PS1ANS09

# PS1ANS09 - UNIVERSITY OF CALIFORNIA HAAS SCHOOL OF BUSINESS...

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UNIVERSITY OF CALIFORNIA HAAS SCHOOL OF BUSINESS EWMBA 201A—Economic Analysis for Business Decisions Fall 2009 Felix Várdy ANSWERS – Problem Set #1 Doing these problems is optional. The solutions to these questions will be posted by Saturday, August 15 and discussed in section that day. The educational value of these exercises will be maximized if you attempt to answer these questions before you look at the answers. Sometimes students find a question in these problem sets frustrating. Since these are not graded, you are free to stop working on a problem whenever you feel the gain from further effort is not worth the cost of further frustration and time. What is important is that you have thought seriously about the problems, not that you have necessarily gotten the correct answer to every one of them. Question 1 Imagine that you work for the World Bank, a development bank that provides loans and policy advice to governments around the world. The World Bank is trying to encourage the Russian government to privatize an industry, and you have been asked to help the Bank determine the market price and quantity that would prevail in the Russian market if competitive forces were allowed to equilibrate the market. The best estimates of the market demand and supply for the Russian good (in U.S. dollar equivalent prices) are given by Q D = 10- 2P and Q s = 2 + 2P, respectively. Both Q D and Q s are measured in billions of units of the good. a. Determine the competitive equilibrium price and quantity. The competitive equilibrium is determined by the intersection of the market demand and supply curves. Algebraically, this simply means that Q D = Q S . Equating demand and supply in this case yields: 10 – 2P = 2 + 2P 8 = 4P P * = 2 Plugging this P back into either the supply or the demand curve yields Q * = 6.

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EWMBA 201a Fall 2009—Várdy b. Based on your analysis, a Russian minister raises the concern that the free market price might be too high for the typical Russian citizen to pay. Accordingly, he asks you to explain what would happen if the Russian government privatized the market, but then set a ceiling price at the Russian equivalent of \$1.50. How do you answer? Since the price ceiling is below the equilibrium price of \$2, a shortage will result. Specifically, when the price ceiling is set at \$1.50, quantity demanded is: Q D = 10 – 2(1.50) = 7 and quantity supplied is: Q S = 2 + 2(1.50) = 5 c. Thinking it will help convince the Russian Minister that privatization will be beneficial, your boss at the World Bank asks you to calculate the consumer surplus that the market would generate if left to its own devices and the competitive equilibrium price and quantity you calculated in part a. prevailed. What would you tell him?
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PS1ANS09 - UNIVERSITY OF CALIFORNIA HAAS SCHOOL OF BUSINESS...

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