1. Auto Maintenance Services (AMS) is a small auto service outlet in a suburban area of Syracuse. In reaction to a small increase in wages that has caused the marginal cost of this auto service establishment to increase from $25 to $30, the owner is considering raising the prices of the services AMS offers. The owner's daughter, who is studying economics and, at the time, takes care of her father's books and finances advises him against that. She has estimated that if AMS raises its prices it will face the weekly demand curve Q = 140 - 2.5
P, whereas if it lowers its price it will face the demand curve Q'= 55-.625P.

a. Determine the (average) price AMS is charging for its services, presently.
b. Determine the number of cars it services each week.
c. Assuming that the owner's daughter is correct, what is the MC range within which AMS should not change its price?
d. AMS's weekly total fixed cost is $250. Assuming that the firm's marginal cost and average variable cost are equal (AVC =MC), determine its weekly profit after the wage increase.
e. What should AMS do if its MC goes up to $40? Explain.

2. FastAuto is a new and the only quick auto service operation in town. As the only quick auto service in the area, it faces the following daily demand curve:

Q = 600 - 30 P

Where Q is the number of cars it services per day and P is the average price of its services.
The cost function of this auto shop has been estimated as follows:

TC = 400 + 6 Q + .03 Q^2
a. Determine the profit-maximizing price of the shop's service assuming FastAuto is behaving as a monopoly.
b. Determine the profit of this establishment.
c. If the firm were to produce as a perfectly competitive firm, how many cars would it service?
d. What price should it charge as a competitive firm?
e. Would it still make a profit if it behaved like a competitive firm?
As a result of the success of FastAuto other similar establishments start appearing in the area. As FastAuto's customers gradually start trying other (new) auto shops, FastAuto's demand curve gets flatter (more elastic) and shifts to the left. In reaction, FastAuto lowers its price and adjust its output to the point that, eventually, its (economic) profit disappears; It becomes equal to zero. At that point its new demand curve would be as follows:

Qd = 747 -50 P

f. Determine the new (equilibrium) average price FastAuto charges for its services.
g. Is FastAuto minimizing its cost at this new output level? Explain.
h. Identify the type of market FastAuto is operating in now and demonstrate it on a diagram.
 

Homework Assignment
1. The following are the long-run cost functions for a manufacturer of small (corporate) passenger jets:

TC =  500,000,000 + 4000 Q + 20 Q ²
MC = 4000 + 40 Q

The demand curve that this manufacturer faces is represented by the equation below:

Q =  516,000 - 2.5 P

a. Determine if this manufacturer has the potential to keep competitors out of the market and become a natural monopoly.
b. What price should it charge as a monopoly?
c. Determine the monopolistic profit of this firm.
d. Can the firm sustain this profit as long as the demand it is facing remains the same? Explain.
Solution:
As a monopoly the firm would set MR = MC:

MR = 206,400 - .8 Q
MC = 4000 + 40 Q

Setting MR = MC, solving for Q, Q* = 4960.8,   P* =  208,384.31

Profit = TR - TC = P*.Q*  - TC = 1,033,749,634.76 - 1,012,030,757.40 = 21,718,877.35

The firm's average total coat at this output level is: 204,006.20

To determine the firm's output at its minimum average cost set MC = ATC and solve for Q:
At the output level 5000 the firm's average cost is minimized at 204,000

Note that the firm's output is very close to its minimum average cost point. If another firm enters the industry and produces, say, 2500 airplanes, the price will fall below the minimum average cost causing losses to both firms. Therefore as long as the demand stays the same there is little incentive for new entries. This allows our firm to maintain its monopolistic position. The firm may choose to price its planes at a price slightly lower than the monopolistic price just to be sure.
 

2. Miracle Pharmaceuticals produces a patented blood pressure pill which it sells in two different markets with different market demands as represented by the following equations:

Q1 = 200 - 1.333 P
Q2 = 100 - 0.5 P

The company's cost functions are as follows:
TC = 100 + 25Q + .125 Q²
MC = 25 + 0.25 Q
a. Assuming that the company is able to price-discriminate between the two markets, determine what price should it charge in each market.
b. What would be the company's profit?
c. Suppose the government wants to force Miracle Pharmaceuticals to charge a price equal to its marginal cost in both markets. What should be the government-mandated price for this drug? Would Miracle Pharmaceuticals still be making a profit?

Solution
Q1 = 200 - 1.333 P   Q2 = 100 - .5 P2
P1 = 150 -.75 Q1   P2 = 200 - 2 Q2
MR1 = 150 - 1.50 Q1   MR2 = 200 - 4 Q2

To maximize profit: MR1 = MR2 = MC

MC = 25 + 0.25 Q = 25 + 0.25(Q1 + Q2 )
MC = 25 + 0.25 Q1 + 0.25 Q2

MR1 = MC
MR2 = MC

150 - 1.50 Q1 = 25 + 0.25 Q1 + 0.25 Q2
200 - 4 Q2 = 25 + 0.25 Q1 + 0.25 Q2

Solving for Q1 and Q2
Q1 =  66.10
Q2 = 37.30
P1 = 100.42
P2 = 125.40
Q = Q1 + Q2 = 103.40

MR1 = MR2 = MC = 50.85

Profit =  P1Q1 + P2Q2 - TC = 11315.18 - 4021.44 = 7293.73

If the government wants to force Miracle Pharmaceuticals to charge a price equal to its marginal costs, MC must be equal to the price in both markets. To determine that price set MC = 25 + 0.25 Q1 + 0.25 Q2 = P1 = 150 -0.75 Q1
     MC = 25 + 0.25 Q1 + 0.25 Q2 = P2 = 200 - 2 Q2
Solving for Q1 and Q2:
Q1 = 65. 71
Q2 = 108.61
P1 = P2 = MC = 68.55 ( The government mandated price )

Q = Q1 + Q1 = 174.32

================================
The following is the estimated weekly demand for lazer eye surgery in a small town.

Qd = 45 - .05 P

Dr. Goodsight is the only lazer surgeon in town facing this demand. Dr. Goodsight realizes that as the only provider of this kind of vision correction procedure he is a monopolist and intends to take full advantage of his position. He has estimated his weekly cost functions as follows:

TC = 5 Q² + 100 Q + 400
MC = 100 + 10 Q
ATC = 5 Q + 400 Q ^-1 + 100
Slope of ATC = 5 - 400 Q ^-2

a. Determine the weekly profit maximizing number of surgeries for Dr. Goodsight.
b. What price should Dr. Goodsight charge for each surgery?
c. What would be his profit?
d. Is Dr. Goodsight minimizing his cost at the profit maximizing level of output? Explain.
e. What is Dr. Goodsight's index of monopoly power?
f. If Dr. Goodsight were to maximize his revenue (rather than profit), what price would he have to charge and how many surgeries would he conduct per week? Would he still be making a profit? Explain.
g. Now suppose to prevent Dr. Goodsight from overcharging his patients the government decides to control the price of lazer eye surgery. If the government were to force Dr. Goodsight to produce at a level equal to his output under competitive conditions, what price should the government set and impose on Dr. Goodsight? Assume Dr. Goodsight is not allowed to price-discriminate and must charge all his patients the same government-mandated fee.
h. Examine the impact of this policy on the consumer and producer surplus and compare them with the case where Dr. Goodsight behaved as an uncontrolled monopolist.
a.
Qd = 45 - . 05 P  or   P = 900 - 20 Qd
MR = 900 - 40 Q
MC = 100 + 10 Q
Set MR = MC and solving for Q,  Q = 16
b.
Substituting Q =16 into the demand equation,  P =  580

c.
Profit = TR - TC  = $6,000

d. Either set the slope of ATC equal to zero or set MC = ATC and solve for Q;   Q = 8.94
Because 8.94 is not equal to 16 ( the profit maximizing Q) the answer is no.
Or check to see if at Q = 16 MC and ATC are equal. At Q = 16  MC = 260 whereas ATC is equal to 205. Because they are not equal, at Q = 16 the average cost is not minimized.

e.
The (Lerner) index =  (580 -260)/580 = .552 = 55.2%

f.
Set MR = 0 and solve for Q;  Q = 22.5  ;   Substituting  22.5 into the demand equation, P = 450
Dr. Goodsight would still be making a profit because at Q = 22.5  ATC = 230.27 and 450> 230.27

g.
Set the demand equal to MC:  900 - 20 Q = 100 + 10 Q; solving for Q = 26.66 and P =  366.66

h.
Before price control (when Dr. Goodsight behaves as a monopoly):
CS = 16 (900 - 580)/2 = 2560
PS = (480+320)(16)/2 = 6400
Total  =                           8960

After price control:
CS = (900 - 366.66)*(26.66)/2 = 7111.8
PS = (266.66 *26.66)/2 =  3554.57
Total  =                            10,666.40

Monopoly deadweight loss = 10,666.40 - 8,960 = 1706.5

============================================
 

1. The following are the supply and demand functions for the rental housing market in a popular region in a metropolitan area.
 

Demand: Qd = 1300 -0.2 P
Supply:   Qs = -50 + 0.1 P

a. Plot the supply and demand and determine the equilibrium price (rent) and quantity in this market.
b. Calculate the consumer produce surplus for this market.
c. Now suppose the government imposes a rent control ceiling of $2500. Determine the effect of this rent control on the consumer surplus.
d. Determine the overall welfare effect of this rent control policy.
Answer Key:
The supply price intersection point:  500
The supply quantity intersection point: -50
The demand price intersection point: 6500
The demand quantity intersection point: 1300

Before rent control:
Price = 4500
Quantity = 400
CS = 800,000
PS = 400,000
Total = 1,200,000

After rent control:
Price = 2500
Quantity = 200
Shortage = 800 - 200 = 600
CS = 700,00
PS = 200,000
Total = 900,000

Net Loss (of Welfare) = 1,200,000 - 900,000 = 300,000
 

2. The market for wheat in a small country is represented by the following two equations:
Demand: Qd = 120,000 - 80 P
Supply:  Qs = -10,000 + 100 P

a. Plot these functions and determine the equilibrium price and quantity in this market.
b. Calculate the consumer and producer surplus for this market.
c. Now suppose the government decides to subsidize wheat growers directly by paying them $50 for each ton of wheat they produce. This subsidy would cause a shift in the supply curve as follows:

Q's = - 5,000 + 100 P
Plot the new supply curve and determine the (new) price and quantity after the subsidy.
d. Determine the impact of this subsidy on the consumer and producer surplus separately.
e. Determine the welfare effect of the subsidy, having in mind that the whole society bears the cost of subsidy.
Answer Key
The demand price intersection point: 1,500
The demand quantity intersection point: 120,000
The original supply price intersection point: 100
The original supply quantity intersection point: -10,000
The new supply price intersection point: 50
The new supply quantity intersection point: - 5000

Price before subsidy: 722.22
Quantity before subsidy: 62,222.22

Price after subsidy: 694.44
Quantity after subsidy: 64,444.44

Before subsidy
CS = 24,197,599
PS = 19,357,954
Total= 43,555,544

After subsidy:
CS = 25,956,754
PS = 20,765,287
Total = 46,722,041

Net gain in CS and PS = 3,166,497

Cost of subsidy = 50 X 64,44.44 = 3,222,222

Net (deadweight) loss:  3,166,497 - 3,222,222 = - 55,725.
 

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Ellen's Pottery is a small pottery outfit that produces fine decorative pottery. The daily short-run cost functions of this outfit have been estimated as follows:

TC = 200 + 34 Q + 0.10 Q ²
MC = 34 + 0.20 Q

a. Write the average cost function for this firm.
b. At what level of output would the firm's average cost reach its minimum level?
c. Suppose the firm is operating in a competitive market and the average market price for its product is $50. How many pieces would this firm have to produce and sell to break even?
d. At what level of output would the firm's profit be maximized?
e. Suppose, anticipating competition, Ellen's pottery decides to invest in upgrading its equipment. The new investment almost doubles the fixed cost of the firm. The following are its new cost functions.
TC = 400 + 32 Q + .055 Q ²
MC = 32 + .11 Q

 Assuming the same market price, determine how this change would affect the firm's break-even out put level and its profitability.
f. Plot the new AVC curve. Do you observe economies of scale? Explain.
g. Now suppose as a result of competition the average price of fine pottery is dropping. At what price would the economic profit of Ellen's Pottery reach zero? Try to demonstrate on your diagram.
h. At what price might Ellen's Pottery be forced to shut down? Explain.

========
FAC is a fast auto service establishment with the following daily short-run total and marginal cost functions:

TC = 120 +  .01 Q³  - .25 Q² + 5 Q
MC = .03Q² - .5 Q + 5

FAC operates in competitive market where the established average market price for quick auto service is $19.
a. What is the minimum number of cars FAC needs to service to break even?
b. At what level of output does its average variable cost reach its minimum?
c. At what level of output does its average total cost reach its minimum?
d.  At what level of output do diminishing returns (to variable inputs) start to take effect?
e. How many cars should FAC service to maximize it profit?
f. What would be its profit at the profit-maximizing level of output?
g. Now suppose as result of increased market demand for fast auto service the price has increased to $25. How would this price change affect FAC?
h. Suppose an auto service equipment sales person visits AFC one day and suggests that if the firm upgrades its equipment it can improve its productivity and thus increase its profit in the long run. The upgrade would increase FAC's fixed cost to $250. With the upgrade the firm's total cost function would however change as follows:

TC = 250 + .008Q ³ - .3 Q² + 4 Q

 Determine if FAC should go ahead with the upgrade investment. How would the
upgrade affect the firm's operation in terms of the minimum break-even output level and profitability? Assume the new $25 price prevails.
i. Try to demonstrate your work graphically as well.
j. Keeping the price at $25, suppose as a result of an increases in input prices (labor, etc.) the total cost function changes again as follows:

TC = 250 + .009Q³ - .18 Q² + 6 Q

 Explain how this change would affect the FAC's operation and profitability.
 

============================
1. The following is the production function for a medical clinic using labor and capital as its inputs. The output is measured in terms of the number treatments delivered.

Q = 20 K L + K L ² - 0.1 K L ³

where K is capital and L represents labor.

a. Does this function exhibit increasing, decreasing, or constant returns to scales?
b. Assuming that in the short run K = 5, calculate the output for L = 1, 3, 5, 7, 10, 12, 17, and 20.
c. Based on your calculations for part b plot (draw) the production function in a two-dimensional space measuring Q vertically and L horizontally.
d. Calculate APL and MPL for labor levels in part b.
e. Draw MPL and APL based on your calculations.
f. At what level of labor is output maximized?
g. At what level of output is APL maximized?
h. At what level of output do diminishing returns to labor kick in?
i. How do the sizes of APL and MPL compare at different levels of output?
j. Increase the capital level, K, to 10. Examine the effect of this change on labor productivity.
( For this exercise those of you who are reasonably familiar with Excel (or any other spreadsheet package) should try to use it. )
 

2. A Cobb-Douglass Production Function: A Special Case

You are given the following production function:

Q = K L ^½

a. Does this function exhibit increasing, decreasing or constant returns to scale?
b. Plot a set of isoquants for Q = 12, 16, 26, and 32.
c. What can you say about MRTS for this production function?
d. Now suppose the capital level, K, is 10, the price of capital, r, is $5, and the price of labor, w, is $10. Write the short-run cost function (in terms of Q) based on the information given.
e. Calculate STC, AFC, AVC, ATC and the marginal cost, MC, for output levels corresponding to L = 1, 2, 4, 6, 10, 20, 100.
f. Plot these cost measures based on your calculation.
g. Increase the capital level to 20 and examine the effect of this change on various cost measures.
h. Now suppose the total cost of the firm stands at $120. Write the cost equation (TC = rK + wL) based on the information given.
i. Draw the isocost for the cost level of $120.
j. Given that the firm is presently using ten units of capital, identify the combination of capital and labor on your isocost and determine the number of units of labor the firm is using.
k. Based on the information you have about the production function and the firm's isoquants, is this mix of capital and labor optimal? Explain.
l. If your answer to (k) is no, keeping its cost at the $120 level, what should the firm do? Can you determine the optimal mix of inputs at this cost level?
 

2. Determine whether each of the following statement is "positive" or normative.
a. About 14 percent of Americans do not have health insurance.
b. To make sure the economy would not go into a recession the Fed should lower the interest rate.
c. Ceteris paribus, when the price of a good increases a consumer should reduce her purchase of it so that she can buy more of other things.
d. Gas prices are too high.
e. An increase in a binding minimum wage will result in a reduction in the quantity of demand for minimum-wage type workers.

3. The price of a certain CD player in 1980 was $400. By 1990 this price had gone down to $350, and by 2000 to $200. The consumer price indexes in these years were 120, 145, and 186, respectively.
a. Determine by what percentage did the real price (in 1980 dollars)changed between 1980 and 2000.
b. A case of California wine in 1980 was $150. In 2000 a case of the same wine in 1980 dollars was $161.30. What was the nominal price of this wine in 2000?

4. The following is the demand function for housing in a given market:
Qd = 20,000 - 4 P + 0.1 I
Where P represents price and I stands for the medium income.
a. Assuming the medium income is $50,000, write and draw the demand (curve) function.
b. Calculate the price elasticity of demand at P= $4,000. Is the demand elastic or inelastic at this price?
c. At what price is the demand unit elastic?
d. Now suppose the supply of housing is represented by the following equation:
         Qs = - 4000 + 8 P
e. Determine the equilibrium price and quantity for this market.
f. Now determine the price elasticity of demand and supply at the equilibrium point.
g. Now suppose the medium income is increased to $100,000. Calculate and demonstrate the effect of this change on the equilibrium price and quantity. Also calculate the impact of this change on the price elasticity of demand.
h. Suppose to control housing prices the government imposes a price ceiling on housing at the original equilibrium price. Explain the implication of this price ceiling.
i. Using the point price elasticity approach, calculate the income elasticity of demand at both equilibrium points.

5. Why do we expect the long-run price elasticity of demand to be higher that the short-run price elasticity of demand?
6. What is an indifference curve?
7. Why is an indifference curve expected to be convex?
8. Why, within an indifference map, indifference curves cannot cross?
9. Jack's after-tax income is spent on food and clothing. The price of food is $10 and the price of clothing is $25. Presently Jack purchases 24 units of clothing and spends the rest of his income on food.
(Hint: Any reasonable income level would work in this problem. For example, you can set the income at $1,000.)
a. Draw Jack's budget line and identify the point that corresponds to Jacks consumption bundle.
b. What is Jack's income?
c. How many units of food is Jack buying?
d. Suppose at this consumption mix Jack's MRS is -.6. Is jack maximizing his utility? Try to demonstrate you answer on a diagram as well. (That requires that you draw an indifference map reflecting your argument.)
e. If your answer to "c" is no, using your diagram, explain what Jack should do.
f. Suppose the price of clothing is lowered to $12.50. Show this change, carefully, on your diagram.
g. Use your analysis to derive the demand curve for clothing.
h. Still using your diagram, can you separate (identify) the income effect from the substitution effect of this price change?
i. Now go back to the original prices and place jack at the point where his utility is maximized. (You could use the same set of indifference curves that drew before.) Suppose Jack's income is increased by 25%. Show the effect of this change on jack's demand for clothing.

10. Which of the following could cause a change (increase or decrease) in demand for DVD players?

a. An increase in the DVD rental fees
b. A new technology that has lowered the production cost DVD players
c. An increase in the price of movie tickets
d. An income tax increase
e. An increase in the cable subscription fee

11. Determine the probable effect of each of the following on the equilibrium market price and quantity of orange juice in the US.

a. An exceptionally extended cold winter in the US has damaged the apple orchards in the north and the orange groves in California and Florida.
b.  Some studies have suggested that drinking orange juice may help prevent certain cancers
c. The government has lowered tariffs on all imported fruit juices
d. A change in the Federal tax code lowers income taxes for individuals making less that $40,000.00 by about 50 percent.
e. The EU countries remove all tariffs from imported citrus fruits and all citrus juices.

12. It has estimated that the price elasticity of demand for beef is -.9 while the income elasticity of demand for this product is 1.2. Presently, at the average price of $3.60 per pound the total daily consumer expenditure on beef is $143.5 million. Suppose households income are expected to increase by 2% while beef prices are expected to reach $4.00 per pound. Determine the expected impact of these changes on consumers' daily expenditure on beef.

13. A consumer likes both chicken and beef. Her weekly meat budget is $25. Presently, the price of beef is $5 per pound whereas chicken is $2.5 per pound.
      a. Draw this consumer's budget line.
      b. Suppose at the present prices the only meat this consumer purchases is chicken.
          Draw   an indifference map reflecting this consumer's utility maximizing choice of
           meet products.
      c. Using your graph, determine what change or changes in prices or income would  cause
          this consumer to purchase at least one pound of beef. Explain.
     d. Use your diagram to construct this consumer's  Engel curves for beef and chicken.
 
 

14. Briefly explain and compare Laspeyers and Paasche price indexes.

15. Explain why chain-weighted indexes are preferred to fixed-weight price indexes.

=========================================
Assignments:
Indifference Curve Exercises
1. Draw a set of indifference curves to represent each of the following cases:
a. Jeff dislikes both coffee and doughnuts.
b. Nicole drinks soda only if for each can of soda she is also given a bag of potato chips.
c. In one of the new reality shows Joe is offered $1000 for each live gold fish that he can eat. Needless to say, Joe does not enjoy eating live gold fish.
d. A local super market offers its customers one free bag of pretzel for each six-pack of beer purchased.

2. Knowing that MRS is - MUx/MUy, explain why we expect an indifference curve for two "good" to be convex (bowed to the origin).
==============================

Due: Sep 22

The following is an elasticity exercise. Answer all the parts but submit only the parts marked by asterisks (*).

The weekly demand for automobile tires in Blueland has been estimated as follow:

Q_d  = 1000 - 100 P + 0.05 I + 0.01 N - 200 P_g

Where:
P = Price of tires
I = Community's medium income = 40,000
N = Population = 160, 000
P_g = Price of gasoline = 2.00

a. Write the demand curve equation based on the information given above.
*b. Suppose the price of tires is $30. Calculate the arc price elasticity of this demand assuming a 5% increase in the price.
*c. Now calculate the point price elasticity of demand for tires at the same price of $30.
d. Assuming that the price remains at $30 and using the information given above, calculate the income elasticity of demand for tires. (Use the pint elasticity approach.)
e. Assuming that the price remains at $30 and using the information given above, calculate the point elasticity of demand for tires with respect to population.
*f. Assuming that the price remains at $30 and using the information given above, calculate the cross price elasticity of demand for tires with respect to the price of gasoline. (Use the pint elasticity approach.)
g. Is the demand for tires at the price of $30 elastic? Explain.
h. Suppose manufactures of tires raise the price of tires to $40. Will that change the price elasticity of demand for tires? Explain. How does this price increase affect their sales (revenue)?
*i. Now suppose wile the price of gasoline drops to $1.50 the population of the town increases to 200,000. Assuming that manufacturers continue to charge $40 for each tire, determine if these changes would affect the (point) price elasticity of demand for tires. If the manufacturers of tires wish to increase their sales (revenue), should they increase their prices further?
j. How do you think the lower gasoline prices might affect the demand for tires in the long run? Explain.
*k. Suppose the market supply of tires is represented by the following function:
Qs = - 1000 + 50 P
  Using your new demand function (in question i), determine the equilibrium price
 of tires.
    Now determine the (point) price elasticity of supply and demand at the
 equilibrium price.
Answers
a. Qd = 4200 -100 P
        P1 = 30; P2 = 31.5;  Q1 = 1200, Q2 = 31.5
b. Arc elasticity with respect to price = (-150/1.5)*(61.2/2250) = -2.72
c. Point price elasticity =  -100 (30/1200) = -2.5
d. Income elasticity = .05 (40000/1200) = 1.66
e. Pop elasticity = .01 ( 160000/1200) = 1.33
f. Cross (gas) price elasticity= -200 ( 2/1200) = - .33
g. Art P = 30 price elasticity is -2.5 whose absolute value is greater than one: elastic
h. Elasticity at P = 40 = -100 ( 40/200) = -20 ( This price increase will cause the TR to go down.)
i. Price elasticity = - 100 (40/700) = -5.7  (Less elastic than in "h", but still elastic: To increase the revenue price should be lowered.)
j. The demand for tires would shit to the right further.
k. P = 38;  Q = 900
Price elasticity of supply = 50 ( 38/900) = + 2.1
Price elasticity of demand = - 100 ( 38/900) = - 4.1

----------------------
Due Date: Sep 15
The following are supply and demand functions for commercial landscaping services in Greenville.

Qs = -a W - bG - c K + d P
Qd = 1000 + e I + f R + h S - m P

Where:
 a = 50
 W = Wage = $7
 b = 25
 G = Gasoline price = $2.00
 c = 1000
 K = Price of capital or interest rate = 0.10
 d = 0.5
 P = Price
 e = .08
 I = Median Income = $25,000
 f = 10
 R = Annual precipitation = 50
 h = .01
 S = Population = 150,000
 m = 2

a. Write the supply curve equation.
b. Write the demand curve equation.
c. Draw the supply and the demand curve and determine the equilibrium price and quantity of landscaping services in this market.
d. Determine and point to the price and quantity intercepts of the supply curve.
e. Determine and point to the price and quantity intercepts of the demand curve.
f. Suppose there the population of Greenville has doubled (to 300,000). Calculate and show the impact of this change on the price and quantity of and landscaping services.
g. Keeping the population at 300,000 suppose the interest has dropped to .05 (or 5 percent). Calculate and show the effect of lower interest rate on the price and the quantity of landscaping services in Greenville.
h. Staying with the population of 300,000 and 5 percent interest rate, suppose the average wage in Greenville has increased to $8.50. Calculate and demonstrate the impact of this wage increase on the price and quantity of landscaping services.
i. Determine and point to the price and quantity intercepts of the supply curve now.
j. Determine and point to the price and quantity intercepts of the demand curve now.

Answers:
a. Qs = -500 + 0.5 P   or  P = 1000 + 2 Qs
b. Qd = 5000 - 2 P  or  P = 2500 - 0.5 Qd
Q = 600,  P = 2200
d. Price intercept = 1000; Quantity intercept = - 500
e. Price intercept = 2500; Quantity intercept =  5000
f. Shift of the demand curve to the right: P = 2800;  Q = 900
g. Shift of the supply curve to the right: P = 2780;  Q = 940
h. Shift of the supply curve to the left (up): P = 2810 ;  Q = 880
i. Price intercept = 1050; Quantity intercept = - 525
j. Price intercept = 3250, Quantity intercept = 6500

=========================================================
August 30- Read Chapter One and think about the following question:

According to the Table 1.1 in your book, between 1970 and 2002 the real price of a dozen of eggs declined by about 64 percent whereas the real price of college education rose by more than 54 percent. Could we conclude that egg producers are now necessarily worse off and educators are better off?

September 1
Do the following problem:
The following are the 1982-84 based price indexes for a number of selected years, starting with 1963.
Years         CPI
1963             30.6
1973             44.4
1983             99.9
1993            144.5
2003            184.0

Answer the following questions:
a. What was the overall rate of inflation between 1973 and 1983?
b. Was the inflation rate between 1993 and 2003 lower or higher than the inflation rate between 1973 and 1983?
c. In 1973 the minimum wage for non-farm workers was $1.60. How much would that be in the 2003 prices? Do the same calculation for the 1963 minimum wage that was $1.25. What do you conclude?
d. In 2003 the average price of a Big Mac was $2.65. Calculate the real price of a Big Mac in the 1963 dollar.

Discuss how these developments have affected the market structures in different US industries. Is the US economy in general becoming more or less competitive? Are there any particular industries that you think have changed more than other?
======================

Essay One
Write a one-page essay (about 360 to 420 words) reflecting on some or all of the following observations.
Due: Friday Oct 1

While since 1970s a combination of disruptions in the supply of crude oil (mostly caused by political upheavals and war) and fluctuations in demand due to economic cycles has made the oil market somewhat unstable, the production of oil has almost steady increased from an average of 46 million barrels per day in 1970 to almost 80 million in 2003. Of course consumption has also increased at just about the same rate. During the last three decades of the 20th century the price of crude, while wildly fluctuating during certain periods, increased from a few dollars per barrel to over $40. In recent months it reached nearly $50.

· What do you think the future holds for the petroleum market?
· There is a close correlation between economic growth (whether it is cyclical or structural) and oil consumption, and oil is after all an exhaustible resource.
· The US acquires about half of its needed energy from foreign sources, and as we grow our dependence on foreign sources of crude increases, as our domestic oil production is not expected to keep up with our increasing demand.
· Many other economies of the world are growing even faster than ours, and those economies too are going to demand more and more oil. That means the US is going to compete with many other buyers of oil in the international market.
· Although the US domestic oil production has not kept up with its growing demand, through their investments in oil producing countries US oil companies have managed to maintain a significant level of influence in the world oil market.
· Should we be concerned? If your answer is yes, what measures do you think we should take to better our chances of avoiding a future energy crisis?

Lecture  One

What is economics?
1. The root of all economic problems: Scarcity
Things that we "need," "want," or "desire," individually or collectively, often exceed what we can afford or what are available. We have to deal with "limits."
2. Economics is the study of people making decisions on how to use (or allocate) scarce resources and the consequences of their decisions with regard to efficiency.
3. Microeconomics studies the behavior of individual economic units in deciding how to allocate their scarce (limited) resources among the various choices available to them. Economic units: consumers, workers, firms, governments
4. Macroeconomics is the study of economic aggregates such as the price level (inflation), interest rates, employment, aggregate consumption, aggregate saving, GDP growth rate, etc. These aggregates are the collective measures of the behavior of the economy as whole. Note that in macroeconomics we are not concerned with the behaviors of individual economic units, rather we study the aggregate measures that largely reflect the collective results of economic units' actions.
5. Division of Labor, Specialization, and Trade
We have discovered that through division of labor, specialization and trade we can make better (more efficient) use of scarce economic resources.
To facilitate trade we have invented a "universal" medium of exchange. We call it money. Money is also used as a measure of "price" or value.
We have also created institutional infrastructures (economic, social, and legal) to support economic activities and interactions. In most modern economies the "market" is the central guiding mechanism of economic activities.
6. Scarcity of resources forces economic units to make choices. Making choices leads to " opportunity costs."
i. Consumers
ii. Workers
iii. Firms
iv. Governments
7. The function of price in decision making by economic units
8. How are the prices determined?
9. Markets and supply and demand

How to Study Economics
1. Economic Theories versus Economic Models
i. The role of theories in sciences
ii. The making of an economic theory
iii. How realistic is an economic theory
iv. A model is constructed based on a theory. It is the application of an economic theory to a specific economic problem, often (but not always) constructed in mathematical forms.
v. Positive versus Normative Economics
Market-Based Economies versus Planned Economies
1. What and how much, how, and for whom?
2. Who makes the choices?
3. The efficiency implications of economic choices
What is economic efficiency?

What Constitutes a Market?
1. Supply and demand revisited: The market actors
2. What determines the scope of the market
3. How is the market price determined?
4. The structure of a market: the degree of market competition
5. Price and market equilibrium
a. Variations in prices
b. Non-competitive prices
6. Price measures:
a. Monetary versus relative price
b. Real versus nominal Price
c. The Consumer Price Index, CPI

A question:

According to the table 1.1 in your book, between 1970 and 2002 the real price of a dozen of eggs declined by about 64 percent whereas the real price of college education rose by more than 54 percent. Could we conclude that egg producers are now necessarily worse off and educators are better off?

Lecture Two
Supply And Demand
The role of price in the allocation and use of resources

Consumers and prices

Producers and prices

How is the price determined?

Supply and Demand
    Supply:
The market supply can generally be defined as the quantity of a good that producers (sellers) of a good offer to the market for sale over given period of time under a given set of conditions. These conditions are chiefly influenced by the input prices (e.g., wages, interest rates, etc.), technology and the number of firms in the market.
     · Supply
     · Supply curve
     · Quantity supplied

Price and other supply determinants

    Demand:
Demand is the quantity of a good or service a buyer (or buyers) would buy under a certain set of conditions. These conditions are characterized by factors such as the price of the good, consumers' incomes, consumers' taste, the price of related goods, etc. A demand function relates the quantity of a good that consumers (buyers) would like to purchase over a given period of time to the variables that influence their decision.
    · Demand
    · Demand curve
    · Quantity demanded

Price and other demand determinants

The market mechanism: Can the market determine the "true" price?

A simple (linear) supply and demand model:

Suppose we say that demand for air travel in a given market is determined by the price
(airfare) (Pa), the median income of the households in the market (I), the number of the households in the
market (N), the amount of money spent by the airline on advertisements (A), and the price of alternative
means of travel (Pt). So we write:

Qda = f ( Pa, I, N, A, Pt)

Qda = 10,000 - 25 Pa + .05 I + .10 N + . 02 A + 5Pt

I = 30,000
N = 200,000
A = 0
Pt = 200
Qda = 10,000 - 25 Pa + .05 (30,000) + .01 (200,000) + 5 (200)
Qda = 14,500 - 25 Pa
Pa = 580 - .04 Qda

Qsa = f (Price of Tickets Wage, Price of Fuel, Interest Rate, Technology, Number of Firms)
Qsa = 15Pa - 50 W - 500 Pf - 50000 R + 2T + 600 N
where Pa is the price of tickets, Pf represents fuel
price, R is the interest rate, T depicts technology, and N is the number of airline companies in the market.

W = 50
Pf = 2
R = .10
T = 500
N = 10

Qsa = 15 Pa - 50 (50) - 500(2) - 50000(.10) + 2(500) + 600(10)
Qsa = -1500 + 15 Pa
or P = 100 + .066 Qsa

Market Equilibrium
Economists define equilibrium as a status or condition at which there is no tendency for change. A market
is at equilibrium when the quantity supplied is equal to the quantity demanded. Graphically, that is where
the supply curve and the demand curve cross. We can solve for the equilibrium price and quantity by
setting the supply and demand equations equal:

Qda = Qsa
14500 -25 Pa = -1500 + 15Pa
Pa = 400
Substituting 400 for price in either the supply or the demand equation, we will get:
Qa = 4500

Elasticity

Consider the following cases:
 

• Making Sale Targets:

• A Public Transportation Problem: Managing Ridership What should the commissioner of public transportation do to have more (or fewer, for that matter) people ride buses or the subway system? Can the daily ridership fluctuations be regulated through a pricing strategy? How dose changing the price affect the revenue?

• The Airliners’ Pricing Problem: How can an airliner fill its planes while maximizing its profit? Or,  does filling the planes necessarily result in maximum profits. How should airliners price their tickets to fill their planes or to maximize their profits?

Let us consider the case of an airliner.  In the following diagram two hypothetical demand curves are drawn: one steeper than
the other one.
 
 

Suppose the initial fare is
$220. The lowering of the
price to $180 would result
in an increase in the quantity
demanded. The size of the
increase depends on the shape
of the demand curve.
 
 

Note that along the D1 the quantity demanded would increase to 200.  Whereas along D2 it only goes up to 140. The difference between the two demand curve is in their price elasticities. The steeper demand curve is less elastic at the price range between 180 and 120 than the flatter one is. In other words, D1 is more price elastic.

The price elasticity has important implications for the company's revenue. If the steeper demand curve is the true demand curve, lowering the price will result in a reduction in the company's sale revenue. But if the flatter line, D1, is the true demand curve, the company's sale revenue will increase.

TR 1 = 220  x  120  =  26,400
TR2  =  180  x  140  =   25,200
TR3  =  180  x 200  =  36,000

Slope and Elasticity
Although in the above example the slopes of the two demand curves, to some extent, reflect the sensitivity of the quantity demanded to a price change, we should be careful in judging the elasticity solely on the basis of the apparent slope of the demand curve.  The slope could be very misleading.
 

The apparent slope of a curve could change if we would simply change the scale on one or both axes.
Although the line in Graph A seems flatter than the line in Graph B, they in fact have the same slope. The horizontal axis in Graph B has larger scale units.
Now we are ready to talk about the concept of elasticity.

Elasticity
A general definition: “Elasticity” is a (standard) measure of the degree of sensitivity ( or responsiveness) of one variable to  changes in another variable.

The price elasticity of Demand
The (self) price elasticity of demand is a measure of the degree of sensitivity of demand to changes in the (self) price, ceteris paribus.
 

Measuring Elasticity
                   Percentage Change in Quantity
  Ep  =     -------------------------------------------
                   Percentage Change in Price
 

                         Change in Quantity
                                                Quantity
Or,         Ep    =      -----------------------------------------
                         Change in Price
                                                  Price
 
 

Ep (a --- b)  = (10/8)/(-2/10) =  -6.25

Ep (c ---d )  = (10/80)/(-2/4) =  -.25
 
 

The elasticity measure is a ratio between two percentage measures: the percentage change in one variable over the percentage change in another variabl; a price elasticity of -6.25 means that for each one percent change in price the quantity demanded will change by 6.25 percent.
Note that if we increased the price,
(from 8 to 10 or 2 to 4)
the original P and Q would be 2 and 8, and 18 and 90, respectively.

Ep = (-10/18)/(2/8) =  -2.22

Ep = (-10/90)/(2/2) =  -.11

         The fact that our elasticity measure changes as we change the direction of the price change is in fact a measurement problem; the larger the price change the less precise our measure of elasticity. To get around this problem without using more advanced mathematics we use the “arc” method of calculation.

          To get the average elasticity between two points on a demand curve we take the average of the two end points (for both price and quantity) and use it as the initial value:
 
 
 

                Q2-Q1                                              10
             --------------                                   ---------
              (Q1+Q2)                                          8+18
Ea  =   --------------------    =       --------------------------- = -3.49
                  P2-P1                                              -2
                -----------                                    ---------
                (P1+P2)                                           10+8

          This method of measuring elasticity is referred to as the “arc” method. The elasticity measure obtained through this method is called "arc elasticity."  Not that in the above formula the denominators of the two fractions (P1+P2 and Q1+q2) are not divided by 2. One could, of course, divide them by 2 to get the average of each pair of end points. That is not mathematically necessary though because the 2s in the nominator and denominator would cancel each other out.

Along a linear demand as the price goes up, |elasticity | increases. Note that between points "a" and  "b" the (arc) elasticity of the above demand curve is -3.49, whereas between "c" and "d" it is -.17 (not calculated).

We say that between points "a" and "b" ,  where |elasticity | > 1, demand is (price) elastic.
Between "c" and "d", where |elasticity |<1, demand is (price) inelastic.

When  |elasticity | =1, we say demand is unit-elastic.

A horizontal demand curve is infinitely elastic.
A vertical demand curve is infinitely inelastic. In other words, the elasticity of a vertical demand curve is zero.

Important Observations
 

• When demand is elastic, a decrease in price will result is an increase in revenue (sales).
• When demand is inelastic, a decrease in price will result is a decrease in revenue (sales).
• When demand is unit-elastic, an increase (or a decrease) in price will not change revenue (sales).

• Necessities versus luxuries

• Availability of substitutes

• How much of our income it takes

• The passage of time

For most goods the price elasticity of demand tends to increase over time. Over time, consumers
tend to change their consumption habits and behavior to adjust to higher (or lower) prices.
Besides, changes in prices could result in the appearance (or disappearance) of substitutes.
 
 

• Income Elasticity of Demand

A measure of the degree of responsiveness of demand  (for a good ) to a change in income, ceteris paribus
(This is the case of a shift in the demand curve.)

            Q2-Q1
            Q2+Q1
  EI =  ------------
           I2-I1
             I1+I2
 

Cross (price) Elasticity of Demand

A measure of the degree of responsiveness of the demand for one good (X) to a change in the price of another good (Y):

(This is also a case of a shift in the demand curve.)

            Qx2- Qx1
               Qx2+Qx1
   Ec = -----------------
           Py2- Py1
               Py1+Py2

=========================================
Utility
The value a consumer places on a unit of a good or service depends on the pleasure or satisfaction he or she expects to derive
form having or consuming it at the point of making a consumption (consumer) choice.

In economics the satisfaction or pleasure consumers derive from the consumption of consumer goods is called “utility”.

Consumers, however, cannot have every thing they wish to have. Consumers’ choices are constrained by their incomes

Within the limits of their incomes, consumers make their consumption choices by evaluating and comparing consumer goods
with regard to their utilities.

How to Measure Utility
Measuring utility in “utils” (Cardinal):
Jack derives 10 utils from having one slice of pizza but only 5 utils from having a burger.

In many introductory microeconomics textbooks this approach to measuring utility is still considered effective for teaching
purposes.

Measuring utility by comparison (Ordinal):
Jill prefers a burger to a slice of pizza and a slice of pizza to a hotdog.
Often consumers are able to be more precise in expressing their preferences.
For example, we could say:
Jill is willing to trade a burger with four hotdogs but she will give up only two hotdogs for a slice of pizza.
We can infer that to Jill, a burger has twice as much utility as a slice of pizza.

Utility and Money
Because we use money (rather than hotdogs!) in just about all of our trade transactions, we might as well use it as our
comparative measure of utility.

(Note: This way of measuring utility is not much different from measuring utility in utils)

Jill could say: I am willing to pay $4 for a burger, $2 for a slice of pizza and $1 for a hotdog.

Note: Even though Jill obviously values a burger more (four times as much) than a hot dog, she may still choose to buy a
hotdog even if she has enough money to buy a burger or a slice of pizza, for that matter.

Total Utility versus Marginal Utility
Marginal utility is the utility a consumer derives from the last unit of a consumer good she or he consumes (during a given
consumption period), ceteris paribus.

Total utility is the total utility a consumer derives from the consumption of (all of the units) of a good over a given consumption
period, ceteris paribus.

                                 Total utility = Sum of marginal utilities

The Law of Diminishing Marginal Utility
Over a given consumption period, the more of a good a consumer has, or has consumed, the less marginal utility an additional
unit contributes to his or her overall satisfaction (total utility).

Alternatively, we could say: over a given consumption period, as more and more of a good is consumed by a consumer,
beyond a certain point, the marginal utility of additional units  begins to fall.

Total and Marginal Utility for Ice Cream

 Q     ($)TU      ($)MU
  0      0
 1      40           40
 2      85           45
 3      120         35
 4      140         20
 5     150         10
 6     157           7
 7     160           3
 8     160           0
 9     155         -5
 10   145       -10
           145
 
 

How much ice cream does Jill buy in a month?
In order to approach this question we need to clarify a few important points.
When a consumer makes a purchasing choice, it entails an opportunity cost. That is the utility that she could derive from
having (buying) another good instead. That implies that, realistically, a consumers almost always have to make choices from
among more than one good. In fact if there were only one consumer good, there would not be any choices for the consumer.
The consumer will buy that good as long as she considers it a "good" (i.e., its marginal utility is positive) and she has money.

In order to determine how much ice cream Jill will buy we need to introduce another good to our model. Let that be
hamburger.

Note: You can think of hamburger as a symbolic good representing all the other goods (other than ice cream) in Jill's
consumption basket.

Let us now build our simple model.
Assumptions:
Jill has a given amount of income: $86
Two goods: Ice cream and hamburger
The prices of ice cream and hamburger are “market-given”
Jill wishes to maximize her total utility from these two goods, using all her income

Note: Opportunity cost of buying one unit (pound) of ice cream is the ($) utility that could be obtained from another (next best)
good bought with the same amount of money.

Wishing to maximize her total utility, within the limits of her income, Jill makes her consumption choices by matching the
marginal utility of each good to its prices.

The Optimal Purchase Rule

For each good
($)Price=($)Marginal utility

As long as the $ price of ice cream is lower than the ($) marginal utility of ice cream, Jill keeps increasing her purchase of ice
cream.

In other words, as long as the marginal net utility of ice cream is positive, Jill keeps buying ice cream.
Marginal net utility =  ($)MU- $P> 0

The Two-Good Rule

($)MUI        ($)MUH
---------  = ----------
   $PI               $PH

MUI= marginal utility of ice cream
MUH= marginal utility of hamburger
PI= price of ice cream
PH= price of hamburger

To maximize his or her total utility a consumer will equalize the marginal utility per dollar across all goods.

Optimal Purchase Mix: Ice Cream and Hamburger
Q     MUI    PI    MUI/PI    MUH   PH     MUH/PH
1      40      10         4            45        6          7.5
2      45      10       4.5           30        6            5
3      35      10       3.5           20        6          3.3
4      20      10       2             15        6          2.5
5     10       10        1              10       6          1.7
6      7        10     0.7             6         6          1
7      3        10     0.3              3         6          0.5
8      0        10      0                0         6          0

Notice that in the above table both the single-good rule ($P=MU, for each good) and the multiple-good rule are observed.

The Purchase Rule and the Demand Curve
Now we are ready to use the utility maximizing behavior of the consumer to explain why the demand curve is downward
sloping.

Recalling that a demand curve is curve showing the quantity of a good (ice cream) a consumer would buy at different prices, let
us see how ice cream Jill would buy at various prices.

If the price of ice cream were $40 per pound, Jill would buy 2 pounds of ice cream (say, per month).
Why? Because the marginal utility of each of the first two pounds of ice cream is either equal or greater than $40.
If the price falls to $30, she would buy 3 pounds.
At the price of $20 per pound she would buy 4 pounds. And on and on ......

From this simple analysis we can derive Jill's demand curve for ice cream. It will be a negatively sloped line in a
two-dimensional space with price on the vertical axis and quantity on the horizontal axis.

Indifference Curves

An indifference curve is a line, drawn in a two-dimensional space, representing various combinations two goods, each measured along one of the two axis, that provide the consumer with the same level of utility.
 

• Assumptions:
• Consumers prefer more (of a good thing) to less
• A consumer's preferences are transitive; if A>B and B>C, then  A>C
• When faced with two choices, A and B, a consumer is capable of deciding if he/she prefers A to B, or B to A, or he or she is indifferent about them.

Consumer's Surplus
For each unit of a good purchased, consumer's surplus is the difference  between the price the consumer actually paid and the
price he or she would have been willing and able to pay based on his or her marginal utility.

In other words, total consumer's surplus is equal to: Total ($) utility - Total expenditure

Note: Total ($)utility of a good = Sum of marginal ($)utilities of all units purchased.

Consumer's Surplus

 Cons.
  Q        ($)MUI    ($)PI   Surplus
    1           40          10          30
    2           45          10          35
    3           35          10          25
    4           20          10          10
    5          10           10            0
 Total       150         50         100
 

Diamond versus Water
A diamond ring is priced at $1000 and a bottle of drinking water is $1.
Shouldn't water more valuable?
When diamonds are scarce and drinking water is abundant, marginal utility of a diamond ring is much higher than the
marginal utility of water. Although the total utility of water may be greater than that of diamond rings. Recall that the price that
a consumer is willing to pay for a good is determined its marginal utility.
Stranded on a desert island with no water, one may be happy, though, to trade his diamond ring for a bottle of drinking water.
Under such conditions, the marginal utility of water must be greater that that of a diamond ring.
 

Demand Revisited:

Other things remaining the same, a change in income could affect the marginal utility of a consumer good (to a consumer).
 
 

Normal Goods
When an increase in income results in an increase in the marginal utility of a consumer good, the demand for that good will
increase (shift to the right); the consumer will buy more of that good at all price levels. We call this kind of goods normal
goods.

Inferior  Good
When an increase in income results in a decrease in the marginal utility of a consumer good, the demand for that good will
decrease (shift to the left); the consumer will buy less of that good at all price levels. We call this kind of goods inferior goods.