Saturday, August 25, 2007

Assignment 3



1. Explain each of the following statements using supply-and-demand diagrams.
a) "When a cold snap hits florida,the price of orange juice rises in supermarkets throughout the country."
b) "When the weather turns warm in New England every summer,the price of hotel rooms in Caribbean resorts plummets."
c) "When a war breaks out in the Middle East,the price of gasoline rises,and the price of a used Cadillac falls."
Ans : a)
In this case below things will happen
1. The cold snap in Florida will destroy oranges
2. This will reduce the quantity of oranges produced which in turn will reduce the supply of the quantity of oranges
3. So, for the same price now there will be less oranges which will shift the supply curve inward.
4. As the figure shows this decrease in supply raises the equilibrium price.
b)
In this case the below things will happen
1. When the weather turns warm, there will be fewer people who will be eager to visit warm places like Carribean
2. So, at the existing prices the hotel rooms will be empty in Caribbean. In other words there will be a decrease in demand for hotel rooms
3. The demand curve will shift to the left
4. The hotel owners will reduce the price to keep the rooms booked
5. As the figure suggests, this will reduce equilibrium price.
c)
In this case following things happen
1. War destroys oil fields ,oil tankers which reduces the supply of oil
2. The supply curve for oil moves inward as a result the supply curve of gasoline, made of oil, also moves inward
3. Thus the price of gasoline increases as is evident from the figure
4. On the other hand, since used Cadillac consumes lot of gasoline, it becomes expensive to run Cadillac
5. People demands less of this car as a result the demand curve moves to the left
6. This reduces the price of used Cadillac cars as is evident from the figure.

2. "An increase in the demand for notebooks raises the quantity of notebooks demanded but not the quantity supplied." Is this statement true or false ? Explain.
Ans : This statement is false. The figure below(FIG 1) shows that when the demand increases for notebooks, the quantity supplied also increases. The statement could have been true if the supply curve were a straight line as shown in the figure(FIG 2)
Fig 1
Fig 2


4.Consider the markets for DVD movies, TV Screens, and tickets at movie theaters.
a. For each pair, identify,whether they are complements or substitutes:
DVDs and TV screens
DVDs and movie tickets
TV screens and movie tickets
b. Suppose a technological advance reduces the cost of manufacturing TV screens. Draw a diagram to show what happens in the market for TV screens.
c.Draw two more diagrams to show how the change in the market for TV screens affects the markets for DVDs and movie tickets
Ans :
a)
DVDs and TV screens - Complements
DVDs and movie tickets – substitutes
TV screens and movie tickets – substitutes
b) Let us say that the market for TV screens is in equilibrium at the market price P1 and quantity demanded Q1. The technological advance reduces the cost of manufacturing TV screens. So, the producers will supply more TV screens at each price. This will result in an outward shift of the supply curve. The new equilibrium point is now at Price P2 and quantity Q2. This results in a fall in price and increase in quantity demanded.
c) When the price of TV screens, complement of DVDs, decreases, the demand for DVDs will increase at each price resulting in an outward shift in the demand for DVDs. This will move the new equilibrium to P2 and Q2 increasing the price as well as the quantity demanded.
When the price of TV screens, substitute of movie tickets, decreases, the demand for movie tickets will fall at each price resulting in a leftward shift of the demand for movie tickets. The new equilibrium will now be at P2 and Q2 decreasing the price as well as the quantity demanded of the movie tickets.
6. Consider these two statements from the In the News box:
a. "Political unrest overseas threatens to disrupt the supply of America's sweetest temptations."
b. "As the price goes up , farmers have motivation to do anything they can to get their product to the market."
Which of these statements refers to a movement along the supply curve? Which refers to a shift in the supply curve? Explain
Ans`: The second statement refers to movement along the supply curve. This is because in this case, the increase in quantity supplied is happening for an increasing price and not for a fixed price.
The first statement refers to a shift in the supply curve. In this case for the same price the quantity supplied is decreasing. As a result the supply curve will shift to the left.
8. Suppose that in the year 2010 the number of births is temporarily high. How does this baby boom affect the price of baby-sitting services in 2015 and 2025? (Hint: 5-year-olds need baby-sitters whereas 15-year-olds can be baby-sitters)
Ans: A temporarily high birth in 2010 will result in higher price for baby sitters in 2015 and lower price in 2025. This is because in 2015, there will be more 5-year-olds who will need baby sitters, so the demand for baby sitting services will rise. In 2025 there will be more 15-year-old which will shift the supply of baby sitting services outward. This will result in a fall in the baby sitting service prices.
9. Ketchup is a complement (as well as a condiment for hot dogs. If the price of hot dogs rises what happens to the market for ketchup? For tomatoes? For tomato juice? For orange juice?
Ans :
Market for ketchup:
If the price of hot dogs rises, it will result in a low demand of hot dog. This in turn will result in low demand of ketchup. This will also lead to price fall in ketchup.
Market for tomato:
Since tomato is a raw material for ketchup, fall in price of ketchup will result in fall in demand of tomato leading to a fall in price of tomato as the producers will try to increase sales by cutting price.
Market for tomato juice:
Since tomato juice is produced from tomatoes, fall in price of tomato will lead to more supply of tomato juice at each price. This will shift the supply curve to the right resulting in a fall of price and increase in demand for tomato juice.
Market for orange juice:
If the price of tomato juice decreases, demand for orange juice decreases because it is a substitute of tomato juice.

11. Because bagels and cream cheese are often eaten together, they are complements.
a. We observe that both the equilibrium price of cream cheese and the equilibrium quantity of bagels have risen. What could be responsible for this pattern—a
fall in the price of flour or a fall in the price of milk? Illustrate and explain your answer.
b.Suppose instead that the equilibrium price of cream cheese has risen but the equilibrium quantity of bagels has fallen. What could be responsible for this pattern—a rise in the price of flour or a rise in the price of milk? Illustrate and explain your answer
Ans :
a. The reason for this pattern is a fall in the price of flour.
Bagel market: When the price of flour which is a raw material for bagel falls, the producers will supply more bagel at each price. So, the supply curve of bagel shifts outwards. This will result in a rise in the equilibrium quantity of the bagel as is evident from the figure below. This will also result in reduced price of bagel.

Cream cheese market: When the price of bagel(complement of cream cheese) falls, the demand for cream cheese increases. This shifts the demand curve to the right thus increasing the equivalent price of cream cheese as is evident form the figure below.
b. The reason for this pattern is a rise in the price of milk
Cream cheese market: Due to the increase in the price of milk, the producers will produce less of cream cheese. This will result in a reduction in supply of cream cheese which will shift the supply curve to the left. This results in a rise in the equilibrium price of cream cheese.
Bagel market: Since the price of the complement increases, the demand for bagel falls. The curve shifts to the left. This results in a fall in the equivalent quantity of bagel.

DIAGRAM
12. Suppose that the price of basketball tickets at your college is determined by market forces. Currently, the demand and supply schedules are as follows:

PRICE QUANTITYDEMANDED QUANTITYSUPPLIED
$ 4 10,000 8000
8 8000 8000
12 6000 8000
16 4000 8000
20 2000 8000
a. Draw the demand and supply curves. What is unusual about this supply curve? Why might this be true?
b. What are the equilibrium price and quantity of tickets?
c. Your college plans to increase the total enrollment next year by 5000 students. The additional students will have the following demand schedule:

PRICE QUANTITYDEMANDED
$ 4 4000
8 3000
12 2000
16 1000
20 0
Now add the old demand schedule and the demand schedule for the new students to calculate the new demand schedule for the entire college. What will be the new equilibrium price and quantity?
Ans:
a.
The unusual thing is that the supply curve is vertical.
This might be true because the basketball stadium might have a fixed number of seats irrespective of the price.
b. equilibrium price is $8, equilibrium quantity is 8000
c.
The new equilibrium price is $12 and equilibrium quantity is 8000.

13. Market research has revealed the following information about the market for Pizza: The demand schedule can be represented by the equation QD = 380 – 20P, where QD is the quantity demanded and P is the price. The supply schedule can be represented by the equation QS = -120 + 30P,where QS is the quantity supplied. Calculate the equilibrium price and quantity in the market for pizza.
Ans : Equilibrium happens when quantity supplied = quantity demanded.
Therefore, QD=QS
380-20P = -120 + 30P
or, 50P = 500
or, P = 10
Therefore Q = 180
The equilibrium price is 10 and the equilibrium quantity is 180

Assignment 2

ASSIGNMENT 2


4. Draw and Explain a production possibilities frontier for an economy that produces corn and rice. What happens to this frontier if a new fertilizer is developed that increases the amount of corn that can be produced on each acre of land?


The PPF in this case will follow the law of increasing opportunity cost which states that as the economy increases its production of any good along its PPF, the opportunity cost of obtaining an additional unit of the good (in terms of the foregone good) will be increasing. This will result in a non-linear curve , it will be a concave curve


When a new fertilizer increases the amount of corn production, the opportunity cost of corn production will be lowered. This will lead to a shift in the PPF




1. Draw a circular flow diagram.Identify the parts of the model that correspond to the flow of goods and services and the flow of dollars for each of the following activities.


a.Martin earns $15 per hour working in a factory

b.Matilda spends $6 for Pizza

c.Madeline's Bakery pays $500 for the rent on its shop

d.Maria purchases a new pair of earrings for $200



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2. Imagine a society that produces military goods and consumer goods ,which we'll call "guns" and "butter"


a.Draw a production possibilities frontier for guns and butter. Using the concept of oppotunity cost, explain why it most likely has a bowed-out shape.

b. Show a point that is impossible for the economy to achieve.Show a point that is feasible but inefficient

c.Imagine that the society has two parallel parties ,called the Hawks(who want a strong military) and the Doves(who want a samller military). Show a point on your PPF that the Hawks might choose and a point the Doves might choose.

d.Imagine that an aggressive neighboring country reduces the size of its military. As a result both the Hawks and the Doves reduce their desired production of guns by the same amount. Which party would get the bigger "peace dividend", measured by the increase in butter production? Explain


Ans:


`

a. It is bowed because the opportunity cost of butter is calculated based on the number of guns and butter the economy is producing. If the economy produces lot of butter, people who are best suited/skilled to make guns are engaged to produce butter. As a result decrease in each unit of gun production results in a small increase in the butter production. The opportunity cost of producing butter is more and the slope is steep for the PPF. While on the other hand, if the economy is producing lot of guns, people skilled in butter production are being used to produce guns. So for each unit decrease in gun production results in huge increase of butter production. The opportunity cost of producing butter is less which means the slope is less resulting in a flat PPF.


b.The point A which is outside the PPF is impossible to achieve by the economy.

Point B which is inside the PPF is feasible but inefficient because all resources are not used for production.


c. The Hawks might choose point H, where guns are produced more and less of butter is produced.

The Doves might choose D, where more butter and less guns are produced.


d.The Hawks will get a bigger "Peace Dividend" if the production of guns are reduced by the same number by both Hawks and Doves. This is because the frontier is flatter at point H than point D, which means that reducing the production of guns at point H will lead to more production of butter than reducing the production of guns at point D.


3.The first principle of economics discussed in Chapter 1 is that people face trade-offs. Use a production possibilities frontier to illustrate society's trade off between two goods - a clean environment and the quantity of industrial output. What do you suppose determines the shape and position of the frontier? Show what happens to the frontier if engineers develop a new way of producing electricity that emits fewer pollutants.




The shape and position of the PPF depend on how costly it is to maintain a clean environment vs the quantity of industrial output produced.


If engineers develop a new way of producing electricity that emits less pollutant, will lead to a shift in PPF as shown above


4. An economy consists of three workers: Larry,Moe and Curly.Each works 10 hours a day and can produce two services :mowing lawns and washing cars.In an hour, Larry can either mow one lawn or wash one car;Moe can either mow one lawn or wash two cars;and Curly can either mow two lawns or wash one car.
a. Calculate how much of each service is produced under the following circumstances,which we label A,B,C,D:

  1. all three spend all their time mowing lawns(A)

  2. all three spend all their time washing cars(B)

  3. all three spend half their time on each activity(C)

  4. Larry spends half his time on each activity,while Moe only washes cars and Curly only mows lawns(D)


b. Graph the production possibilities frontier for this economy. Using your answers to part(a),identify points A,B,C,D on your graph


Ans :


  1. 40 lawns mowed, 0 cars washed

  2. 0 lawns mowed,40 cars washed

  3. 20 lawns mowed,20 cars washed

  4. 25 lawns mowed,25 cars washed





6.Classify each of the following statements as positive or normative. Explain.

  1. An increase in the minimum wage will increase the rate of teenage unemployment

  2. The government should raise the tax on tobacco to reduce the quantity of cigarettes sold

  3. An increase in the rate of growth of the money supply will lead to a rise in the price level

  4. An increase in the interest rate will cause a decline in investment

  5. The government should provide healthcare to anyone who does not have health insurance.


Ans


A . Positive

B. Normative

C. Positive

D. Positive

E. Normative


Assignment 1

3. You have an economics exam tomorrow and you are planning to study tonight. Your best friend calls to tell you that he has an extra ticket to a concert tonight that he will give to you( for free). What is the true cost of attending the concert? Now,suppose that you are scheduled to work tonight at your part-time job.What is the true cost of attending the concert in this case? Explain
Ans : 1. a.Prospect of not doing good in the exam resulting in not getting a better opportunity after passing the exam
b. Spending money to travel to the concert
c. Spending money on food and beverage in the concert.
2. a.Losing the salary of the part time job
b. Spending money to travel to the concert
c. Spending money on food and beverage in the concert.
4. You win $100 in a basketball pool. You have a choice between spending the money now or putting it away for a year in a bank account that pays 5 percent interest. What is the opportunity cost of spending the $100 now.
a.giving up the opportunity to spend $105 after 1 year
5. The company that you manage has invested $5 million in developing a new product,but the development is not quite finished. At a recent meeting,your salespeople report that the introduction of competing products has reduced the expected sales of your new product to $3million.If it would cost $1million to finish development and make the product,should you go ahead and do so? What is the most that you should pay to complete development.
Do not spend $1million - Loss is $5 million
Spend $1million- marginal profit is $2million
Maximum pay - $3million - no more increase in profit at the margin
6. Three managers of the magic potion company are discussing a possible increase in production. Each suggests a way to make this decision.
Harry : We should examine whether our company's productivity--gallons of potion per worker----would rise or fall.
Ron: We should examine whether our average cost -cost per worker - would rise or fall
Hermione:We should examine whether the extra revenue from selling the additional potion would be greater or smaller than the extra costs
Who do you think is right and why?
Hermione is right since she is thinking of marginal profit. Rational people makes decision by comparing marginal benefits and marginal costs
9. Your roommate is a better cook than you are,but you can clean more quickly than your roommate can.If your roommate did all of the cooking and you did all of the cleaning,whould your chores take you more or less time than if you divided each task evenly? Give a similar example of how specialization and trade can make two countries both better off.
Dividing task will take more time. If they take the comparative advantage of each other, it will increase total production and/or reduce total labor
Let us assume that USA can produce 10 computers or 1 bottle of water per worker and India can produce 1 computer or 1 bottle of water per worker.
In USA, the opportunity cost of producing one bottle of water is 10 computers. In India, the opportunity cost of producing one bottle of water is one computer. So, USA has a comparative advantage in computer and India in bottle of water.
If both countries specialize , let us see what is the result. Let us assume both countries have 2 worker. So,US worker will specialize in producing 20 computers and Indian worker in producing two bottles of water. If India trades 1 bottle of water for 5 computers, then India will end up with 5 computers and 1 bottle of water, USA will end up with 15 computers and 1 bottle of water. So, in this process both countries get richer.
11.Nation with corrupt police and court systems typically have lower standards of living than nations with less corruption. Why might be that case?
It reduces productivity for the following reasons
It increases the cost to domestic business which leads to less productivity and also less affordability.
It acts as an inhibitor to foreign direct investment
It affects annual per capita GDP growth

12.Explain whether each of the following government activities is motivated by a concern about equity or a concern about efficiency. In the case of efficiency ,discuss the type of market failure involved.
a. providing unemployment insurance
b. regulating electrical utilities
c. evaluating mergers of American companies
d. operating public health clinics
e. providing national defense
f. instituting fines for firms who pollute
a. equity
b. efficiency - market power
c. efficiency - market power
d. equity
e. efficiency - market power
f. efficiency - externality
13.Discuss each of the following statements from the standpoints of equity and efficiency
a. "Everyone in society should be guaranteed the best healthcare possible."
b."When workers are laid off,they should be able to collect unemployment benefits until they find a new job."
a. Less efficient more equity-- Even the rich who can pay for the healthcare will get the best healthcare(which is costly) at a much lower price. The government could have used the money the rich people would have spend for a better healthcare for some other purposes. So, in this case the resources are not efficiently managed.
More equity because everyone will get the same level of healthcare irrespective of their affordibality.
Less efficient more quity - The money to be paid to the unemployed will collected as taxes from the employed who is earning the money being productive. If higher taxes are levied, their income after tax will reduce , it will be a disincentive to their productivity.

15. Suppose Americans decide to save more of their incomes.If banks lend this extra saving to business ,which use the funds to build new factories,how might this lead to faster growth in productivity?Who do you suppose benefits from the higher productivity? Is society getting a free lunch?

More people will be employed and their hours will be utilized to create more goods and services. So, the hours which were wasted through unemployment is now utilized to create more goods and services.. This enhances the productivity by making more people productive.
The entire society benefits form the higher productivity, the standard of living of the society will increase.
No, the buliding of new factories, more work, more goods and services means
People in the society has now less time to spend on fun and other leisure activities
The factories might contribute to pollution
More goods and services and its demand cause firms to raise prices - Inflation

Economics - Session 4



Elasticity - Elasticity is the responsiveness of demand for change in price. It is calculated by dividing %change in demand by %change in price.

Price elasticity of demand =% change in Qd / % change in P

In a demand curve, P and Q move in the opposite direction which makes price elasticity negative.
Although elasticity value is negative, we take the absolute value of elasticity and represent it by MOD(e) = e


Determinants of Price Elasticity



  1. Price elasticity is higher, when close substitutes are
    available
  2. Price elasticity is higher for narrowly defined goods than
    broadly defined ones.
  3. Price elasticity is higher for luxuries, than for necessities.
  4. Price elasticity is higher in the long run, than in the short run

Rule of thumb

Flatter the demand curve, bigger the elasticity Steeper the curve, smaller the elasticity

Variety of Demand curves

Inelastic Demand

  1. Quantity demanded does not respond strongly to price changes.
  2. Price elasticity of demand is less than 1

Elastic Demand

  1. Quantity demanded responds strongly to changes in price
  2. Price elasticity of demand is greater than one.

Perfectly Inelastic

  1. Quantity demanded does not respond to price changes
  2. Price leasticity of demand is zero

Perfectly Elastic

  1. Quantity demanded changes infinitely with any change in price
  2. Price elasticity of demand is infinite

Unit Elastic

  1. Quantity demanded changes by the same percentage as the price
  2. Price elasticity of demand is less than one

Furthur reading : Chapter 5 - Principles of Economics by MANKIW

Saturday, August 18, 2007

Economics - Session3




DEMAND

The other non-price determinants of Demand are

Number of buyers
Consumer Income
Prics of related goods
Tastes
Expectations

Giffen goods - In a broader sense, goods which do not follow law of demand are giffen goods. In a narrower sense, giffen goods are those goods for which if price falls, demand also falls other things remaining constant.

Giffen goods are named after Sir Robert Giffin. Example of a giffen good may be an expensive brand of liquour. If the price of the brand falls, it is no longer perceived as an exclusive or a high status drink, so its demand falls.
For more information on giffen goods, please visit http://en.wikipedia.org/wiki/Giffen_goods

Normal goods - Normal goods are those for which demand increases when income increases. For eaxample demand for cars increases when one's income increases.
For more information visit http://en.wikipedia.org/wiki/Normal_good

Inferior goods - Goods for which demand decreases when income increases are inferior goods. For example if income increases, demand for two wheeler goes down.
For more information visit http://en.wikipedia.org/wiki/Inferior_good

NOTE: For our exam purpose, if nothing is specified we should assume that the good is a normal good.

  1. If price changes movement is along the demand curve. Here the change is of quantity demanded
  2. If other non-price determinant thing changes, ther is shift in demand curve.Here the demand changes.

Substitute

Let's say that the price of burger is decreasing, then the demand of burger will increase. When the demand for burger increases people will consume more burger and less hotdog. So the demand for Hot dog falls. In this scenario, burger is a substitue for hot dog.

An increase in price for one kind of good will result in an increase in demand for its substitute good and a decrease in price will result in decrease in demand for its substitute goods.

Other examples of substitute goods are margarine and butter, petroleum and natural gas

Compliments- TO BE DEVELOPED(TBD)

SUPPLY

- TO BE DEVELOPED(TBD)

DEMAND AND SUPPLY
- TO BE DEVELOPED(TBD)

Wednesday, August 15, 2007

Economics - Session 2



1.Slope :If independent variable increases by 1 unit, what is the change in the dependent variable
2.The slope of a production possibility frontier is the marginal opportunity cost of a commodity.
3.The shape of PPF is commonly drawn as concave downward to represent increasing opportunity cost with increased output of a good
4.If the opportunity cost of computer rises as the economy produces more of it, PPF is bow-shaped

The Market forces of Demand and Supply

A competitive market is one where
Ø there are large number of buyers and sellers;
Ø each buyer and seller has perfect knowledge about the market conditions
Ø no single buyer and seller can influence the market price – each is a price-taker
and must the market determined price

A competitive market is a 'Price Taker' market

Other things equal, the quantity demanded is negatively
related to the price. This relationship is true for most goods in
the economy and hence called the law of demand

Normal good - Demand falls when income falls
Inferior good - Demand rises when income falls
Ordinary good - Follow law of demand;demand falls if price rises