Question

TNT Ltd produces casual shirts for men. Based on its market study, it finds that when the price is Rs500 per unit, the quantity demanded is 4000 units while when the price drops to Rs350, the quantity demanded is 7000 units. The equilibrium price in the market is Rs425, whereby 5500 units are bought and sold. (a) Using a demand and supply diagram, show how you will represent the above information. In your answer, clearly label your axes, prices and quantities and the equilibrium price. [6 marks] (b) Calculate the price elasticity of demand for casual shirts using the above information. Is the demand price-elastic or price-inelastic? Why? [8 marks] Given that the cost of cotton has risen in the past 2 months, TNT Ltd finds that its cost of producing casual shirts rises significantly. (c) Using a demand and supply diagram, show how you will represent the above information. In your answer, clearly indicate the new equilibrium price and quantity, if any. Note: You do not need to give an accurate numerical figure for any new price/quantity. [6 marks] The government decides to intervene in the market and fix a minimum price of Rs500. TNT Ltd believes that it can supply 10,000 units at this price. (d) In a demand and supply diagram, combine your answer to (c) with the new information above. Indicate the amount of shortage/surplus that will be created, if any. [5 marks]

Answer 1

a.Shown in the image below.Equilibrium at price $425 and quantity 5500

b.Elasticity is a responsiveness to change in particular input. If it is price then price elasticity of demand (Ped) means the degree of responsiveness of demand to a change in price which is given by formula:

Ped= %change in quantity demanded/ % change in price

In this case, price changes from $500 to $350 and quantity from 4000 to 7000 hence,

% change in price = (350-500/500)*100 = -30%

% change in Quantity = (7000-4000/4000)*100 = 75%

Ped = 75/-30 = -2.5(neglecting the sign), as Per s more than 1, it show elastic demand.

c. Fig.c

d. Fixing minimum prices is price floor. If price is floored at $500 then supply will be 10,000 but demand as shown in the schedule will be 4000 only, hence excess of 6000 shirts would be made.