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Homework
Ionut-Gabriel Radu - 335CC

Chapter 1 Answer to Questions

1.1 Question 1

What would happen to the study of economics if scarcity disappeared? Economics is dened as the social science concerned with using scarce resources to maximize satisfaction of unlimited wants. All resources, even those which seem to be in complete abundance (such as water), are scarce. Thus, economics deals with how to use these resources to make maximum ecient use to satisfy the maximum number of these wants. If we suppose the resources are unlimited, then the role of economy would become useless, we can have everything we want regardless of the quantity.

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Question 2

Dene the opportunity cost. What is the opportunity cost to you of attending college? What was your opportunity cost of coming to class today? Denition: The cost of an alternative that must be forgone in order to pursue a certain action. Put another way, the benets you could have received by taking an alternative action. The opportunity cost of going to college is the money you would have earned if you worked instead. On the other hand, you lose four years of salary while getting your degree. 3

CHAPTER 1. ANSWER TO QUESTIONS

The opportunity cost of coming to class today is two more hours of sleep.

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Question 3

Under what condition might government intervention in an economy improve the market outcome? If there is a market failure, such as an externality or monopoly, government regulation might improve the well-being of society by promoting eciency. If the distribution of income or wealth is considered to be unfair by society, government intervention might achieve a more equal distribution of economic well-being.

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Question 4

Explain the dierence between absolute advantage and comparative advantage. Which is more important trade patterns, absolute advantage or comparative advantage? Why? Absolute advantage Economists use the term absolute advantage when comparing productivity of one person, rm or nation to that of another. The producer that requires a smaller quantity of inputs to produce a good is said to have an absolute advantage in producing that good. Comparative advantage The gains from specialization and trade are based not on absolute advantage but on comparative advantage. When each person specializes in producing the good for which he or she has a comparative advantage, total production in economy rises. This increase in the size of the economic pie can be used to make everyone better o. Trade can benet everyone in society because it allows people to specialize in activities in which they have a comparative advantage.

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Question 5

Suppose that a worker in Taiwan can make 2 TVs or 10 pairs of shoes per week, and a worker in Korea can make 3TVs or 20 pairs of shoes per week.

1.6. QUESTION 6

a. In what sense do TVs and shoes cost less in Korea than in Taiwan? b. In what sense do TVs cost less in Taiwan than in Korea? c. If Taiwan and Korea were to engage in trade, which country would export which good? d. Would the answer to the above question change if a worker in Korea would make 4 TVs per week? In terms of labour time spent making TVs and shoes, both goods cost less in Korea than in Taiwan: 0.33 weeks per TV and 0.05 weeks per pair of shoes in Korea, and 0.5 weeks per TV and 0.1 weeks per pair of shoes in Taiwan. In terms of opportunity cost, TVs cost less in Taiwan than in Korea: 5 pair of shoes per TV in Taiwan, and 6.67 pairs of shoes per TV in Korea. Since Taiwan has a comparative advantage in TVs, it will export TVs. Since Korea has a comparative advantage in shoes, it will export shoes. If Korea would make 4 TVs per week, then no country would have a comparative advantage since opportunity costs will be the same for both countries.

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Question 6

Gary and Diane must prepare a presentation for their marketing class. As part of their presentation, they must do a series of calculations and prepare 50 PowerPoint slides. It would take Gary 10 hours to do the required calculation and 10 hours to prepare the slides. It would take Diane 12 hours to do the calculations and 20 hours to prepare the slides. a. How much time would it take the two to complete the project if they divide the calculations equally and the slides equally? b. How much time would it take the two to complete the project if they use comparative advantage and specialize in calculating or preparing slides? c. If Diane and Gary have the same opportunity cost of 5 dollars per hour, is there a better solution than for each to specialize in calculating or preparing slides? If both tasks are divided equally, it will take 11 hours for the calculations and 15 hours for the writing, for a total of 26 hours.

CHAPTER 1. ANSWER TO QUESTIONS

If Diane specializes in calculating and Gary specializes in preparing slides, it will take 22 hours to complete the project. If Diane specializes in calculating, her opportunity cost will be 60 dollars, Diane would be better o if she paid Gary any amount less than 60 to do the calculating. Since Garys opportunity cost of doing the calculations is only 50 dollars, he would be better o if Diane paid him between 50 and 60 dollars to do the calculations. In this case the total time spent on the project would be 20 hours.

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Question 7

The only two countries in the world, Alpha and Omega, face the following production possibilities frontiers. a. Assume that each country decides to use half of its resources in the production of each good. Show these points on the graphs for each country as point A. b. If these countries choose not to trade, what would be the total world production of popcorn and peanuts? c. Now suppose that each country decides to specialize in the good in which each has a comparative advantage. By specializing, what is the total world production of each product now? d.If each country decides to trade 100 units of popcorn for 100 units of peanuts, show on the graphs the gain each country would receive from trade. Label these points B.

Figure 1.1:

1.8. QUESTION 8

a. Alpha would be producing 125 units of peanuts and 75 units of popcorn and Omega would be producing 50 units of peanuts and 150 units of popcorn.

Figure 1.2: b. The total world production of peanuts would be 175 units and the total world production of popcorn would be 225 units. c. The total world production of peanuts would now be 250 and the total world production of popcorn would now be 300 units. d. Alpha would be producing 250 units of peanuts and would trade 100 of them to Omega, leaving Alpha with 150 units of peanuts. Alpha would then receive 100 units of popcorn from Omega. Omega would be producing 300 units of popcorn and would trade 100 of them to Alpha, leaving Omega with 200 units of popcorn. Omega would the receive 100 units of peanuts from Alpha.

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Question 8

Suppose we are analyzing the market for hot chocolate. Graphically illustrate the impact each of the following would have on demand or supply. Also show how equilibrium price and quantity have changed. a. Winter starts and the weather turns sharply colder. b. The price of tea, a substitute for hot chocolate, falls. c. The price of cocoa beans decreases. d. The price of whipped cream falls. e. A better method of harvesting cocoa beans is introduced.

CHAPTER 1. ANSWER TO QUESTIONS

f. The Surgeon General of the U.S. announces that hot chocolate cures acne. g. Protesting farmers dump millions of gallons of milk, causing the price of milk to rise. h. Consumer income falls because of a recession and hot chocolate is considered a normal good. i. Producers expect the price of hot chocolate to increase next month. j. Currently, the price of hot chocolate is 0.5 dollars per cup above equilibrium. a. As a consequence of getting colder, people tend to buy more hot chocolate, so demand increases. b. If the price of tea falls, the people tend to buy more tea, and the demand for hot chocolate decreases. c. If the price of cocoa beans decreases, then the supply for hot chocolate increases and the price decreases. d. If the price of whipped cream falls then, the demand for hot chocolate increases. e. If a good method of harvesting cocoa has been introduced, then the supply for hot chocolate increase and the price decreases. f. If the Surgeon General of the U.S. announces that hot chocolate cures acne the demand for hot chocolate increases, and as a result the price increases as well. g. If farmers dump millions of gallons of milk, causing the supply to decrease, and as a result the prices increases. h. If the consumers income falls of a recession the demand for hot chocolate decreases, and, as a result the price decreases. i. If the producers expect the price of hot chocolate to increase next month, then the supply in reduced, and as a result the price increases. j. A price change will aect both quantity demanded and quantity supplied and will cause a surplus in the market. It will not cause either demand or supply to shift. To see the graphic plot of price as a function of quantity see Annex.

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Question 9

Consider the following pairs of goods. Which would you expect to have the more elastic demand? Why? a. water or diamonds.

1.10. QUESTION 10 b. c. d. of e. insulin or nasal decongestant spray food in general or breakfast cereal gasoline over the course of a week or gasoline over the course a year personal computers or IBM personal computers.

a. The elasticity of diamonds is greater than that of water because the water is of strict necessity and the diamonds are luxury goods. b. The elasticity of decongestant spray is greater than that of insulin, because insulin cannot be substituted. c. The elasticity of breakfast cereal in greater than that of food in general because, breakfast cereal can be substituted. d. The elasticity of gasoline over the course of a year is greater than that of gasoline over the course of a week because, if the price of gasoline increases, on short term the gasoline demand is not aected, but on long term it tends to become more elastic.

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Question 10

You own a small town movie theatre. You currently charge 5 dollars per ticket for everyone who comes to your movies. Your friend who took an economics course in college tells you that there may be a way to increase your total revenue. Given the demand curves shown, answer the following questions. a. What is your current total revenue for both groups? b. The elasticity of demand is more elastic in which market? c. Which market has the more inelastic demand? d. What is the elasticity of demand between the prices of 5 dollars and 2 dollars in the adult market? Is this elastic or inelastic? e. What is the elasticity of demand between 5 dollars and 3 dollars in the childrens market? Is this elastic or inelastic? f. Given the graphs and what your friend knows about economics, he recommends you increase the price of adult tickets to 8 dollars each and lower the price of a childs ticket to 3 dollars. How much could you increase total revenue if you take his advice? a. Total revenue from children: 5x20 = 100 dollars and total revenue from adults 5x50 = 250 dollars. b. The demand for childrens tickets is more elastic.

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CHAPTER 1. ANSWER TO QUESTIONS

c. The demand for adults tickets is more inelastic. d. The elasticity of demand between 5 dollars and 2 dollars is 0.26 which is less than 1, thus, the elasticity is inelastic. e. The elasticity of demand between 5 dollars and 3 dollars is 1.25 which is greater than 1, thus, the elasticity is elastic. f. If you increase the price of adults tickets to 8 dollars, the total revenue for adults would be 320 dollars. Meanwhile, if you decrease the price for childrens tickets to 3 dollars then, the total revenue for children would be 120 dollars. As a result, the total revenue would be 320+120=440 dollars and the increase of the venue would be 440-350=90 dollars.

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Question 11

Two drivers - Tom and Jerry - each drive up to a gas station. Before looking at the price, each places an order. Tom says, I would like 10 gallons of gas. Jerry says, I would d like 10 dollars worth of gas. What is each drivers price elasticity of demand? In case of Tom the change in quantity is 0, then the elasticity of demand would be 0 (perfectly inelastic). In case of Jerry the elasticity is unitary because the product QxP is constant (suppose that the variation of price per gallon is small). In case of a greater variation of price per gallon the demand would become perfectly inelastic.

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Question 12

Consider public policy aimed at smoking. a. Studies indicate that the price elasticity of demand for cigarettes is about 0.4. If a pack of cigarettes currently costs 2 dollars and the government wants to reduce smoking by 20% by how much should it increase the price? b. If the government permanently increases the price of cigarettes, will the policy have a larger eect in smoking 1 year from now or 5 years from now? c. Studies also nd that teenagers have a higher price elasticity than do adults. Why might this be true?

1.13. QUESTION 13
Q

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Q 0.2 2 0.4 a. P = 0.4 P = 0.4 0.2( P ) = 0.4 P = 0.4 P = 1$. P 2 The government has to take the decision to increase price of cigarettes by 1.00$. b. The impact will be larger on 5 years because people have more time to nd substitutes. People react less on short term because it is harder to adjust the smoking behaviour to the price in such short time. c. The cigarette demand on teenagers is more elastic than that of adults because they tend to renounce easier as price increases.

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Question 13

Explain why the following might be true: A drought around the world raises the total revenue that farmers receive from the sale of grain, but a drought only in Romania reduces the total revenue that Romanian farmers receive. The rst armation is true, because if a drought aects all countries, then the supply for grain would decrease, and as a result the price would increase (which leads to a raise in the total revenue of farmers). The second armation is also true, because if a drought aects only Romania, then the decrease in supply of Romanian grain would be substituted by the grain from export, and, as a result, the total supply would not decrease (only the supply of Romanian grain would decrease), thus the total revenue of would decrease.

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Question 14

The government decided that the free-market price of cheese is too low. a. Suppose the government imposes a binding price oor in the cheese market. Draw a supply-and-demand diagram to show the eect of this policy on the price of cheese and the quantity of cheese sold. Is there a shortage or surplus of cheese? b. Farmers complain that the price of oor has reduced their total revenue. Is this possible? Explain. c. In response to farmers complains, the government agrees to purchase all the surplus cheese at the price oor. Compared to the basic price oor, who benets from this new policy? Who loses?

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CHAPTER 1. ANSWER TO QUESTIONS

a. See Annex. b. The farmer complain that the price of oor has reduced their total revenue because the demand is elastic, and, thus , the quantity would decrease much more that the price would increase. c. In this case farmers would benet from this policy because they have someone who buy their cheese at the price established by government. Those who lose are consumers.

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Question 15

Suppose a technological advance reduces the cost of making computers. a. Draw a supply-and-demand diagram to show what happens to price, quantity, consumer surplus, and producer surplus in the market for computers. b. Computers and adding machines are substitutes. Use a supply-and-demand diagram to show what happens to price, quantity, consumer surplus, and producer surplus in the market for adding machines. Should adding machine producers be happy or sad about the technological advance in computers? c. Computers and software are complements. Draw a supply-and-demand diagram to show what happens to price, quantity, consumer surplus, and producer surplus in the market for software. Should software producers be happy or sad about the technological advance in computers? d. Does this analysis help explain why software producer Bill Gates is one of the worlds richest man? a. See Annex. The eect of decreasing the price of computers has lead to a displacement to the right of the supply diagram. The equilibrium price has decreased and the quantity has increased. The decrease in price has lead to an increase in the consumers surplus (surface delimited by A and A+B+C+D). Before the decrease of price, the producers surplus was the surface B+E. After the decrease of price the producers surplus is E+F+G. Thus, the producers surplus has been modied by F+G-B. b. See Annex. Because the fact that calculators can be substituted by computers, and the price of computers has decreased, the calculators has been gradually substituted by computers, thus, leading to a displacement to the left of demand diagram. The result is an increase both in demand and supply. The consumers surplus has increased from B+C to A+C with a

1.16. QUESTION 16

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relative change of A-C. The producers surplus has changed from E to C+D+E, with a relative change of C+D. d. See Annex. Because software products and computers are complementary, a fall in price and an increase in quantity means an increase of demand for software products, displacing the demand diagram from left to right. The result is an increase in both demand and supply. The consumers surplus has been modied from B+C to A+B, with a relative change of A-C. The producers surplus has been modied from E to C+D+E, with an increase of C+D. e. The fact that Bill Gates is one of the wealthiest man in the world is the his rm oers software that is pre-installed on computers.

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Question 16

The supply and demand for broccoli are described by the following equations: Supply: S(p) = 4P 80 Demand: D(p) = 100 2P a. Graph the supply curve and the demand curve. What is the equilibrium price and quantity? b. Calculate consumer surplus, producer surplus, and the total surplus at the equilibrium. c. If a dictator who hates broccoli were to ban the vegetable, who would bear the large burden - the buyers or sellers of broccoli? a. See Annex. 4P 80 = 100 2P 6P = 180 P = 30$ Q = 40. b. Consumers surplus: (0.5) 20 40 = 400$ Producers surplus: (0.5) 10 40 = 200$ Total surplus is: 600$ c. If a dictator prohibit the broccoli, the both consumers and producers surplus would become 0. The most aected would be consumers because the fall of the surplus is greater.

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Question 17

Evaluate the following two statements. Do you agree? Why or why not?

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CHAPTER 1. ANSWER TO QUESTIONS

a. A tax that has no deadweight loss cannot raise any revenue for the government. b. A tax that raises no revenue for the government cannot have any deadweight loss. a. The rst statement is false because imposing a 100% tax would cause the market to close and no prot would be obtained. b. The second statement is false because imposing a huge tax would cause the market to close and no prot would be obtained.

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Question 18

Suppose that the government imposes a tax on heating oil. a. Would the deadweight loss from this tax likely be greater in the rst year after it is imposed or in the fth year? Explain. b. Would the revenue collected from this tax likely be greater in the rst year after it is imposed or in the fth year? Explain. a. The deadweight loss from this tax would be greater in the fth year because people would try to nd substitutes for heating oil. b. The prot obtained from this tax would be greater in the rst year because people do no not have enough time to nd substitutes for heating oil.

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Question 19

Suppose that a market is described by the following supply and demand equations: O(p) = 2P C(p) = 300 P a. Solve the equilibrium price and the equilibrium quantity. b. Suppose that a tax of T is placed on buyers. Solve the new equilibrium. What happens to the price received by sellers, the price paid by buyers, and the quantity sold? c. Use your answer to part (b) to solve for the tax revenue as a function of T. Graph this relationship for T between 0 and 300. d. Solve for deadweight loss as a function of T. Graph this relationship for T between 0 and 300.

1.19. QUESTION 19

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e. The government now levies a tax on this good of 200$ per unit. Is this a good policy? Why or why not? Can you propose a better policy? a. 2P = 300 P P = 100 Q = 200 b. D(P ) = 300 P T New equilibrium 300 P T = 2P 300 T = 3P P = 100 T 3 2 c. R = T Q = T (200 2 T ) R = 200T 2 T3 3 2 R = 2 T3 + 200T = 0 T (2 T + 200) = 0 T1 = 0(0, 0), 3 T2 = 300(300, 0). 4 T + 200 = 0 Tmax = 2003 = 150. 3 4 Rmax = 150 (200 2 150 ) = 150 100 = 15000. 3 2 2 d. W = T (Qa Qb ) = T (200 200 + 2 T ) = 2 T6 = T3 . 2 2 3 T2 = 0 T = 0.T = 100 W = 13333.34 T = 300 W = 3 30000.T = 200 W = 13333.34, R = 13333.34. The policy is good because R = W and the revenue obtained by the government after imposing the tax is equal deadweight loss. Another policy would be: T = 0 W = 0.