HOMEWORK 2: Review of Microeconomics

Transcription

1 HOMEWORK 2: Review of Microeconomics 30 Points Due: Wednesday, January 28 th, 2015 LEARNING OBJECTIVES Prices measure the trade-offs available in the market place and coordinate the independent decisions of the consumers and producers, i.e. supply and demand. Economic shocks affect equilibrium price and quantity. Measure how one economic variable affects another, i.e. elasticity and tax INSTRUCTIONS Carefully read the question before answering. Make sure your pages are in order and stapled together. Your work should be clear and easy to follow. When prompted, make sure you that you explain your answer completely. QUESTION 1. (5 points) Twenty-one states recently voted to increase the minimum wage: What are the economic arguments against a minimum wage (i.e. price floor)? Use a graph to illustrate the impact on the labor market and the welfare (consumer/producer surplus) of the labor market. Explain the equilibrium before and the outcome after the price floor is implemented. Would all laborers/employers be made worse off with a minimum wage? Provide at least a paragraph (4+ sentences) explanation. Assume the market wage is w and the imposed minimum wage is w min. As you see in figure 1, at a the minimum wage, which is higher than the market wage, the quantity of labor supplied, Q s, is greater than the Q D. This occurs because more laborers want to work for a higher price; however, at a higher price, employer s costs increase, which decreases their quantity demanded of labor. As a result, more people want jobs than there are available and unemployment is created. This also results in a loss of efficiency in the economy, or deadweight loss (area F+G). Not all laborers are hurt by the minimum wage. For example, those workers that are able to find work will receive a higher wage than they would have otherwise received. Notice, that both laborer s and employer s CS and PS are reduced with a minimum wage.

2 2. (7 points) Consider the market for diabetes medicine (insulin, specifically). a. Is the demand of insulin somewhat elastic, somewhat inelastic, perfectly elastic, or perfectly inelastic? Explain with at least 3 sentences. Since people with diabetes require insulin to live, regardless of the price, the demand curve is most likely perfectly inelastic. Typically, companies that produce a good with a perfectly inelastic demand curve would be able to set the price higher than a good that is relatively elastic. There are very few examples of perfectly inelastic (or elastic) demand curves because consumers are usually able to find an alternate or substitute for the good. b. Draw the demand curve for insulin. c. Suppose 150,000 insulin shots are required annually, and the annual supply of insulin is Q S = 50, ,000P. What is the equilibrium price and quantity of insulin shots? Q D = 150,000 Q S = 50, ,000P 150,000 = 50, ,000P P = $4 Q = 150,000 d. Suppose, through exercise and diet, some individuals begin to manage their diabetes without insulin shots. As a result, the annual insulin shots required annually falls to 75,000. What is the new equilibrium price and quantity? Q D = 75,000 Q S = 50, ,000P 150,000 = 50, ,000P P = $1 Q = 75,000

3 e. In one graph, illustrate c. and d. 3. (5 points) The supply of oil is partly to blame for the fall in oil prices: Suppose Venezuela s inverse supply function of oil is: p = Q 1 and for other OPEC countries is: p = Q 2 a. Find OPEC s total supply function (market supply). Remember that Q 1 + Q 2 = Q M. Therefore, the indirect demand equations must be rearranged to answer this question. Q 1 = P 4 50 Q 2 = P Q 1 + Q 2 = Q M 50 + P P 2 = Q M Q M = P 4 b. Graph all three supply curves (Venezuela s, OPEC, and market supply).

4 4. (8 points) We can use information about demand and supply to answer an important public policy question: Would selling oil from the Arctic National Wildlife Refuge (ANWR) substantially affect the price of oil? Established in 1980, ANWR covers 20 million acres and is the largest of Alaska s 16 national wildlife refuges. It is believed to contain massive deposits of petroleum. For decades, a debate has raged over whether ANWR S owners the citizens of the United States should keep it undeveloped or permit oil drilling. Let s say oil demand is and oil supply is Q s = p. a. What is the initial equilibrium using the demand and supply equations listed above? Make sure you describe the equilibrium for both price and quantity. Q s = p p = p p = 50 Q = 82 The MB from the consumption of oil equals the MC of producing oil, or where supply= demand, occurs at a price of $50 per barrel. The quantity at this point will be 82 million barrels. b. Now incorporate a negative oil shock of 8 million barrels a day, due to a hurricane in the Gulf of Mexico. Without the ANWR production, how much will prices rise compared to the equilibrium price in part a.? Q s = p p = p p = Q = % change in P = an increase of 13.94% c. Still assuming a negative oil shock of 8 million barrels a day, how much will prices rise if the ANWR produces 0.8 million barrels of oil a day? Compare your new price to the equilibrium price in part a. Q s = p p = p

5 p = % change in P = Or % change in P = an increase of % relative to part a This is a decrease of 1.23% relative to part b. d. Given your analysis from parts b. and c., should the U.S. permit oil drilling? (Note: of course, other analysis like environmental valuation would have to be done before you could completely answer this question.) Admittedly, this is a loaded question and answers will vary here. Replies need to reference the results in part b and c. 5. (5 points) Under what two conditions will consumers bear the entire burden of a tax (or when will consumers pay the entire amount of the tax). Explain with a graph and at least 4 sentences. Consumers will bear the entire burden of a tax, τ, when the demand is perfectly inelastic or the supply is perfect elastic.