Microeconomics review

  • Draw two production possibilities frontier for guns and butter. One production possibilities frontier should show increasing opportunity cost, and the other constant opportunity cost. • Label 3 points on each graph: an attainable (or feasible) point), an unattainable (or infeasible), and a point that is attainable but leaves some resources unused. • Illustrate the opportunity cost (slope) at two locations along the frontier. On which graph is the slope different at each point, on which graph is it the same at all points? What is the economic interpretation of this idea?     • Sally has $100 to spend on pizza and beer this weekend. The price of beer is $10 and pizza is $20. (This is gourmet pizza and craft beer). What is the maximum number of beers she can buy, what is the maximum number of pizzas? • On a graph with the number of pizzas on the x-axis and the number of beers on the y-axis, draw the two points where she buys minimum beer and minimum pizza. Draw a line between the two points. If beer and pizza could be purchased in any quantity (not just a whole number) this line would represent every possible combination of beer and pizza that Sally could purchase with $100. This is called a budget constraint. • Now suppose Sally gets utility from beer and pizza and her preferences can be modeled by the function u(pizza, beer)=(pizza)1/2(beer)1/2. Suppose Sally wants to get utility 5. Use a graphing calculate or tool to graph 5=(pizza)1/2(beer)1/2–substitute x for pizza and y for 1 beer. This curve represents all of the points where Sally gets 5 utility from her choice of pizza and beer. Now try giving Sally 10 utility. What happens to the curve? (remember the shape of the curve) • Sketch this type of curve three times on your budget constraint graph. The first time sketch the curve so that it never touches the budget constraint. The second time sketch the curve so that it intersects the budget constraint twice. The third time sketch the curve so that it just touches the constraint at one point. Which of these curves represents the maximum utility that Sally could get from her choice of pizza and beer?   Question 3. Supply and Demand • Draw and fully label a supply and demand graph (price on the y-axis). What is the relationship between quantity demanded and price, between quantity supplied and price? • Label the equilibrium quantity supplied, quantity demanded, and price. (Mark the equilibrium with a asterisk e.g. p⇤ ). • Find a price where the quantity supplied exceeds the quantity demanded. Draw a horizontal line at this price through the supply and demand curves. What is the term for when the quantity supplied exceeds the quantity demanded? • Find a price where the quantity supplied is less than the quantity demanded. Draw a horizontal line at this price through the supply and demand curves. What is the term for when the quantity supplied is less than the quantity demanded? Question 4. Elasticity of supply and demand. • Draw a demand curve passing through the points (1,8) and (2,5). Draw a supply curve passing through the points (1,3) and (2,5). Compute the own price elasticities of supply and demand for each curve using the points given (i.e. quantity changes from 1 to 2 after the price changes from 8 to 6 for demand or 3 to 5 for supply: use the mid-point formula). • Label the graph that is more elastic and the graph that is more inelastic relative to the other. • Draw a second demand curve representing an increase in income and an increase in the number of available substitutes. (Hint: draw each change separately and then put it together). What happens to price and quantity? What happens to the elasticity of the demand curve? • Next the government imposes a tax on the production/selling of the good. Draw the resulting shift in supply. On which demand curve is there a larger change in the quantity of the good produced and consumed in equilibrium? Question 5. Consumer and producer surplus. • Draw a supply and demand graph. Shade and label the consumer and producers surplus in equilibrium. 2 • Draw graph with quantity supplied less than equilibrium. Shade the DWL. Explain why both producers and consumers gain when quantity is increased by a small amount (shade the gained surplus). • On a second supply and demand graph show the total expenditures of consumers and the total revenue of firms in the market in equilibrium. Question 6. Cost curves. • Fill in the table to derive the 4 cost curves (compute marginal cost by computing the slope (rate of change) of TC): Units VC FC TC ATC AFC AVC MC 0 0 – 10 30 50 20 70 30 120 40 180 50 250 60 330 • Draw a graph of ATC, MC, AVC, and AFC curves. (Don’t use the numbers in the table). • Where does MC intersect ATC? At what price are profits equal to 0? Question 7. Perfect Competition (producer’s side). • For any firm that maximizes profits in all market structures what is the marginal benefit from producing an additional unit of a good? • If firms are price taking what is their marginal benefit? Graph the marginal benefit curve of the perfectly competitive producer, and include a marginal cost curve (increasing marginal cost). What is the optimal (profit maximizing) quantity for the producer? What things are equal at this quantity? • Add a ATC cost curve to your graph so that at the profit maximizing quantity there are positive profits. Under the assumption of free entry what will happen to these profits in the long run? Question 8. Perfect Competition (consumer’s side). • Consumers of goods also face marginal cost and marginal benefits. If consumers are price taking what is their marginal explicit cost when buying an additional unit of a good–is this constant or increasing? What is their marginal implicit (opportunity cost), is it constant or increasing? Is the combination of the explicit and implicit marginal costs increasing or decreasing? • Graph the marginal benefit and marginal cost curves of a price taking consumer. Assume diminishing marginal benefits. What is the optimal quantity for the consumer? 3 • Consider the case of a labor market (when the consumer is a firm). If the price of the good the firm sells goes up, draw the effect on the firm’s demand for labor. If a perfect complement for labor is purchased by the firm, so that workers can produce more, draw the effect on the firm’s demand for labor.