Assignment 1, Microeconomics ECN 2103

Name: .................................................. Student ID: ........................ Assignment 1, Microeconomics ECN 2103 Part A: Short essay questions (10 marks) A1 What does the concept of Pareto-efficiency state? Why is an inefficient point in the graph of the production possibility frontier also Pareto-inefficient? A 2 Riots are one of a number of events which may be caused because a “tipping-point” has been crossed. Shortly explain why this is so! A3 Draw a production possibility frontier which is bowed outwards. What does this shape imply for the opportunity cost of each good? A4 Explain the difference between positive and normative statements in economics! A5 In a graph how you obtain the market demand curve from individual demand curves (for the illustration it is sufficient to use two individual demand curves). Shortly explain what you are doing! Part B: Problem sets (5 marks each) B1: In Bedrock during the Stone Age, the Flintstones live next door to the Rubbles. Together, Wilma and Fred Flintstone (left) can make in a day four coconut-milkshakes or 8 cheese pies. In the same time, Betty and Barney Rubble can make 6 coconut- milkshakes or 6 cheese pies. (potential output per day) Coconut-Milkshakes Cheese pies Flintstones 4 8 Rubbles 6 6 Table 1 a) Which is the opportunity cost of coconut-milkshakes and cheese pies respectively for the Flintstones and the Rubbles? If the two families want to produce efficiently: Who should specialize in doing what? At which exchange ratios would the families be willing to trade Coconut-milkshakes for cheese pies? b) Suppose four cheese cakes sell for three coconut-milkshakes (i.e. 1 cheese cake sells for ¾ coconut-milkshakes). Using the following table, demonstrate that with specialization and trade everybody can consume at least the same quantities as without trade! Coco-Milk Cheese Cake, Coco-Milk Cheese Cake Flintstones Flintstones Rubbles Rubbles A) no trade: produc- 3 2 3 3 tion = consumption B) trade: production C) traded goods: (indicate sales with a “-“sign and purchases with a “+” sign) D) consumption with trade: D = B + C E) gains from trade E = D - A c) Draw a graph showing the production possibilities for the Flintstones and the Rubbles. What can be said about the relationship between the point which they attain through trade and their production possibilities? d) (slightly more difficult!) Now suppose that unlike in the case of part a) the Rubbles can only produce 4 coco-milkshakes or 4 cheese cakes and that without trade they produce and eat 2 Milkshakes and 2 Cheese cakes. It is easy to check that when the Flintstones and the Rubbles fully specialize, there are now fewer coco-milkshakes in Bedrock than if there were before trade! If we further assume that two coconut-milkshake sell for three cheese pies: What can the Flintstones do if they want to make sure that they can consume the same amount of coco- milkshakes as under autarky? Fill out the following table supposing that the Flintstones have adjusted such that they continue to consume three coco-milkshakes! Answer (what the Flintstones need to do): Coco-Milk Cheese pies, Coco-Milk Cheese pies Flintstones Flintstones Rubbles Rubbles A) no trade: produc- 3 2 2 2 tion = consumption B) trade: production C) traded goods: (indicate sales with a “-“sign and purchases with a “+” sign) D) consumption with trade: D = B + C E) gains from trade E = D - A B2: Suppose you are the only firm operating in the market for ice cream cones. Your demand curve is given by P = 60 – ½ Q a) For the following points on the demand curve calculate the elasticity of demand in that point. Figure 1 b) Refer to figure 1. Suppose you sell 30 cones of ice cream. Your sales manager says she believes that the revenue from ice cream sale could be increased if you lowered the price of ice cream cones. Is she right? Justify your answer! c) The following figure depicts three supply curves: S 1, S 2 and S 3. Along which supply curve is elasticity greatest, along which supply curve is elasticity smallest? Justify your answer! Part C: Short Essay Questions (10 marks) (in the midterm you will be given a choice to do one question which will be worth 10 marks!) Illustrate how the price mechanism in the market for ice cream cones coordinates demand and supply: (a) How is a market equilibrium defined? b) Suppose we start out in a market equilibrium in the market for ice cream cones! Then, a new movie comes out where a very popular film star is seen eating an ice cream cone. Suddenly, eating ice cream cones becomes fashionable or, in the economist’s language: There is a change in consumers’ tastes and their appreciation of ice cream cones increases! How is this change in tastes reflected in a price signal? Explain how this price signal creates incentives for producers to adjust their production! Use graphs to support your explanations! c) “If the economy had not adjusted to the change in consumers’ tastes, the market outcome would have been inefficient.” Is this statement true? Explain! .

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