Economics 102 Introductory Macroeconomics - Spring 2006, Professor J

Economics 102 Introductory Macroeconomics - Spring 2006, Professor J. Wissink

Problem Set 2 – ANSWERS

1. Let's model a month in the life of the rental market for apartments in Ithaca.

a) Graph the supply and demand curves.

b) Demand is given as: XD = 10,000-5P and supply is given as: XS = -2000+15P

Solve for equilibrium: 10,000-5P = -2000+15P

12,000 = 20P

600 = P

E.g. from demand we get: XD=10,000-5*600=7,000.

The equilibrium rent price is $ 600 and the equilibrium quantity is 7000 apartments

c) At price ceiling $500, there is an excess demand for apartments, since XD(500)=7,500>XS(500)=5,500.

The number of apartments rented will be 5,500.

d) Price ceiling $ 700 is not effective (not binding) because it is above equilibrium price $ 600. Original equilibrium price (P=600) and quantity (X=7,000) will not change.

e) Ms. Carolyn Peterson, see:

http://ithaca.govoffice.com/index.asp?Type=B_LIST&SEC={472F75C9-54AC-42C9-ACE4-016834ABB71C}

2. Critically evaluate the following sequential statements and explain why they are true, false or uncertain.

a) True.

As the price of coffee decreases, consumers demand more coffee creamer at each creamer price, i.e. demand for coffee creamer increases.

b) True.

Since demand for coffee creamer increased, equilibrium price of creamer increased.

c) False.

Since price of creamer increased, producers increased quantity of creamer supplied. There is no increase in supply of creamer.

d) False.

As we know from part c) there was no change in supply of creamer.

Suppose that the demand curve for cantaloupes is P=120-3Qd, where P is the price per pound (in cents) of cantaloupe and Qd is the quantity demanded per year (in millions of pounds). Suppose that the supply curve for cantaloupes is P=5Qs, where Qs is the quantity supplied per year (in millions of pounds).

a) Let XS=XD, i.e. 120-3X=5X. It follows that the equilibrium quantity is 15 million pounds per year and the equilibrium price 75 cents.

b) Suppose the government imposes a price floor of 80 cents per pound on cantaloupe.

i) How much would then be supplied?

At an 80-cent floor: XS(80)=16 million pounds will be supplied.

ii) Calculate the resulting surplus or shortage.

There will be a surplus. The surplus will equal to XS-XD=16-13.33=2.66 million of pounds.

c) Taking each event separately, would the demand curve shift to the left, to the right, or stay in place if:

i) a report by the U.S. Surgeon General suggested that eating cantaloupes causes cancer?

The demand curve would shift left.

ii) the price of honeydew melons rose by 10 percent?

As long as honeydew is a substitute for a cantaloupe, the demand curve for cantaloupes would shift right.

iii) per capita incomes rose by 20 percent?

Assuming that a cantaloupe is a normal good, the demand curve would shift right.

Assuming that a cantaloupe is an inferior good, the demand curve would shift left.

iv) the wages of workers employed in supplying cantaloupes to the market increased by 25 percent?

The demand curve would stay in place unless workers demand cantaloupes, in which case, it would shift right as in (iii).

Assume an isolated island economy has two labor markets (unskilled and skilled). The supply and demand conditions in each labor market are as follows.

a) Equilibrium is at P=20, Q=80 for unskilled labor, and P=40, Q=120 for skilled labor. The graphs follow:

b) Assume that the government sets a minimum wage of $30,000 per year. (No company can pay less than the minimum wage.) Using diagrams, illustrate the impact of this minimum wage on equilibrium price and quantity in EACH labor market.

A minimum wage of $30,000 per year is illustrated by the following graphs.

Notice that the minimum wage causes greater quantity supplied of unskilled labor compared to quantity demanded. This represents a shortage of jobs or unemployment in the unskilled labor market.

However, the skilled worker market continues to clear at equilibrium

c) The minimum wage is eliminated. However, producers can now replace unskilled workers with robots. The rental rate of a robot is $15,000 per year, and each robot can do the work of one unskilled worker. Using diagrams, illustrate the impact that access to robots has on the market for unskilled labor.

Access to $15,000 robots mean that the producers will never pay more than $15,000 to employ an unskilled worker. Therefore, demand drops to zero for all prices above $15,000.

5. MULTIPLE CHOICE ANSWERS: C, C, D.