Econ301 - Answer Key to Problem Set 1 Sergei Severinov...

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Answer Key to Problem Set 1. Sergei Severinov Exercise 1, Ch 1. Decide whether each of the following statements is true or false and explain why: a. Fast-food chains like McDonald’s, Burger King, and Wendy’s operate all over the United States. Therefore the market for fast food is a national market. This statement is false. People generally buy fast food locally and do not travel large distances across the United States just to buy a cheaper fast food meal. Because there is little potential for arbitrage between fast food restaurants that are located some distance from each other, there are likely to be multiple fast food markets across the country. b. People generally buy clothing in the city in which they live. Therefore there is a clothing market in, say, Atlanta that is distinct from the clothing market in Los Angeles. This statement is false. Although consumers are unlikely to travel across the country to buy clothing, they can purchase many items online. In this way, clothing retailers in different cities compete with each other and with online stores such as L.L. Bean. Also, suppliers can easily move clothing from one part of the country to another. Thus, if clothing is more expensive in Atlanta than Los Angeles, clothing companies can shift supplies to Atlanta, which would reduce the price in Atlanta. Occasionally, there may be a market for a specific clothing item in a faraway market that results in a great opportunity for arbitrage, such as the market for blue jeans in the old Soviet Union. c. Some consumers strongly prefer Pepsi and some strongly prefer Coke. Therefore there is no single market for colas. This statement is false. Although some people have strong preferences for a particular brand of cola, the different brands are similar enough that they constitute one market. There are consumers who do not have strong preferences for one type of cola, and there are consumers who may have a preference, but who will also be influenced by price. Given these possibilities, the price of cola drinks will not tend to differ by very much, particularly for Coke and Pepsi. Review Question 9, Ch2. (p. 62) The city council of a small college town decides to regulate rents in order to reduce student living expenses. Suppose the average annual market-clearing rent for a two-bedroom apartment had been $700 per month, and rents were expected to increase to $900 within a year. The city council limits rents to their current $700-per-month level. a. Draw a supply and demand graph to illustrate what will happen to the rental price of an apartment after the imposition of rent controls. Initially demand is D 1 and supply is S, so the equilibrium rent is $700 and Q 1 apartments are rented. Without regulation, demand was expected to increase to D 2 , which would have raised rent to $900 and resulted in Q 2 apartment rentals. Under the city council regulation, however, the rental price stays at the old equilibrium level of $700 per month. After demand increases to D 2 , only Q 1 apartments will be Rent Apartments 700 900 D 1 D 2 S Q 1 Q 2 Q 3
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