## Principles of Economics: Problems: Supply and Demand: Sunnydale Lattes

Suppose that, on and near the U.C. Sunnydale campus, the weekly supply curve for lattes is given by the equation Q = max(1000 P - 2000, 0) : nobody makes any lattes unless the price is above $2/latte, and for each$1 the price is above $2 an extra 1000 lattes are made. 1. Suppose that customers have$10,000/week to spend on lattes. Draw the supply curve and the demand curve.

2. What is the equilibrium price of lattes? What is the equilibrium quantity of lattes?

## Principles of Economics: Problems: Utility and Spite and Envy: RMU and Cabo Vacations

Suppose we have students going to Railroad Monopoly University who spend their money on only two things all semester: vacations in Cabo San Lucas (V) and renting BMWs for the weekend (R). And suppose that their utility function is the Cobb-Douglas function with θ = 1/3, and suppose that a student named Jonah H. takes vacations in Cabo on three weekends and rents a BMW for the other 15 weekends of the semester.

1. What, for that consumption pattern, is Jonah’s marginal rate of substitution between Cabo vacations and renting BMWs? That is, if he takes an additional vacation, by how many BMW rentals could he cut back his BMW renting and still be as happy, still be on the same indifference curve?

2. Suppose that Channing T. is also a student at Railroad Monopoly University, with the same utility function as Jonah. But suppose that Channing takes vacations in Cabo on six weekends and rents a BMW for six weekends of the semester. What, for that consumption pattern, is Channing’s marginal rate of substitution between Cabo vacations and renting BMWs—that is, if he takes an additional vacation, by how many BMW rentals per average semester could he cut back his BMW-renting and still be as happy, still be on the same indifference curve?

3. Suppose that renting a BMW costs $50 a weekend and taking a vacation in Cabo costs$500, and that Jonah has $2250 to spend and Channing$3300. Is either Channing or Jonah making a mistake in choosing their consumption pattern? If only one is, which one is making a mistake? Why are they making a mistake?

4. Explain to either Channing or Jonah—whichever one you think is making a mistake, or both— how they could make themselves happier (or at least more dissipated) if they changed their consumption pattern. In what direction do you think they should change their consumption pattern(s)? How far do you think they should change their consumption pattern(s)? (Or, if you think neither is making a mistake, explain why you think both are doing what they ought to do.

5. Brie, with only $1100 per semester to spend, has different tastes and preferences. Her utility function has θ=5/6. If Cabo vacations cost$500 and BMW rentals cost $50, is she happiest buying 0, 1, or 2 vacations and spending the rest of her money on BMW rentals? Explain why her optimal ratio of vacations to rentals is different than the optimal ratio for Channing and Jonah. 6. Suppose that there is a BMW shortage. BMWs now rent for not$50 a weekend but $500 a weekend. And suppose that Jonah, Channing, and Brie have$2500, $3500, and$1000 to spend, respectively. How should each of the three spend his or her money? Explain your reasoning

7. Suppose Phil and Chris notice that neither Channing nor Jonah actually likes riding around in BMWs. What they like, instead, is impressing each other by renting more BMWs than their co- star—and they feel unhappy when their co-star rents more BMWs than they do. That is, the utility function for Jonah and Channing are actually: Uj = (Vj)θ(Rj/Rc)(1-θ) and Uc = (Vc)θ(Rc/Rj)(1-θ). Phil and Chris calculate how many vacations and BMW rentals, if BMW rentals cost $50 and Cabo vacations cost$500, Channing and Jonah should spend their money on to collectively make them the happiest. What do they conclude? Explain your reasoning. (Hint: suppose Phil and Chris decide to calculate the geometric mean of Channing’s and Jonah’s utility, and then to try to make that product as large as possible...)

8. Suppose that Phil and Chris are right, that you are in charge of Railroad Monopoly PDC, and that you try to make both Channing and Jonah happier by imposing a tax on BMW rentals. How high a tax do you think you should impose? Explain your reasoning.

## Principles of Economics: Problems: CBO

Websurf your way over to the Congressional Budget Office’s most recent Long-Term Budget Outlook at http://www.cbo.gov/ftpdocs/115xx/doc11579/06-30-LTBO.pdf. Read it.

1. What is federal health care spending currently as a percentage of GDP?

2. What does the CBO think that federal health care spending—Medicare, Medicaid, CHIP, and Exchange Subsidies—is likely to be as a percentage of GDP in 2035?

3. What does the CBO say that Social Security spending currently is as a percentage of GDP?

4. What does the CBO think that Social Security spending is likely to be as a percentage of GDP by 2035? In 2035, CBO projects it to be 6.2%

5. Why, in your own words, does the CBO believe that the share of GDP the federal government spends on its major “mandatory” programs is going to rise between now and 2035?

6. What does the Congressional Budget Office project that the federal debt held by the public will be, as a share of GDP, in 2035, if congress and the president either adhere to the “baseline” of current federal programs or if they hold to PAYGO— that is, cut one program or raise taxes by the amount by which they raise another program? What, in your own words, is the logic behind this projection?

7. What does the Congressional Budget Office project that the federal debt held by the public will be, as a share of GDP, in 2035, if congress and the president continue to do business more- or-less as they have done business since 1980? What, in your own words, is the logic behind this projection?

## Principles of Economics: Problems: Global Economic Growth

In 8300 BC there were roughly 5 million people in the world—with an average standard of living of about $500/year. In 1700 there were roughly 640 million people in the world—with an average standard of living of about$500/year. In 1900 there were roughly 1.6 billion people—with an average standard of living of about $565/year. Today there are roughy 7.2 billion people— with an average material standard of living of$8035 dollars per year.

1. Use the Rule of 72 to calculate the average population growth rate and the average global real GDP growth rate between 8300 BC and 1700 AD.

2. Use the Rule of 72 to calculate the average global real GDP growth rate between 1700 and 1900 AD.

3. Use the Rule of 72 to calculate the average global real GDP growth rate between 1900 and 2012.

4. How much faster has global real GDP growth been over 1900-2012 than it was over 8300 BC-1700 AD?

5. How much faster has global real GDP growth been over 1900-2012 than it was over 1700-1900?

6. What would global real GDP be in 2100 if it were to grow as rapidly between now and 2100 as it grew from 1900-2012?

7. If there are 10 billion people in the world in 2100 and if global real GDP be in 2100 if it were to grow as rapidly between now and 2100 as it grew from 1900-2012, what would average living standards be in 2100?

8. Why do they call it the “Industrial Revolution”?

## Principles of Economics: Problems: Phillips Curve II

In the Phillips Curve framework in which:

π = E(π) + β(u* - u)

the inflation rate π equals the previously- expected inflation rate E(π) plus the “slope” β times the difference between the natural rate of unemployment u* and the actual rate of unemployment u—and in which this year’s expected inflation E(π) is last year’s actual inflation, calculate the rate of inflation π:

1. In the first year, if the starting E(π)=2% per year, β = 1⁄2,u*=5%, and u=5%

2. In the second year, if E(π) is what inflation was the previous year—that is, if E(π) is your answer to part a—β = 1⁄2, u = 5%, but structural changes in the economy raise u* to 7%

3. In the third year, if E(π) is what inflation was the previous year—that is, if E(π) is your answer to part b—β = 1⁄2, u = 5%, but structural changes in the economy keep u* at 7%

4. In the fourth year, if E(π) is what inflation was the previous year—that is, if E(π) is your answer to part c—β = 1⁄2, u = 5%, but structural changes in the economy keep u* at 7%.

5. What should the government and central bank do if they want to keep inflation from rising?

## Principles of Economics: Problems: Foundations of Supply: Six Characters Plus Mao Zedong

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. 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?

2. If you allow the market system to work, what price of yoga lessons £Y would have the economy teaching as many students as you expect to get in Mao’s economy? How many lattes would that market economy produce? How much better off would consumers be as a result?

3. If you allow the market system to work, at what price of yoga lessons £Y would the economy make as many lattes as you expect to get in Mao’s economy? How many yoga lessons would that market economy teach? How much better off would consumers be as a result?

4. Write a paragraph, 400 words at most, in which you make your argument to Mao Zedong that he should decontrol the Chinese economy and let it revert back to a market economy. For extra credit, in an appropriate and sensible place, quote Deng Xiaoping: “It is not important whether a cat is red or white; it is important whether a cat catches mice!”

5. What do you think Mao would say and do in answer to your attempt to convince him to reverse his economic policy course?

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

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 plates, for every 1-latte increase in the price of pots, they are willing to make ten additional pots.

Suppose that demand for pots follows this rule: 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 ten pots.

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?

## Problems: Say's Law

On January 13, 2009, University of Chicago Business School Professor Eugene Fama wrote:

[S]timulus plans are not a cure.... In a ‘fiscal stimulus,’ the government borrows and spends the money.... [G]overnment infrastructure investments must be financed -- more government debt. The new government debt absorbs private and corporate savings, which means private investment goes down by the same amount.... The government gives with one hand but takes them back with the other, with no net effect on current incomes...”

Write down how you would explain to Professor Fama that this is simply the argument Jean-Baptiste Say made in 1803 (and that he recanted in 1829), and the argument that John Stuart Mill identified the flaw in in 1829. What is the flaw?

## Problems: Fundamentals of Supply: An Lushan etc.

Consider a toy economy with eight workers--Lucy, Ricky, Ethel, Fred, Chingachgook, Galla Placidia, Ibn Sina, and An Lushan--that produces two commodities: lattes (large, vanilla-caramel, half-caff, sweetened, made half with skim milk and half with half-and-half--all lattes are equivalent, and take the same time and skill to make), and yoga lessons.

In a shift the eight workers could each teach at most the following number of yoga lessons: An Lushan 8; Chingachgook 8; Ibn Sina 4; Galla Placidia 3; Lucy 1; Ethel 1; Ricky 1; Fred 0.

In a shift the eight workers could prepare at most the following number of lattes: Lucy 20; Chingachgook 20; Ibn Sina 12; Ethel 10, Ricky 10, Fred 5; An Lushan 3; Galla Placidia 2.

Workers can split shifts: spend half their time teaching yoga and teaching half their maximum number of lessons and the other half pulling lattes and making half their maximum number, etc.

All 8 workers want to work a full shift.

1. What is the largest number of yoga lessons that this economy could teach?
2. What is the largest number of lattes that this economy could make?
3. Suppose Joe Djugashvili comes along and--out of the goodness of his heart and his desire to serve the people--volunteers to take on the onerous labor of the head of Production Distribution Coordination and assign people to shifts and tasks. He grabs four workers at random and says “you are pulling lattes”. He tells the rest “you are teaching yoga classes”. What is the expected value of the number of yoga classes taught? What is the expected value of the number of lattes made?
4. Graph the Production-Possibility Frontier--the PPF--of this economy.
5. Louie von Mises comes along and says that Joe Djugashvili is a really lousy head of PDC. Is Louie right or wrong? Use the PPF you drew in (4) to motivate your answer.
6. How many yoga lessons could the economy produce and still produce as many lattes as Joe Djugashvili expected the economy he ran to produce in (4)?
7. How many lattes could the economy produce and still produce as many yoga lessons as Joe Djugashvili expected the economy he ran to produce in (4)?
8. Suppose that lattes sell for $4 each. What is the opportunity cost for each of the eight workers of putting them to work teaching an extra yoga lesson? 9. Suppose that all the students in a yoga lesson collectively pay$15 per lesson. What is the opportunity cost for each of the eight workers of putting them to work pulling an extra latte?
10. Suppose Joe is still head of PDC. Oskar Lange comes along bearing the results of your calculations from (8) and says that he has a plan by which the economy can produce more than the random-assignment economy of (3). In what order does he tell Joe to pick the people who are going to teach the yoga lessons?
11. What is the relationship between your answer to (10) and your answer to (4). Is Louie now happy (or at least less unhappy)?
12. Suppose customers are willing to pay $4 each for lattes and$15 for yoga lessons. Who should Joe assign to teach yoga? To pull lattes? How many lattes will the economy make and how many yoga lessons will it teach?
13. Suppose customers are willing to pay $4 each for lattes but only$5 for yoga lessons. Who should Joe assign to teach yoga? To pull lattes? How many lattes will the economy make and how many yoga lessons will it teach?
14. Suppose customers are willing to pay $4 each for lattes and$45 for yoga lessons. Who should Joe assign to teach yoga? To pull lattes? How many lattes will the economy make and how many yoga lessons will it teach?
15. Which economy--(3), (12), (13), or (14)--is the worst economy? Why?
16. Which economy--(3), (12), (13), or (14)--is the best economy? Why?
17. Suppose that the price of lattes is $4 each. Let the price of yoga lessons vary from$0 to $100, and draw the supply curve for yoga lessons. 18. Suppose that the price of lattes is$2 each. Let the price of yoga lessons vary from $0 to$100, and draw the supply curve for yoga lessons.
19. Why is your supply curve in (17) different from your supply curve in (18)?
20. Suppose that the price of yoga lessons is $20 each. Let the price of lattes vary from$0 to $40, and draw the supply curve for lattes. 21. Suppose that the price of yoga lessons is$10 each. Let the price of lattes vary from $0 to$40, and draw the supply curve for lattes.
22. Why is your supply curve in (20) different from your supply curve in (21)?
23. For the supply curve you drew in (18), suppose consumers demand 22 yoga lessons. What is the equilibrium price of yoga lessons?
24. For the supply curve you drew in (18), suppose consumers demand 12 yoga lessons. What is the equilibrium price of yoga lessons?
25. For the supply curve you drew in (18), suppose consumers are willing to pay $22 for yoga lessons. What is the equilibrium quantity of yoga lessons? 26. For the supply curve you drew in (18), suppose consumers are willing to pay$4 for yoga lessons. What is the equilibrium quantity of yoga lessons?

## Problems: Fundamentals of Demand and Supply: Kautilya etc.

Suppose that there are four people in the economy who demand yoga lessons: Kautilya (a government economist) with an income of $1000/week, Thasuka Witko (a herder and politician) with an income of$500/week, Buffy Summers (a student at U.C. Sunnydale) with an income of $300/week, and Sappho (a poet) with an income of$600/week. Kautilya spends 1/5 of his income on yoga lessons, Thasunka Witko spends 1/10 of his income on yoga lessons, Sappho spends 1/4 of her income on yoga lessons, and Buffy Summers spends half of her income on yoga lessons.

1. Draw the demand curve for yoga lessons in this economy. What is demand for yoga lessons if the price of yoga lessons is $10/hour?$20/hour? $30/hour?$40/hour? $50/hour? 2. Consider the same situation as in question (1) but with one difference. Changes in Buffy Summers's life circumstances--the opening of the Mouth of Hell on the U.C. Sunnydale campus--lead her to have no demand for yoga lessons at all as she has to spend all of her income buying sharp wooden stakes. Learning about Buffy's predicament leads Kautilya to boost his yoga expenditures to 1/4 of his income, leads Thasuka Witko to drop yoga entirely and join Buffy in her family business, while Sappho continues to spend 1/4 of her income on yoga lessons. Draw the demand curve for yoga lessons in this economy. What is demand for yoga lessons if the price of yoga lessons is$10/hour? $20/hour?$30/hour? $40/hour?$50/hour?

3. This new situation sees the rapid growth of a wooden stake-making industry to deal with the influx of vampires onto the U.S. Sunnydale campus. Buffy can make 20 stakes a shift and has an alternative occupation she enjoys as much as stake-making that pays her $60 a shift. Kautilya can make 10 stakes a shift and has an alternative occupation he enjoys as much as stake-making that pays him$200 a shift. Sappho has an alternative occupation she enjoys as much as stake-making that pays her $120 a shift and can make 30 stakes a shift. Thasuka Witko has an alternative occupation he enjoys as much as stake-making that pays him$100 a shift and can make 8 stakes a shift. Draw the supply curve for stakes on the U.C. Sunnydale campus. How many stakes are supplied if the price of each stake is $1?$2? $4?$8? $15?$30? $50? 4. In this new situation, Buffy realizes that she can order wooden stakes over the internet in unlimited quantities for a price including next-day FedEx shipping of$10/stake. Draw the new supply curve for stakes.

5. In the same situation as problem (4), suppose that there is a demand for 10 stakes a shift. Who makes stakes? What is the market price of stakes? How about if there is a demand for 50 stakes a shift? 100 stakes a shift? 200 stakes a shift?

6. Suppose that, on and near the U.C. Sunnydale campus, the weekly supply curve for lattes is given by the equation Q = max(1000 P - 2000, 0) : nobody makes any lattes unless the price is above $2/latte, and for each$1 the price is above $2 an extra 1000 lattes are made. Suppose that customers have$10,000/week to spend on lattes. Draw the supply curve and the demand curve. What is the equilibrium price of lattes? What is the equilibrium quantity of lattes?

7. Suppose, in the same situation as (6), that the arrival of new, charismatic yoga teachers reduces the amount of money customers have to spend on lattes to $6,000/week. Draw the supply curve. Draw the old and the new demand curves. What is the new equilibrium price of lattes? What is the new equilibrium quantity of lattes? 8. Suppose that, in the same situation as (6), scary newspaper stories about the health dangers of yoga lead customers to cut back on their purchases of yoga lessons and increases the amount of money they have to spend on lattes to$14,000 a week. Draw the supply curve. Draw the old and the new demand curves. What is the new equilibrium price of lattes? What is the new equilibrium quantity of lattes?

9. Suppose that, on and near the U.C. Sunnydale Campus, the supply curve for yoga lessons is Q = 100 P. Suppose that customers have $10,000/week to spend on yoga lessons. Draw the supply and demand curves. What is the equilibrium price of yoga lessons? What is the equilibrium quantity? Suppose that the amount of money customers have to spend on yoga lessons rises to$14,000/week? Suppose it falls to $6,000/week? 10. In the same situation as (9), suppose that the professors at Crony Capitalism Corrupt Rail Baron University 50 miles to the south become lazier, decide they want to teach less, and offer full course credit toward their degree to students who are willing to offer yoga lessons at U.C. Sunnydale. Suppose that enough students to teach 500 places in yoga classes a week drive up to U.C. Sunnydale to add to those offering yoga classes. Draw the new supply curve. Draw the demand curve if people have$10,000/week to spend on yoga lessons. What is the equilibrium price of yoga lessons? What is the equilibrium quantity?

11. Suppose that the amount of money customers have to spend on yoga lessons rises to $14,000/week? 12. Suppose it falls to$6,000/ week?

## Problems: Economics Overview II

1. Why does Partha Dasgupta choose to spend so much of his book writing about the (imaginary) Becky and Desta?
2. Why did Milton Friedman and Rose Director Friedman feel that freedom was under threat and in retreat at the end of the 1970s?
3. How many people need to cooperate to make--efficiently make--a pencil? How do all the people making the pencil for me know that I want one?
4. In your estimation, what are the two most important reasons Partha Dasgupta believes are responsible for the fact that Becky's life options are broader than Desta's?

## Problems: Plan, Market, and Firm

1. Why did Friedrich von Hayek deserve his Nobel Prize?

2. Apple Computer and Toyota Motors do not allocate goods and services within their organizations with the market system--they use internal corporate central planning. If central planning is as poisonous to an economy as Professor DeLong has maintained, why are large successful corporations are large islands of command-and-control central planning within the market system that do well?

3. Describe how a market economy efficiently allocates scarce resources among alternative uses.

## Problems: Foundations of Supply: Yoga and Lattes

Suppose that we have an economy with four workers. Paris H. can teach 3 yoga lessons or make 20 lattes a shift. Kim K. can teach 2 yoga lessons or make 8 lattes a shift. Mike S. can teach 1 yoga lesson or make 40 lattes a shift. And Pauly D. can teach 4 yoga lessons or make 4 lattes a shift. Suppose customers are willing to pay $4 each for lattes and$15 for yoga lessons.

1. Who should teach yoga?
2. Who should pull lattes?
3. How many lattes will the economy make and how many yoga lessons will it teach?

## Problems: Review

Suppose that it is May 15, the day before the Econ 2 exam. You have a friend who has blown off the course entirely, knows nothing, but must take the exam on the morrow. It is your task to explain to them how it is that markets can fail to be optimal societal mechanisms for guiding production and distribution decisions. Use graphs and make arguments to try to equip your friend to pass the Econ 2 exam--but remember how little your audience knows, and how basic your explanations must be.

## Problems: Natural Monopoly: Apple

Apple is the only company that can produce the iPhone. Suppose the demand for iPhones in 2011 is:

Q = 60,000,000 - 50,000 x $P. 1. For what prices is the elasticity of demand for iPhones greater than one? 2. For what prices is the elasticity of demand for iPhones less than one? 3. At what price is the elasticity of demand for iPhones equal to one? 4. What can you say about the price (i.e., adding up what the purchaser pays Apple and what the phone company pays Apple) Apple should have charged for iPhones in 2011 to maximize its year-2011 profit? 5. Suppose that you learn that it only costs Apple$50 to purchase and ship an additional iPhone to the U.S. Does this allow you to sharpen your answer?

## Problems: Supply and Demand: Sunnydale Yoga

Consider the following two demand curves for yoga lessons in Sunnydale: Q = 120 - 3P; and PQ2 = 20000.

1. Consider the market-day supply curve Q = 20. What is the price for each demand curve? Suppose that on one day the market day supply curve is Q = 15. What is the price for each demand curve?

2. Consider the short-run supply curve Q = 3 x P. What is the price for each demand curve? What is the quantity?

3. Suppose that the short-run supply curve is Q = 3 x P + 10. What is the price for each demand curve? What is the quantity?

4. Consider the very long run supply curve P = 20. What is the quantity for each demand curve?

5. Suppose that improvements in technology lead the very long run supply curve to shift down to P = 15. What is the quantity for each demand curve?

## Problems: 20th Century as a Natural Experiment in Really Existing Socialism

Professor DeLong has claimed that the experience of the twentieth century teaches us that what share of our prosperity rests on the foundations of the market economy? Why has he said this? Do you find his argument convincing? Why or why not?

## Problems: Quotas, etc.: Crony Capitalism University and Ice Cream Sandwiches II

Suppose that we 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 - 1000P

1. What is the equilibrium price? What is the equilibrium quantity? What is the equilibrium producer surplus? Consumer surplus? Pricey ice-cream sandwiches, aren’t they?

2. Suppose that Production Distribution Coordination—PDC—puts a quota ceiling of 2000 on the number of ice-cream sandwiches that can be sold in Old Stick each day, on the grounds that it does not like people eating too many frozen desserts. 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. Why might the standard analysis of the costs of a quota (i.e., the one in Krugman and Wells's Economics underestimate how much value the quota would destroy?

4. Can you make an argument that the quota is nevertheless a good thing? What is the argument? How convincing do you find it?

## 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?