Department of Economics, SUFFOLK UNIVERSITY
Jonathan Haughton
ECONOMICS 311: Intermediate Microeconomic Theory
ASSIGNMENT 1
Answers to this assignment are due back by Wednesday, January 28, 2015.
1.
Production Possibilities
Investment goods
Production Possibility Frontier
Here is the production possibility frontier (PPF)
for Czechoslovakia in 1990.
120
a. Show what happened to the PPF when
100
Czechoslovakia split into two parts – the
80
Czech Republic, and Slovakia. Assume that
60% of the productive capacity was in the
60
Czech part of Czechoslovakia.
40
b. In the first years after it split away from
20
Czechoslovakia there was an increase in
0
unemployment in Slovakia. What effect, if
0
20
40
60
80
100
120
any, did this have on its PPF? Explain.
Consumption goods
c. On the original PPF for Czechoslovakia,
what is the opportunity cost, in terms of
investment goods, of raising consumption from 85 to 95?
d. If consumer goods production is 85, will economic growth be (potentially) higher or lower than when
consumer goods production is 95? Why?
e. What is the most difficult trade-off that you face currently? How do you resolve the dilemma?
2.
Demand and Supply
This question develops a demand and supply diagram for wine. Suppose that the demand schedule is as
follows:
Price ($/liter)
Wine demanded (liters/month)
Wine supplied (liters/month)
a.
b.
c.
d.
e.
f.
g.
21
70
370
18
140
350
15
210
320
12
280
280
9
350
240
6
420
200
3
490
160
Graph the demand and supply curves, labeling the axes and curves carefully.
What is the equilibrium price of wine? The equilibrium number of liters demanded and supplied?
The government wants to discourage drinking, so it decrees that the minimum price of a liter of wine
should be $18. At this price how much wine will be supplied? Demanded?
Does the revenue of wine sellers rise or fall under this new rule? Explain.
What will the government have to do to keep the price at $18 per liter?
A new tennis club is set up in the town, and demand for wine increases by 55 liters per month (i.e.
demand shifts out by 55 for any given price level). Graph the new demand curve and compute the
new equilibrium price of wine (approximately). Assume that public pressure has, by now, led to the
repeal of the price floor legislation.
A serious disease (phylloxera) hits the vineyards, reducing the supply of grapes. Show and explain
what effect this would have on the market for wine.
[Historical note: This is not merely hypothetical. Grape phylloxera are aphid-like insects that
attack the roots of grape vines. In the 1870s, wine production in France fell by three quarters as
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a result of phylloxera infestation. US grapes are resistant to phylloxera, and are now used as
root stock; the European wine varieties are grafted onto this stock.]
3.
Shifting Curves
Use basic demand and supply diagrams to aid your explanation of each of the following.
a. Why is the price of tomatoes higher in February than in August?
b. Why does the price of toys fall after Christmas?
c. Why is the price of computers falling over time? [Aside: Moore’s law: the power of computers
doubles every 18 months.]
d. Why does an increase in the Boston property tax not increase the price of land?
e. Why is the price of gasoline much cheaper than three months ago? [You may need to look up a
bit of background information on this one.]
4.
Diamonds vs. Water
In An Inquiry into the Nature and Causes of the Wealth of Nations, Adam Smith writes: “Nothing is more
useful than water: but it will purchase scarcely anything; scarcely anything can be had in exchange for it.
A diamond, on the contrary, has scarcely any use-value; but a very great quantity of other goods may
frequently be had in exchange for it.” Explain this “diamond-water paradox” using demand and supply
curves.
5.
Commodity Price Stabilization
In the 1970s, there was serious concern about the instability of commodity prices. One of the planks of
the then-fashionable New International Economic Order was that efforts should be made to stabilize the
prices of goods. Consider the following scheme: When the price of rubber is low, an international rubber
marketing board (IRMB) would buy up rubber at some reference price and store it; when the price of
rubber is above the reference price, the IRMB would sell rubber from its stock. Use demand and supply
diagrams to show that if the price fluctuations are due to variations in demand, this price stabilization will
help rubber farmers, but if the price fluctuations are due to variations in supply (i.e. some years there is a
good harvest, in other years there is not), then the price stabilization scheme will hurt rubber farmers.
6.
Solving for Demand and Supply
The demand for carrots is given by Qd = 40 – 4P while the supply is given by Qs = 4P - 8.
(i)
Graph these curves, and solve for equilibrium price and quantity.
(ii)
New research shows the health benefits of carrots, so the demand shifts to Qd = 48 – 4P.
Graph the new demand curve and compute the new equilibrium values of P and Q.
7.
PPF and Trade
An economy has a production possibility frontier given by X 2 + 4Y2 = 100.
(i)
Graph this ppf.
(ii)
Calculate the opportunity cost of an extra unit of good X when
a. X = 2
b. X = 8.
(iii)
If consumers want to consume equal amounts of X and Y, how much of each should be
produced?
(iv)
Now the country can trade. It produces only X, and for every unit of X that it ships abroad it
gets one unit of Y in return. Graph this consumption possibility curve.
(v)
Given that the country can trade on these terms, and that consumers still want to consume
equal quantities of X and Y, how much X and Y will they consume?
(vi)
How much does this country benefit by being able to trade?
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