Download ECON 201 – Honors Macro Principles Spring 2013 Answers to

ECON 201 – Honors Macro Principles
Spring 2013
Answers to Problem Set #3
1.
(3) What is opportunity cost? In well-functioning markets, why do prices of inputs reflect their highest
valued alternative uses?
Opportunity cost is the highest valued alternative foregone. In markets, the price one must pay for an
input must at least equal the price paid to the input in an alternative use or otherwise one will not be
able to attract any of the input into employment. The value, in turn, paid by the alternative user
reflects the contribution to output in the alternative use. Thus, in well-functioning markets, were
opportunities are not artificially constrained, the price of an input equals the highest of all alternative
uses.
2.
(5) Suppose that a firm can use inputs to produce either refrigerators or freezers according to the
following graphical presentation of its production possibilities. Suppose that consumers are willing to
pay $300 per unit for refrigerators and $150 per unit for freezers. How many refrigerators and how
many freezers will the firm produce to maximize its net revenues?
Refrigerators
100
99
97
92
84
74
57
32
0
Freezers
0
10
20
30
40
50
60
70
80
Using the rule of MB = MC and beginning at 100 Refrigerators
and 0 Freezers, the firm would progress until the combination
of 92 refrigerators and 30 freezers is produced, since the MB
of moving from 20 to 30 freezers produced is $1500 and the
MC is 5 freezers valued at $300 each, or $1500.
Suppose the price that consumers are willing to pay for freezers rises to $300, ceteris paribus. Now how
many refrigerators and how many freezers will the firm produce to maximize its net revenues?
With the increase in price of freezers to $300, the marginal benefit of producing freezers rises. Using
the same rule, the firm will progress to producing 74 refrigerators and 50 freezers, since the MB of
moving from 40 to 50 freezers is $3000 and the MC is 10 freezers valued at $300 each, or $3000.
3.
(5) State the Law of Supply. What other factors generally affect the supply of a good? State how a
change in each of these factors would affect supply. Distinguish between “change in supply” and
“change in quantity supplied.”
The Law of Supply is “the quantity supplied of a good or service is a positive function of the good’s
own price, ceteris paribus.” Other factors that generally affect supply are technology, prices of factors
of production, expected future price, the price of alternative output, and the number of suppliers. An
improvement (retardation) in technology increases (decreases) supply; an increase (decrease) in the
price of an input decreases (increases) supply; an increase (decrease) in expected future price will
tend to decrease (increase) supply now; an increase (decrease) in the price of an alternative output
decreases (increases) supply, and an increase (decrease) in the number of suppliers increases
(decreases) market supply. A change in supply is a willingness to buy more or less at ALL prices and is
reflected as a shift in the entire supply curve left or right . A change in supply is caused by a change in
any factor other than own-price. A change in quantity supplied is a willingness to buy more or less due
to a price change and is reflected as a movement along a given supply curve. A change in quantitysupplied occurs as a result of change only in the good’s own price.
4.
(2) State the three equivalent definitions of equilibrium.
1.
2.
3.
5.
At a given price, quantity demanded equals quantity supplied.
At a given price, the desires of buyers are coordinated with the desires of sellers so there are
no frustrated plans.
At a given quantity, demand price (the maximum price buyers are willing to pay) equals the
supply price (the minimum price suppliers are willing to accept).
(10) State how equilibrium price and equilibrium quantity would change in each of the following
situations? (a) What happens in the peanut butter market if the price of almond butter falls?
(Demand for peanut butter decreases – peanut and almond butters are substitutes) Price falls and
quantity falls.
(b) What happens in the strawberry jam market if the price of peanut butter falls?
(Demand for strawberry jam increases – jam and pb are complements) Price rises and quantity rises.
(c) What happens in the lobster market if consumer income increases?
(Demand increases – lobster is normal good) Price rises and quantity rises.
(d) What happens in the market for second-hand clothing if consumer income decreases?
(Demand increases – second-hand clothing inferior good) Price rises and quantity rises.
(e) What happens in the market for toilet paper if the price of toilet paper is expected to increase by a
large amount in the future?
(Demand increases now – toilet paper is costly to store but a large enough expected price increase will
overcome storage costs) Price rises and quantity rises.
(f) What happens in the market for borrowed funds if consumers expect their income to increase in the
future?
(Demand for loans will increase since can pay back out of higher future income) Price increases and
quantity increases.
(g) What happens in the market for fresh oranges if a freeze damages part of the crop?
(Supply to fresh orange market decreases) Price rises and quantity falls.
(h) What happens in the market for automobiles if the wages of autoworkers rise?
(Supply decreases -Autoworkers are an input to autos) Price rises and quantity falls.
(i) What happens in the market for peaches if the rental price of land falls?
(Supply increases – land is an input to peaches) Price falls and quantity rises.
(j) What happens in the market for bangles if the technology of bangle production improves?
(Supply increases) Price falls and quantity rises.