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Metropolitan State University
ECON 202 Fall 2010
Assignment #3, due 9/20
1. Here in the U.S., police regularly target sellers of illegal drugs.
A. Do you think the demand for illegal drugs is elastic or inelastic.
B. What is the impact of a reduction in supply on total expenditures on illegal drugs in an
area?
C. If half of the supply (and suppliers) to an area is eliminated, what impact will this have
on the remaining suppliers?
2. In an effort to reduce gasoline consumption and save the world, The Government
takes Chris' car and replaces it with a new car that is identical in every way except that
the new car gets twice the number of miles per gallon that his old car did. Will this
necessarily cause Chris to reduce the amount of gasoline he uses, other things held
constant? Which price elasticity of demand plays an important role here?
3. Al's Online service is thinking of changing how they bill their users. Previously, they
charged $10/month plus $1/hour for time spent on line. As a result, an average user spent
twenty hours a month on line. The new plan they're considering would charge $25/month
plus $0.25/hour.
A. How will their revenues change as a result of implementing this new plan, assuming
they neither lose nor attract customers?
B. What potential problems do they face with implementing the new plan?
C. How does your answer change if you relax the assumption that they neither lose nor
attract customers due to the change in plans? Explain.
4. Calculate the following numbers based on price elasticity of demand.
A. If the price rises from $10 to $18 and the quantity falls from 87 to 73, calculate the
price elasticity of demand.
B. If the price falls by 15% and the quantity demanded rises by 20%, calculate the price
elasticity of demand.
C. If the price elasticity of demand is –1.5 and the price falls by 20%, calculate the
resulting change in quantity demanded.
D. If the initial quantity is 240 and the price elasticity of demand is –2.0 and the price
falls from 30 to 20, calculate the new quantity.
5. Read the article “Recession May Have Pushed U.S. Birth Rate to New Low,” which
you can find at http://www.dailycommercial.com/health/story/recessionbirths and answer
the following questions.
A. What does the article imply about the nature of children as a good? That is, what type
of good are children?
B. To put the question somewhat differently, why does Al Gore, despite his concern
about world population growth, have four children?
C. Interestingly, highly education women tend to have higher incomes, but fewer
children. What explanation might there be for this curious result?
Happy Fun Questions
1. The following reasons have been advanced by citizen watchdog groups and transit
experts for a decline in patronage of Metro buses. Classify each as a movement along or
a shift in the demand curve for bus travel.
A. Rising fares
B. Increase in income in King County
C. Increasing crime, grime and raucous behavior in buses
D. Falling relative price of gasoline
2. After frost destroyed a large part of the South American coffee crop, a number of
news commentators described the situation in roughly the following terms:
"While the reduction in coffee supply will increase its price, the price rise will reduce
demand and bring the price back down."
Is this correct? Why or why not?
3. Diagram the effects of the following events on the indicated markets. Be sure to say
what will happen to price, quantity, consumer surplus and producer surplus.
a. butter: Incomes go up.
b. pineapple juice: the price of orange juice rises.
c. automobiles: the price of gasoline rises.
d. computers: a new invention lowers the cost of manufacture.
e. milk: the price of grain and hay fall.
f. housing: the price of lumber increases.
4. At least one Seattle City Council member has supported rent control. Describe the short
and long term effects on the quantity and quality of the housing stock in Seattle. How are
apartment owners able and likely to substitute toward non-rental housing or commercial real
estate?
5. It's summer and water is scarce. The good folks of Sombertown are currently paying
$20/month for water service plus $5/hundred gallons consumed, but at this rate the
reservoir will be empty by August 1. Councilman Berger suggests using economics to
solve the problem and proposes doubling the monthly charge for water service to $40,
saying, "If we increase the price, the quantity demanded will fall and there will be enough
water." Councilman Kringle suggests increasing the charge for water usage to
$15/hundred gallons, saying, "This increase in price will reduce the demand and there
will be enough water." Clarisse, a local anarchist and schoolteacher, responds angrily by
saying, "This is ridiculous. Price is clearly irrelevant when talking about something as
necessary to life as water. People will continue to consume what they need regardless of
the price." Comment on each of these statements. Who's right?
6. A city gets enough additional revenue from a tax imposed on adult economics journals
(don’t ask) to hire an additional employee. They can hire either an additional policy
analyst or an additional animal control officer. The marginal value of the contribution to
be made by each is given in the table below:
Number MVanalyst MVanimal control
1
$80,000
$50,000
2
$60,000
$45,000
3
$40,000
$40,000
4
$30,000
$35,000
5
$20,000
$30,000
6
$10,000
$25,000
A. If the city currently has three policy analysts and two animal control officers,
calculate the average value of the contribution made by each. Which position has the
highest average contribution?
B. Which position should the city hire one more of? Explain.
7. Farmers currently use 50 units of capital and 25 hours of labor to harvest an acre of
tomatoes. Capital costs $2.00 per unit and labor costs $5.00 per hour, so the total cost is
50(2) + 25(5.00) = $225.00 per acre. The minimum wage is increased to $5.75 per hour.
The Labor Department estimates that costs will rise by 25(5.75 - 5.00) = $18.75, to
$243.75 per acre. Is that likely to be an over or underestimate? Are there conditions
when it will be exactly right?
8. It is surprisingly common for public water providers to practice non-linear pricing.
That is, the amount you pay isn't simply the quantity you use multiplied by some price
per quantity. They may charge a monthly fee simply for water service and then a per unit
price. They may also charge a price which increases with the quantity of water
consumed, so the first 100 gallons are priced at $0.03 while the second 100 gallons are
priced at $0.05. Finally, they might charge a decreasing rate, so that the first 100 gallons
are priced at $0.05 and all subsequent water is priced at $0.03. Diagram these and
comment on the extent to which they transfer consumer surplus to the water utility and on
the extent to which they encourage conservation.
9. In the 1960s in the U.S., the federal government instituted a measles vaccination
program. They did this through grants to state and local health departments intended to
reduce the cost to the departments of purchasing and administering measles vaccine, with
the goal of reducing the cost of the vaccination and increasing the number of people
vaccinated.
A. Will this program change demand for the measles vaccination?
B. How do the benefits of this program depend on the price elasticity of demand for the
measles vaccine?
C. What is your best guess about the price elasticity of demand for something like the
measles vaccine, and under this condition what would be the benefits of this federal
program?
10. For those of you who are interested in environmental questions, here's one that gets to
the heart of most environmental problems. You, and a person very similar to you, live in
separate apartments and you each spend about $30/month on hot water.
A. If you decide to share an apartment, will your combined hot water bill be greater than
$60, less than $60 or very close to $60?
B. How does your answer change if you marry this person?
C. What does this have to do with the environment?
Hint: Answers involving added efficiencies in living together or even in showering
together are interesting, but not the point of this question. If you like, consider the
extreme example of sharing accommodations with 1,000 people as I did in a dormitory at
U of M.
11. The following table shows the market demand for cable TV subscriptions:
Subscriptions
demanded per month
2000
2500
2250
1750
3000
Price of
subscription
$10.00
10.00
10.00
15.00
7.50
Per capita
income
5000
6000
6000
6000
6000
Price of
movies
$2.50
2.50
2.00
2.50
2.50
Determine the following [remember the ceteris paribus principle (other things held
constant)]:
A. price elasticity of demand for subscriptions between p = 10 and p = 7.50.
B. income elasticity of demand for subscriptions.
C. cross elasticity of demand for subscriptions with respect to movies.
12. Currently, the people of Minnesota consume a total of 27 million wubbies annually.
To help close the state budget deficit, legislators are proposing a tax of $3 per wubbie.
The claim is that this will generate additional revenue of $81M. Explain why this
estimate might be too high, too low or just about right.
13. The City of Seattle owns a major skyscraper downtown (Key Tower). They are
considering using the building as city hall. Since they own the building, the argument goes,
they can use it for free. What is the opportunity cost of doing this?
14. WPPS is working on a major power plant in eastern Washington. The plant originally
was expected to cost $40M. Now, however, $40M has been spent and the plant is not done.
Experts all agree that finishing the plant will cost an additional $30M. Critics say that we've
already spent too much and that the project should be abandoned. Plant advocates say that
after spending so much on the plant, we really can't abandon it now. Who's right? What
should the decision be based on and should the plant be completed?
15. You are the project manager for a new dormitory at Stanford. The original cost
estimate for the dorm was $10 million and the estimated time to completion was two years.
Now, you have been working on the dorm for two years and not only is it not completed, but
you believe it will take an additional year and another $10 million to complete (due to a new
requirement that the architecture match that of the shopping mall on campus). If the cost of
abandoning the project is zero and the expected benefits after completion haven't changed,
should the project be completed or abandoned? Briefly explain your decision.