ECON 200 Homework 3_answerkey

ECON 200 Homework 3_answerkey - ECON 200 Homework 3 Answer...

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Unformatted text preview: ECON 200 Homework 3 Answer Key 1. 2. 3. Due Thursday, 1/25/10 As part of the housing the crisis, the government gave all first time buyers an $8000 tax credit, effectively reducing the cost of all homes to new buyers by $8000 (unless the house cost under $8000, as in places like Detroit). Do you think this encouraged first time homebuyers to buy larger, more expensive houses or smaller, less expensive houses? The housing credit will lead people to buy more smaller, less expensive houses since the credit makes it relatively cheaper to buy smaller houses than before the credit. To show this, imagine that before the credit, larger houses cost $300,000 but smaller houses cost $100,000. Buying a large house means foregoing 3 small houses. With the credit large houses cost $292,000 and small houses cost $92,000. Now buying a large house means giving up 3.17 small houses, making the large houses relatively more expensive. If you order wine at a restaurant, there is always a mark‐up on these wines so that they are considerably more expensive than if you bought them at the store. Why is it hard to find cheap wines on restaurants wine lists? Make up some prices to support your argument. It is harder to find cheap wine on restaurant lists because after all the costs associated with eating at a restaurant, it becomes relatively cheaper to buy nice wine so that there is not much demand for the cheap wine. Imagine that a nice bottle of wine costs $20 at the grocery store while a cheap bottle costs $5. The cost of a nice bottle of wine in terms of cheap wine is 4 bottles. When you eat out, the restaurant adds $10 to the price to cover its expenses. Now a nice bottle costs $30 and a cheap bottle costs $15, such that the cost of a nice bottle is 2 cheap wine bottles. Thus the relative price of cheap wine has decreased, so there will be an increase in the demand for nice bottles relative to cheap bottles. John and Charlie have the following marginal value schedules for t‐shirts. They both currently have 4 t‐shirts. a. b. c. Q 1 2 3 4 5 6 7 8 Will they each keep their 4 t‐shirts, or will they trade with each other? If you say they will trade, why do they trade? When will they stop trading? Why do we say that this trade is economically efficient? John's MV 8 7 6 5 4 3 2 1 Charlie's MV 12 11 10 9 8 7 6 5 4. They will trade with each other because there is a difference in how they each value their fourth shirts. Charlie would pay up to $8 for a 5th shirt, while John would sell his 4th shirt for $5, so there is an opportunity for them to make a mutually beneficial trade. They will keep trading until their marginal values are equal, meaning that they both value their last shirt equally and thus no further trades could be made that would make both of them better off. This will happen when John as 2 shirts and Charlie has 6 shirts. This is economically efficient because they have exhausted the gains from trade‐‐there are no further trades that would make them both better off. Now imagine John has 8 t‐shirts, but he can sell these in a market if he wants to. a. Given his marginal demand schedule in the first two columns below, fill in his supply schedule for the market prices below. Quantity demanded 1 2 3 4 5 6 7 8 b. John's MV 8 7 6 5 4 3 2 1 Quantity supplied 0 1 2 3 4 5 6 7 Price 1 2 3 4 5 6 7 8 Calculate John’s total costs and supplier rents when the price is $4. Explain why John gets this rent. When the price is $4, John supplies 3 t‐shirts. The total cost for him of supplying these goods is the sum of the marginal cost of giving up the 3 t‐ shirts ($2 for the 1st shirt + $3 for the 2nd shirt + $4 for the 3rd shirt = $9 total). Since he sells 3 shirts at $4 each, he collects $12 in revenue. Since he is paid $12 when it only cost him $9 to provide the shirts, he gets $3 worth of rent. He gets this rent because his total revenue from supplying shirts is larger than the total cost of providing them. c. Draw his supply curve and label his total costs and supplier rents if the price of apple pies is $4. P Supply Price=$4 Rent Total cost Total revenue=total costs + rent Q How do we define economic efficiency? Why do we achieve economic efficiency when the economy is operating where supply equals demand? We say that something is economically efficient when all the gains from trade have been exhausted, meaning there are no trades that could take place that would make both parties better off. At the point in a market where supply equals demand, the marginal value consumers have for a good is exactly equal to the marginal cost of a supplier to supply a good, meaning all of the trades where the marginal value is greater that the marginal cost have taken place and there are no more gains to be had from trading further. ...
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