Question

The three questions are based on the Mankiw Principle of Economics. Please, try to illustrate your answer using graphs and figures, where you can. You can either use any graphical computer tools, or re-scan a printed out and solved version of this document.

1. Consider market of the product "face mask" a perfectly competitive one, and let's assume, that the product itself is a normal good. Based on these assumptions, please, try to answer the following questions.

a) Please, plot a supply and demand curve for this product, mark the equilibrium price and quantity. (2 points)

b) The government makes it mandatory to wear face masks in public building, ie. shopping malls, public transportation, etc. How will this affect the market of face masks (think about possible changes in supply and/or demand)? Use your previous graph to describe the changes, also explain it in a written form. (3 points)

c) How will this decision of the government affect the price elasticity of mask demand? Why? (3 points)

d) Due to decreasing availablity of masks from abroad, the total supply of mask decrease in the market. How will this change affect the equilibrium price and quantity? How will this affect the income of firms, based on your previous answers? (3 points)

2. Now imagine, that are different types of masks, made of different materials, designs. Let's imagine, there is a particular one, that you have just bought with a Mickey Mouse design (or if you wish substitute Mickey Mouse with your own idea). It was pretty pricey, compared to other, plain masks. You friends tell you, you shouldn't have bought it for this high price, as it is overpriced. Based on what you have learned on consumer's bevaviour, try to explain them, why they are wrong. (4 points)

3. Your cousin decides to give up her carrier as a salesperson with an annual salary of 15 thousand Euros to start her business of sewing designer masks. According to her calculations, she will need an initail investment of 3000 Euros to start the firms, while the costs of materials for one mask youd be 2 Euro. She thinks, she could sell 3000 masks of year for a price of 5 Euros.

a) Calculte the total revenue, fixed costs, variable costs, and total costs, and the total profit of this firm. (3 points)

b) Based on this, do you think it's worth for your cousin to launch this business? Why? (2 points)

Answer 1

Solution to Question 1 :

Part a :

Part b :

As Government makes wearing face masks necessary, face masks become a necessity good. In a perfectly competitive market, demand curve for a necessity good has a steep slope. Hence, the demand shifts and changes its slope from Demand(Initial) to Demand(New). We can see that the demand was initially flat but now it has become very steep. With the supply side constant, this change in demand results in a new equilibrium at E1 which has lower equilibrium price and quantity of face masks.

Part c :

The price elasticity of demand of any commodity is the slope of its demand curve. As the demand curve becomes steeper, a unit change in price of face mask will result in less than proportional change in demand for face masks. Hence, the price elasticity has now become relatively inelastic.

Also, any necessity good has a price elasticity lower than 1, i.e. inelastic demand.

Part d :

As total supply in the market decreases, the supply curve shifts to the left. Due to this, a new equilibrium forms at E1. At this equilibrium, the equilibrium price has increased while the equilibrium quantity has fallen.

As the rise in prices is significantly more than the fall in quantity, the total revenue or the income of the firms will also rise. This happens because the good face mask has inelastic demand, so a rise in price decreases the demand less than proportionately to the change in price.

NOTE : As per our guidelines, in case of multiple questions, only the first question is answered if there is no specification as to which needs to be answered.