Download APS2

Economics 102 Introductory Macroeconomics - Spring 2005, Professor J. Wissink
Problem Set 2 – ANSWERS
1.
a) The equilibrium price is $30,000 and the equilibrium quantity is 50 thousand workers.
Tom pkins County Labor Market
60
Salary (thousand $)
50
Supply
40
30
20
10
Demand
0
0
10
20
30
40
50
60
70
80
90
100
Workers (thousands)
b) There is a surplus of 30,000 laborers (i.e. 70,000-40,000 = 30,000)
Tom pkins County Labor Market
60
Salary (thousand $)
50
Supply
40
30
20
10
Demand
0
0
10
20
30
40
50
60
70
80
90
100
Workers (thousands)
c) The number of workers satisfying conditions (a) and (b) is 10,000 (i.e. 50,000-40,000). These are the workers
who were hired by the firms that had a willingness to pay salaries between $30,000 and $40,000 and that reduced
their personnel due to the new price floor. The cost of the program to the government will be $7,000 x 10,000 =
$70 millions.
2. Suppose the demand and supply for newspapers are described by the following equations:
Demand: XD = 1450 – 100P and Supply: XS = -125 + 125P (Where "P" is measured in dollars and X in number of
newspapers, in thousands.)
a) By solving XD = XS it can be shown that the equilibrium price P* = 7 and the equilibrium quantity X* = 750.
New spapers Market
16
14
Supply
Price (dollars)
12
10
8
6
4
2
Demand 1
0
0
500
1000
1500
2000
New spapers (thousands)
b) The new equilibrium under XD = 1000 – 100P is P* = 5 and X* = 500.
New spapers Market
16
14
Supply
Price (dollars)
12
10
8
6
4
2
Demand 1
Demand 2
0
0
500
1000
1500
2000
New spapers (thousands)
c) A price floor of $4 per newspaper will not have any effect in the workings of the market since it is below the new
equilibrium price of $5 per newspaper. However if the price floor is $6 per newspaper, then the price floor will be
binding and quantity supplied will be XS = 625, while the quantity demanded will be XD = 400, so there will be a
surplus of newspapers of 225.
d) The statement: "Removal of controls would result in an increase in demand but at a higher price, which would
benefit newspaper editors." is incorrect. Removal of the price controls would result in an increase in the quantity
demanded (and a reduction in the quantity supplied), and it will be associated with lower prices for newspapers
until a new equilibrium is reached.
3. Denote qd - quantity demanded, qs - quantity supplied, p* - equilibrium price, q* - equilibrium quantity, D - demand,
and S - supply.
a) There is a rise in the wholesale price of ground beef.
"Fast Food" Burgers Market
S
↓ meaning a ↓qs at
each price
D
unchanged
Supply 2
Supply
Price (dollars)
at old p* there is a shortage so
price starts to rise
p*
↑
q*
↓
Demand
Burgers
b) There is a price reduction in the market for “Fast Food” fajitas (a close substitute for these hamburgers).
"Fast Food" Burgers Market
S
unchanged
D
↓ meaning a ↓qd at
each price
Price (dollars)
Supply
at old p* there is surplus so
price starts to fall
Demand
Demand 2
Burgers
p*
↓
q*
↓
c) There is a new outburst of the “Mad-Cow” disease.
"Fast Food" Burgers Market
Supply 2
S
↓ meaning a ↓qs at
each price
D
↓ meaning a ↓qd at
each price
p*
? depends on the
sizes of the demand
and supply shift
q*
↓
Price (dollars)
Supply
Demand
Demand 2
Burgers
d) The price of french-fries (usually consumed together with hamburgers) goes down due to an overproduction of
potatoes.
"Fast Food" Burgers Market
Price (dollars)
Supply
S
unchanged
D
↑ meaning an ↑qd
at each price
at old p* there is a shortage so
price starts to rise
Demand 2
Demand
p*
↑
q*
↑
Burgers
4. “Economists don’t know anything. They claim that demand curves are negatively sloped, however when ‘Nike’
launched its aggressive publicity campaign for their products the people bought more of those and the price went up
too.”
ANS. This statement is wrong. When ‘Nike’ launched an aggressive publicity campaign it most likely altered the
tastes of consumers with respect to ‘Nike’s’ products, creating a shift outwards (expansion) of the demand curve.
This explains that both quantity and price of equilibrium went up due to the campaign, even when the demand
curve is still negative. Note, market data on P and Q is equilibrium data, and neither supply nor demand, but the
intersections of supply and demand. One needs to do careful econometric analysis to tease out the demand and
supply curves themselves with more data.
5. When oranges are "in-season" they are relatively cheaper than when they are out of season, and, in-season, relatively
greater quantities are sold. When vacations in Hawaii are "in-season", greater quantities of them are also sold, but in-
season rates are relatively higher than out-of-season rates. Explain this seemingly paradoxical situation using supplydemand analysis.
ANS. When oranges are “in-season” it means that there is a shift outwards of the supply curve, which explains the
higher quantity sold and lower price in equilibrium. When vacations in Hawaii are “in-season” it means that there
is a shift outwards of the demand curve, which leads to a higher quantity sold and a higher price in equilibrium.
6. The embargo imposed on Iraqi and Kuwaiti oil after Iraq's invasion of Kuwait in August, 1990 reduced the supply of
oil by 4.3 million barrels a day. President Bush claimed on September 26 that there was no need for a surge in oil
prices because additional production by Saudi Arabia and other countries had restored 2/3 of the daily production
initially removed by the embargo.
ANS. The statement of the President is wrong; because being short of 1/3rd of the daily production of oil means
that there is an inward shift in the supply curve of oil, which will cause a shortage at the old equilibrium price,
which will cause the market price to go up. The reason we see a subsequent increase in quantity supplied is
because the market price went up to stimulate all the other countries to increase their quantity supplied. They are
not doing this out of the “goodness” of their hearts. They are doing it precisely because the market price went up!
7. Multiple Choice:
1. Which of the following will increase the demand for SUV’s?
a.
b.
c.
d.
e.
A fall in the price of small automobiles.
A fall in the price of gasoline.
A fall in the price of SUV’s.
A fall in buyers' incomes.
A fall in consumer preferences for driving SUV’s.
2. A supply curve will shift with changes in:
a.
b.
c.
d.
e.
f.
technology.
income.
tastes.
number of buyers.
market price.
none of the above.
3. Which of the following would result in a change in the quantity demanded?
a.
b.
c.
d.
e.
An increase in population.
A change in tastes.
An increase or decrease in the price of a substitute or complement.
A change in income.
A shift in the supply curve.
4. If there is both an increase in demand and a decrease in supply for a good:
a.
b.
c.
d.
e.
the quantity sold will necessarily fall.
both quantity sold and price will necessarily fall.
the price will necessarily rise.
the quantity sold will necessarily rise.
neither price nor quantity sold will be affected.