ECON 200 Homework 3 Answer Key Due Monday 4/26/10 1. Because of the baby boom, there are more people in the U.S. between the age of 40 and 66 than any other age group. There is concern about what is going to happen to the labor market as they all start retiring. When they start retiring, what will be the effect on the equilibrium wage (i.e. price) and quantity of senior-level jobs (i.e. manager, principals, any position that requires lots of experience). How do you think this will affect the wage and quantity of mid-level jobs? When the baby boomers start retiring, the supply of workers with the experience to hold senior-level positions will decrease from S to S 1. This will lead to an increase in the equilibrium wage for these positions to P 1 and a decrease in the number of workers holding these jobs (Q 1 ). There are a couple ways of thinking about what would happen in the market for mid-level labor. One way is that since there are less experienced workers, and the cost of hiring the ones left has increased, employers will substitute midlevel workers for the senior-level workers. This will increase the demand for these workers from D to D 1, which will increase the number of these workers employed (Q 1 ) and the wage that they get (P 1 ). Another way, not drawn above, is that employers will promote mid-level workers to senior-level jobs, so there will be a decrease in the supply of mid-level labor. This would drive the wage up and the number of mid-level workers employed would decrease. 2. In 2006 there was a major recall of fresh bagged spinach after e. coli was found in some bags of spinach. Possibly tainted bags were removed from grocery store shelves and consumers were warned about the dangers of eating bagged spinach. a). How did this recall affect the demand and/or supply of bagged fresh spinach? Draw a graph and indicate how the price and quantity of bagged fresh spinach changes. Briefly explain any changes you draw on the graph.
The recall took spinach off the shelves, leading to a decrease in supply, while demand decreased as consumers learned about the health risks of spinach. This led to a decrease in the quantity of spinach bought and sold, but whether price increases or decreases depends on whether the supply or demand decrease is larger. b). Frozen spinach was not affected by the e. coli (the e. coli came from the bagging machinery being contaminated). Do you think the recall had any effect on the supply and/or demand for frozen spinach? You can assume that bagging fresh spinach and frozen spinach are different enough processes that it is not easy for a food processor who was bagging spinach to switch to freezing spinach. Show any changes on a graph and indicate what happens to the equilibrium price and quantity of frozen spinach. Briefly explain any changes you draw on the graph. There would be an increase in demand since frozen spinach is a substitute for bagged spinach, while there would be no change in supply since bagged spinach suppliers cannot easily switch to frozen spinach. This would lead to an increase in price and quantity of frozen spinach. c). How would your answer to b) change if it was very easy for food processors to switch to freezing spinach instead of bagging it, which would completely avoid the risk of contaminating the spinach? Show any changes on a graph and indicate what happens to the equilibrium price and quantity of frozen spinach. Briefly explain any changes you draw on the graph.
Now there would be an increase in the supply of frozen spinach as well, since suppliers could easily switch from bagged to frozen spinach (there would still be an increase in demand since frozen spinach). This would lead to an increase in the quantity of frozen spinach, while whether the price increases or decreases depends on whether the supply or demand increase is larger. 3. With the crash of the housing market, many people have found themselves owing more on their house than it is worth. In response, many of these people have either walked away from their house or been foreclosed upon. a). What is the effect of all of these people losing their houses on the market for renting apartments in the short run? Draw a graph and briefly explain. In the short run the supply of apartments is perfectly inelastic: there are only so many apartments available and it takes years to build new apartments. The demand for these apartments increases as more people lose their houses, driving rents on apartment up. If the supply is perfectly inelastic, there will be no change in the number of apartments rented, just their price. b). What is the effect of all of these people losing their houses on the market for renting apartments in the long run? If it is different than the long run, why is it different? Draw a graph and briefly explain.
In the long run the supply of apartments becomes much more elastic since there is time to build new apartments as demand increases. Thus the increase in demand for apartments will increase the apartment rents some, but much less than in the short run, and there will be an increase in the equilibrium quantity. c). Despite the expectations from part a, rents have actually decreased in the Seattle area. How could you explain this? There could be multiple things that contribute to the decrease in rent but the most common explanation is that while the housing crisis increased the demand for apartments by former home-owners, the large unemployment caused by the recession also worked to decrease the demand for apartments. Some people who lost their houses moved in with family instead of getting apartments, and some people who would normally have gotten apartments also moved in with friends and family. So the overall demand for apartments actually fell, driving the price down. Another reason is that since house prices have dropped, some people who couldn t afford to buy a house before are now able to buy, further decreasing the demand for apartments. 4. Explain why the following might be true: A drought around the world raises the total revenue that farmers receive from the sale of grain, but a drought only in Kansas reduces the total revenue that Kansas farmers receive. (Hint: think about how the demand for the world s grain might differ from demand for Kansas farmers grain) Kansas grain market The demand for Kansas grain is quite elastic, given all the substitutes there are for Kansas wheat (i.e. wheat from anywhere else). Thus if there was a drought that decreased the supply of wheat and drove up prices only in Kansas, consumers would switch away from Kansas wheat to consume wheat from other areas instead. The decrease in consumption would outweigh the increase in price, and thus Kansas farmers revenue would decrease. The demand for all grain is much more inelastic since there aren t as many substitutes. If a drought decreased the supply and drove up the price of all wheat, the resulting decrease in quantity wouldn t be as large since there aren t many substitutes. The increase in price would outweigh the decrease in quantity demanded, and thus farmers total revenue would increase.
5. Below is information about the market for professional movers. There are 5 firms that can be hired to help you move (each one can only move 1 person), with their costs shown below. There are 5 people who are looking to buy moving services, with their willingness to pay shown below. Consumer Q Marginal value Total value Total expenditures Consumer surplus Grant 1 110 110 110 0 Kyle 2 100 210 200 10 Jenny 3 90 300 270 30 Tricia 4 80 380 320 60 Jason 5 70 450 350 100 Supplier Q Marginal Cost Total cost Total revenue Producer surplus Firm A 1 50 50 50 0 Firm B 2 60 110 120 10 Firm C 3 70 180 210 30 Firm D 4 80 260 320 60 Firm E 5 90 350 450 100 a). Draw the supply curve and demand curve for movers in this economy. (You can draw the graph either way) b). What is equilibrium price and quantity of movers in this market? The equilibrium price is $80 and the equilibrium quantity is 4 movers. c). Who is the marginal consumer and who is the marginal supplier and explain how they affect the equilibrium price? Tricia is the marginal consumer and Firm D is the marginal supplier. The equilibrium price is determined by where the willingness to pay of the marginal consumer is equal to the marginal cost of the marginal supplier. While Grant, Kyle and Jenny were all willing to pay more than $80, the price has to fall to $80 to induce Tricia to hire a mover. Likewise, while Firms A, B and C would have supplied their labor if the price was less than $80, the price had to rise to $80 to induce Firm C to supply its labor.
d). Who gets consumer surplus and what is the total consumer surplus? Grant, Kyle and Jenny will get a consumer surplus and the sum of their surplus is $60. e). Which suppliers get a producer surplus and what is the total producer consumer surplus? Label the producer and consumer surplus on the graph Firms A, B and C get a producer surplus and the sum of their surplus is $60. f). Assume that an increase in the price of gasoline causes the cost of each mover to increase by $20. Show how this affects the supply, demand and equilibrium price and quantity of movers hired. Show how consumer and producer surplus change. This would decrease the supply of movers. The new equilibrium price is $90 and the equilibrium quantity will be 3. This change decreases total consumer surplus, since there are less consumers who are able to buy a mover and the remaining ones have to pay a higher price. Producer surplus also decreases since the suppliers are not able to fully pass the increase of their costs onto consumers (the cost of each mover increases by $20 but the price they are paid by consumers only increases $10). 6. Explain why economists say that competitive markets are the most economically efficient way to allocate resources. A functioning competitive market is the most economically efficient way to allocate resources. Because the price can adjust, goods are traded until the marginal value of a good (the amount the last consumer is willing to pay) is exactly equal to the marginal cost of producing that good (cost of the last supplier), a market ensures that all mutually beneficial trade takes place, and in doing so, maximizes total surplus. Through the signal that the market price sends, those consumers who value goods most will be the ones that consume them (highest total value), ensuring the highest consumer surplus possible. The price signal also works to allocate production of goods to the lowest cost suppliers, ensuring the lowest total cost of production possible and thus the highest producer surplus.