PS1 solutions - Department of Economics University of...

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Department of Economics Spring 2008 University of California, Berkeley Economics 1 Problem Set #1 Page 1 of 10 Suggested Solutions for PROBLEM SET #1 1. (1.5 points total) For each of the events described below, sketch a supply and demand graph that illustrates the event. Be sure to properly label all curves and relevant points in your graph. In the area to the left of your graph, explain why you think your graph is correct. In that area, also answer the questions asked. a) New Textbooks: For each chapter in a 40-chapter textbook, the publishers pay 20 people $500 each to read and review the chapter. (Previously, the publishers had used only 5 reviewers and had paid them $200 per chapter.) Deterred by high prices of new books, many students buy used textbooks instead. What happens to the price of new textbooks? To the quantity of new textbooks purchased? An increase in the production costs of new textbooks leads to an increase in the market price and a decrease in the quantity of books sold. Reminder : Always remember to label the axes of graphs!! The S 0 and D 0 curves in the graph below illustrate initial supply and demand, respectively, in the market for new textbooks. Initial equilibrium in this market occurs at point A, and is summarized by market price p* 0 and quantity q* 0 . The question seeks to determine what happens to this equilibrium price and quantity when the cost of producing textbooks increases. Recall that the supply curve for a product displays the quantities supplied by producers at different prices. This curve is derived holding constant other factors, such as costs of production, prices of related products, and number of producers in the industry. Thus, changes in the price of the product in question are represented by a movement along the supply curve, while changes in any of these other factors are represented by shifts in the supply curve. The publishers decided to both have more reviewers read each chapter and pay each reviewer more. This translates into a shift upward (left) of the supply curve. This is illustrated in the graph as S 0 shifts in to S 1 . Notice that at every quantity of new textbooks supplied, the price level is higher. The change in price due to the shift in supply (i.e. the movement from p* 0 to p* 1 ) results in a decrease of quantity demanded. Intuitively, this is happening because some students find that new textbooks now cost more than they are willing to pay. These students decide to buy used textbooks instead. Graphically, this increase in price is reflected in a movement along the demand curve from point A to new equilibrium point B. Notice that changes in factors that are held constant in the model (in other words, not presented on the axes) result in a shift of the curve, while changes in factors that are not held constant in the model (in this case, price, which is presented on the vertical axis) result in a movement along the curve.
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Department of Economics Spring 2008 University of California, Berkeley Economics 1 Problem Set #1 Page 2 of 10 b)
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