.

Over the next three years, a firm is expected to earn economic profits of Rs 120,000 in the first
year, Rs 140,000 in the second year, and Rs 100,000 in the third year. After the end of the third year,
the firm will go out of business.
a. If the risk-adjusted discount rate is 10 percent for each of the next three years, what is the value of
the firm (in Rs) ? At what price firm could be sold today?
b. If the risk-adjusted discount rate is 8 percent for each of the next three years, What is the value of
the firm (in Rs). At what price firm could be sold today?

Solution
(a) The value of the firm is Rs 299,924.868, So it could be sold at Rs 299,924.868 or above.
(b) The value of the firm is Rs 310,521.77 at 8%, So it could be sold at Rs 310,521.77 or above.

Q2. Suppose that in their divorce settlement, Pankaj offers Priya Rs. 10 million spread evenly over 10
years, but she instead demands Rs. 5 million now. If the appropriate discount rate is 8 percent, which
alternative is better for Pankaj and which for Priya? What if the discount rate is 20 percent?

Solution
Present value of 10 million spread over 10 years at 8% is Rs. 6,71,081.399. So this a better alternative
for Priya, whereas present value at 20% amounts to Rs 4,192,472.086 which is a better alternative for
Pankaj

Q3. Your institute is considering eliminating the use of trays in the cafeteria as a
way of reducing energy costs.  Advocates indicate that the fewer the number of
trays used, the lower will be the costs of cleaning the trays, resulting in savings on
water and overall energy usage.  Based on an experiment conducted last year in
which students were asked to voluntarily reduce their use of trays, institute was
able to estimate the annual cost savings associated with varying levels of
cooperation, and are given in the table below (See table1 ). In the experiment,
however, it became clear that as students used fewer trays, additional help was
needed to bus tables and clean them after meal periods were over.  Additional labor
costs were estimated to be an additional Rs. 20.00 for every tray no longer used. 
Also, higher energy costs were needed to keep the cafeteria open and lighted to
clean it, amounting to Rs. 500 per 100 trays reduced annually.   

The Director of Food Service is not sure whether to continue the experiment based
on this information, and has asked you to provide input.  Write a half-one  page
report outlining your determination of the appropriate course of action.                                         

Number of Trays No Longer Used Total Cost Savings (Rs)

5,000 100,000
6,000 190,000
7,000 270,000
8,000 340,000
9,000 400,000
10,000 450,000
11,000 490,000
12,000 520,000
13,000 540,000
14,000 550,000

Solution

Number of Trays no Longer Used Total Cost Savings MB Total Cost MC NB

5000 100000   125000   -25000
6000 190000 90 150000 25 40000
7000 270000 80 175000 25 95000
8000 340000 70 200000 25 140000
9000 400000 60 225000 25 175000
10000 450000 50 250000 25 200000
11000 490000 40 275000 25 215000
12000 520000 30 300000 25 220000
13000 540000 20 325000 25 215000
14000 550000 10 350000 25 200000
So in the above table we could notice that we have calculated marginal benefit and marginal cost as
we are already aware that optimal decisions are made at the margin.     I hope its clear how do we
get Marginal cost ..like for each tray reduced you are actually incurring a extra cost of Rs. 25 per so
Total cost for say 5000 plates reduced will be 25*5000 = 125000   , similarly for 6000 tray reduced it
will be 25*6000 = 150000 . Then we can calculate Marginal cost from these figures i.e.  (150000-
125000)/(6000-5000) = 25000/1000 =25.  Similarly calculate MB too. Now I can see till the point the
plates are reduced to 12000, MB > MC so its profitable. After that its not profitable because MC i.e.
25> MB i.e 20 for 13000 plates

Q4. A study conducted by Yahoo! revealed that chocolate is the most popular flavor of ice cream in
America. For each of the following, indicate the possible effects on demand, supply, or both as well as
equilibrium price and quantity of chocolate ice cream.

a. A severe drought in the Midwest causes dairy farmers to reduce the number of milk-producing cattle
in their herds by a third. These dairy farmers supply cream that is used to manufacture chocolate ice
cream.
b. A new report by the American Medical Association reveals that chocolate does, in fact, have
significant health benefits.

c. The discovery of cheaper synthetic vanilla flavoring lowers the price of vanilla ice cream.

d. New technology for mixing and freezing ice cream lowers manufacturers’ costs of producing
chocolate ice cream.
SOLUTION

a. The demand curve for chocolate ice cream Does not shift.
The supply curve for chocolate ice cream
Shifts to the left.

The equilibrium price of chocolate ice cream increases.

The equilibrium quantity of chocolate ice cream decreases.

b. shifts to the right.

does not shift.

increases.

increases.
c. shifts to the left.

does not shift

decreases

decreases
d. does not shift
 shifts to the right

decreases

increases
Q5. A white-water rafting company wishes to raise their rates from $75 to $80 per person. He is afraid
that in doing this, the number of customers will decrease from 100 to 90 per week.

a) What is the elasticity of demand?

b) Should the company raise the price?

Solution

a) Price Elasticity of Demand = % Change in Quantity Demanded / % Change in Price

Therefore, (using Mid-Point Method) % Change in QD = {90-100/ (100+90 / 2 )} * 100 . Which is = -
10.53 %
Now, % Change in Price = {80-75 / (75+80 / 2) } * 100 = 6.45%
Therefore, Price Elasticity of Demand= -10.53% / 6.45% = -1.63. Which is > 1, so Elastic.
b) Increasing price by 1 % will lead to decrease in quantity demanded by 1.63%, so the company
should not increase the price as it will lead to decrease in consumer share in the market, vis-à-vis,
decrease in overall revenue (considering other factors constant).

Q6. The price of gasoline falls and consumer incomes generally increase. In the market for bus rides, we
should expect to see a curve or curves shift. How will the demand curve and supply curve shifts in the
market for bus rides?

Solution

shift down - shift to the left

Falling gas prices reduce the cost of production of bus rides and shift supply down and
to the right. Consumer incomes rise, reducing the demand for bus rides. Option B
describes the shifts.

Q7. If the demand for a product is given by Q = 1000 – 2P 2

, find the elasticity at

1) P = 10.

2) P=15
Comment on your answers in both the parts.
Q8. If the PES is 2.0 for CDS: and the firm supplied 4,000 when the price was $30. If the price increased
from $30 to $36, what will be the new Q?

Q9. Suppose I = entertainment budget; X=video rentals; Y=CDs

You have been given with the consumer utility function as U = X 2/3 Y1/3 and I = $120 and
Px = $2, Py = $10 . Solve for the optimum consumption bundle of the consumer.

Q10. Try the following example:

I = food budget; Good X = health food (H); Good Y = junk food (J)
U = H0.6J0.4
I = $160; Ph = $2; Pj = $1 Solve for consumer optimization bundle.
Q11. When demand is estimated to be p = 50 – 0.5x, calculate the loss in consumer surplus when a tax
drives price from $1 to $5. [Ans : $376]

Q12. Consider the market for corn flour below. What is the social surplus /welfare ?

Q13. Briad spends 150 per month on coffee and buns at the cafeteria. A cup of coffee costs Rs. 15 and a
bun costs 10 Rs.

a) Write the equation for Briad’s cafeteria budget constraint and draw it in a diagram.

b) Assume that Briad never drinks coffee without eating one bun, and never eats buns without drinking
coffee. How much of each will she consume? Draw some of her indifference curves.

c) What do we call goods that are always consumed in the same proportion?
Q14. Every utility function uniquely determines the ordinal preferences, but for any ordinal preferences,
there are many utility functions that represent those preferences . What do you think is it true or false and
why?

Q15. Consider the demand and supply diagram below.

If a price floor of $20 is introduced, then which area will represent the dead weight loss?
Calculate its value.

Q16. John produces and distributes the Libertarian Magazine, "Anarchy." Demand is given by P = 55 -
2Q. His cost function is TC = 100 - 5Q + Q 2.

a. What is this john’s marginal revenue as a function of Q?

b. If john wants to maximize profits, what price does he charge? How much profit and consumer surplus
are generated at this price?

c. If john wants to maximize total social surplus what price does he charge? What are his profits at this
price?

Q17. The marginal product of labor in the production of computer chips is 50 chips per hour. The
marginal rate of technical substitution of hours of labor for hours of machine capital is 1/4. What is
the marginal product of capital?

Q18. Jane’s Juice Bar has the following cost schedules: Quantity Variable cost Total cost 0 vats of
juice $0 $30 1 10 40 2 25 55 3 45 75 4 70 100 5 100 130 6 135 165 Calculate average variable cost,
average total cost, and marginal cost for each quantity

Q19. [23-Sep 2:35 PM] Dr. Rashmi Ahuja

Suppose a firm is currently using 500 laborers and 325 units of capital to produce its product. The
wage rate is Rs 25, and the price of capital is Rs 130. The last laborer adds 25 units to total output,
while the last unit of capital adds 65 units to total output. Is the manager of this firm making the
optimal input choice? Why or why not? If not, what should the manager do?

Q20.

c. Derive the short-run TVC, TFC, and TC functions.

d. Derive SMC, AVC, ATC, and AFC.

Q21.

Q22.
Q23.
 Q24. Calculate the profit maximising qty and price for this monopolist….(1) Q = 100 - p;
(demand curve for firm output)

(2) C(Q) = 1,000 + 20Q; (cost curve)

Q25. 1.Suppose that a monopolist has a total cost (LTC) of 16 + 4Q. Suppose the demand curve is P =
20 – Q. If the monopolist can charge only one price calculate that price ?

2.Suppose that a monopolist has a marginal cost of $4, and a fixed cost of $48. Suppose also that the
demand curve is given by Q = 12 – (P/2).
i)What is the marginal revenue of the monopolist as a function of Q?
ii)What is the profit maximizing price and quantity for the monopolist?
iii)What is the efficient price?
iv)What is the deadweight loss from the monopolist’s maximizing profits?
v)What are the monopolist’s profits at the profit maximizing price?

Q26. Compare the DWL in monopoly with DWL in Perfect competition. Show it via graphs.

Q27. Suppose that two identical firms produce widgets and that they are the only firms in the
market. Their costs are given by C1 = 60Q1 and C2 = 60Q2 , where Q1 is the output of Firm 1 and Q2
the output of Firm 2. Price is determined by the following demand curve: P = 300 - Q where Q = Q1
+ Q2 . a. Find the Cournot-Nash equilibrium. Calculate the profit of each firm at this equilibrium. b.
Suppose the two firms form a cartel to maximize joint profits. How many widgets will be produced?
Calculate each firm’s profit. c. Suppose Firm 1 were the only firm in the industry. How would market
output and Firm 1’s profit differ from that found in part (b) above?
Q28.