ECON 2200, John Diggelman Name: Problem Set #2 1. Production Possibilities Suppose a farmer has two different fields that can be used to grow either corn or wheat. a. Field A consists of 10 acres and each acre will produce either 50 bushels of wheat or 50 bushels of corn. Graph a production possibilities curve for Field A with wheat on the horizontal axis and corn on the vertical axis. The PPC will be a straight line intersecting each axis at 500 bushels. b. Field B consists of 20 acres and each acre will produce either 50 bushels of corn or 100 bushels of wheat. Graph a production possibilities curve for Field B with wheat on the horizontal axis and corn on the vertical axis. The PPC will be a straight line hitting the corn axis at 1000 and the wheat axis at 2000 bushels. c. What we really want is to be able to graph a production possibilities curve that includes both fields. To do this, we need to figure out which field has a comparative advantage in wheat production. What is the definition of comparative advantage? For field A, what is the opportunity cost of 1 bushel of wheat? 1 bushel of corn For field B, what is the opportunity cost of 1 bushel of wheat? ½ bushel of corn Which field has a comparative advantage in wheat production? Field B d. Now for the compound production possibilities curve. Start by figuring out how much corn could be produced if the farmer grew no wheat. Next, decide which field you will use if you want to start producing some wheat. (Hint: use the field with the comparative advantage in wheat production) If the farmer grows 200 bushels of wheat, how much corn can be grown? Fill out the following table, but be sure to figure out when the farmer fills one field with wheat and starts using the other field. Graph the farmer s production possibilities curve using the table. Since it costs less to produce wheat in Field B than in Field A, we will gradually add wheat to Field B until it is full. At that point we will start to plant wheat in both Fields and the marginal cost per bushel of wheat will double from ½ bushel of corn to 1 bushel of corn. The PPC will consist of two line segments with the slopes of the PPCs you found in part a and part b.
Wheat (bushels) Corn (bushels) 0 200 1000 2000 Field A: 250 2000 2250 1000 1500 900 1400 500 1000 0 500 Field A: 250 0 250 2000 2500 0 2. Marginal Analysis and Efficiency. Suppose a local company is trying to decide how much advertising to pay for. Research indicates that the first TV ad will boost sales by $1000 per week, the second will boost sales by $700, the third will boost sales by $400 and the fourth ad just annoys people without boosting sales at all. If each ad costs $500, what is the efficient level of advertising? Use this information to graph MC and MB, then use your graph to support your answer. $1,200.00 $1,000.00 $800.00 $600.00 $400.00 $200.00 $- 0 1 2 3 4 5
MB is the downward sloping line, MC is constant at $500 and the efficient amount of advertising occurs between 2 and 3 ads. If you can t buy partial ads (15 second spots) then the simple answer is 2 ads. 3. Demand Shifts. Review the determinants of demand and then predict how each of the following events would likely affect the demand for breakfast burritos in Albuquerque. a. Average incomes in Abq fall. DECREASE b. The price of breakfast burritos goes up. NO SHIFT, quantity demand may fall but the curve doesn t shift. c. The price of an Egg McMuffin falls. DECREASE d. The price of a complementary product rises. What s a complement to breakfast burritos? DECREASE. Lipitor or napkins both come to mind. e. The population of Albuquerque rises. INCREASE f. Are you sure about a? What did you assume in order to answer a? That burritos are normal goods. g. Are you sure about b? Does the demand curve shift? 4. What will happen to equilibrium price and quantity? For each scenario draw a basic supply-demand diagram and use dotted lines to show changes in equilibrium prices and quantities. Using words or symbols, predict the impact on equilibrium price and quantity. a. Demand increases and supply stays the same. P and Q both rise. b. Supply increases and demand stays the same. P falls and Q rises. c. Demand decreases and supply stays the same. P and Q both fall. d. Demand increases and supply decreases. P rises, but the impact on Q is unclear. e. Demand and supply both increase. Q rises, but the impact on P is unknown. 5. 2. Supply and demand for breadfruit. Quantity Demanded Price Quantity Supplied 180 $1.40 90 170 $1.70 110 160 $2.00 130 150 $2.30 150 140 $2.60 170 130 $2.90 190
a) Graph the Supply and Demand curves, label everything! b) Find the equilibrium price and quantity. Explain in detail why $1.40 is NOT the equilibrium price. $2.30, 150 breadfruit. At $1.40 there would be a shortage of 90 breadfruit and price would likely rise. c) Suppose that the price of mangos increases. If mangos are a substitute to breadfruit, show how this would affect the graph in part a). Predict the impact on price and quantity of breadfruit. Demand curve for breadfruit will shift to the right. P and Q will both rise. d) Suppose the farmer has to pay higher wages to breadfruit pickers. How will this affect the supply and demand curves? Predict the impact on equilibrium price and quantity. Supply curve for breadfruit will shift left. P will rise and Q will fall. e) Suppose c and d happen at the same time. Predict the impact on equilibrium price and quantity. P will rise and we can t be sure what Q will do. 6. Elasticity. Price $5 $4 $3 $2 Quantity 1 2 3 4 Demanded Using the midpoint formula, calculate the price elasticity of demand for this product. You get to do this 3 times. a. Find the price elasticity of demand as the prices moves from $5 to $4. Hint: the quantity will move from 1 to? -3 b. Find the price elasticity of demand as the prices moves from $4 to $3. -1.4 c. Find the price elasticity of demand as the prices moves from $3 to $2. -.71 d. What can you say about elasticity along a linear demand curve? e. Calculate total revenue (TR) for each price. Price $5 $4 $3 $2 Quantity 1 2 3 4 Demanded Total Revenue $5 $8 $9 $8 7. Elasticity and revenue. For each of the scenarios, will total revenue rise, fall or stay the same? a. If demand is relatively elastic and price falls. RISE b. If demand is relatively inelastic and price rises. RISE c. If demand is unit elastic and price falls. STAY THE SAME 8. More elasticities.
a. What is the income elasticity of demand? If the income elasticity of demand is negative, what does it tell us? That income and demand are moving in opposite directions. INFERIOR GOOD. b. What is the cross price elasticity of demand? Is the cross price elasticity of demand between Coke and Pepsi likely to be positive or negative? An increase in the price of Coke will cause the demand for Pepsi to rise POSITIVE. 9. Suppose we know that the price elasticity of demand for green chiles is 0.8 Is the demand for green chiles relatively elastic or inelastic? Suppose half of the green chile crop is destroyed by E. coli contamination. What will happen to the price of chiles? Give a prediction of an exact percentage change in price. Ed = %change Q / % change P -0.8 = -50% / x -0.8x = -50% x = -50% / -0.8 PRICES WILL RISE 62.5%