ECON2113 L3&L4 Microeconomics, 2019 Fall Homework

Instructor : Wooyoung Lim

1. (20pts) Suppose that Wooyoung’s production possibilities are

Food (pounds per month) Sunscreen (gallons per month)

300 0
200 50
100 100
0 150

a. (5pts) Draw a graph of Wooyoung’s PPF and explain how your graph illustrates a trade-
off.
c. (5pts) What is Wooyoung’s opportunity cost of producing 1 pound of food?
d. (5pts) What is Wooyoung’s opportunity cost of producing 1 gallon of sunscreen?
e. (5pts) What is the relationship between your answers to parts (c) nd (d)?

2. (50pts) Suppose Kim can produce 40 pies an hour or 400 cookies an hour. Lim can produce
100 pies an hour or 200 cookies an hour.

a. (10pts) Who has a comparative advantage in producing pies?

b. (10pts) If Kim and Lim spend 30 minutes of each hour producing pies and 30 minutes
producing cookies, how many pies and cookies does each of them produce?
c. (10pts) Suppose that Kim and Lim specialize in producing only the good in which they
have a comparative advantage. How many pies and cookies does each of them produce?
d. (10pts) What is the highest price of a pie at which Kim and Lim would agree to trade
pies and cookies?
e. (10pts) Suppose that Lim sells 20 pies to Kim according to the price you find at (d).
What are the gains from trade for each person compared to (b)?

3. (50pts) Suppose that the market demand for oil is

P = 800 − 2QD . (1)

There are three identical suppliers in the oil market, each of which has the following individual
supply of oil:
P = 200 + 3QS . (2)

The price of oil is expressed in dollars, and the quantities are expressed in barrel of oil per
day.

a. (10pts) Draw a graph of the oil market, label the axes and the curves, and mark in the
equilibrium price and quantity. Calculate the market equilibrium price and quantity.

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 b. (10pts) Calculate the consumer surplus, the producer surplus, and the total surplus.
Determine whether the market equilibrium is efficient or inefficient. Explain.
c. (15pts) The government decides to open the oil market for free international trade. The
world price of oil is 300 dollars. (Assume that this national market is so small that
the demand and supply of the market cannot affect the world market.) Graphically
demonstrate the benefit of trade.
d. (15pts) The domestic oil suppliers hire some lobbyists. After several days of lobbing
activity the government decides to impose the import quota Q = 100 barrels per day.
Who are the winners and the losers from this policy? Explain.

4. (30pts) The demand schedule for computer chips is

Price (dollars per chip) Quantity demanded (millions of chips per year)
200 50
250 45
300 40
350 35
400 30

a. (10pts) What happens to total revenue if the price falls from $400 to $350 a chip and
from $350 to $300 a chip? At what price is total revenue at a maximum?
b. (10pts) At an average price of $350, is the demand for chips elastic, inelastic or unit
elastic? Do NOT use total revenue test to answer this question.
c. (10pts) At an average price of $250, is the demand for chips elastic, inelastic or unit
elastic? Use total revenue test to answer this question.

5. (40pts) Your price elasticity of demand for bananas is 4. If the price of bananas rises by 5
percent, what is

a. (10pts) The percentage change in the quantity of bananas you buy?

b. (10pts) The change in your expenditure on bananas?

Now your income elasticity of demand for bananas is 12 . If your income rises by 10 percent,

c. (10pts) What is the percentage change in the quantity of bananas you buy?
d. (10pts) Is banana a normal good or not? Explain.

6. (30pts) In September 15, 1999 there was an article in New York Times with the title “Should
We Raise the Minimum Wage?” In this article, they argued that

“an increase in the minimum wage that would raise the yearly salary of a minimum-
wage employee working full time to $12,700 from $10,700 could make a significant
difference in reducing poverty.”

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 Can you provide some economic argument based on the demand-supply analysis (you learned
in Chapter 6) to either criticize or support the above statement?

7. (80pts) The following is a summary of the CBS news article “New toll policy creates huge
traffic jam,” October 1, 2012. Please read this summary carefully and answer the questions
below.

• China government decided to abandon the use of tolls on roads during the eight-day
“Golden Week” holiday for the Mid-Autumn Festival and National Day in year 2012.
• On the first day of the holiday, more than 85 million travelers took to the roads, about
10 million travelers more than on the first day of the holiday in 2011. (In the Golden
Week holiday 2011, the China government did not use such policy.)
• Li Daokui, a renowned professor of Economics at Tsinghua University, criticized the toll-
free policy in a micro blog post, calling it the most foolish in the world. He said that
rising the tolls by 50 percent would have benefited people more.

Assume that each traveler needs to pay the toll fee, 10 RMB, in usual days. The market
demand for roads in usual days is
P = 70 − Q. (3)

The price is expressed in RMBs, and the quantities are expressed in million of travelers per
day. Assume further that 1) any traveler requires to pay the toll fee only once, 2) any traveler
who wants to use the road can use it (as long as he/she pays the toll fee), and 3) one road is
enough for one travel.

a. (10pts) Draw a graph of the market, label the axes and the curves, and mark in the
equilibrium price and quantity for usual days. Calculate the market equilibrium price
and quantity.
b. (10pts) Suppose that the market demand for roads in Golden week is P = 85 − Q.
Graphically demonstrate what happened to the demand curve and supply curve in 2011
Golden week. Calculate the market equilibrium price and quantity.
c. (10pts) Graphically demonstrate the effect of government’s new toll policy in 2012 Golden week.
Calculate the market equilibrium price and quantity.
d. (10pts) Explain whether the change in 2011 Golden week is a change in the quantity
demanded or a change in demand. What about the change in 2012 Golden Week?
e. (10pts) By taking the market equilibrium point in 2011 Golden week and that in 2012 Golden week
as an initial point and an end point respectively, calculate the price elasticity of demand.
f. (20pts) Suppose that each traveler needs to bear additional time costs when more trav-
elers use the road simultaneously. The time cost is Q2 /150 when there are Q million
travelers on the road. Define NCS (Net Consumer Surplus) as a standard Consumer
Surplus minus Total Time Cost. Calculate NCS for (1) usual days, (2) 2011 Golden
week, and (3) 2012 Golden week, and evaluate the new toll policy based on the NCS.

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 Evaluate the policy suggested by Professor Li Daokui and discuss whether or not his
claim is right.
g. (10pts) Discuss the effectiveness of the new toll policy by China government when the
market demand is much more inelastic.

8. (45pts) The following is a summary of the Wall Street Journal article “Heat Rises in Hong
Kong Property Market”, Sep. 18, 2012. Please read this summary carefully and answer the
questions below.

...Hong Kong’s average property prices have doubled over the last four years... In
a lot of Hong Kong property markets, the bubble that has been building is fueled
by mainland Chinese money coming over the border and purchasing the properties
here... Since 2009, the HK government has been 1) tightening mortgage rules for
people with more than one mortgage, 2) raising transaction taxes on property trans-
actions, and 3) reintroducing the selling of affordable subsidized public housing for
qualified families... but price is still going up... Ultimately, a lot of economists say
in order to really cool the market the government needs to do two things: 1) restrict
foreign ownership of apartments in HK, and 2) really drastically increase the land
supply.

a. (10pts) Draw a graph of the Hong Kong private housing market before year 2008, label
the axes and the curves, and mark in the equilibrium price and quantity, and graphically
demonstrate the effect of huge inflow of mainland Chinese money on the Hong Kong
private housing market.
b. (10pts) Graphically demonstrate the effects of each of the government policies specified
above. (When you analyze (2) assume that the transaction taxes are imposed on the
buyers.)
c. (10pts) Based on the policy failure of Hong Kong government (property price is not going
down much even after the policies are implemented) highlighted above, discuss whether
the price elasticity of demand of houses in Hong Kong private housing market is high
or low. To do so, please take two extreme cases–almost perfectly elastic and almost
perfectly inelastic demand curves–and clarify the effect of the same policy (that results
in the same amount of shift of the demand curve) on the price of private housing.
d. (10pts) Taking your answer for question (c) into account, evaluate the effectiveness of
the two new policies suggested by economists.
e. (5pts) In your opinion, what is the main root problem that results in the rising property
price in Hong Kong, so that HK government could not leave it alone, but determined to
intervene the market?

9. (40pts) The following is part of the article “Hong Kong should follow Singapore in subsidizing
private preschool, says educator” in South China Morning Post, March 19, 2014.

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 “Hong Kong can learn from Singapore, where the government subsidizes private
kindergartens to make them affordable for poorer families, says a Singapore-based
international education group.”

a. (20pts) Assume that the private preschool supply in Hong Kong is perfectly inelastic. Use
the demand-supply analysis to either criticize or support the above statement. Evaluate
the suggested policy in terms of market price and social welfare.
b. (20pts) Assume that the private preschool supply in Hong Kong is perfectly elastic. Use
the demand-supply analysis to either criticize or support the above statement. Evaluate
the suggested policy in terms of market price and social welfare.

10. (50pts) Sara’s income is $12 a week. The price of popcorn is $3 a bag, and the price of cola
is $1.5 a can. Assume that both are normal goods.

a. (15pts) By using the budget line and indifference curves, graphically demonstrate Sara’s
optimal consumption behavior.
b. (15pts) Suppose that the price of cola rises to $3 a can. All other things remain the
same. Graphically demonstrate Sara’s optimal consumption behavior.
c. (20pts) Graphically demonstrate the price effect. Especially, you need to separate the
income effect and the substitution effect clearly.

11. (40pts) The following is a part of an article in “The Sports Economics”, October 2010.

Enjoying his best run of pitching in more than two years, the always-controversial
Carlos Zambrano (Chicago Cubs’ Pitcher) said after winning his ninth game of the
season Wednesday that he will retire when his contract ends after the 2012 season.
Zambrano said:
“This will be my last contract. I won’t be playing anymore. I don’t want to play
anymore. Life is short. Sometimes you miss things with your family, like very
important people, like my daughter. Sometimes you miss things in life because of
baseball that you shouldn’t miss. I want to be there any moment for my daughter
and my family. Baseball takes a lot of time away from us.”
....Besides, who can criticize a man for wanting to spend more time with his family
after his contract runs out especially one as wealthy as Carlos Zambrano?

Zambrano’s decision in the above article can be explained by the “backward-bending labor
supply curve.”

a. (20pts) By using the budget line, indifference curves, and consumers’ optimal con-
sumption behavior, graphically demonstrate Zambrano’s backward-bending labor supply
curve.
b. (20pts) Explain the backward-bending labor supply curve in terms of price effect. In
particular, explain what happens to income effect, substitution effect and their relative
size as the income of Zambrano increases.

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12. (40pts) During the Enlightenment, the City of Calgary had a more-or-less free market in
taxi services. Any respectable firm could provide taxi service as long as the drivers and cabs
satisfied certain safety standards. Let us suppose that the constant marginal cost per trip of
a taxi ride is $5 and that the average taxi has a capacity of 20 trips per day. Let the demand
function for taxi rides be given by D(p) = 1100 − 20p, where demand is measured in rides per
day, and price is measured in dollars. Assume that the industry is perfectly competitive.

a. (10pts) What is the competitive equilibrium price per ride? What is the equilibrium
number of rides per day? What is the minimum number of taxi cabs in equilibrium?
b. (10pts) During the Calgary Stampede (big outdoor show), the influx of tourists raises
the demand for taxi rides to D(p) = 1500 − 20p. Find the following magnitudes, based
on the assumption that for these 10 days in July, the number of taxicabs is fixed and
equal to the minimum number found in part (a): equilibrium price; equilibrium number
of rides per day; profit per cab.
c. (10pts) Now suppose that the change in demand for taxicabs in part (b) is permanent.
Find the equilibrium price, equilibrium number of rides per day, and profit per cab per
day, How many taxi cabs will be operated in equilibrium? Compare and contrast this
equilibrium with that of part (b). Explain any differences.
d. (10pts) With care and precision on one diagram, graph the three different competitive
equilibria found in part (a) through (c). In each case identify the supply curve, the
demand curve, and the equilibrium price and quantity.

13. (20pts) Suppose the demand curve is P = 10 − Q and thus the marginal revenue curve is
M R = 10 − 2Q. If the marginal cost if constant at 4, what is the profit-maximizing monopoly
price and output? Graphically demonstrate the monopoly outcome.

14. (40pts) Railways are often considered a typical example of a natural monopoly. The very
high costs of laying track and building a network, as well as the costs of buying or leasing
the trains, would prohibit, or deter, the entry of a competitor. With natural monopolies,
economies of scale are very significant so that minimum efficient scale is not reached until the
firm has become very large in relation to the total size of the market.

a. (10pts) Graphically demonstrate the long-run average cost of the natural monopoly.
b. (10pts) Combining the long-run average cost curve with a linear market demand and a
constant marginal cost, explain how the potential entry of a competitor is deterred.
c. (10pts) Graphically demonstrate 1) the socially efficient outcome and 2) monopoly profit
maximizing outcome.
d. (10pts) Explain if the government can achieve the socially efficient outcome by setting
the price cap.

15. (30pts) Suppose that you are now a salaried employee who earns $40 of net salary per year.
In one morning, you feel deeply insulted by rudeness of your young boss. In the evening

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 when you go back home, you want to drink some beers but realize that there is no pub in the
local market. After careful investigation, you find out that in the local market for beers there
are two types of potential consumers: A consumer type 1 has an inverse demand schedule
P = 5 − Q, while a consumer type 2 has an inverse demand P = 10 − Q. Normalize the total
number of type 1 consumer to 1 and the total number of type 2 consumer to 1 for 1 year.
Suppose that

• Assume that your marginal cost of owning your own pub and selling beers is c = $0.
You need $3 of fixed cost for owing your own pub.
• The types of consumers are unknown.

Provide a price scheme that allows you to thrust your resignation and start your own pub to
sell beers. Explain why and how the price scheme works in details.

16. (40pts) Consider the following duopoly market: There are two firms, firm 1 and firm 2 on
the market. Firm 1 and firm 2 simultaneously choose quantity to produce, q1 ∈ {2, 3, 4} and
q2 ∈ {2, 3, 4}. The total cost of firm 1 and firm 2 are T C1 (q1 ) = 2q1 and T C2 (q2 ) = 2q2 ,
respectively. The marginal cost of both firms are therefore 2. The market demand is given by
P = 6− Q
2 where Q = q1 +q2 . The marginal revenue of firm 1 and firm 2 are M R1 (q1 ) = 6−q1
and M R2 (q2 ) = 6−q2 , respectively. Let πM and πC denote the monopoly profit and the profit
from perfect competition.

Firm 2
q2 =2 q2 = 3 q2 = 4
πM πM
q1 = 2 2 , 2 ? ?
Firm 1 q1 = 3 ? ? ?
πC πC
q1 = 4 ? ? 2 , 2

a. (10pts) Complete the following game matrix with the payoff of firm 1 and the payoff of
firm 2 for each cell.
b. (10pts) Find all Nash equilibria? Explain why they are Nash equilibria.
c. (10pts) Explain why it is not a Nash equilibrium that two firms coordinate and jointly
produce the Monopoly quantity.
d. (10pts) Compare the equilibrium payoff of the firms in this duopoly market with that
in the monopoly market and that in the perfect competition. What about consumer
surplus and deadweight loss?

17. (60pts) Consider the rivalry between A and B to develop a new commercial jet aircraft.
Suppose B is ahead in the development process and A is considering whether to enter the
competition. If A stays out, it earns zero profit, whereas B enjoys a monopoly and earns
a profit of $1 billion. If A decides to enter and develop the rival airplane, then B has to
decide whether to accommodate A peaceably or to wage a price war. In the event of peaceful

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 competition, each firm will make a profit of $300 million. If there is a price war, each will lose
$100 million because the prices of airplanes will fall so low that neither firm will be able to
recoup its development costs.

a. (10pts) Find the extensive form representation of the game (i.e. draw the game tree).
b. (10pts) Find the rollback equilibrium and describe the firms’ equilibrium strageties.
c. (10pts) Find the strategic form representation of the game (i.e. draw the game matrix).
d. (10pts) Find all Nash equilibria.
e. (10pts) Find a Nash equilibrium which is not a backward induction solution. Is this
equilibrium reasonable? Explain.
f. (10pts) Is there a (either weakly or strictly) dominant strategy in this game? Explain.

18. (40pts) Find ALL Nash equilibria of the following games. For each game, explain if there is
any strictly and weakly dominated strategy.

Column Column
Left Right Left Right
Up 10,10 0,15 Up -5,-5 10,0
a. Row b. Row
Down 15,0 2,2 Down 0,10 2,2

Column
Column Left Middle Right
Left Right Top 3,1 2,3 10,2
Up 1,1 0,0 High 4,5 3,0 6,4
c. Row d. Row
Down 0,0 2,2 Low 2,2 5,4 12,3
Bottom 5,6 4,5 9,7

19. (25pts) Consider an agricultural village in which the villagers graze their cows on a common
field. It costs 10 dollars to buy a cow. How much milk the cow produces will depend on how
many other cows are grazed on the common land. Let f (c) be the value of the milk produced
by all cows if there are c cows grazed on the common. Assume that f (c) = 60c − c2 and
df (c)
f 0 (c) = dc = 60 − 2c.

a. (10pts) Consider the private ownership where someone owns the field and decides how
many cows should graze there. How many cows would be grazed on the common if the
owner wants to maximize the total wealth of the village?
b. (10pts) Consider the common ownership where the field is owned in common by the
villagers and access to it is free and unrestricted. How many cows would be grazed?
c. (5pts) Graphically illustrate the tragedy of the commons.

20. (25pts) Two villages (V1 and V2 ) lie on opposite sides of a lake. There is a small but growing
stock of valuable fish in the lake. The current value of the fish in the lake is k. At the end of

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 each month the size of the stock is twice the size of the stock at the beginning of that month
minus the amount fish hat have been caught. After 6 months all remaining fish in the lake die
off. By custom, one village can only go out fishing during odd months, and the other village
can only go out fishing during even months. No matter how many fish there are in the lake, it
takes less than one month to catch them all. For simplicity, assume that each villages has two
options: Take all or nothing. Also assume that fishing is done without effort and therefore
costless.

a. (10pts) Draw a game tree. Your tree needs to include players, strategies, and payoffs.
b. (10pts) Find a roll-back equilibrium. Explain how you find the equilibrium.
c. (5pts) Discuss if Adam Smith’s invisible hand is still working in this situation.

21. (50pts) Suppose that there are three roommates who have to decide whether or not to acquire
a TV that costs $300. Person A and B are willing to pay $80 each to have the TV present,
while person C is willing to pay $150. The willingness-to-pay is one’s private information.

a. (10pts) Determine whether acquiring a TV is efficient or not. Explain.

b. (10pts) Discuss if every person has an incentive to contribute $100. Explain.
c. (30pts) Provide a Groves-Clarke mechanism to achieve an efficient outcome. Especially,
explain who the pivotal person(s) is and calculate the tax for the pivotal person(s).
Explain why person A and C have no incentive to misreport their willingness-to-pay.