HW2_sol_0930 - 1. Suggested Solution to HW2 (ECON1110) Prof...

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Unformatted text preview: 1. Suggested Solution to HW2 (ECON1110) Prof Evans a) Demand curve describes how much is the quantity demanded for a given price. Given a price consumers will demand more units if its marginal benefit is larger than its marginal cost. The amount at which marginal cost equals marginal benefit will be the quantity demanded for that price. It is interesting to see, at this point, the consumer is maximizing consumer surplus. To see why this is true you may think of the following two cases. Consumer surplus when consumers consume quantity=q can be written as: CS q MV Price Price 0 ), his/her If benefit of consuming one more unit is larger than the cost (i.e. MV cost (i.e. MV Price consumer surplus could be improved by having one more unit. If the benefit is smaller than the 0 ), the consumer surplus would decrease if he/she decides to have one Price , what you add to CS, is more. To maximize CS you want to increase q whenever MV positive and decrease q whenever it is negative. The symmetrical argument applies to supply curve. Note that the benefit of supplying one more unit is the price and the cost is marginal cost. 100 80 Price per unit 60 40 20 0 0 1 2 3 4 5 6 7 8 9 10 11 Demand Supply PS q Price MV Units b) If the given price is $32, the quantity demanded would be 3. The quantity supplied is 9. Hence there is excess supply of 6 units. c) Gains from trade(GFT) is sum of Consumer surplus and Producer surplus. Efficient level of GFT is when GFT is maximized and it is obtained when price is set so that quantity demanded and quantity supplied are equal. Consumer surplus is Total value – Total expenditure. Producer 1 Suggested Solution to HW2 (ECON1110) Prof Evans surplus is Total revenue – Total cost. Total value and Total cost could be calculated by summing marginal values and marginal costs respectively up to a given quantity. The price that enables efficient level of GFT is 12 as you can see from the table. At this price, quantity demanded and quantity supplied is 5. Total revenue and total expenditure is 5×price=60. Total Value = 86+51+32+17+12 = 198. Total Cost = 6+6+9+11+12 = 44. So, the efficient level of GFT is TV‐TE + TR – TC = 198 ‐ 44 = 154. To see if it is really maximized at quantity 5, let’s consider quantity 4 and 6. At 4, TV=186 and TC=33 hence GFT=153. At 6, TV=207 and TC=58 hence TC=149. Total amount spent on vaccines is total expenditure, which is 60. d) At quantity 2, TV=86+51=137 and TC=6+6=12 thus GFT=TV‐TC=125. Notice the gains from trade is less than the optimal value in 1.c). 2 2. a) Suggested Solution to HW2 (ECON1110) Prof Evans Price S(w,τ,Z) CS P* PS GFT=CS+PS D(Px,I,X) Q* Efficient Point Figure 1 CS, PS at Efficient Point Quantity b) At price zero, consumers will demand Qe.(See Figure 2) The problem assumes that this amount is actually consumed. We know CS=TV‐TE. TV is area under the demand curve up to Qe. Since price is zero TE is zero, so CS is TV. c) Qe is assumed to be possible to consume. We know GFT = TV – TC. At this price, CS may be maximized, but TC is becomes large resulting small, even possibly negative, GFT. 3 Suggested Solution to HW2 (ECON1110) Prof Evans Price S(w,τ,Z) D(Px,I,X) CS TC GFT = CS — TC P*=0 Quantity Figure 2 Qe d) It is not efficient because the GTF is not maximized. Although consumers are benefiting from the policy, the producers are suffering losses resulting in lower GTF than efficient GTF. 3. Create a competitive market for kidneys. We could think that the kidney market has excess demand because given the current price of kidney there is larger quantity demanded than supplied. If we set up a competitive market for kidneys and let the price be set between suppliers and consumers, we could reach an efficient GFT. 4 4. a) Suggested Solution to HW2 (ECON1110) Prof Evans Price OIL Price SUV S1(w,τ,Z) P1* D1(P,I,X) P2* S2(w,τ,Z) D2(P,I,X) Q1* Quantity Q2* Quantity b) Increase in oil demand results in increase in oil price. Increase in oil price decrease demand for SUVs because SUV and oil are complements. Price OIL Price SUV S1(w,τ,Z) P1’ P1* D1’(P,I,X) D1(P,I,X) Q1* Q1’ Quantity P2* P2’ S2(w,τ,Z) D2(P,I,X) D2’(P,I,X) Q2’ Q2* Quantity c) Increase in oil demand Increase in oil equilibrium price Decrease in SUV demand Decrease in SUV equilibrium price. Equilibrium quantity of oil decreases and that of SUV increases. 5 5. a) Suggested Solution to HW2 (ECON1110) Prof Evans Price GOLD Price GOLD S(w,τ,Z) P* D(P,I,X) P’ P* S(w,τ,Z) D’(P,I,X) D1(P,I,X) Q* Quantity Q* Q’ Quantity b) Since gold is normal good, increase in income increases demand for gold. Increase in demand causes equilibrium price and quantity to rise. The effect on consumer surplus is uncertain(see the figure below; or think of fixed supply and perfectly elastic supply). However, producer surplus becomes larger if demand increases(since supply doesn’t change and the equilibrium price moves along the curve) Price P’ P* GOLD S(w,τ,Z) Price GOLD D’(P,I,X) P’ P* S(w,τ,Z) D’(P,I,X) D(P,I,X) Q* Q’ Quantity Quantity D1(P,I,X) Q* Q’ Quantity d) Total revenue increases since equilibrium price and quantity has gone up. TR=P×Q 6 6. a) Suggested Solution to HW2 (ECON1110) Prof Evans Price Auto Price Auto S’(w,τ,Z) S(w,τ,Z) P* D(P,I,X) P’ P* S(w,τ,Z) D1(P,I,X) Q* Quantity Q’ Q* Quantity b) Increase in input prices decreases supply. The equilibrium price increases and equilibrium quantity decreases. Consumer surplus decreases since equilibrium price and quantity moves along the demand curve to the direction where it gives smaller CS. c) Uncertain. It depends on the shape of demand curve, in particular elasticity. ‐ Perfectly elastic (horizontal demand curve) => Revenue decreases ‐ Perfectly inelastic (vertical demand curve) => Revenue increases 7 7. Suggested Solution to HW2 (ECON1110) Prof Evans The policy affects both demand and supply. It decreases supply since it increases production cost and it increases demand as the cars became more favorable. Increase in demand pushes equilibrium price and quantities up. Decreases in supply increases equilibrium price but lowers equilibrium quantity. Considering the above two effects, we are sure that the equilibrium price will go up, but we are uncertain about the changes in equilibrium quantity. Price Auto S’(w,τ,Z) S(w,τ,Z) P’ P* D1(P,I,X) D1(P,I,X) Q’Q* Quantity 8 ...
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This note was uploaded on 03/27/2009 for the course ECON 1110 taught by Professor Wissink during the Fall '06 term at Cornell.

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