# Supply and Demand and Demand Curve

Pages: 10 (2877 words) Published: September 10, 2013
TUTORIAL 2:

Topic 1: The Firm and Its Goals

1) a. If a stock is expected to pay an annual dividend of \$20 forever, what is the approximate
present value of the stock, given that the discount rate is 5%?
b. If a stock is expected to pay an annual dividend of \$20 forever, what is the approximate
present value of the stock, given that the discount rate is 8%?
c. If a stock is expected to pay an annual dividend of \$20 this year, what is the approximate
present value of the stock, given that the discount rate is 8% and dividends are expected to
grow at a rate of 2% per year?

a. P = D/k = 20/.05 = \$400
b. P = 20/.08 = \$250
c. P = D1/(k - g) = 20/(.08 - .02) = \$333.33

2) If a stock is expected to pay a dividend of \$40 for the current year, what is the approximate present value of this stock, given at discount rate of 5% and a dividend growth rate of 3%?

Answer: P = \$40/(0.05 - 0.03) = \$40/0.02 = \$2,000

Topic 2: Supply and Demand

1) Suppose that the demand for oranges increase. Explain the long -run effects of the guiding function of price in this scenario.

Answer: In the long run, the higher price of oranges will signal more firms to enter the orange market, as it will seem more profitable than some other markets. As firms enter, supply increases, causing the price to fall relative to the short-run price and quantity to increase further. The higher short-run price has guided more resources into the market.

2) Suppose that the demand for oranges increases. Carefully explain how the rationing function of price will restore market equilibrium.

Answer: The increase in demand causes a shortage at the original equilibrium price; the quantity supplied is less than the new quantity demanded at that price. The existence of the shortage will cause the price to rise. As price rises, the quantity supplied will increase and the quantity demanded will decrease (along the new demand curve) until equilibrium is reached at a higher price (and quantity). 3) For each of the following changes, show the effect on the demand curve, and state what will happen to market equilibrium price and quantity in the short run. a. Consumers expect that the price of the good will be higher in the future. b. The price of a substitute good rises.

c. Consumer incomes fall, and the good is normal.
d. Consumer incomes fall, and the good is inferior.
e. A medical report is published showing that this good is hazardous to your health. f. The price of the good rises.

a. Demand increases (now); equilibrium price and quantity increase. b. Demand increases; equilibrium price and quantity increase. c. Demand decreases; equilibrium price and quantity fall.
d. Demand increases; equilibrium price and quantity increase. e. Demand decreases; equilibrium price and quantity fall.
f. This is a movement along the demand curve, and the quantity demanded will decrease.

4) For each of the following changes, show the effect on the supply curve, and state what will happen to market equilibrium price and quantity in the short run. a. The government requires pollution control filters that raise good on costs. b. Wages of workers in this industry fall.

c. There is an improvement in technology.
d. The price of the good falls.
e. Producers expect that the price of the good will fall in the future.

a. Supply decreases; equilibrium price rises and quantity falls. b. Supply increases; equilibrium price falls and quantity rises. c. Supply increases; equilibrium price falls and quantity rises. d. This is a movement along the supply curve, and the quantity supplied will decrease. e. Supply increases (now); equilibrium price falls and quantity rises.

5) For each of the following sets of supply and demand curves, calculate equilibrium price and quantity.
a. QD = 2000 - 2P; QS = 2P
b. QD = 500 - P; QS = 50 + P
c. QD = 5000 - 10P; QS = -1000 + 5P

a. Q = 1000, P = 500...