Download Part 1: (60 points total)

Part 1: (60 points total)
Pretend that you have a lemonade stand and that the demand for lemonade in your
neighborhood is estimated to be:
Q = 60 - 100 P
Just like in the lecture, you get all the materials to make the lemonade for free so we assume
that the costs of production are zero. Your goal, your objective, is to maximize profits which
is the same as maximizing total revenue given the zero cost assumption.
a) (5 points) What is the profit (revenue) maximizing price and quantity (in cups) of
lemonade and the corresponding maximum profit.
Suppose that there was a demand shock so that the new estimated demand function for
lemonade in your neighborhood changes to:
Q = 100 - 100 P
b) (5 points) Name and support two reasons why demand would change like this.
c) (5 points) Solve for the new profit (revenue) maximizing price and quantity (in
cups) of lemonade and the corresponding profit.
d) (5 points) Compare your quantity sold and your profit in part c) to the quantity sold
and profit if you kept 'sticky' lemonade prices - that is, what would be the quantity
sold and profit if you did not change prices?
GRAPHICS (30 points total for a correct and completely labeled diagram)
Just like in the lecture on the lemonade stand, draw a demand curve in your top
diagram and a total revenue function below making sure that you exploit the fact
that the horizontal axis is the same in the top and bottom diagrams. Label the initial
equilibrium points according to your answer in part a) as points A. Then, label on
both diagram as points B, the answer you gave in part c). We can think of this as the
long run since you will increase price in the long run. Then, label as point C, the
quantity sold and profit if you did not change price (i.e., your work from part d).
e) (5 points) On a separate diagram, draw a supply curve that pertains to your
behavior from points A to B and another supply curve that pertains to points A and
C. Pretending that these are short-run aggregate supply curves, under which curve
would macroeconomic (demand side) policies have the most effect on output? On
prices? In other words, which supply curve is more Keynesian and which is more
Classical?
f) (5 points) Suppose that in order to change prices, you need to make a new sign which costs
you $5, these are referred to as menu costs. Is it worth it for you to change prices, why or why
not? Explain.