Economics

Question 2

(a) You have decided to spend $40 this month on Fish and Bread. The total utility you receive from different quantities of fish and bread are shown in the table below. The prices of fish and bread are both $10 per unit.

Apply the rational spending rule to determine the combination of Fish and Bread that optimises your total utility. Explain why applying the rational spending rule is a more appropriate decision making tool for optimizing consumption, compared to simply evaluating the total utility of different bundles of goods.

(10 marks)

(b) A large pharmaceutical company estimates that the demand function for its medicine is

P = 60 – 5Q. It is currently selling the medicine at $40 per unit.

(i) Calculate the price elasticity of demand at this price.

(5 marks)

(ii) Do you think it is a good idea for the company to raise its price to earn more revenue? Explain your answer using the relevant elasticity concepts without reference to graphs or equations.

(5 marks)

(iii) At what price does the company maximise its revenue? Show your work.

(5 marks)

Question 4

Consider a monopolist producer who faces a linear demand curve P = 24 – Q, where P is the price the producer charges and Q is the quantity consumers purchase. The producer produces this good at a constant average and marginal cost of $6.

(a) Identify the price and quantity if the monopolist wishes to maximise revenue.

(5 marks)

(b) Identify the price and quantity if the monopolist wishes to maximise profits. Support your answer with a diagram.

(10 marks)

(c) Suppose the government imposes a tax of T dollars per unit on the producer. By how much will the consumer shoulder the tax burden? By how much will the producer shoulder the tax burden? Explain why, in general, the consumer shoulders part of a tax burden even when the tax is imposed directly on the producer.