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Principles of Microeconomics – Discussion Section Week 4 TA: Kanit Kuevibulvanich

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Principles of Microeconomics – Discussion Section Week 4 TA: Kanit Kuevibulvanich ECON 101: Principles of Microeconomics – Discussion Section Week 4 TA: Kanit Kuevibulvanich This week, you will learn - Demand and Supply: Qualitative Shifts and Indeterminacies - Demand and Supply: Equilibrium, Consumer Surplus and Producer Surplus - Demand and Supply: Quantitative Shifts - Market Intervention: Price Ceiling, Price Floors, Subsidy (Price Guarantee) Exercises Question 1 (Qualitative Shifts and Indeterminacies) Consider the market for iPhone (in general) where there is a downward sloping demand curve and an upward sloping supply curve. For each scenario, graphically explain what would happen to the demand and supply curve and find the effect on equilibrium price and quantity. (Answer each question by "increase," "decrease," or "ambiguous.") 1. The new iPhone 5S is released and it becomes a fashionable accessories. 2. Aliens have stolen aluminum metal supplies required in producing the rear case. 3. Widespread virus in Android and Windows phones wreaks havoc non-iPhone users; concurrently, Foxconn factory (suppliers of Apple) improves production method. 4. Rumor has it that Apple will slash the price by half during Black Friday, while transportation from suppliers to Apple shop is cheaper and faster. 5. Suppose iPhone is a normal good and loads of money falls from the sky. However, Android fan burns down Foxconn factory. 6. iOS 7 is too slow making iPhone useless as a brick, while shop workers go on strike. Question 2 (Equilibrium, Consumer Surplus and Producer Surplus) The market supply is given by: Q = P – 1. The market demand is: Q = 7 – P. 1. Find the equilibrium price and quantity. 2. Find the consumer surplus, producer surplus and the total welfare. (Total surplus) Question 3 (Price Ceiling) Demand for lift tickets at Aspen is given by P = 90 – Q; supply is given by Q = 2P. 1. Find the equilibrium price and quantity, consumer surplus and producer surplus. 2. To encourage tourism in Aspen, the Pitkin County imposes a price ceiling of $10. Suppose there is no black market. Does this cause a shortage or surplus? What size? 3. Find consumer surplus and producer surplus after the price ceiling is imposed. Question 4 (Price Floor) Demand for potato is given by P = 30 – 2Q; supply is given by P = 10 + 2Q. Government implements a price support (price floor) program at $24. 1. Is the price floor binding? 2. Find the quantity demanded and quantity supplied under the program. 3. What is the value of excess supply? Question 5 (Subsidy – Price Guarantee) With the same potato market in previous question, let the government implement a price subsidy program by targeting the price at $24. 1. How many pounds of potatoes will be supplied in this program? 2. At what price are consumers willing to buy all 7 pounds of potatoes? 3. What is the cost of the subsidy program? 1 ECON 101: Principles of Microeconomics – Discussion Section Week 4 TA: Kanit Kuevibulvanich Solution Question 1 1. Demand shifts right, Q* increases, P* increases 2. Supply shifts left, Q* decreases, P* increases 3. Both demand and supply shift right, Q* increases, P* ambiguous 4. Demand shifts left and supply shifts right, Q* ambiguous, P* decreases 5. Demand shifts right and supply shifts left, Q* ambiguous, P* increases 6. Both demand and supply shifts left, Q* decreases, P* ambiguous Question 2 1. Mind with the axes! Try to systematically solve with P on left-hand-side (whenever it’s easy and possible) to facilitate graph drawing. The demand becomes P = 7 – Q and supply becomes P = 1 + Q. Solve for equilibrium by setting demand equal to supply 7 – Q = 1 + Q, so Q* = 3 and P* = 1 + 3 = 4. 2. Draw the demand and supply curves. The area under demand curve above the price paid is consumer surplus CS = ½ x (7 – 4) x 3 = $4.5. The area above supply curve under the price received is producer surplus PS = ½ x (4 – 1) x 3 = $4.5. Total welfare is the sum of surpluses on both sides of the market, so TS = $9. Question 3 1. Mind the axis of supply curve, we have P = Q/2 to draw the supply curve. But here, it is better to solve with Q on left-hand- side since we can avoid fraction, so from the demand, Q = 90 – P, set equal to supply of Q = 2P, we have 90 – P = 2P, so P* = $30, Q* = 2 x 30 = 60. The area under demand curve above the price paid is consumer surplus CS = ½ x (90 – 30) x 60 = $1,800. The area above supply curve under the price received is producer surplus PS = ½ x 30 x 60 = $900. 2. Since at P = $10, quantity demanded is Q = 90 – 10 = 80, but quantity supplied is Q = 2(10) = 20, so there exists a shortage of 80 – 20 = 60 units. 3. The area under demand curve above the price paid at quantity traded, which is a trapezoid, is consumer surplus CS = ½ x (90 + 80) x 20 = $1,500. The producer surplus is smaller at PS = ½ x 10 x 20 = $100. Question 4 1. Solve for equilibrium price by setting demand equals supply, so 30 – 2Q = 10 + 2Q, so Q* = 5, thus, P* = 30 – 2(5) = 20. Hence, price floor is binding since at price P = 24 > 20 = P*. 2. At price P = 24, quantity demanded is Qd = 3 and quantity supplied is Qs = 7. 2 ECON 101: Principles of Microeconomics – Discussion Section Week 4 TA: Kanit Kuevibulvanich 3. Excess supply is 7 – 3 = 4 units at price of $24 per unit, so the value of excess supply is $24 x 4 = $96. Question 5 1. At P = $24, quantity supplied is Qs = 7. 2. At Qd = 7, the price must be P = 30 – 2(7) = $16 to have the consumers take all produces. 3. Government must pay the price difference of $24 - $16 = $8 per unit, with the quantity transacted of 7 units, this brings the program cost to ($24 - $16) x 7 = $56. 3 .
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