Week 2
1.
Individuals and Government and Math Review
Consider the equation of Q = 20 – 0.5P, graph it and put P on the vertical axis and Q on
the horizontal axis.
a)
What is the intercept for horizontal axis?
20
b)
What is the intercept for vertical axis?
40
c)
What is the slope of the graph?
-2
d)
Is the slope constant, increasing or decreasing as values of P change?
Constant at 2
e)
What is the value of Q when P = 12?
Q = 14
f)
Considering the second equation of Q = 10 + 0.5P, solve for P and Q using both
equations.
P* = 10 & Q* = 15
2.
Market demand for hats is given by Q = 300 − 2P, where Q is total quantity purchased
by consumers at each price and P is price in dollars. Supply of hats is given by P = 30
+ Q, suppose hats are sold in a competitive market.
a)
Please draw the demand and supply curves on a diagram. Find equilibrium price
and quantity of hats, denote Q*and P*.
P* = 110 & Q* = 80
b)
In your own words explain the concept of marginal value (MV), does MV
represent marginal private benefits from consumption? Calculate marginal and
total value of hats in the equilibrium outcome. How much money is spent on
hats in equilibrium? In your own words explain what consumer surplus (CS) is.
Calculate CS and show on your diagram.
Econ 290 Week 2 Tutorial
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Marginal value measures the enjoyment a consumer receives from consumption of
an additional (one more) unit of a good. Since the problem specifies that the market
is competitive: no externalities, public goods etc., MV is exactly the same as marginal
private benefits from consumption. MV is equal to the height of the D curve at a
corresponding unit.
MV=P=110
TV of 80 units is 10,400.
Expenditure on hats is
·
= 8,800.
Consumer surplus measures the net benefits from consumption: how much the quantity
is worth to consumers (TV) minus what was paid to purchase the quantity (expenditure):
CS=TV-PQ. On diagram it is a triangle below D and above P. CS=1,600.
c)
What is the marginal cost (MC) of hats in competitive equilibrium? Calculate
and show on your diagram producer surplus (PS).
MC = Supply curve = price = 110
On diagram PS is triangle above S below P. PS=3,200.
d)
Is equilibrium outcome efficient? What is net marginal social benefit in the
competitive equilibrium? Is Q = 75 efficient? Is Q = 100 efficient?
Efficient outcome means that social welfare is maximized. Recall the optimality
conditions. We need MSB=MSC for social welfare to be maximized. In competitive
equilibrium consumers and producers maximize their own individual well-being and
arrive to the outcome in which MV=P=MC, in other words, we have MPB=P=MPC.
When assumptions of the competitive markets are satisfied, social and private marginal
costs and benefits are the same. Also in competitive equilibrium net marginal benefits are
zero: the output is at the optimal level. Producing less or more output than * is not
efficient and under/over production is associated with welfare loss.
Q=75 is not efficient. Since marginal benefits are greater than marginal costs and net
marginal benefits are positive, increasing the activity (production of hats in this case)
will increase social well being. Another way to look at it: since at this point MV of hats
is above MC gains from trade are available if more hats are produced.
Q=100 is not efficient. Marginal benefits are lower than marginal costs (which literally
means that the product is not worth the production costs: at this level of output
consumers’ enjoyment from the last 20 units produced is lower than the marginal costs
of production of those units); net marginal benefits are negative, meaning that lowering
production of hats will increase social welfare.
Econ 290 Week 2 Tutorial
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3.
What is efficiency (efficiency criterion)? Suppose your TA brings as 80 candies to the
tutorial and there are 20 girls and 40 boys in the class; suppose all students like candies
and are not allowed to trade or exchange candies they are given. Determine which
situations satisfy efficiency criterion:
a)
TA gives one candy to each student and throws the rest of the candies away
Inefficient
b)
TA splits candies equally among girls
Efficient
c)
TA gives all candies to one of the students
Efficient
d)
TA puts all candies in the middle of the room and lets students fight for the
candies; stronger students will get more candies, one third of candies will be
destroyed during the fight (this one is tricky, be careful).
If instead TA could allocate the candies exactly the way they
would be distributed during fighting plus distribute the candies that are not
destroyed -then fighting generates the waste and results in inefficient outcome.
4.
Suppose that the total social benefits of a swimming pool exceed total social costs of the
swimming pool. Does this mean that the swimming pool should be expanded?
No. We make decision at the marginal. MB and MC matter not TB and TC.
Econ 290 Week 2 Tutorial
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