Econ 604.

Problem Set #1 KEY

1. Statistical evidence indicates that equations defining the demand and supply functions
of 1 pound bags of Starbucks Coffee at The Ukrops near VCU to be

Qd = 1050 - 50P - 100Ps + .1I

Qs = 60 + 20P - 40w

Where P is the price of a 1 pound bag of coffee

Ps is the price of maple walnut scones ABD
I is mean per capita monthly disposable income of students.

w is the mean hourly wage pad to coffee roasters.

Currnelty I = $1,000
Ps = $1.50
w = $8

a. Write the demand and supply curves for Starbucks coffee

Qd = 1050 - 50P - 150 + 100

= 1000 - 50P

Qs = 60 + 20P - 40(8)
= -260 + 20P

b. Solve for the equilibrium price and quantity

Qd = Qs
1000 - 50P = -260 + 20P
1260 = 70P
P = 18
Q = 100
c. Graph your solution. Inverse supply and demand are

Ps = (Qs + 260)/20
and
Pd = (1000 - Qd)/50
24
22
20
18
Price

16
14
12
10
0 50 100 150 200 250
Quantity

Suppose that Starbucks employees negotiate a $2 per hour wage increase.

d. Find the new supply curve

Qs = 60 + 20P - 40(10)
= -340 + 20P

e. Find the new equilibrium

Qd = Qs
1000 - 50P = -340 + 20P
1340 = 70P
P = 19.14
Q = 42.86

f. Graph the change on your chart. New inverse supply is Ps = Qs/20 +17. Plotting as the
dashed line,

24
22
20
Price

18
16
14
12
10
0 50 100 150 200 250
Quantity
g. Analyze the changes. When did a change in supply occur? When did a change in
quantity supplied occur?

The upward shift of the supply curve in response to the wage increase represents a
change in supply. Quantity supply adjusts with price movements from the initial
equilibrium to the new one.

2. Suppose that a society’s conditions of medical care and military goods is given by the
equation

3X2 + 2Y2 = 100

where X represents Bradley fighting vehicles and Y represents doctors trained.

a. Graph this relationship. In your chare illustrate the following

- Inefficient points and efficient by unattainable points
- Increasing marginal opportunity cost

b. Find the slope of the above expression. Use it to analytically illustrate the
notion of increasing marginal opportunity costs.

Y = ((100 – 3X2)/2)1/2
dY = (½)((100 – 3X2)/2)-1/2(-3X)dX
dY/dX = (-1.5X)/Y

When X = 1, Y = 6.956, so dY/dX = -.215

When X = 2, Y = 6.63, so dY/dX = -.452
When X = 3, Y = 6.04, so dY/dX = -.75
And so on. In general, constant increments of X require society to give up
increasing increments of Y.
 c. Suppose that the right hand side of the above expression increased to 200. What
effect would that have on your production possibilities frontier? What economic
explanation might motivate such a change?

The entire curve would shift out. A technological development may motivate such
a change.
2.2. If we cut four congruent squares out of the corners of a square piece of cardboard 12
inches on a side, we can fold up the four remaining flaps to obtain a tray without a top.
What size square should be cut in order to maximize the volume of the tray?

Volume = lwh. Here we set h=l. Thus we maximize

h (12-2h)2
h(144 – 24h +4h2)
144h -24h2 + 4h3
Taking FONC
144 – 48h + 12h2 =0
Dividing
12 -4h +h2
(6-h)(2-h)

Roots are 6 and 2. But from second order condition

-48 + 24h
We see that the expression is negative only for h=2.

Area is 2(8)(8) = 128

2.7 Suppose a firm’s total revenues depend on the amount produced (q) according to the
function

TR = 70q – q2

Total costs also depend on q:

TC = q2 + 30q + 100

a. What level of output should the firm produce in order to maximize profits (TR-TC)?

 = TR - TC
= 70q-q2 - (q2 + 30q + 100)

d/dq = 70-2q - 2q-30 = 0

Thus 40 – 4q = 0
q=10

b. Show that the second-order conditions for a maximum are satisfied at the output level
found in part (a)

d2/dq2= -4 <0. Thus a maximum

c. Does the solution calculated here obey the “marginal revenue equals marginal cost”
rule? Explain

Yes, MR = 70-2q and

MC = 2q+30