1. Demand

Carrot Cake is the best of all possible deserts. Your friend Taylor has left school to open a bakery, which specializes in carrot cake and Thai food.  She has done some market research and finds that your neighbors value slices of carrot cake according to the following schedule:

a. Graph the demand curve for carrot cake.  Does the demand curve have a positive or negative slope?  Why?

b. How many slices will Taylor sell at $26.24?  How many at $19.13?

c. What will happen to the demand curve if a new study comes out showing cream cheese is bad for you?  What will happen to the demand curve if instead a study comes out showing carrots have major health benefits?

2. Production

Taylor makes cake using equipment that she rents for $15 and real carrots and other ingredients that cost $6.22 a slice.  She hires workers and finds that they produce cakes according to the following schedule:

Workers are paid $17/hour.

a. Calculate and graph the marginal cost of each slice.  Show your calculations! Why does the MC curve have the slope (up, down, or flat) that it does?

b. Calculate and graph the marginal cost of each slice under the following situations (consider each separately).  Show your calculations.

i. If workers become  more productive so each cake slice can be made with only 70% as much labor

ii. If workers get a raise to $30/hour, with the old productivity.

iii. If there is a great harvest of carrots so the cost of ingredients falls to $2/slice

iv. If the rental price on her oven rises to $30.

3. Perfect competition and equilibrium. 

a. Put the demand and supply curves together (at the original productivity and wages).  Taylor assumes that she is in a perfectly competitive market.  How many slices will she sell?  At what price?

If Taylor assumes she is in a perfectly competitive market, she will sell 7 slices at $19.13 because that is the point at which MC and MU are equal.

b. Draw the graph again and shade in the entire area of consumer surplus.  Shade in the entire area of producer surplus.

c. Calculate consumer surplus as the sum of the difference between the marginal utility and the price for each slice up to the last slice sold.  Calculate producer surplus as the sum of the difference between price and marginal cost for each slice.

CS = MU-19.13

PS = 19.19-MC

CS = $538.90

PS = $51.64

4. Monopoly and equilibrium

a. Taylor gets smart and realizes that she is the only cake shop around.  Calculate the marginal revenue she gets for each additional sale as the change in total revenue (price times sales).  Graph this and give the new quantity of sales and the new price.  Note that you will need to estimate the new price from the graph because there is not an exact match of integral number of slices.

b. Shade in the entire area of consumer surplus on your monopoly graph.  Shade in the entire area of producer surplus.

c. Calculate total consumer and total producer surplus under the monopoly situation.

d. Compare the sum of consumer and producer surplus for the monopoly with the results for perfect competition.  Which is better for consumers?  Which is better for producers?  Which is better for society? Explain.

Perfect competition is better for consumers, as it results in lower prices for them. However, producers prefer a monopoly-based system and the huge profits that come with it.

5. Is Small Beautiful?

Consider the arguments about big business in Chris Tilly, "Is Small Beautiful "(article 5.1 in Real World Micro), Edward Herman's "Brief History of Mergers and Antitrust Policy" (article 5.2), and Rob Larson, "Not Too Big Enough" (5.5).  Should we have a more aggressive policy to break up large businesses and promote competition?  State their arguments and give reasons why you agree or disagree.  

In my own personal opinion, I believe that we should have more aggressive policies to break up large businesses and promote competition.