Economics 103 Problem Set 2

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Problem Set 2


Total 25 points.


1.      (4 points) Cheesecakes.  After her great success making pies with Johnny Depp in Sweeney Todd, your friend Helen B. Carter has opened a bakery.  She has done some market research and finds that your neighbors value cheesecakes according to the following schedule



Marginal Value



















a.       (2 points) Graph the community's demand curve for cheesecakes assuming that there are 100 identical people.  Does the demand curve have a positive or negative slope?  Why?


b.      (1 point) How many cheesecakes will she sell at $17.71?  How many at $9.41?


c.       (1 point)  What will happen if a new doctor comes to town and tells everyone to that cheesecake is good for you?  What will happen if she changes her recipe and her cheesecakes no longer taste as good?


2.      (4 points) Production.  Helen makes cheesecakes using equipment that she rents for $300 and cheese and butter that cost $4.55 a cake.  She hires workers and finds that they produce according to the following schedule:





















            Workers are paid $10/hour.

a.       (2 points) Calculate and graph the marginal cost of each cheesecake.  Why does the MC curve have the slope (up, down, or flat) that it does?

b.      (2 points) Calculate and make a new graph giving the marginal cost of each cheesecake if workers become 25% more productive, that is to say, if each cake can be made with only 75% as much labor.  Calculate and make a new graph of the marginal cost if workers get a raise to $15/hour, with the old productivity.


3.       (7 points) Equilibrium: PC and monopoly.  Surplus.

a.       (2 points) Put the demand and supply curves together (at the original productivity and wages).  Even though she is the only cheesecake maker, Helen acts as if she is in a perfectly competitive market.  How many cheesecakes will she sell?  At what price?  


b.      (2 points) Helen gets smart and realizes that as the only cheesecaker around, she can act as a monopolist.  Does this mean that she can charge any price she likes? Why not?  Calculate the marginal revenue he gets for each additional sale as the change in total revenue (price times sales).  Graph this and show the new (monopoly) quantity of sales and the new price.


c.       (2 points) Calculate the consumer and producer surplus for perfect competition and for monopoly.  Identify the area of consumer and producer surplus on your graphs of perfect competition and monopoly. Which situation is better for consumers?  Which is better for the business?  Which is better for society?


d.      (1 point) Helen’s landlady raises her rent to $500.  What happens to prices and quantities under perfect competition?  What happens to prices and quantities under monopoly? 


4.      (2 points) Moving Equilibrium.  For each of the following changes in price and quantity, identify whether there was a change in demand or supply and give a possible explanation for the change.

a.       (0.5 points) Prices rise and quantity sold falls.

b.      (0.5 points) Prices rise and quantity sold increases. 

c.       (0.5 points) Prices fall and quantity sold increases.

d.      (0.5 points) Prices fall and quantity sold falls. 


5.      (2 points) Public goods and global warming.  Evaluate each of the following proposals to raise money to address global warming.  Consider for each the equity issues, whether the proposal will work, and the efficiency in terms of minimizing transactions costs. 

a.       (0.5 points) An advertising campaign urging everyone to walk and bicycle to work instead of driving..   

b.      (0.5 points) Impose a tax on carbon (a component in gasoline, heating oil, and coal).   

c.       (0.5 points) Raise the income tax and dedicate the money to subsidizing solar and wind power and home conservation. 

d.      (0.5 points) Impose an international tax on all activities that produce atmospheric carbon dioxide and use the revenue to pay people in low-lying countries to relocate when the ocean levels rise.


6.       (3 points) Externalities.  My neighbors are college students who sometimes have late-night parties.  Assume that the nuisance cost of these parties to the rest of the neighborhood exceeds the joy they have in partying hearty.

a.       (1 point) What are the conditions of an efficient resolution to this dispute? 

b.      (1 point) If there is a law restricting late-night parties then what the college students do?  Can there be an efficient outcome?   

c.       (1 point) If there is a law allowing parties, then what could the neighbors do?  Can there be an efficient outcome? 


7.      (3 points) Is Small Beautiful?  Do you agree with the arguments in Chris Tilly’s article (article 5.1 in Real World Micro) and Edward Herman’s “Brief History of Mergers and Antitrust Policy” (article 5.4 ).  State their arguments and give reasons why you agree or disagree.  Should we have a more aggressive policy to break up large businesses and promote competition? 





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