COMM 220 Practice Problems 2 2
COMM 220 Practice Problems 2 2
COMM 220 Practice Problems 2 2
Analysis of Markets
Practice Problems, Winter 2010
125P
Qs = 440 + 165P
Quantities are measured in millions of bushels; prices are measured in dollars per bushel.
(a) Calculate the equilibrium price and quantity that will prevail under a completely free
market.
(b) Calculate the price elasticities of supply and demand at the equilibrium values.
(c) The government currently has a $4.50 bushel support price in place. What impact will
this support price have on the market? Will the government be forced to purchase corn
under a program that requires them to buy up any surpluses? If so, how much?
(a) Determine the change in consumption rate of good B due to (1) the substitution eect
and (2) the income eect.
(b) Determine if product B is a normal, inferior, or Gien good. Explain.
5. Suppose that the demand for artichokes (Qa) is given as: Qa = 120 - 4P
(a) What is the point price elasticity of demand if the price of artichokes is $10?
(b) Suppose that the price of artichokes increases to $12. What will happen to
the number of artichokes sold and the total expenditure by consumers on
artichokes?
(c) At what price if any is the demand for artichokes innitely elastic?
Output
0
150
Marginal Product
Average Product
200
200
760
150
150
Answer:
Input
0
1
2
3
4
5
6
Output
0
150
200 2 = 400
x = 600
760
x = 910
x = 150 6 = 900
Marginal Product
Average Product
150=1 = 150
200
600=3 = 200
760=4 = 190
910=5 = 182
x=6 =150
2. Does the following production function exhibit increasing, decreasing, or constant returns to
scale? include supporting calculations
Q = KL0:5
Solution:
For any
> 0;
f ( K; L) = ( K)( L)0:5 = K
0:5 0:5
1:5
[KL0:5 ] =
1:5
3. A rms marginal product of labour is 3, and its marginal product of capital is 9. If the rm
adds one unit of labour, but does not want output to change, calculate how much it should
change capital.
4. You manage a plant that mass produces engines by teams of workers using assembly machines.
The technology is summarized by the production function
Q = 5KL
where
M PL = 5K
and
M PK = 5L
where Q is the number of engines per week, K is the number of assembly machines, and L
is the number of labour teams. Each assembly machine rents for $10,000 per week and each
team costs $5000 per week. Engine costs are given by the cost of labour teams and machines,
plus $2000 per engine for raw materials. Your plant has a xed installation of 5 assembly
machines as part of its design.
(a) Determine the total cost function for your plant; that is, how much would it cost to
produce Q engines? (Hint: determine an algebric expression for total cost as a function
of output)
(b) Determine an algebric expression for average total cost and marginal cost
(c) Calculate the number of teams required to produce 250 engines. Calculate the average
cost per engine
(d) Is the rm minimizing cost at its current level of output? (Hint: No calculations are
required)
Solution:
(a) From the given information, we have
T C = 5000L + 10000K + 2000Q
Remember, we need to nd TC as a function of Q: First, use the fact that K = 5 (xed
as given); therefore, we have
T C = 50; 000 + 5000L + 2000Q
and
Q = 5KL = 25L
Now we need to express L in terms of Q and plug it back into the cost function to get
rid of L: From the production function, we have
L=
Q
25
Q
+ 2000Q
25
Simplify
T C = 50; 000 + 2200Q
4
(b)
AT C =
TC
50; 000
=
+ 2200
Q
Q
MC =
dT C
= 2200
dQ
TC
50; 000
=
+ 2200
Q
Q
AT C =
50; 000
+ 2200 = 2400
250
For Q = 250
5000
1
5K
=
=
5L
10000
2
or
L = 2K
That is, the number of teams should be twice the number of assembly machines. Since
the rm is using L = 10 and K = 5 (xed), then we conclude that the rm is minimizing
cost at the current level of output
5. A paint manufacturing company has the production function (Q) shown below.
The rm faces a price of labour of $15 per unit, and a price of capital of $10 per
unit
Q = KL2
where
M PL = 2KL
and
M PK = L2
(a) Determine the COMBINATION of labour and capital that minimizes the
cost of producing ANY given level of output
(b) Calculate the cost minimizing usage of the two inputs necessary to produce
10,000 units, the current level of output.
(c) Calculate the minimum cost to produce the current output
(d) Suppose the rm increases output to 20,000 units. Calculate the cost minimizing usage of the two inputs to produce this new level of output. Calculate
the minimum cost to produce the new level of output
5
2K
3
= =) 4K = 3L
L
2
or
4
L= K
3
So, the combination is that for each 1 unit of labour, we use 4/3 units of capital.
(b) We have
4
L= K
3
and
10000 = KL2
(1)
(2)
4
L = (17:78) = 23:71
3
(c)
T C = 15L + 10K = 15(23:71) + 10(17:78) = 533:45
(d)
K = 22:41;
L = 29:88
%4C
26
=
= 0:3 < 1
%4Q
100
and
%4Q=
672:3 533:45
533:45
100 = 100%
100 = 26%
since
"c < 1 =) Economies of scale
6
6. Duane breeds parrots for a living. He has discovered that the production function for parrot
chicks (Q) is:
Q = K 1=2 L1=2 ;
where K is capital (for example nest boxes, cages and the like) and L is parrot food. The
price of K is $8 and the price of L is $2.
(a) What type of production function is this?
(b) Does this production function exhibit constant, increasing or decreasing returns to scale?
Explain.
(c) What is the average product of capital?
(d) Does capital obey the law of diminishing returns? Explain.
(e) Suppose that Duane wants 144 parrot chicks, how much K and L should be employed to
minimize costs, and what is the cost of producing 144 parrot chicks?
(f ) Suppose that Duane is faced with the same problem as in (f) except that he has a xed
amount of K. In fact, K = 16. How much L should be employed to minimize costs, and
what is the total cost?
7. The cost of producing 600 small berglass sailboats per year, and the cost of producing sails
and ttings necessary to make the boats seaworthy in a single plant, are together $780,000.
If produced in separate plants, the boat cost $540,000, and the sails and ttings would cost
$180,000. From this information, what can be learned about (1) economies of scale and (2)
economies of scope in the production of sailboats, sails, and ttings? Perform any necessary
calculations and explain.
8P
QS = 500 + 4P;
where P = monthly rent, and Q = number of apartments available for rent. For
purposes of this analysis, apartments can be treated as identical.
(a) Calculate the equilibrium price and quantity that would prevail without the
price ceiling.
(b) Calculate producer and consumer surplus at this equilibrium (sketch a diagram showing both).
(c) What quantity will eventually be available if the rent ceiling is imposed?
Calculate any gains or losses in consumer and/or producer surplus.
(d) Does the proposed rent ceiling result in net welfare gains? Would you advise
the town council to implement the policy?
2. The demand and supply functions for basic cable TV in the local market are given as:
QD = 200; 000
4; 000P
500P
QS = 800 + 100P:
To help pork producers, the U.S. Congress is considering legislation that would put a price
oor at $2.25 per unit. If this price oor is implemented, how many units of pork will the
government be forced to buy to keep the price at $2.25? How much will the government spend
in total? How much does producer surplus increase?
4. The market for semiskilled labor can be represented by the following supply and demand
curves:
LD = 32000
4000W
LS = 8000 + 6000W;
where L = millions of person hours per year, and W = the wage in dollars per hour.
(a) Calculate the equilibrium price and quantity that would exist under a free market. What
impact does a minimum wage of $3.35 per hour have on the market?
(b) The government is contemplating an increase in the minimum wage to $5.00 per hour.
(c) Calculate the impact of the new minimum wage on the quantity of labor supplied and
demanded.
(d) Calculate producer surplus (laborerssurplus) before and after the proposed change.
(e) Comment on the net eect of the proposed change upon workers as a whole and on
individual workers. How does this price oor dier from an agricultural support price?
(f ) Is the policy e cient from an economists viewpoint?
5. A country which does not tax cigarettes is considering the introduction of a $0.40 per pack tax.
The economic advisors to the country estimate the supply and demand curves for cigarettes
as:
QD = 140; 00025; 000P
QS = 20; 000 + 75; 000P;
where Q = daily sales in packs of cigarettes, and P = price per pack. The country has hired
you to provide the following information regarding the cigarette market and the proposed
tax.
(a) What are the equilibrium values in the current environment with no tax?
(b) What price and quantity would prevail after the imposition of the tax? What portion of
the tax would be borne by buyers and sellers respectively?
(c) Calculate the deadweight loss from the tax. Could the tax be justied despite the deadweight loss? What tax revenue will be generated?
6. The total and marginal cost functions for a typical soft coal producer are:
T C = 75; 000 + 0:1Q2 ;
where Q is measured in railroad cars per year. The industry consists of 55
identical producers. The market demand curve is:
QD = 140; 000
425P;
where P is the price per carload. The market can be regarded as competitive.
(a) Calculate the short run equilibrium price and quantity in the market. Calculate the quantity that each rm would produce. Calculate producer surplus,
consumer surplus, and total surplus at the equilibrium values. Calculate the
rms prot (or loss).
(b) The Federal government is considering the imposition of a $15 per carload
tax on soft coal. Calculate the short-run equilibrium price and quantity
that would exist under the tax. What portion of the tax would be paid
by producers and what portion by consumers? Calculate the producer and
consumer surplus under the tax and analyze the e ciency consequences of
the tax. Calculate the rms prot (or loss) under the tax. Could the tax
be justied despite its e ciency implications?
7. The market demand and supply functions for cotton are:
QD = 10
QS = 38P
0:04P
20
Calculate the consumer and producer surplus. To assist cotton farmers, suppose
a subsidy of $0.10 a unit is implemented. Calculate the new level of consumer
and producer surplus. Did the increase in consumer and producer surplus exceed
the increased government spending necessary to nance the subsidy?
(a) Write an algebric expression for Sarahs marginal rate of substitution of x for y: Simplify
your answer
(b) Write an algebric expression for Janes marginal rate of substitution of x for y: Simplify
your answer
(c) Calculate the quantities of x and y that Sarah should consumer to maximize her utility
(d) Calculate the quantities of x and y that Sarah should consumer to maximize her utility
(e) Write the condition(s) for equilibrium in this exchange economy. Show numerically that
the values you calculated in parts (c) and (d) satisfy the equilibrium condition(s)
2. Explain the dierence between partial equilibrium and general equilibrium analysis.
3. Explain the concept of input e ciency. State the condition for its existence, and show that
it exists if the input market is perfectly competitive. Illustrate your answer with a diagram.
4. Show that the allocations of two goods, X and Y, between two consumers, A and B, are Pareto
e cient if the marginal rate of substitution of Y for X is the same for the two consumers.
5. Two individuals, A and B, are free to engage in trade of clothing and food. Initially, A has
12 units of clothing and 9 units of food, and B has 8 units of clothing and 11 units of food.
The individuals have the following utility functions in clothing C and food F:
UA = 0:15QC QF
UB = 0:08QC QF
where QF represents units of food, QC represents units of clothing, and U represents utility.
Determine if a mutually benecial trade is possible between A and B. If so, who would trade
for what?
6. On planet Economus, the countries Blib and Flib can produce the amounts of string and
rope indicated in the table below with one unit of land. The country of Blib has 20 units
of land available while the country of Flib has 10 units of land. Does either country have
an absolute advantage? Which country has a comparative advantage in string production?
Which country has a comparative advantage in rope production? Is it possible for the two
countries to benet from trade?
Country String Rope
Blib
10
20
Flib
25
10
7. Germany and France can produce the amounts of wine and beer indicated in the table below
with one unit of land. Each country has 10 units of land. Does either country have an absolute
advantage? Which country has a comparative advantage in beer production? Which country
has a comparative advantage in wine production? Is it possible for the two countries to benet
from trade?
Country Beer Wine
France
2
4
Germany 10
1
10
w
2. Richard is a stock market day trader. His utility of wealth function is U (w) = 4 1;000;000
:
Richard has seen a recent upward trend in the price of Yahoo stock. He feels that there is a
30% chance the stock will rise from $175 per share to $225. Otherwise, he believes the stock
will settle to about $150 per share. Richards current wealth is $1.75 million. Assume that
if Richard purchases the stock, he will use his entire wealth. Given his risk preferences, will
Richard buy Yahoo?
Answer: Richard will purchase the stock if his expected utility from owning the stock exceeds
his current utility of wealth. His currently utility of wealth is: U(w = $1,750,000) = 4(1.75)2
= 12.25.
Richards expected utility from owning the stock is: EV[U(w)] = 0.3 4(2.25)2 + 0.7 4(1.5)2=
0.3(20.25) + 0.7(9)= 12.375. Since Richards expected utility of wealth from owning the stock
exceeds his utility of wealth with certainty, Richard will buy the stock.
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