Microeconomic Analysis - Problem Set #1 Ryan Safner Fall 2016 Conceptual & Critical Thinking Questions (5 points each) Please answer the following questions clearly and concisely (1-3 sentences). Use examples and/or give further explanation as necessary. 1. Explain, in your own words, the law of diminishing marginal utility. Give an example. 2. Why are competitive markets efficient? 3. What do consumer surplus and producer s surplus mean? If Ann is willing to pay up to $6,000 for a used car, but buys it at a market price of $2,000, what is her consumer surplus? What is the producer s surplus for Frank, who sells Ann the car for $2,000, but would be willing to go as low as $1,000? 4. For each of the following pairs, which of the two goods is more likely to be inelastically demanded and why? (a) Demand for tangerines vs. demand for fruit (b) Demand for beef next month vs. demand for beef over the next decade (c) Demand for Exxon gasoline at the corner of 7th and Grand vs. demand for gasoline in the entire city (d) Demand for insulin vs. demand for vitamins 5. For each of the following pairs, which of the two goods is more likely to be elastically supplied? (a) Supply of toothpicks or scotch whiskey (b) Supply of construction workers in Binghamton, New York, vs. supply of construction workers in New York State (c) Supply of breakfast cereal vs. supply of food (d) Original Van Gogh paintings or pencils 1
6. Two drivers, Tom and Jerry, each drive up to a gas station. Before looking at the price, each places an order with the attendant. Tom says, I d like 10 gallons of gas. Jerry says, I d like $10 of gas. Who has a higher price elasticity of demand for gas? 7. Suppose someone claims that food prices have gone up, so people will consume less food. Under what conditions will this conclusion be correct? Under what conditions will this conclusion be wrong? 8. As we saw, taxes depend on elasticity. Decades ago, Washington, D.C., a fairly small city, wanted to raise more revenue by increasing the gas tax. Washington, D.C., shares borders with Maryland and Virginia, and its very easy to cross the borders between these states without even really noticing: The suburbs just blend together. (a) How elastic is the demand for gasoline sold at stations within Washington, D.C.? In other words, if the price of gas in D.C., rises, but the price in Maryland and Virginia stays the same, will gasoline sales at D.C., stations fall a little, or will they fall a lot? (b) Take your answer in part a. into account when answering this question. So, when Washington, D.C., increased its gasoline tax, how much revenue did it raise: Did it raise a little bit of revenue, or did it raise a lot of revenue? (c) How would your answer to part b. change if D.C., Maryland, and Virginia all agreed to raise their gas tax simultaneously? These states have heavily populated borders with each other, but they dont have any heavily populated borders with other states. 9. Someone argues that charging higher prices for goods during an emergency, such as a natural disaster, compared to the price before the emergency, is price-gouging, and should be illegal. [A diagram may help, but is not necessary to answer the questions.] (a) What are the causes of sellers charging these higher prices? (b) What would happen over time if it were legal to charge any price? (c) What would happen with an anti-gouging law that makes charging high prices illegal? (In effect, this is a price ceiling set at the original, pre-disaster, market price). (d) Why do you think these laws exist? 10. A lot of people are concerned about Uber, the ride-sharing app (where someone can pick up and drive another person in their car, met through the app, in exchange for a fee, much like a taxi) employs surge pricing. That is, during times when there is peak demand for getting rides, (e.g. Friday nights, holidays, etc), Uber raises the price of any given ride by a certain multiple (e.g. 1.5 or 2x higher fare than usual). Using the economic way of thinking, respond to these criticisms. What would be different if Uber did not use surge pricing (or suppose the government passes a law preventing surge pricing)? [Hint: The analysis is very similar to the previous question!] Page 2
11. The NFL is ending its blackout policy, whereby the television broadcast of a game is made intentionally unavailable to citizens in the region nearby a playing team if its stadium tickets are not sold out within 72 hours of the game. How does ending this policy affect the market for tickets to go to the stadium to watch the game? Who do you think supported these laws? What do you suppose has caused them to change? 12. The Federal Insurance Contributions Act (FICA) tax for Social Security levies a tax of 12.4% of wages (up to a maximum of $110,100) to be evenly borne by the employer and employee, each contributing 6.2%. Is the economic burden of this tax truly split between the employer and employee? Why or why not? Problems Please answer the following questions. Show all of your work and be sure to fully label all axes, points, and curves on any graphs (if applicable). 13. (3 points) If oil executives read in the newspaper that massive new oil supplies have been discovered under the Pacific Ocean but will likely only be useful in 10 years, what is likely to happen to the market for oil today? (Assume consumers do not know this.) What will happen to equilibrium price and quantity? 14. (3 points) Airline workers go on strike. How does this affect the markets for air travel, and for train travel? What will happen to equilibrium price and quantity for each market? 15. (4 points) Draw a graph of the effects of a price ceiling on efficiency and welfare (consumer & producer surplus, etc). Label all shaded regions, and describe is happening to each. 16. (3 points) Suppose there is a bitterly cold and unusually snowy winter that has significantly depleted the amount of available rock salt used to treat the roads. This is a major event. Suppose there is also a minor event another snow storm coming next week, and roads and sidewalks need to be salted. What will happen to equilibrium price and quantity? 17. (7 points) The Ministry of Tourism in the Republic of Palau estimates that the demand for its scuba diving tours is given by Q D = 6, 000 20P, where Q D is the number of divers served each month and P is the price of a two-tank dive. The supply of scuba diving tours is given by Q S = 30P 2, 000. [Note: It may help to draw a graph for this question] (a) Solve for the equilibrium price and quantity. (b) Find the consumer surplus received by divers visiting Palau. (c) Find the producer surplus received by the dive ships. Page 3
(d) Who earns more surplus, consumers or producers, and why? (e) Suppose that the demand for scuba diving services increases, and that the new demand curve is given by Q D = 7, 000 20P. Calculate the impact of this change in demand on the values of consumer and producer surplus. (f) Are consumers better off after the increase in demand? (g) Are producers better off after the increase in demand? 18. (6 points) In 2013, WMATA raised the maximum fare for riding the DC Metro from $5.00 to $5.75. Partially as a result, ridership in 2013 fell from 218 million in 2012 to 209 million in 2013. (a) Estimate the arc price elasticity of demand between these two data points for riding the metro. (b) What does your estimate say about the responsiveness of metro-riders to rate changes? (c) What does your estimate imply about the revenues of the WMATA when the fare rises? (d) Why might this elasticity be an unreliable guide for metro policy? (e) If you were to create a demand function from the data we have (assume a simple, linear demand function) what would the equation be? (f) Using your new demand equation, how many rides will consumers take when the fare is $7.00? 19. (6 points) The demand for movie tickets in a small town is given by Q D = 1000 50P. (a) What is the point elasticity of demand for a price of $5? Is this relatively elastic or relatively inelastic? What is the total revenue at $5? (b) What is the total revenue at a price of $5? (c) What is the point elasticity of demand for a price of $12? Is this relatively elastic or relatively inelastic? (d) What is the total revenue at $12? Is this higher or lower than the total revenue at $5, and why? (e) At what price is demand unit elastic, i.e. E D = 1? (f) What is the total revenue at this price? 20. (8 points) The market for hotel rooms in a small town is characterized by the following equations: Q D = 200 0.4P Q S = 0.8P 40 (a) Find the equilibrium price and quantity, and graph these. Page 4
(b) Calculate the consumer and producer surplus. (c) Who receives more surplus, hotel suppliers or demanders? Why? (d) Now suppose this small town is desperate for revenue, and levies a $150 tax on hotels. Solve for the new post-tax gross price, net price, and quantity. Draw these on your graph. (e) How much revenue does this tax collect? Show this on the graph. (f) How much deadweight loss does this tax generate? Show this on the graph. (g) What are the new consumer and producer surpluses? Show this on the graph. (h) Who bears more of this tax, and why? Page 5