SOLUTION PS5

# SOLUTION PS5 - 1 ECO 100 Problem Set#5 These problems are...

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ECO 100 Problem Set #5 These problems are of the style that our midterm questions will have, but this is a way longer exercise than the midterm will be. The problems are all short answer, and you need not show any work. 1. As everyone knows, brioches and cappuccinos are complementary goods in the typical Italian breakfast. Suppose there is a decrease in the price of coffee. What is the most likely effect on equilibrium quantity and price of brioches? a Price will rise and quantity will fall b Both price and quantity will fall c Both price and quantity will rise d Price will fall and quantity will rise e Price will rise; change in equilibrium quantity is ambiguous Explanation: Both answers (b) and (c) depending on what are the assumptions one makes. If coffee is considered a substitute to cappuccinos, then the demand curve for cappuccinos shifts to the left when there is a decrease in the price of coffee and the price of cappuccinos rise. As a consequence, the demand curve for brioches shifts to the left and both price and quantity fall. If coffee is considered an input in the production of a cappuccino, then the supply curve of cappuccinos shifts to the right and there is a decrease in the price of cappuccinos. As a consequence, the demand curve for brioches shifts to the right and both price and quantity rise. 2. Customers in the USA can buy either domestic cheese or imported cheese. Suppose the government introduces an import tax on cheese. What is the most likely effect on equilibrium quantity and price of domestic cheese? a Price will rise and quantity will fall b Both price and quantity will fall c Both price and quantity will rise d Price will fall and quantity will rise e Price will fall; change in equilibrium quantity is ambiguous Explanation: The import tax on cheese raises the price of domestic cheese above the international price of cheese by the amount of the tax. The increase in the price of cheese induces domestic suppliers to increase their production of domestic cheese while the increase in price reduces the quantity of imported cheese. 3. The table below represents the willingness to pay of four buyers (assume that the willingness to pay for the second unit is \$0 for every buyer). 1

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BUYER WILLINGNESS TO PAY (Maximum Bid Price) Bill O’Reilly \$12 Ann Coulter \$35 Julio Sanchez \$ 6 Dung Li-Chin \$25 If the Price is \$12, what is the total consumer surplus? a. \$78 b. \$30 c. \$36 d. \$0 e. \$60 Explanation: Julio Sanchez does not buy the good because his willingness to pay is smaller than the price. Bill O’Reilly is indifferent between buying the good or not and his consumer surplus is zero. Ann pays 6 but her willingness to pay is 35 so her consumer surplus is 23. Dung’s consumer surplus is 13. Thus, total consumer surplus is 36.
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## This note was uploaded on 07/09/2008 for the course ECO 100 taught by Professor R.willig during the Spring '08 term at Princeton.

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SOLUTION PS5 - 1 ECO 100 Problem Set#5 These problems are...

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