MICROECONOMICS 1 (ECEU600101): HOMEWORK #1 FOR DISCUSSION 12

SEPTEMBER 2019

Chapter 2

1. Are the following statements true or false? Explain your answers (using graphs in some cases).
a) The elasticity of demand is the same as the slope of the demand curve.
b) The cross-price elasticity will always be negative.
c) The supply of student accommodation (kos-kosan) is more inelastic in the short run than the long
run.

2. The government of the City of Depok decides to regulate rents in order to reduce student living
expenses. Suppose the average annual market-clearing rent for a student kos-kosan had been Rp700,000
per month and that rents were expected to increase to Rp800,000 within a year. The government limits
rents to their current Rp700,000-per-month level.
a) Draw a supply and demand graph to illustrate what will happen to the rental price of an apartment
after the imposition of rent controls.
b) Do you think this policy will benefit all students? Why or why not?

3. Suppose the demand curve for a product is given by

Q = 10 - 2P + PS
where P is the price of the product and PS is the price of a substitute good. The price of the substitute good
is $2.00.
a) Suppose P = $1.50. What is the price elasticity of demand? What is the cross-price elasticity of
demand?
b) Suppose the price of the good, P, goes to $2.00. Now what is the price elasticity of demand? What
is the cross-price elasticity of demand?

4. In 2010, Americans smoked 315 billion cigarettes, or 15.75 billion packs of cigarettes. The average retail
price (including taxes) was about $5.50 per pack. Statistical studies have shown that the price elasticity of
demand is -0.4, and the price elasticity of supply is 0.5.

a) Using this information, derive linear demand and supply curves for the cigarette market.
b) In 1998, Americans smoked 23.5 billion packs of cigarettes, and the retail price was about
$2.00 per pack. The decline in cigarette consumption from 1998 to 2010 was due in part to
greater public awareness of the health hazards from smoking, but was also due in part to
the increase in price. Suppose that the entire decline was due to the increase in price. What
could you deduce from that about the price elasticity of demand?

5. Example 2.9 (page 76) analyzes the world oil market. Using the data given in that example:

a) Show that the short-run demand and competitive supply curves are indeed given by
D = 36.75 - 0.035P; SC = 21.85 + 0.023P
b) Show that the long-run demand and competitive supply curves are indeed given by
D = 45.5 - 0.210P; SC = 16.1 + 0.138P
 c) In Example 2.9 we examined the impact on price of a disruption of oil from Saudi Arabia.
Suppose that instead of a decline in supply, OPEC production increases by 2 billion barrels
per year (bb/yr) because the Saudis open large new oil fields. Calculate the effect of this
increase in production on the price of oil in both the short run and the long run.

Chapter 3

6. Draw a budget line and then draw an indifference curve to illustrate the satisfaction-maximizing choice
associated with two products, rice and clothing. Use your graph to answer the following questions.
a) Suppose that rice is rationed (there is a quota that each consumer can purchase). Explain
why the consumer is likely to be worse off.
b) Suppose that the price of rice is fixed at a level below the current price. Is it true that as a
result of this policy, the consumer is not able to purchase as much as she would like? Is the
consumer better off or worse off?
7. Describe the equal marginal principle. Explain why this principle may not hold if increasing marginal
utility is associated with the consumption of one or both goods.

8. The price of DVDs (D) is $25 and the price of CDs (C) is $10. Philip has a budget of $150 to spend on the
two goods. Suppose that he has already bought one DVD and one CD. In addition, there are 3 more DVDs
and 5 more CDs that he would really like to buy.
a) Given the above prices and income, draw his budget line on a graph with CDs on the
horizontal axis.
b) Considering what he has already purchased and what he still wants to purchase, identify the
three different bundles of CDs and DVDs that he could choose. For this part of the question,
assume that he cannot purchase fractional units.

9. Antonio buys five new college textbooks during his first year at school at a cost of Rp400,000 each. Used
books cost only Rp250,000 each. When the bookstore announces that there will be a 10 percent increase
in the price of new books and a 5 percent increase in the price of used books, Antonio’s father offers him
Rp200,000 extra.
a) What happens to Antonio’s budget line? Illustrate the change with new books on the
vertical axis.
b) Is Antonio worse or better off after the price change? Explain.

10. Consumers in Jakarta pay twice as much for potatoes as they do for cabbages. However, potatoes and
cabbages are the same price in Bogor. If consumers in both cities maximize utility, will the marginal rate
of substitution of potatoes for cabbages be the same for consumers in both cities? If not, which will be
higher?