1. THE ECONOMY: THE CORE PROJECT

2. UNIT 8. SUPPLY AND DEMAND : PRICE TAKING AND COMPETITIVE MARKETS

3. T8.1 Price-taking firms
The market demand curve of a particular good is downward-sloping. Based on this information, which of the following statements is correct regarding a price-taking firm producing that good?
Select one answer
The demand curve faced by the firm is downward-sloping.
The firm chooses the price that equals its marginal cost.
The firm chooses its output such that the marginal cost equals the price.
A price-taking firm cannot be profit-maximising.
Section 8.3

4. ANSWER: T8.1 Price-taking firms
The market demand curve of a particular good is downward-sloping. Based on this information, which of the following statements is correct regarding a price-taking firm producing that good?
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The firm does not face the market demand curve, but instead faces a curve determined by the price charged by all other firms. Therefore the firm’s demand curve is horizontal.
The firm cannot choose the price; it is a price-taker.
The firm can only choose output, taking the price as given. To maximise profits, the firm chooses the output such that marginal cost equals price.
d. By profit-maximising, a price taking firm chooses the output that equates its marginal cost with the market price.
Select one answer
The demand curve faced by the firm is downward-sloping.
The firm chooses the price that equals its marginal cost.
The firm chooses its output such that the marginal cost equals the price.
A price-taking firm cannot be profit-maximising.
Section 8.3

5. T8.2 Consumer and producer surplus
The following diagram shows the consumer and producer surplus in the market for bread. Consider changes in the elasticities of the demand and supply curves. Assuming that the market equilibrium output and price are unchanged, which of the following statements is correct?
Select one answer
A less elastic supply curve will lead to a larger producer surplus.
A more elastic demand curve will lead to a smaller producer surplus.
A less elastic demand curve will lead to a smaller consumer surplus.
Consumer and producer surplus do not depend on the elasticities of the demand and supply curves.
Section 8.5

6. ANSWER: T8.2 Consumer and producer surplus
The following diagram shows the consumer and producer surplus in the market for bread. Consider changes in the elasticities of the demand and supply curves. Assuming that the market equilibrium output and price are unchanged, which of the following statements is correct?
Select one answer
A less elastic supply curve will lead to a larger producer surplus.
A more elastic demand curve will lead to a smaller producer surplus.
A less elastic demand curve will lead to a smaller consumer surplus.
Consumer and producer surplus do not depend on the elasticities of the demand and supply curves.
Feedback
A less elastic supply curve has a steeper slope, which increases producer surplus.
A more elastic demand curve means a flatter curve. This will lead to a smaller consumer surplus. It does not affect the producer surplus if the market equilibrium output and price remain the same.
An inelastic demand curve is steeper, which will lead to a larger consumer surplus.
Less elastic demand or supply means steeper curves, which will increase the consumer or producer surplus, respectively.
Section 8.5

7. T8.4 The effect of taxes
The following diagram depicts the demand and supply curves in the salt market. It also depicts the shift in the supply curve due to a 30% tax on the price of salt. Now suppose that the market demand curve for salt is less elastic than in the diagram. The equilibrium before tax is still at (Q*, P*). Let the post-tax equilibrium be denoted by (Q2 , P2) (not shown on the diagram). Based on this information, which of the following statements is correct?
Select one answer
For the prices, P* < P2 < P1.
For the outputs, Q1 < Q2 < Q*.
The tax revenue raised would be lower if the demand curve were less elastic.
Proportionally, more of the burden of the tax would be on the producer if the demand curve were less elastic.
Section 8.7

8. ANSWER: T8.4 The effect of taxes
The following diagram depicts the demand and supply curves in the salt market. It also depicts the shift in the supply curve due to a 30% tax on the price of salt. Now suppose that the market demand curve for salt is less elastic than in the diagram. The equilibrium before tax is still at (Q*, P*). Let the post-tax equilibrium be denoted by (Q2 , P2) (not shown on the diagram). Based on this information, which of the following statements is correct?
Feedback
Less elasticity implies a steeper demand curve. Therefore, P2 will be higher than P1.
The demand curve would be steeper, so the equilibrium quantity demanded would be in between Q1 and Q*.
The government’s tax revenue would be greater if the demand curve were steeper. Alternatively, the tax revenue is given by (P2 – P0) x Q2. Given that P2 > P1 and Q2 > Q1, this is unambiguously bigger than the original tax revenue (P1 – P0) x Q1.
Proportionally, more of the burden of the tax would be on the consumer if the demand curve were steeper.
Select one answer
For the prices, P* < P2 < P1.
For the outputs, Q1 < Q2 < Q*.
The tax revenue raised would be lower if the demand curve were less elastic.
Proportionally, more of the burden of the tax would be on the producer if the demand curve were less elastic.
Section 8.7