Econ 101 Discussion Section - Handout #7, October 15th , 2014

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Important Key Concepts of the week:

  • Trade: So far we have seen why countries engage in trade only from the opportunity cost perspective. However is trade always good for everybody?
  • What happens if the international price is below the domestic price?
  • Should government interfere to protect one side of the market?
  • Is the government efficient?
  • Are there any differences when the demand is inelastic or elastic?
  • Tools of the government: How can the government preclude or impulse trade?
  • Tariffs
  • Quotas
  • Trade Agreements
  • Math Review: Percentages!

Problems:

  1. (Moshi’s old problem)Consider the market of Economics books in Country X. Take quantities in the units of thousands of books.

Domestic demand: P = -3Q+ 100

Domestic supply: P = Q

  1. Assume that the economy of Country X is closed . Calculate the equilibrium quantity, price, consumer surplus, and producer surplus in the market.
  1. Suppose the world price of Economics books is $10. Now assume that this economy opens to world trade. How many units of books will this country import or export? What's the total surplus? Is there a dead-weight loss when this economy opens to trade?
  1. Continue to assume that this economy is open to world trade, but now the government has imposed a tariff of $9 per book. Calculate the new equilibrium and the dead-weight loss in the market when this economy imposes this tariff.

Consider the Sewers of New York City, home of the Teenage Mutant Ninja Turtles. Their rule the sewers as a small closed economy. They love pizza, poor Raphie produces the pizza. Imagine that the aggregate demand of the rest plus master Splinter is per day:

Q = 30

Ralphael supplies the Pizza with the following relationship:

P = Q

Where P and Q are the price per slice of pizza in dollars, and Q is the numbers of slices sold in this market.

  1. Find the equilibrium price, equilibrium quantity and producer surplus in this little market. Graphically illustrate your answers.

Equilibrium price can be solved by substituting the domestic demand into the domestic supply equation, this gives P = $30and Q = 30.Producer surplus can be found as the area above the supply curve and under the price Raphael receive at the quantity sold, so 1/2 x 30 x 30 = $450.

  1. Domino´s Pizza charges $15 per slice, with full deliver to the sewers.If master Splinter allows the turtles to order. Find the price that pizza trades for in Sewers. How many units of pizza are consumed and how many are imported or exported in the sewers of New York when the turtles order in? What is the producer surplus for Raphael? Graphically illustrate your answers.

Since the world price of $15 is lower than domestic equilibrium price, the turtles will import at dominos price; hence, the price of pizza in sewers is $15. At the price of $15, the turtles and Splinter consume 30 units. Since the price is $15 per unit, Raphael is willing to supply up to Q = 15 units, leaving 30 – 15 = 15 units that need to be imported. Producer surplus is the area above the supply curve and under the price producers receive. ($15) at the quantity sold (15 units) so 1/2 x 15 x 15 = $112.5

  1. Mike uses the only phone in the sewers all day (usually to prank April), and somehow he manages to impose a $10 tariff, not because he wants to help his brother, but to continue his monopoly on the phone. Find the price that pizza trades for in the Sewers given this tariff. How many slices are consumed and how many are imported given this tariff? What is now Raphael’s surplus when this tariff is imposed in this market? Given the tariff, how much revenue will Mike raise and what is the size of the deadweight loss? Graphically illustrate your answers

The price of Pizza with the tariff will be $25 per slice. Since this price with the tariff is lower than the domestic equilibrium price, the turtles will still order from dominos given the tariff price. At the tariff price of $25, The turtles are willing to consume 30 units. Since the price after the tariff is $25 per unit, Raphael is willing to supply up to Q = 25 slices, leaving 30 – 25 = 5 slices that need to be ordered. Raphael surplus is the area above the supply curve and under the price Ralphie receive ($25) at the quantity sold (25units) so 1/2 x 25 x 25 = $312.5. Since the imported 5 units are subject to the $10 per unit tariff, Mike’s revenue is $50. The deadweight loss is the triangular area generated by the tariff which 1/2x(25-15)x10=50

  1. Hamato Yoshi, (also Known as Master Splinter), asks Leonardo and Donatello to kick Mike ass and let the phone alone. However to help Raphael, changes his public policy. Now allows to import only 10 unitsinstead of the tariff described in (c). Given this import quota (and no tariff), find the price that pizza will trade for in the Sewers. Given this import quota, how many units of pizza are consumed and how many are imported? Given this import quota, what is Raphael’s surplus? How much revenue will the Master Splinter raiseand what is the size of the deadweight loss? Graphically illustrate your answers.

To derive the supply curve of pizza in the turtle’s home when the import quota is imposed,First realize that Raphael producers will produce the first 15 units of pizza. Then 10 slices of pizza will be ordered as a lower cost alternative than having poor Ralphie cooking an additional slice. Once the quota limit is reached at 25,additional pizza will have to be produced by Raphael: thus, the import quota effectively shifts the domestic supply curve horizontally to the right by 10 slices of pizza. Thus, the new supply curve incorporating the import quota is given by:

P = Q, when 0 ≤Q ≤15 (Domestic production before importation)

P = 15, when 15 ≤Q ≤25 (Importation under quota)

P = Q –10, when Q ≥25 (Domestic production after quota)

Solve for the equilibrium price under the import quota by equating P = Q – 10 and Q =

30, so P = 20. Quantity consumed in the TMNT home with the import quota is Q = 30 slices of pizza, of which 10 units are imported due to the imposition of the import quota.

To illustrate producer surplus, deadweight loss and quota revenue, rearrange the order of the import quota and the domestic production on the graph. Producer surplus is the area above the supply curve and under the price producers receive ($20) at the quantity sold, (20 units) so 1/2 x $20 x 20 = $200. Since 10 units are imported at the world price of $15but sold in at price $20 per unit, the quota revenue is $10 x 20 = $200. The deadweight loss is the triangular area generated by the quota, which exhibits the inefficiency of production; there is no second triangle from under-consumption in this case. Hence, the deadweight loss is 1/2 x (20-15)x(20-15) = $12.5.

3) Percentages: Solve the following Problems

a) Suppose my wage drops from $12.50/hour to $10/hour. What percent pay cut have I taken?

20% Pay cut

b) I put $100 in my back account at the beginning of the year. I earn 4% interest a year. If I do not deposit or withdraw, how much will I have at the end of the first year? The second year? The third? In each year, round the bank’s interest deposits to the 2nd decimal place. What is the percentage increase in my back account after 3 years?

At the end of first year $104

At the end of second year $108.16

At the end of third year $112.49

The percentage increase is 12.49%