Principles of Microeconomics Problem Set

Problem Set #1 Economics 105 – Fall Quarter 2017

Answers due in class on 9/18/17 Instructions: Answer all questions. You are welcome (encouraged, actually) to work in groups of 2 or 3. If you do so, please hand in one copy of the problem set with all names on it.

1. Water is a scarce resource, especially in some places in the United States like Los

Angeles. Give an example of how water scarcity leads to a trade-off. Describe how an economist might evaluate that tradeoff.

2. Use the principle of marginal benefit and marginal cost to answer the following questions. Be sure to explicitly state the marginal cost and marginal benefit associated with the question of interest before answering the question.

a. Katie is planning to sell her house, and she is considering making two upgrades to the house before listing it for sale. Replacing the carpeting will cost her $2,500 and replacing the roof will cost her $9,000. Katie expects the new carpeting to increase the value of her house by $3,000 and the new roof to increase the value of her house by $7,000. Should she undertake either of the projects? Why? b. Peter buys and sells real estate. Two weeks ago, he paid $300,000 for a house on Pine Street, intending to spend $50,000 on repairs and then sell the house for $400,000. Last week, the city government announced a plan to build a new landfill on Pine Street just down the street from the house Peter purchased. As a result of the city’s announced plan, Peter is weighing two alternatives: He can go ahead with the $50,000 in repairs and then sell the house for $290,000, or he can forgo the repairs and sell the house as it is for $250,000. What should he do?

3. Jessica makes photo frames. She spends $10 on the materials for each photo frame. She can create one photo frame in an hour. She earns $10 per hour at a part-time job at the local coffee shop. She can sell a photo frame for $25 each.

a. What would an accountant calculate Jessica's per frame costs to be? b. What would an economist calculate Jessica's per frame costs to be? c. Why is (a) different than (b)? d. If Jessica can get as many hours as she wants at the coffee shop, what is the profit associated with each frame she makes and sells? Profit is total revenue minus

total cost. i) How would an economist answer this question? ii) How would an accountant answer this question?

4. Suppose that the supply and demand curves can be described by the following two

equations: Q=3P-6 Q=120-3P

a. Which equation is the supply curve and which equation is the demand curve? How do you know?

b. Solve for the equilibrium in this market (i.e. the price and quantity one would expect to result from these supply and demand curves)

5. Suppose the market for oranges is in equilibrium. a. Draw a generic picture of this equilibrium. Be sure to label both axes and the

equilibrium price and quantity. b. Suppose that doctors discover that consumption of oranges decreases one's risk of getting cancer. i) What thing that was previously held fixed (from the supply FUNCTION or demand FUNCTION) is likely to change? ii) What curve shifts and how? iii) Draw the new equilibrium. Show (and describe) what happens to equilibrium price and quantity compared to the original equilibrium?

c. Separately, suppose that orange growers develop a new fertilizer that makes orange trees more productive.

i) What thing that was previously held fixed is likely to change? ii) What curve shifts and how? iii) Draw the new equilibrium associated with (c). Show (and describe) what happens to equilibrium price and quantity compared to the original equilibrium in (a)?