EC1000 – Question Sheet 1 – Week 4

1. (Ch 1) Three managers of the Magic Potion Company are discussing a possible increase in production. Each suggests a way to make this decision.

Harry: We should examine whether our company’s productivity (gallons of potion per worker) would rise or fall.

Ron: We should examine whether our average cost would rise or fall.

Hermione: We should examine whether the extra revenue from selling the additional potion would be greater or smaller than the extra costs.

2. (Ch 1) Explain whether each of the following government activities is motivated by a concern about equity or a concern about efficiency. In the case of efficiency, discuss the type of market failure involved.

a. regulating telephone call charges

b. providing some poor people with vouchers that can be used to buy food

c. prohibiting smoking in public places

d. breaking up Microsoft into two smaller companies

e. imposing higher personal income tax rates on people with higher incomes

3. (Ch 2) Imagine a society that produces "guns" and "butter."

a. Draw a production possibilities frontier for guns and butter. Explain why it must be decreasing.

b. Show a point that is impossible for the economy to achieve, and a point that is feasible but inefficient.

c. Imagine that the society has two political parties, called the Hawks (who want a strong military) and the Doves (who want a smaller military). Show a point on your production possibilities frontier that the Hawks might choose and a point the Doves might choose.

d. Imagine that an aggressive neighbouring country reduces the size of its military. As a result, both the Hawks and the Doves reduce their desired production of guns by the same amount. Which party would get the bigger increase in butter production? Explain how the answer to this question depends on the shape of the production possibility frontier you have drawn.

4. (Ch 5) Two drivers - Tom and Jerry - drive up to a gas station. Before looking at the price, each places an order. Tom says, “I’d like 10 litres of gasoline.” Jerry says, “I’d like £10

of gasoline.” What is each driver’s price elasticity of demand?

5. (Ch 5) Explain why the following might be true: A drought around the world raises the total revenue that farmers receive from the sale of grain, but a drought only in Ukraine reduces the total revenue that Ukrainian farmers receive.

6. (Ch 15) The Clean Springs Water Company has a monopoly on bottled water sales in California. If the price of tap water increases, what is the change in Clean Springs' profit-maximizing levels of output, price, and profit? Explain in words and with a graph.

7. (Ch 15) Jimmy Jazz and the Repercussions (a band from Tadcaster) have just finished recording their first CD. Their record company's marketing department determines that the demand for the CD is as follows:

Price / Number of CD’s
£24 / 10,000
22 / 20,000
20 / 30,000
18 / 40,000
16 / 50,000
14 / 60,000

The company can produce the CD with no fixed cost and a variable cost of £5 per CD.

a. Find total revenue for quantity equal to 10,000, 20,000, and so on. What is the marginal revenue for each 10,000 increase in the quantity sold?

b. What quantity of CDs would maximize profit? What would the price be? What would the profit be?

c. If the band had an agent, and if you were the band's agent, what recording fee would you advise them to demand from the record company? Why?

8. (Ch 15) Larry, Curly, and Moe run the only saloon in town. Larry wants to sell as many drunks as possible without losing money. Curly wants the saloon to bring in as much revenue as possible. Moe wants to make the largest possible profits. Using a single diagram of the saloon’s demand curve and its cost curves, show the price and quantity combinations favoured by each of the three partners. Explain.

9. (Ch 15) Paul is the manager of Alpha Company, a firm that has a monopoly in the market for bicycle breaks thanks to a patented innovative technology. The owner of the firm, David, hires a consulting company to estimate the price elasticity of bicycle brakes. The consultants find that a 10% increase in the price would decrease demand by 5%. As a result, David decides to fire Paul and hire a new manager. Why? If you were Paul, what could you argue to convince David not to fire you?

10. It is a hot day, and Bert is thirsty. Here is the value he places on a bottle of water:

Marginal willingness to pay for first bottle / £7
Marginal willingness to pay for second bottle / £5
Marginal willingness to pay for third bottle / £3
Marginal willingness to pay for fourth bottle / £1

a. From this information, calculate Bert’s total willingness to pay for one, two, three and four bottles.

b. Derive Bert's demand schedule. Graph his demand curve for bottled water.

c. If the price of a bottle of water is £4, how many bottles does Bert buy? How much consumer surplus does Bert get from his purchases? Show Bert's consumer surplus in your graph.

d. If the price falls to £2, how does quantity demanded change? How does Bert's consumer surplus change? Show these changes in your graph.

11. During the 1990s, technological advances reduced the price of computers. How do you think this affected the demand for computer software? For typewriters?

12. Consider two products, 1 and 2, and two consumers, A and B. Company Alpha has a monopoly over both products. Products are indivisible and consumers buy at most one unit of each. The products are independent (that is, neither substitutes nor complementary). Both products have a unit production cost equal to £2. The following table gives the willingness to pay for the two products:

A’s willingness to pay / B’s willingness to pay
Product 1 / £10 / £8
Product 2 / £8 / £10

a. What is the monopoly price and the monopoly profits if the two products are sold separately?

b. What happens if the firm bundles the two products and sell them as a single product?