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841169672
Foundations of Economic Analysis
Homework #2
Stratton
Name _________Key___________
Objective: to provide practice and assessment of your understanding of Demand, Supply, and
Market Equilibrium. (Hint: you may want to work out your answers on another sheet of paper and
transfer your work to this one to avoid submitting a messy worksheet.) {See HW02_DS for
graphs}
Instructions: For each term, write a short definition in your own words and explain the
significance of the term in the space provided or attach additional sheets if necessary. Each
numbered question is worth 2 points – total 50 points.
Definitions:
1.
Market Demand – A functional (inverse) relationship between the price of a good or
service (commodity) and the quantity of that good or service which consumers are
willing and able to offer to purchase at each possible price. The willingness depends on
consumer preferences; the ability depends on consumer income. The market demand is
the horizontal sum of individual demand functions. This provides half of the information
needed to determine the market equilibrium (price and quantity).
2.
Quantity demanded – The quantity of a good or service which consumers are willing and
able to offer to purchase at a specific (given) price. It is important to understand that this
quantity depends on the price. If the price changes, typically so will the quantity
demanded.
3.
Market Supply – A functional (positive or direct) relationship between the price of a good
or service (commodity) and the quantity of that good or service which suppliers are
willing and able to offer to sell at each possible price. The willingness depends on
profitability; the ability depends on the production function. The market supply is the
horizontal sum of individual supply functions. This provides half of the information
needed to determine the market equilibrium (price and quantity).
4.
Quantity supplied – The quantity of a good or service which suppliers are willing and
able to offer to sell at a specific (given) price. It is important to understand that this
quantity depends on the price. If the price changes, typically so will the quantity
demanded.
5.
Transaction costs – Costs incurred when making a trade or exchange. They include
search, contractual, enforcement, etc. Transaction costs impede the efficiency of markets.
6.
Market equilibrium – A situation (or market price) at quantity demand equals the quantity
supplied. Sellers can sell all of the output they desire, at that price; consumers can buy all
of the good or service (commodity) they desire, at that price. A price at which there is no
internal tendency for the price to change.
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7.
Market shortage – A situation at which the quantity supplied is greater than the quantity
demanded; the price is below equilibrium. Shortages create incentives for demanders to
bid up the price of the product.
8.
Public good – A good or service which is characterized by non-rival consumption, thus
no marginal cost to supply additional consumers and by non-exclusion indicating one
consumer cannot be excluded from its benefits, if the commodity is provided to other
consumers. Public goods are not usually provided by private markets, since individuals
have little incentive to reveal their true preferences and provide the resources to obtain
them.
9.
External benefit – A benefit of production or consumption which does not accrue to the
consumer or producer. Private, unregulated markets tend to provide fewer units of such
goods than is optimal. That is some units that would provide positive net benefits
(MC<MB) are not provided.
Instructions: Answer the questions in the space provided or attach additional sheets if necessary
Problems
Scenario:
Below is a hypothetical world market demand for coffee beans.
Qx = 12.5 – 10Px
Price
(Dollars per pound)
1.10
1.09
1.08
1.07
1.06
1.05
1.04
1.03
1.02
1.01
1.00
Coffee beans
(billions of pounds)
1.5
1.6
1.7
1.8
1.9
2.0
2.1
2.2
2.3
2.4
2.5
1. Draw the demand curve on the graph below?
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Price (dollars per pound)
Demand
1.12
1.10
1.08
1.06
1.04
1.02
1.00
0.98
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
Quantity (billion of pounds per year)
2. What is the quantity demanded at a price of $1.06 per pound? On both the table and
graph, indicate this point. 1.9 billion pounds per year.
3. Assume that a new beverage that most coffee drinkers find to be a close substitute for
coffee is developed. Indicate in the table and graph the impact of the introduction of this
beverage on the coffee bean market. [Hint: you may not be able to “know” exact
numbers, but you should be able to guess at reasonable ones.] The introduction of a close
substitute tends to reduce the demand for the good in question (coffee). Thus there should
be a new demand curve to the left of the old one. On the table there will be a new column
which indicates a lower quantity demanded at each price.
4. Assume consumer income increases by 10 percent. Indicate in the table and graph the
impact of the increased income on the coffee bean market. [Hint: you may not be able to
“know” exact numbers, but you should be able to guess at reasonable ones.] If coffee is a
normal good, demand should increase. If it is a necessity (next week) it will increase by
less than 10%; if a luxury by more than 10%.
Scenario:
Below is a hypothetical market supply for Brazilian coffee beans.
Qx = 20 Px -19
Price
(Dollars per pound)
1.10
1.09
1.08
1.07
1.06
1.05
1.04
1.03
1.02
1.01
1.00
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Coffee beans
(billions of pounds)
3.0
2.8
2.6
2.4
2.2
2.0
1.8
1.6
1.4
1.2
1.0
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1. Fill in the table above.
2. Draw the supply curve on the graph below?
Price (dollars per pound)
Market Equilibrium
1.12
1.10
1.08
1.06
1.04
1.02
1.00
0.98
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
Quantity (billion of pounds per year)
3. What is the quantity supplied at a price of $1.06 per pound? On both the table and graph,
indicate this point. 2.2 billion pounds per year.
4. Assume there is a hard freeze in Brazil this weekend that kills one third of the coffee
trees. Indicate in the table and graph the impact of weather on the coffee bean market.
[Hint: you may not be able to “know” exact numbers, but you should be able to guess at
reasonable ones.] The weather and the killing of the trees are likely to reduce the supply
of coffee beans from Brazil, shifting the supply curve to the left. Thus there should be a
new supply curve to the left of the old one. On the table there will be a new column
which indicates a lower quantity supplied at each price.
5. Assume that five years ago farmers in Viet Nam plant coffee trees for the first time and
their first crop will be ready this year. Indicate in the table and graph the impact of this on
the coffee bean market. [Hint: begin from the original supply curve, ignore the events
mentioned above. Also you may not be able to “know” exact numbers, but you should be
able to guess at reasonable ones.] This represents an increase in the number of suppliers
and should shift the supply curve to the right. Thus there should be a new supply curve to
the right of the old one. On the table there will be a new column which indicates a higher
quantity supplied at each price.
Scenario:
Given the original market demand and supply functions presented above, answer
the following questions. Demand Qx = 12.5 – 10Px; Supply Qx = 20 Px -19
1. Is a price of $1.06 per pound the equilibrium price in this market? Please explain how
you know. At a price of $1.06 the quantity demanded (1.9 billion pounds per year) is less
than the quantity supplied (2.2 billion pounds per year). Thus there is a surplus and the
price will be bid lower. Equilibrium requires the quantity demanded to equal the quantity
supplied.
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2. What is the equilibrium price? What is the equilibrium quantity? The equilibrium price is
$1.05 per pound. At this price the quantity demanded and supplied are both 2.0 billion
pounds per year.
3. Assume the demand for coffee changes to Qx = 14 – 10Px.
a. Is this an increase or decrease in demand? This is an increase in demand. The
quantity demanded increases at each price.
b. What is the new equilibrium price and quantity? The new equilibrium price is
$1.10 per pound. At this price the quantity demanded and supplied are both 3.0
billion pounds per year.
4. Now assume that the supply of coffee also changes to Qx = 20 Px -17. So now the demand
is Qx = 14 – 10Px and the supply is Qx = 20 Px -17.
a. Is this an increase or decrease in supply? This is an increase in supply. The
quantity supplied increases at each price.
b. What is the new equilibrium price and quantity? Please show your work! The
new equilibrium price is between $1.03 and $1.04 ($1.033) per pound. At this
price the quantity demanded and supplied are both between 3.6 and 3.7 (3.67)
billion pounds per year.
Price (dollars per pound)
Market Equilibrium
1.12
1.10
1.08
1.06
1.04
1.02
1.00
0.98
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
Quantity (billion of pounds per year)
Scenario:
Return to the original market demand and supply functions presented above:
Demand Qx = 12.5 – 10Px; Supply Qx = 20 Px -19. However, now assume this is for ONLY the
market for Brazilian coffee beans.
Assume the Brazilian government wanted to subsidize the income of coffee growers and set a
minimum price for coffee of $1.06 per pound. The government buys all the coffee growers want
to sell at $1.06 per pound and then sells that coffee in the market.
1. How much coffee will Brazilian growers produce? At a price of $1.06 per pound,
growers will produce 2.2 billion pounds per year.
2. At what price will the Brazilian government be able to sell all of the coffee beans? To sell
all 2.2 billion pounds of coffee, the price can be no more than $1.03 per pound.
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3. What is the net cost to the Brazilian government? The government net cost is $0.03 per
pound times 2.2 billion pounds per year or $66 million per year.
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