## Problems: Price Ceilings, etc.: Ice-Cream Sandwiches in Crony Capitalism Junior University

Consider the daily market for ice-cream sandwiches in the neighborhoods surrounding Crony Capitalism Junior University in the town of Old Stick...

Supply: Q = 500(P - 2)

Demand: Q = 11000 - 1000 P

1. Let us say that Production Distribution Coordination--PDC--imposes a price ceiling of $4 on ice-cream sandwiches, on the grounds that nobody should ever have to pay more than$4 for an ice-cream sandwich. What is the equilibrium price? What is the equilibrium quantity? What is the equilibrium producer surplus? Consumer surplus? Deadweight loss relative to the free- market equilibrium?

2. Let us say that PDC imposes a price floor of $10 on ice-cream sandwiches—on the grounds that underpaid sandwich makers deserve more money. What is the equilibrium price? What is the equilibrium quantity? What is the equilibrium producer surplus? Consumer surplus? Deadweight loss relative to the free-market equilibrium? 3. Suppose that you have been chosen to give a three-minute—300 word—presentation to PDC arguing to them that the price floor of$10/ice-cream sandwich they imposed in (2) is doing more harm than good. What do you say?

4. When, broadly, is it a good thing for a government to impose per-unit taxes on production? For it to offer per-unit subsidies? For it to impose quotas? Price ceilings? Price floors?

Suppose that Johnny D’s Pirate Emporium has daily fixed costs of $10000, and its marginal cost curve is given by Q = P/2. Suppose that it produces an undifferentiated product in a perfectly competitive industry. Suppose that it is the most efficient firm around.Suppose that its technology and organization is easily copied. At what scale of production—what level of daily quantity Q—is its average total cost minimized for this firm? What does the long-run supply curve look like for this perfectly-competitive industry? Explain your reasoning. ## Problems: Short-Run and Long-Run Supply: Brie L.'s Brie-and-Red-Pepper Gourmet Suppose that Brie L.’s Brie-and-Red-Pepper Gourmet Shoppe has daily fixed costs of$1000, and its marginal cost curve is given by Q = 5 x P. Suppose that it produces an undifferentiated product in a perfectly competitive industry, is the most efficient firm around, but that its technology and organization is easily copied.

1. At what scale of production—what level of daily quantity Q—is its average total cost minimized? What does the long-run supply curve for this perfectly-competitive industry look like? Explain your reasoning ￼
2. Now suppose that Brie L.’s Brie-and-Red-Pepper Gourmet Shoppe has the same cost structure as in (1) but suppose that it produces a differentiated product in a monopolistically competitive industry alongside lots of firms like it. Suppose that it faces the firm demand curve: Q = (100000/N)(20.5 - P). For a total number of firms N equal to 1000, what is the profit-maximizing price and quantity for Brie L.’s Brie-and-Red-Pepper Gourmet Shoppe? How much money does the firm make? Explain your reasoning.

3. With the same industry demand curve (Q = 100000(20.5 - P)), under what circumstances would you rather have the perfectly-competitive industry of (1) and under what circumstances would you rather have the monopolistically-competitive industry of (2)? Explain your reasoning.

4. Now suppose that Brie L.’s Brie-and-Red-Pepper Gourmet Shoppe has become a monopoly: 1000 kitchens, daily fixed costs per kitchen of $1000, a marginal cost curve for each plant given by Q = 5 P, and no competitors—a business-model patent on brie-and-red-pepper products. With the same industry demand curve (Q = 100000(21 - P)), what price does it charge, how much does it make, and what are its daily profits in the short run? 5. Now consider Brie L.’s Brie-and-Red-Pepper Gourmet Shoppe monopoly not in the short run but in the long run, in which it can vary the number of kitchens it operates. If it has no fear of entry, competition, or regulation, how many kitchens will Brie choose to operate? What price will she charge? What quantity will she make? How much money will she make? ## Problems: Natural Monopoly: Channing T.'s Designer Chemicals Channing T.’s Designer Chemicals has no variable or marginal costs at all--what he is selling is simply water, food dye, and a few organic molecules, thus he can produce as many doses of Channing’s Magical Fitness Elixir as he wants for free, after he has invested a$1000 startup cost.

Channing has a patent: he does not need to fear competition.

1. Suppose that he faces a demand curve for CMFE of: Q = 100(20 - P); How many doses will he produce? What price will he charge? How much profit would he make?

2. Suppose that Channing is a good-hearted guy who doesn’t want to make money but rather to make the world a happier place and who seeks to maximize the sum of producer and consumer surplus. In this setup, how many doses will he produce? What price will he charge? How much profit would he make?

3. One criticism of market economies is that they do not do a good job in situations in which there are increasing returns--in which marginal costs are always low or zero. In view of (1) and (2), what do you think of this criticism?

Price Indexes: suppose Channing T. has the utility function Csθ x Cv(1-θ), θ=0.75, where Cs is purchases of sporting equipment and Cv is purchases of video games. Suppose each item of sporting equipment costs $100, each videogame costs$25, and Channing T. has an income of $800. 1.What does Channing T. choose to purchase and consume? 2. Suppose that an evil cartel raises the price of video games to 16 times their original price. If Channing’s income remains the same, what does he decide to purchase and consume? 3. Suppose that as the price of video games rises, the price of sporting equipment falls. By how much would the price of sporting equipment have to decline in order to make Channing as happy after as he was before the price changes? What is his consumption basket after the price changes? ## Problems: Inequality Inequality: suppose that consumers have the utility function Csθ x Cv(1-θ), θ=0.5, where Cs is purchases of sporting equipment and Cv is purchases of video games. Video games can only be produced by people with college degrees. Sporting equipment can be produced by anybody. 1. Suppose that 40% of the labor force have college degrees. What multiple of average income will the income of the college-educated be? What fraction of average income will the income of the non-college-educated be? 2. suppose that technological improvement in video games shifts the theta in the production function from 0.5 to 0.6. What happens to the income of the college-educated? What happens to the income of the non-college-educated? 3. Suppose you were given the job of persuading a bunch of non-college-educated that they should vote for higher taxes to provide bigger subsidies for higher education. What would you say? ## Problems: Keynes, Friedman, Minsky II Classify each of the situations below into one of our three types of depression: monetarist, Keynesian, and Minskyite: 1. Very low interest rates on short-term and long-term government bonds, but high interest rates on risky corporate bonds and low stock prices. 2. Very high interest rates on short-term and long-term government bonds, high interest rates on risky corporate bonds and low stock prices. 3. Very low interest rates on short-term and long-term government bonds, low interest rates on risky corporate assets and depressed stock prices. 4. Very low interest rates on short-term government bonds, high interest rates on risky corporate bonds, low stock prices, and high interest rates on long-term government bonds. ## Problems: Keynes, Friedman, Minsky Minskyites tend to say that both Keynesians and monetarists are wrong--at least in dealing with deep depressions. From their perspectives, attempts to boost either the economy's money stock or the planned amount of (risky) investment in building firm capacity are likely to fail to relieve depression. 1. What is the Minskyite story for why normal monetarist attempts to cure depression by printing money are unlikely to be completely successful? 2. What is the Minskyite story for why normal Keynesian attempts to cure depression are unlikely to be completely successful? ## Problems: Macroeconomic Policy II Suppose that the government has decided that it wants to boost the equilibrium level of real GDP Y, is working within the Keynesian framework, and is deciding whether it will try to do this by increasing the level of of G, of I, or by increasing c0. 1. What is the principal argument for preferring to attempt to increase G rather than I or c0? 2. What is the principal argument for preferring to attempt to increase I rather than G or c0? 3. What is the principal argument for preferring to attempt to increase c0 rather than G or I? 4. How should a government working within the Keynesian framework implement these plans? ## Problems: National Income Accounting III Suppose that the appliance store buys a refrigerator from the manufacturer on December 15, 2010 for$600, and that you then buy that refrigerator on February 15, 2011 for $1000: 1. What is the contribution to GDP in 2010? 2. How is the refrigerator accounted for in the NIPA in 2010? 3. What is the contribution to GDP in 2011? 4. How is the refrigerator accounted for in the NIPA in 2011? ## Problems: Real and Nominal Calculating real magnitudes: 1. When you calculate real GDP, do you do so by dividing nominal GDP by the price level or by subtracting the price level from nominal GDP? 2. When you calculate the real interest rate, do you do so by dividing the nominal interest rate by the price level or by subtracting the inflation rate from the nominal interest rate? 3. Are your answers to the two parts the same? Why or why not? ## Problems: National Income Accounting II Explain whether or not, why, and how the following items are included in the calculation of GDP: 1. Increases in business inventories. 2. Fees earned by real estate agents on selling existing homes. 3. Social Security checks written by the government. 4. Building of a new dam by the Army Corps of Engineers. 5. An economist earning$2,000 by giving a speech to members of San Francisco's private Commonwealth Club.
6. Interest that your parents pay on the mortgage they have on their house

## Problems: Keynesian Cross

Consider the simple Keynesian closed-economy income- expenditure model; Y=C+I+G. The idea is that if production and national income Y is less than or greater than spending C+I+G, production and income will rise or fall until they are equal. Suppose C = 5 + 0.666Y

1. G=3, I=2: what is Y?
2. I falls by 0.5: what happens to Y?
3. I recovers and rises by 0.3, but G falls by 0.3: what happens to Y?
4. I falls by 0.25: what happens to Y?
5. I recovers and rises by 0.2, but G falls by 0.3: what happens to Y?

## Problems: National Income Accounting

Explain whether or not, why, and how the following items are included in the calculation of GDP:

2. Fees earned by real estate agents selling newly-built homes.

3. Medicare payments to doctors by the government.

4. Repair of an old dam by the Army Corps of Engineers.

5. Rent paid on an already-built house.

## Principles of Economics: Problems: Utility

Suppose we have students going to Euphoric State University who spend their money on only two things all semester: yoga lessons Y and lattes L. Suppose that Channing T. has a Cobb-Douglas utility function of the form:

U = Y(θ)L(1-θ)

Suppose that the price of a yoga lesson is $20 and the price of a latte is$5, and that in a week Channing T. buys 4 times as many lattes as he takes yoga lessons. If his preferences are consistent, what is his personal θ?

## Problems: Phillips Curve

Consider the Phillips Curve framework in which π = E(π) + β(u* - u)—the inflation rate π equals: (i) the previously-expected inflation rate E(π), (ii) plus the “slope” coefficient β, (iii) times the difference between the natural rate of unemployment u* and the actual rate of unemployment u.

Calculate the rate of inflation π if:

1. E(π) = 2% per year, β = 1⁄2, u* = 6%, u = 4% 3%
2. E(π) = 9% per year, β = 1⁄2, u* = 5%, u = 7% 8%
3. E(π) = 2% per year, β = 1⁄2, u* = 4%, u = 8% 0%
4. E(π) = 4% per year, β = 1⁄2, u* = 5%, u = 10% 1.5%
5. E(π) = 6% per year, β = 1⁄2, u* = 5%, u = 8% 4.5%
6. E(π) = 0% per year, β = 1⁄2, u* = 6%, u = 4%

Suppose that it is December 2012 and you are called to Washington to audition for a cabinet-level post in the next administration and to advise him on the proper size of the economic stimulus program. Your forecast is that, were 2014 to be a normal business-cycle time, that the level of GDP in 2014 would be $17.0 trillion/year. You are conducting your analysis in the income-expenditure framework where: Y = C + I + G, C = co + cyY. You believe that cy = 0.5. You project that there will be little change from trend in consumer confidence co, which you project at$3 trillion/year in 2014. you project that business demand for investment spending will be $4 trillion/year in 2014. And you project that the Federal Reserve will not take additional steps to stimulate the economy. 1. What level of government purchases spending G do you recommend for 2014? Why? 2. Suppose that the President-Elect’s political advisors say that it is very important, politically, to cut government spending. What do you say in response? 3. Suppose that the collapse of the euro suddenly drives up interest rate spreads, and leads you to forecast that I in 2014 will be not$4 trillion but $3.5 trillion. How do you change your recommendation for G? ## Problems: Foundations of Supply: Six Characters II Consider a toy economy with six producing workers— Arya, Bran, Tegan, Taylor, Sarah, and Zedd--that produces two commodities: lattes (large, vanilla-caramel, half-caf, sweetened, made half with skim milk and half with half-and-half), and yoga lessons. In an hour the six workers could each teach at most the following number of yoga students: Arya 10; Bran 6; Tegan 4; Taylor 4; Sarah 2; and Zedd 0. In an hour the six workers could prepare at most the following number of lattes: Arya 60; Bran 10; Tegan 20; Taylor 30; Sarah 30; and Zedd 60. Now we are going to introduce money: the £, the purchasing power of which the government sets so that £1 purchases one latte. And let us call the price paid to the yoga instructor by each yoga student £Y. 1. Suppose that the price of a yoga lesson is £5.50. Who would rather teach yoga? Who would rather draw lattes? 2. Suppose the price of a yoga lesson is £10. Who would rather teach yoga? Who would rather draw lattes? 3. Suppose the price of a yoga lesson is £15. Who would rather teach yoga? Who would rather draw lattes? 4. With the price of yoga lessons along the vertical axis and the quantity of yoga students taught on the horizontal axis, draw the supply curve for yoga lessons for the economy. 5. Suppose that ten students want to and must take yoga lessons. What will the market equilibrium price of yoga lessons be? 6. Suppose that every potential student is willing to pay £6 for a yoga lesson. What will the market equilibrium quantity of yoga lessons be? 7. Suppose that the price of a yoga lesson is £6. How much do each of the six workers make per hour. 8. Suppose that the price of a yoga lesson is £11. How much do each of the six workers make per hour? 9. Suppose that the price of a yoga lesson is £15. How much do each of the six workers make per hour? 10. Suppose that the price of a yoga lesson is £1. How much do each of the six workers make per hour? ## Problems: Foundations of Supply: Six Characters Consider a toy economy with six producing workers—Arya, Bran, Tegan, Taylor, Sarah, and Zedd--that produces two commodities: lattes (large, vanilla-caramel, half-caf, sweetened, made half with skim milk and half with half-and-half), and yoga lessons. In an hour the six workers could each teach at most the following number of yoga students: Arya 10; Bran 6; Tegan 4; Taylor 4; Sarah 2; and Zedd 0. In an hour the six workers could prepare at most the following number of lattes: Arya 60; Bran 10; Tegan 20; Taylor 30; Sarah 30; and Zedd 60. 1. What is the largest number of yoga students that this economy could teach in an hour? 2. What is the largest number of lattes that this economy could make in an hour? 3. Suppose that some central planner—Mao Zedong, say—grabs three people at random and says “you are making lattes” and tells the other three “you are teaching yoga students”. How many lattes do you expect Mao’s allocation to make in an hour? How many yoga students do you expect Mao’s allocation to teach an an hour? 4. Is that the best the economy can do? If so, explain why. If not, propose an alternative assignment of workers to jobs and demonstrate that it is better. Is your alternative the best the economy can do? Explain why or why not. ## Principles of Economics: Problems: Income-Expenditure III Consider an economy like the U.S., only with all planned spending categories in round numbers: • I--business investment spending--determined by business executives' "animal spirits"--$3 trillion/year
• G--government purchases--determined by politics--$3 trillion/year • T--net taxes and transfers--determined by politics--$3 trillion a year
• X--exports of goods and services--determined by foreigners--$3 trillion/year • C--consumption spending on domestically-produced commodities--determined by households according to the equation: C = c0 + cy(Y - T) 1. Suppose c0 = 0 + cy = 0.6 and suppose that the economy is in equilibrium with E = Y. What is total planned expenditure E = C + I + G + X? 2. Suppose c0 =$3 trillon + cy = 0.4 and suppose that the economy is in equilibrium with E = Y. What is total planned expenditure E = C + I + G + X?

3. Suppose c0 = $3 trillion + cy = 0.6 and suppose that the economy is in equilibrium with E = Y. What is total planned expenditure E = C + I + G + X? 4. Suppose c0 = 0 + cy = 0.4 and suppose that the economy is in equilibrium with E = Y. What is total planned expenditure E = C + I + G + X? ## Problems: Quotas, Price Ceilings, Taxes: Vanilla II Suppose we have a demand equation (D:) P = 100 - Q and a supply equation (S:) Q = 60: 1. Calculate, for these equations (D:) and (S:), equilibrium price, quantity, consumer surplus, and producer surplus. 2. Do any of these calculations generate numbers that strike you as strange? If so, explain why the numbers strike you as strange, and why it is that the calculations came out the way that they did. 3. Suppose that the government imposes a quota: (Q:) Q=40. Calculate, for (D), (S), and (Q), equilibrium price, quantity, consumer surplus, and producer surplus. 4. Explain how the government’s quota-intervention in the marketplace has shifted the equilibrium values of all four of these variables. Explain how you would go about assessing whether this quota was a good policy or a bad policy. 5. Suppose that, instead of a quota, the government imposes a price ceiling (C:) P = 1. Calculate, for (S:), (D:), and (C:), equilibrium price, quantity, consumer surplus, and producer surplus. 6. Explain how the government’s price-ceiling intervention in the marketplace has shifted the equilibrium values of all four of these variables that you found in part (1). Explain how you would go about assessing whether disturbing the competitive market equilibrium by this price ceiling was a good policy or a bad policy. 7. Explain how the government’s price-ceiling intervention in the marketplace shifted the equilibrium values of all four of these variables from that that you found in the quota-equilibrium in part (3). Explain how you would go about assessing whether redisturbing the competitive market equilibrium by shifting from the quota (Q:) to the price ceiling (C:) was a good policy or a bad policy. 8. Now return to our original competitive equilibrium with our supply and demand equations (D:) P = 100 - Q and a supply equation (S:) Q = 60. Suppose the government imposes a tax (T:) of$30: it drives a wedge of $30 between Ps and Pd : Ps + 30 = Pd. Calculate the equilibrium values of the price received by producers, the price paid by consumers, the consumer surplus, and the producer surplus. 9. Compare the tax equilibrium of part (8) with the competitive market equilibrium of part (1). What conclusions do you draw? 10. Compare the tax equilibrium of part (8) with the quota equilibrium of part (3). What conclusions do you draw? 11. Compare the tax equilibrium of part (8) with the price-ceiling equilibrium of part (5). What conclusions do you draw? ## Problems: Quotas and Price Ceilings: Vanilla Suppose we have a demand equation (D:) P = 100 and a supply equation (S:) P = Q: 1. Calculate, for these equations (D:) and (S:), equilibrium price, quantity, consumer surplus, and producer surplus. 2. Do any of these calculations generate numbers that strike you as strange? If so, explain why the numbers strike you as strange, and why it is that the calculations came out the way that they did. 3. Suppose that the government imposes a quota: (Q:) Q=70. Calculate, for (D), (S), and (Q), equilibrium price, quantity, consumer surplus, and producer surplus. 4. Explain how the government’s quota-intervention in the marketplace has shifted the equilibrium values of all four of these variables. Explain how you ￼would go about assessing whether this quota was a good policy or a bad policy. 5. Suppose that, instead of a quota, the government imposes a price ceiling (C:) P = 70. Calculate, for (S:), (D:), and (C:), equilibrium price, quantity, consumer surplus, and producer surplus. 6. Explain how the government’s price-ceiling intervention in the marketplace has shifted the equilibrium values of all four of these variables that you found in part (1). Explain how you would go about assessing whether disturbing the competitive market equilibrium by this price ceiling was a good policy or a bad policy. 7. Explain how the government’s price-ceiling intervention in the marketplace shifted the equilibrium values of all four of these variables from that that you found in the quota-equilibrium in part (3). Explain how you would go about assessing whether redisturbing the competitive market equilibrium by shifting from the quota (Q:) to the price ceiling (C:) was a good policy or a bad policy. 8. Now return to our original competitive equilibrium with our supply and demand equations (D:) P = 100 - Q and a supply equation (S:) Q = 60. Suppose the government imposes a tax (T:) of$30: it drives a wedge of $30 between Ps and Pd : Ps + 30 = Pd. Calculate the equilibrium values of the price received by producers, the price paid by consumers, the consumer surplus, and the producer surplus. 9. Compare the tax equilibrium of part (8) with the competitive market equilibrium of part (1). What conclusions do you draw? 10. Compare the tax equilibrium of part (8) with the quota equilibrium of part (3). What conclusions do you draw? 11. Compare the tax equilibrium of part (8) with the price-ceiling equilibrium of part (5). What conclusions do you draw? ## Principles of Economics: Problems: Income-Expenditure II Consider an economy like the U.S., only with all planned spending categories in round numbers: • I--business investment spending--determined by business executives' "animal spirits"--$3 trillion/year
• G--government purchases--determined by politics--$3 trillion/year • T--net taxes and transfers--determined by politics--$3 trillion a year
• X--exports of goods and services--determined by foreigners--$3 trillion/year • C--consumption spending on domestically-produced commodities--determined by households according to the equation: C = c0 + cy(Y - T) And suppose that planned total production and income Y is$15 trillion:

1. Suppose c0 = 0 + cy = 0.6. What is total planned expenditure E = C + I + G + X? Is it equal to planned income? What are people planning to do with respect to their holdings of cash?

2. Suppose c0 = $3 trillon + cy = 0.4. What is total planned expenditure E = C + I + G + X? Is it equal to planned income? What are people planning to do with respect to their holdings of cash? 3. Suppose c0 =$3 trillion + cy = 0.6. What is total planned expenditure E = C + I + G + X? Is it equal to planned income? What are people planning to do with respect to their holdings of cash?

4. Suppose c0 = 0 + cy = 0.4. What is total planned expenditure E = C + I + G + X? Is it equal to planned income? What are people planning to do with respect to their holdings of cash?

## Problems: Market Equilibrium: Vanilla II

Suppose that we are given the supply equation (S:) P = 40, and the demand equation (D:) P = 200 – 50 Q:

1. Draw a graph of these two supply and demand curves.
2. Redraw your graph, and label it to explain how—if you were just given the graph—you would, from the graph, learn that the equations (S) and (D) were as specified
3. What is the equilibrium price and what is the equilibrium quantity?
4. What is the consumer surplus?
5. What is the producer surplus?
6. Suppose that a People Magazine story that the product produced is bad for your health leads to a shift in demand: the new demand equation is (D2:) P = 150 – 50 Q while the supply equation remains (S:) P = 40. What are the new values for the new equilibrium price, quantity, consumer, and producer surplus?

## Problems: Market Equilibrium: Vanilla

Suppose that we are given the supply equation (S:) P = 10Q, and the demand equation (D:) P = 200 – 50 Q:

1. Draw a graph of these two supply and demand curves

2. Redraw your graph, and label it to explain how—if you were just given the graph—you would, from the graph, learn that the equations (S) and (D) were as specified.

3. What is the equilibrium price and what is the equilibrium quantity?

4. What is the consumer surplus?

5. What is the producer surplus?

6. Suppose that resource depletion makes the inputs—what suppliers must buy in order to produce—of lower quality and the supply equation shifts to (S2:) P = 20Q with the demand equation remaining (D:) P = 200 – 50 Q. What are the new values for the new equilibrium price, quantity, consumer, and producer surplus?

7. Did you expect an adverse shock to supply like this to lead to such a shift in the values of these variables? If not, attempt to explain why it is that such an adverse shock to supply had these effects on equilibrium

## Problems: Externality, Resource Depletion, Asymmetric Loss Functions, Uncertainty: The Codfish

Suppose we have a demand curve for Atlantic cod right now this year, in tons of fish and thousands of dollars per ton:

Pd = 40 - 0.001Q;

and suppose we have a supply curve for Atlantic cod of:

Ps = 4

1. Calculate the equilibrium price and quantity. Calculate the equilibrium producer and consumer surplus.

2. Suppose that we add a resource depletion externality--if we catch too many codfish this year, there will be no little codfish next year, and no big codfish to catch five years from now. The total magnitude of this resource depletion externality is: XC =6.5 x 10-15 x Q4 (yes, that is the quantity squared, and then squared again). What Pigovian tax would you set?

3. In the same setup as (2), suppose that fishers miscalculate, and in aggregate 50% of the time catch 20,000 tons more and 50% of the time catch 20,000 tons less than they had planned when they set out to sea. Would this change the amount of tax you charged? If so, why? If not, why not?

## Principles of Economics: Problems: Income-Expenditure

Consider an economy like the U.S., only with all planned spending categories in round numbers:

• C--consumption spending on domestically-produced goods--$9 trillion/year • I--business investment spending--$2 trillion/year
• G--government purchases--$2 trillion/year • X--exports of goods and services--$2 trillion/year

1. What is total planned spending E in this economy this year?

2. Suppose irrational exuberance pushes business investment spending up to $3 trillion/year this year as businesses decide they can spend down their cash reserves. What do you expect to happen? 3. Suppose irrational pessimism pushes business investment spending down to$1 trillion/year this year as businesses decide they need to cut back and build up their cash reserves. What do you expect to happen

## Problems: Elasticity III

1. What can you say about how revenue varies with quantity produced when there is a price elasticity of demand of -1?

2. What can you say about how revenue varies with quantity produced when there is a price elasticity of demand of <-1?

3. What can you say about how revenue varies with quantity produced when there is a price elasticity of demand of >-1?

## Problems: Elasticity II

Suppose we have a demand curve Pd = 10000 x Q-1; or Pd = 10000/Q

1. Pick a point on the demand curve. Calculate the elasticity of demand at that point.

2. Now pick the point on the demand curve with twice the quantity produced that you originally chose. Which point on the demand curve sees a greater dollar volume of sales?

## Problems: Market Failure Overview

1. Explain why competitive markets in equilibrium subject to externalities will not, unless carefully and correctly tweaked by the government, produce an outcome that maximizes anyone’s idea of social welfare.

2. ￼Explain why competitive markets in equilibrium subject to non-excludibility cannot produce an outcome that maximizes anyone’s idea of social welfare.

3. ￼Explain why non-rivalry is a problem for those of us who hope that markets in equilibrium can be competitive and produce an outcome that maximizes anyone’s idea of social welfare.

4. Explain why competitive markets in equilibrium in a situation of maldistribution will not, unless carefully and correctly tweaked by the government, produce an outcome that maximizes anyone’s idea of social welfare.

5. Explain why competitive markets in equilibrium in a situation of miscalculation will not produce an outcome that maximizes anyone’s idea of social welfare.

6. Explain why competitive markets in equilibrium subject to moral hazard or adverse selection may not produce an outcome that maximizes anyone’s idea of social welfare.

7. What can keep markets from being competitive? Can a non-competitive market be a proper societal calculation and management device for controlling our incredibly fine and incredibly productive social division of labor?

8. How likely are markets to be in equilibrium, anyway?

## Principles of Economics: Foundations of Macroeconomics III

Consider an economy like the U.S., only with all planned spending categories in round numbers:

• C--consumption spending on domestically-produced goods--$9 trillion/year • I--business investment spending--$2 trillion/year
• G--government purchases--$2 trillion/year • X--exports of goods and services--$2 trillion/year

1. What is total planned spending E in this economy this year?

2. If the economy is in equilibrium--if people are actually able to buy all the currently-produced goods and services they plan to--what will total income Y be in the economy this year?

3. Suppose that less is produced than was planned to spend. What will happen to inventories?

4. How are employers likely to change the amount that they will produce next year in response to what happened to inventories this year?

## Problems: Natural Monopoly: Gold Rush Town II

Consider the market for first-run opening-week movies in Gold Rush Town:

• 2000 people in the town;
• one movie theatre;
• ample capacity to seat everyone who might want to come to see this week’s first-run movie;
• Demand Curve: Pd = 20 - .02 Q;
• no variable or marginal costs of showing the movie to more people: a non-rival good; and
• it costs $6000 to make a movie. 1. How many people should see the movie if we are to maximize societal well- being? What price should be charged to moviegoers? How much consumer surplus is there? How much is there in the way of costs that must be covered somehow? 2. Suppose people worry that government bureaucracies will produce lousy movies, so it is decided not to nationalize the movie industry but instead to let a monopoly make and show movies. What happens? 3. Suppose that we do nationalize the movie industry, and pay for it by imposing a$3 a person “movie tax” on everyone in the town. Relative to monopoly, and relative to no movies being shown, who gains and who loses from this scenario?

4. What would you think of a proposal to encourage better movies by doubling the movie tax and giving an annual prize to the best movie as voted by moviegoers as a way of keeping the bureaucracy from leading to low-quality movies?

## Problems: Externalities: Resource Depletion--Codfish

Suppose we have a demand curve for Atlantic cod right now this year , in tons of fish and thousands of dollars per ton: Pd = 40 - 0.001Q; and suppose we have a supply curve for Atlantic cod of Ps = 4:

1. Draw the supply and demand curves.

2. Calculate the equilibrium price and quantity. Calculate the equilibrium producer and consumer surplus.

3. Suppose we notice that there is an externality cost: the total burden from resource depletion by this year’s fishing is: XC = 10 x Q—each ton of fish landed costs an extra ten thousand dollars in resource depletion. What tax would you impose on the fishing industry, and why?

4. Would you think that fishers would be very upset at this tax, and lobby against it? Why or why not?

Suppose that in the area around Euphoric State University in the state of Euphoria there are 1500 workers: 500 potters, 500 baristas, and 500 yoga instructors. On January 1, every worker has $4,000 in cash on hand. produces$4,000 worth of their goods each month, which they then send off to the consignment store which sells their goods for them and pays them (in cash) at the very end of the month. Every worker gradually spends their cash on hand down steadily during the month so that they run out of cash just as the month ends--at which point in time the consignment shop pays each of them $4000. Bearing in mind that everyone's income is someone else's expenditure, suppose that the consignment shop announces on February 1 that it won't require cash for purchases in the last quarter of the month--that people can settle up by having their last quarter of the month's purchases deducted from their start-of-the-month payment: 1. How much do you think each of the 1500 workers will plan to spend in February? 2. How large do you think will be the payments that each worker receives on March 1, and how much cash does each of the workers have on hand at the end of March 1? 3. How much do you think each of the 1500 workers will plan to spend in March? ## Problems: Elasticity Suppose we have the demand curve: Pd = 1000 x Q-1.5: 1. Pick a point on the demand curve. Calculate the elasticity of demand at that point. 2. Now pick the point on the demand curve with twice the quantity produced that you originally chose. Which point on the demand curve sees a greater dollar volume of sales? 3. What is the relationship between your first two answers? ## Problems: Market vs. Central Planning Suppose that you find yourself the subject of some bizarre psychology experiment. You are seated in a locked room with a sociology or an anthropology major, and you have ten minutes to persuade him or her in ten minutes that it is broadly and on balance a good thing that we here today have a mixed and market-heavy economy rather than a centrally-planned economy like Stalin’s Russia, Mao’s China, Castro’s Cuba, or (shudder) Kim Jong Un’s North Korea. If you succeed, you win$1000. If you fail, you get nothing.

Write down, in order of importance, the things you would say to try to convince your experiment partner that it is broadly and on balance a good thing that we here today have a mixed and market-heavy economy.

## Principles of Economics: Problems: Foundations of Supply: Euphoric State

Suppose that there are six workers, Arya, Bran, Tegan, Taylor, Sarah, and Zedd, all trying to decide whether they should go to work teaching yoga lessons or pulling lattes.

In an hour the six workers could each teach at most the following number of yoga students: Arya 10; Bran 6; Tegan 4; Taylor 10; Sarah 2; and Zedd 0.

In an hour the six workers could prepare at most the following number of lattes: Arya 60; Bran 10; Tegan 20; Taylor 30; Sarah 30; and Zedd 60. The government sets the vale of its currency, the pound, so that £1 purchases one latte. Call the price paid to the yoga instructor by each yoga student £Y.

1. Suppose that the price £Y of a yoga lesson is £5.50. Who would rather teach yoga? Who would rather draw lattes?

2. Suppose the price of a yoga lesson is £10. Who would rather teach yoga? Who would rather draw lattes?

3. Suppose the price of a yoga lesson is £15. Who would rather teach yoga? Who would rather draw lattes?

4. With the price of yoga lessons along the vertical axis and the quantity of yoga students taught on the horizontal axis, draw the supply curve for yoga lessons for the economy.

## Problems: Natural Monopoly: Gold Rush Town

Consider the market for first-run opening-week movies in Gold Rush Town:

• 4000 people in the town;
• one movie theatre;
• ample capacity to seat everyone who might want to come to see this week’s first-run movie;
• Demand Curve: Pd = 20 - .01Q;
• no variable or marginal costs of showing the movie to more people: a non-rival good;
• suppose that it costs $1000 to make a movie. 1. How many people should see the movie if we are to maximize societal well-being? 2. What price should be charged to moviegoers to maximize societal well-being? 3. How much consumer surplus is there? 4. How much is there in the way of costs that must be covered somehow? 5. Suppose people worry that government bureaucracies will produce lousy movies, so it is decided not to nationalize the movie industry but instead to let a monopoly make and show movies. What happens? 6. Suppose that other movie companies petition for the right to use the theatre, and get it. Suppose that if N movie companies make movies, each sells 2000/(N+1) tickets, and the price of tickets is the price at which that number of tickets satisfies demand. In equilibrium—where it is not worth another movie company’s while to enter the market—what happens? ## Principles of Economics: Problems: Foundations of Macroeconomics Suppose that in the area around Euphoric State University in the state of Euphoria there are 1500 workers: 500 potters, 500 baristas, and 500 yoga instructors. On January 1, every worker has$4,000 in cash on hand. produces $4,000 worth of their goods each month, which they then send off to the consignment store which sells their goods for them and pays them (in cash) at the very end of the month. Every worker gradually spends their cash on hand down steadily during the month so that they run out of cash just as the month ends--at which point in time the consignment shop pays each of them$4000.

Bearing in mind that everyone's income is someone else's expenditure, suppose that all 1500 workers decide on February 1 that they need to be safer in their financial transactions--that they need to start the month of March not with $4000 in cash but with$4500 in cash:

1. How much do each of the 1500 workers plan to spend in February?

2. How much cash on hand do each of the 1500 workers have on February 28?

3. How large are the payments that each worker receives on March 1, and how much cash does each of the workers have on hand at the end of March 1?

4. How much do you think each of the 1500 workers will plan to spend in March?

5. How large do you think the payments that each worker receives on April 1 will be?

## Problems: Identifications--Micro

1. Demand Curve
2. Supply Curve
3. Producer Surplus
4. Consumer Surplus
5. Willingness to Pay
6. Opportunity Cost
7. Equilibrium
8. Movement along a Demand Curve
9. Shifting a Demand Curve
10. Moving along a Supply Curve
11. Shifting a Supply Curve
12. Externalities
13. Market Failure
14. Rivalry
15. Excludibility
17. Moral Hazard
18. Quotas
19. Taxes
20. Price Ceilings
21. Increasing Returns to Scale
22. Natural Monopoly
23. Miscalculation
24. Maldistribution
25. Excess Demand
26. Excess Supply
27. Expectations
28. Monopoly
29. Oligopoly
30. Collusion
31. Monopolistic Competition

## Assignments: Letter of Introduction

Letter of Introduction: By the start of your section meeting during the week of January 20-26, please write a 500-word essay--a “letter of introduction”--to your section instructor. Include your name, and discuss:

• the reasons why you are choosing to spend 3% of your scarce college curriculum time taking this course this year,
• what you hope to learn from this course,
• what you hope to do in the future as a result of this course, and
• whatever else about yourself that you would like to share with your section instructor; in addition
• please also include or embed a photo of yourself, as this will help us learn your name.

## Principles of Economics: Problems: Market Equilibrium: Pots, Yoga Lessons, and Lattes at Euphoric State University IV

The economy around Euphoric State University has only three workers—Dharma, Egbert, and Greg--and three commodities--lattes, yoga lessons, and ceramic pots. Each is able to produce any of the three commodities (lattes, yoga lessons, and ceramic pots). Their abilities to produce the three commodities in one hour are: Coffee Yoga Plates

• Dharma can produce 2 lattes, or teach 5 students yoga lessons, or make 4 pots
• Egbert can make 2 lattes, or teach 1 student a yoga lesson, or make 3 pots
• Greg can make 9 lattes, or teach 1 student a yoga lesson, or make 5 pots

1. Suppose that we are going to specialize—have each person produce one and only one of the commodities. Decide which of the three commodities should be produced by which of the three people, and explain your reasoning.
2. Suppose that we take lattes to be our standard of value. Quote the prices of yoga lessons and of ceramic pots in terms of lattes, and suppose that a yoga lesson is worth 2 lattes and a ceramic pot is worth 1 latte. Does this change your view of the production allocation you had arrived at? Why or why not?
3. Suppose that a yoga lesson is worth 2 lattes and a ceramic plate is also worth 2 lattes? Does this change your view of the best production allocation you had arrived at for questions 7 and 8? Why or why not?

## Principles of Economics: Problems: Market Equilibrium: Pots, Yoga Lessons, and Lattes at Euphoric State University III

The economy around Euphoric State University has three types of workers—-Dharmas, Egberts, and Gregs—-who produce yoga lessons, ceramic pots, and lattes, respectively. In this economy the prices of yoga lessons and ceramic pots are expressed in terms of lattes.

Suppose that Egberts are willing to produce pots according to the following rule: at a price of zero, they will make zero pots, for every 1-latte increase in the price of pots, they are willing to make ten additional pots.

1. Suppose that if pots cost 10-lattes, nobody wants to buy any. Each 1-latte reduction in the price of pots leads consumers to want to buy an additional five pots. a. What is the market equilibrium price of pots in this market? b. What is the market equilibrium quantity of pots exchanged in this market? c. What is the consumer surplus in this market, in units of lattes? d. What is the producer surplus in this market, in units of lattes?

2. Suppose that if pots cost 5-lattes, nobody wants to buy any. Each 1-latte reduction in the price of pots leads consumers to want to buy an additional ten pots. a. What is the market equilibrium price of pots in this market? b. What is the market equilibrium quantity of pots exchanged in this market? c. What is the consumer surplus in this market, in units of lattes? d. What is the producer surplus in this market, in units of lattes?

3. Suppose that if pots cost 20-lattes, nobody wants to buy any. Each 1-latte reduction in the price of pots leads consumers to want to buy an additional three pots. a. What is the market equilibrium price of pots in this market? b. What is the market equilibrium quantity of pots exchanged in this market? c. What is the consumer surplus in this market, in units of lattes? d. What is the producer surplus in this market, in units of lattes?

## Principles of Economics: Problems: Market Equilibrium: Pots, Yoga Lessons, and Lattes at Euphoric State University II

The economy around Euphoric State University has three types of workers—-Dharmas, Egberts, and Gregs—-who produce yoga lessons, ceramic pots, and lattes, respectively. In this economy the prices of yoga lessons and ceramic pots are expressed in terms of lattes.

Suppose that Egberts are willing to produce pots according to the following rule: at a price of zero, they will make zero pots, for every 1-latte increase in the price of pots, they are willing to make ten additional pots.

If pots cost more than 5 lattes, nobody wants to buy any. However, consumers are willing to buy an unlimited number of pots at a price of 5 lattes per pot.

1. What is the market equilibrium price of pots in this market?
2. What is the market equilibrium quantity of pots exchanged in this market?
3. What is the consumer surplus in this market, in units of lattes?
4. What is the producer surplus in this market, in units of lattes?

## Principles of Economics: Problems: Spite and Envy: BMWs at Crony Capitalism University

If in the state of Euphoria you drive 50 miles south of the city of Holy Frank along the Royal Road, you come to the town of Tall Stick. In Tall Stick we find Crony Capitalism University—endowed by one of the early governors of Euphoria with money he diverted from the railroad connecting the state of Euphoria with the outside world.

Let us say that every year 1000 freshmen arrive at CCU and each immediately think about buying a BMW convertible. They are, you see, mostly from Angel-Queen City. They have not walked anywhere since they started kindergarten. CCU is a mile walk under the hot Euphoric sun from even the closest shops of Tall Stick, and the palm trees along the walk--although pretty--do not cast much shade.

Suppose that the selling price of BMW convertibles is $55,000, and suppose that each of the 1000 freshmen values a BMW convertible$50,000 for purposes of transportation.

But there is a catch. Each student who owns a BMW convertible feels $10 worth of utility happier—call it spite—for each and every one of his or her 999 peers who does not own a BMW convertible. Each student who does not own a BMW convertible feels$10 of utility unhappier—call it envy—for each of his or her 999 peers who does own a BMW convertible. Thus the first student to show up would feel no envy if he or she did not buy (for nobody else owns one) but would receive 999 x $10 =$9,990 worth of spite plus $50,000 worth of transportation if he or she were to buy a BMW convertible: 1. Will the first freshman student to show up at CCU buy a BMW convertible? 2. How many of the 1000 freshmen students to show up at CCU will buy BMW convertibles? 3. What will be the total consumer surplus received by the 1000 freshman students of CCU from their purchase of BMW convertibles? 4. Suppose you are the chair of the Department of Economics at CCU, and the President of CCU asks you how much the university should charge freshmen for parking spaces. Suppose that there is ample parking—this is suburban Euphoria, after all—but all of it is on university land. What do you think is the right price to charge for parking? Why? ## Problems: Natural Monopoly: The Movie Theatre in Ihavefoundit III In the far north of the state of Euphoria there is a small town called Ihavefoundit. There is one theater in Ihavefoundit, and there is no connectivity to the outside world whatsoever. This means that the 1000 or so residents of Ihavefoundit who have a fondness for watching classic Japanese cinema with subtitles have only one way to do so: somebody has to rent a copy of a movie and rent the theater—paying$420 to do both of those things—and then show the movie, charging admission. No matter how many people show up to the theater the cost of showing the movie remains the same: $420. You are conducting market research to discover the shape of the demand curve. You determine that there is nobody who will pay a price of$60, 1 who will pay $59, 2 who will pay$58, and so on down until you hit $10, at which point there will be 50 willing to pay to see the movie. Then 55 people will be willing to pay$9, 60 in total will be willing to pay $8, 65 will be willing to pay$7, 70 will be willing to pay $6, and 75 will be willing to pay$5. Below $5 a ticket things change: 90 people will be willing to pay$4, 105 will be willing to pay $3, 120 will be willing to pay$2, 180 will be willing to pay $1, and 360 will come if it is free. Suppose that the profit-making Monopolist Entrepreneurial Company is thinking of entering the business as the only—the monopoly—seller of opportunities to see classic Japanese cinema in the benighted, fog-bound, and redwood-infested town of Ihavefoundit. They hire you to analyze the situation given your extensive market research. After you have finished your market research, MEC refuses to pay your bill. Next, Production Distribution Coordination--PDC--for the state of Euphoria now calls you up and asks whether they should give the RCC a$420 grant from public funds—have movies shown not by a for-profit company and not by a non-profit collective but instead by a public movie-showing program.

1. What price per ticket does the RCC now have to charge to take even?
2. What is the consumer surplus now when the RCC breaks even?
3. By how much has consumer surplus increased as a result of this $420 grant? 4. What are the arguments that this$420 grant is a good use of the government's money?
5. What are the arguments that this $420 grant is a bad use of the government's money? ## Problems: Natural Monopoly: The Movie Theatre in Ihavefoundit II In the far north of the state of Euphoria there is a small town called Ihavefoundit. There is one theater in Ihavefoundit, and there is no connectivity to the outside world whatsoever. This means that the 1000 or so residents of Ihavefoundit who have a fondness for watching classic Japanese cinema with subtitles have only one way to do so: somebody has to rent a copy of a movie and rent the theater—paying$420 to do both of those things—and then show the movie, charging admission. No matter how many people show up to the theater the cost of showing the movie remains the same: $420. You are conducting market research to discover the shape of the demand curve. You determine that there is nobody who will pay a price of$60, 1 who will pay $59, 2 who will pay$58, and so on down until you hit $10, at which point there will be 50 willing to pay to see the movie. Then 55 people will be willing to pay$9, 60 in total will be willing to pay $8, 65 will be willing to pay$7, 70 will be willing to pay $6, and 75 will be willing to pay$5. Below $5 a ticket things change: 90 people will be willing to pay$4, 105 will be willing to pay $3, 120 will be willing to pay$2, 180 will be willing to pay $1, and 360 will come if it is free. Suppose that the profit-making Monopolist Entrepreneurial Company is thinking of entering the business as the only—the monopoly—seller of opportunities to see classic Japanese cinema in the benighted, fog-bound, and redwood-infested town of Ihavefoundit. They hire you to analyze the situation given your extensive market research. After you have finished your market research, MEC refuses to pay your bill. Annoyed, you go to the Redwood Collective for Culture and argue that they should take on the business of showing movies as a non-profit. The RCC is—let us suppose—an efficient organization, able to actually rent a theater, rent a print of the movie, collect money, and not have it stolen. The only constraint on the RCC is that it has to break even. 1. At what price charged per ticket does the RCC break even—that is, collect the$420 it needs to run its operations?
2. What is the consumer surplus when the RCC breaks even?
3. How does that compare to the consumer surplus when a profit-maximizing entrepreneurial company like MEC had a monopoly and showed the movies?
4. How does that compare to the sum of consumer surplus when a profit-maximizing entrepreneurial company like MEC had a monopoly and showed the movies?
5. Which comparison—that of consumer surplus with the RCC to consumer surplus with the profit-making MEC in part (c), or that of consumer surplus with the RCC to consumer plus producer surplus with the profit-making MEC in part (d)—is the best one to keep in mind in guiding your analysis of whether classic Japanese cinema in Ihavefoundit should be shown by a private company or by a nonprofit organization?

## Problems: Natural Monopoly: The Movie Theatre in Ihavefoundit

In the far north of the state of Euphoria there is a small town called Ihavefoundit. There is one theater in Ihavefoundit, and there is no connectivity to the outside world whatsoever. This means that the 1000 or so residents of Ihavefoundit who have a fondness for watching classic Japanese cinema with subtitles have only one way to do so: somebody has to rent a copy of a movie and rent the theater—paying $420 to do both of those things—and then show the movie, charging admission. No matter how many people show up to the theater the cost of showing the movie remains the same:$420.

You are conducting market research to discover the shape of the demand curve. You determine that there is nobody who will pay a price of $60, 1 who will pay$59, 2 who will pay $58, and so on down until you hit$10, at which point there will be 50 willing to pay to see the movie. Then 55 people will be willing to pay $9, 60 in total will be willing to pay$8, 65 will be willing to pay $7, 70 will be willing to pay$6, and 75 will be willing to pay $5. Below$5 a ticket things change: 90 people will be willing to pay $4, 105 will be willing to pay$3, 120 will be willing to pay $2, 180 will be willing to pay$1, and 360 will come if it is free.

Suppose that the profit-making Monopolist Entrepreneurial Company is thinking of entering the business as the only—the monopoly—seller of opportunities to see classic Japanese cinema in the benighted, fog-bound, and redwood-infested town of Ihavefoundit. They hire you to analyze the situation given your extensive market research. They ask:

1. What price maximizes profits for the Monopolist Entrepreneurial Company?
2. What profits will the MEC make at that price?
3. What is the consumer surplus for that price?
4. What is the total social surplus for that price?

## Principles of Economics: Problems: Quotas: Yoga Lessons in Avicenna

In the central part of the state of Euphoria there is a small city, Avicenna, which is the home of Euphoric State University. [“Avicenna” is a corruption of the Arabic Ibn Sina, the byname of the great eleventh-century Iranian Abu Ali al-Husayn ibn Abd Allah ibn Sina: academic administrator, Quran reciter, astronomer, chemist, geologist, psychologist, theologian, mathematician, physicist, physician, poet, and paleontologist.] We will look at the daily market for yoga lessons in Avicenna

Suppose that the quantity of yoga lessons demanded (Qd) and the quantity of yoga lessons supplied (Qs) are given by the equations:

Qd =126-5P

Qs = 2P

where P is the price of a yoga lesson in dollars.

Now suppose that somebody stands up at PDC and gives a persuasive speech that yoga is an alien fitness discipline and that we should be encouraging all-American forms of exercise—like hot-dog eating contests. As a result, PDC passes a decree that no more than 20 people should take yoga lessons a day. However, they do not restrict the price that those lucky enough to be allowed to offer the 20 lessons can charge.

1. To what price will consumers bid up the price of yoga lessons?
2. What will the consumer surplus be?
3. What is the average reservation price for which potential yoga teachers will want to teach yoga lessons?
4. Suppose that the average teacher who succeeds in signing up to give the 20 lesson slots has the average valuation among all those who wish to sign up. What, then, is the producer surplus?
5. Who has gained and who has lost from this decree relative to the market equilibrium, and how much?
6. Can you think of a reason why this decree from the PDC might be popular?
7. Suppose it is your job to argue that the decree should be repealed. What would you say?
8. Do you think those who persuaded PDC to pass this decree should be tried and punished for convincing PDC to pass a bad decree? Why or why not?