EC2010-Intermediate Economics Trinity College Dublin
Microeconomics Module Department of Economics
Lecturer: Martín Paredes Hilary Term 2007
Solutions for Assignment 1
1. Chapter 1, Problem # 1.3
a) The production manager wants to minimize total costs TC = PE*E + PL*L.
b) The constraint is to produce Q = 200 units, so the manager must choose E and L so that = 200.
c) The endogenous variables are E and L, because those are the variables over which the production manager has control. By contrast, the exogenous variables are Q, PE, and PL because the production manager has no control over their values and must take them as given.
2. Chapter 1, Problem # 1.4
In 2003, the initial equilibrium is at price P1 and quantity Q1. As national income increased, demand for aluminum shifted to the right, as depicted in the graph below by the shift from D1 to D2. The fall in the price of electricity shifted the supply curve to the right, from S1 to S2. Both shifts have the effect of increasing the equilibrium quantity, from Q1 to Q2. However, it is unclear whether price will rise or fall – if the demand shift dominates, price would rise; if the supply shift dominates, price would fall.
3. Chapter 1, Problem # 1.5
Assuming we have and . Graphing these yields:
The equilibrium occurs at , .
At a price of 18, implying an excess supply of wool. Because sellers will not be able to sell all of their wool at this price, they will need to reduce price to attract buyers. At the lower price, the suppliers will offer a lower quantity of output for sale, and consumers will want to purchase more.
At a price of 14, , implying an excess demand for wool. Buyers will begin to bid up the price of wool until the new equilibrium is reached. At the higher price, the suppliers will offer a higher quantity of output for sale, and consumers will want to purchase less.
4. Chapter 1, Problem # 1.7
Formulate each plan as a function of V, the number of videos to rent.
Then we have
Plan B provides the lowest possible cost of $200 if you will purchase 75 videos.
Plan C provides the lowest possible cost of $275 if you will purchase 125 videos.
In this case, the number of videos rented is exogenous because we are choosing a plan given a fixed level of videos.
Because you may choose the plan, the plans are endogenous. Note, though, that the details of the individual plans are exogenous.
Because you may choose the plan and the plans imply a total cost given a fixed level of videos, you are implicitly choosing the level of total expenditure. Total expenditures are therefore endogenous.
5. Chapter 1, Problem # 1.8
Now formulate each plan as a function of , the level of total expenditure on videos.
This gives
With plan A you could rent 41 movies, with plan B you could rent 37 movies, and with plan C you would not be able to rent any movies (because the membership fee exceeds your total budget). Plan A, therefore, will allow you to rent the most videos with a budget of $125.
Now plan C offers the opportunity to rent the most videos.
The number of videos rented depends on the choice of plan. The number of videos rented is endogenous, then, since you can choose the plan.
As before, because you may choose any of the three plans, this choice is endogenous.
In this problem total expenditure is exogenous because we are choosing a plan given some fixed video rental budget.
6. Chapter 1, Problem # 1.12
Positive analysis – this statement indicates what the consequences of the U.S. action will be, ignoring any value judgment when making the claim.
Positive analysis – again this statement simply indicates the consequences of a change in an exogenous variable on the market, ignoring any value judgments.
Normative analysis – here the author implies that there are two possible solutions to providing additional revenues for public schools and suggests, based on a value judgment, which of the alternatives is better.
Normative analysis – again the author makes a claim based upon his own value judgment, namely that telephone companies offering cable TV service would be a good thing.
Positive analysis – The author is making a positive statement. The author is predicting the effect of a policy change on the price in a market.
Normative analysis – here the author is making a prescriptive statement about what should be done. This is a value judgment about the policy to subsidize farmers.
Positive analysis – the author is making a prediction about what will happen if the tax on cigarettes is increased. While the claim may not be accurate, the statement is predictive and made without the author imposing any value judgments on the prediction.
7. Chapter 2, Problem # 2.2
a) The graph is shown below:
b) We know that the value of the price elasticity of demand is given by
Here, –b = –1/2. For demand to be unitary elastic it must be that
which implies that P = 5.
8. Chapter 2, Problem # 2.4
a) Since the price is being bid up above the official price, quantity demanded must exceed quantity supplied at the official price. This is a situation of excess demand and the official price must be below the equilibrium price.
b) Lowering the official price would increase the amount of excess demand, but would have no effect on the demand or supply curves. Thus the equilibrium price would remain unchanged.
9. Chapter 2, Problem # 2.5
This could occur as a result of the demand curve shifting to the right, increasing both equilibrium price and quantity. This would not contradict what was learned regarding downward sloping demand curves.
10. Chapter 2, Problem # 2.9
a)
b) The choke price occurs at the point where . Setting in the inverse demand equation above yields .
c) At , the choke price, the elasticity will approach negative infinity.
11. Chapter 2, Problem # 2.13
a) Substituting the values of R and T, we get
In equilibrium, 70 – 2P = –14 + 5P, which implies that P = 12. Substituting this value back, Q = 46.
b) Elasticity of Demand = –2(12/46), or –0.52. Elasticity of Supply = 5(12/46) = 1.30.
c) . The negative sign indicates that titanium and golf balls are complements, i.e., when the price of titanium goes up the demand for golf balls decreases.
12. Chapter 2, Problem # 2.15
a)
Using and gives
b) Market demand is given by . Assuming the airlines charge the same price we have
When , . This implies an elasticity equal to
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