Class Handout 2-

1.  Suppose there is a small, closed economy that produces bananas. The domestic demand and domestic supply curves for bananas in this small, closed economy are given as:

Domestic demand: P = 20 - (1/2)Q

Domestic supply: P = 2 + (1/10)Q

a. What is the equilibrium price and quantity of bananas in this small, closed economy?

b. Suppose that the world price of bananas is $8 per unit of bananas and this economy opens to trade. Provide a numerical measure of this country's imports or exports of bananas once the market is open to trade.

c. If this closed economy opens its banana market to trade with the world price of bananas equal to $8 per unit of bananas, what will be the change in consumer surplus due to this decision?

d. Suppose that the world price of bananas is $2.50 per unit of bananas. If this market opens to trade, what will be the level of imports or exports of bananas?

e. Given the scenario in part (d), what will be the change in consumer surplus when this economy goes from being a closed economy with regard to the banana market to being an open economy with regard to the banana market?

f. Suppose that the world price of bananas is $2.50 per unit of bananas and that this economy is open to trade. Suppose the government implements a tariff of $1.00 per unit of bananas. Calculate the tariff revenue from the implementation of this policy and the deadweight loss from the tariff.

g. Suppose the government wishes to replace the tariff described in part (h) with a quota that results in the same consumer surplus as the consumer surplus with the tariff, the same producer surplus as the producer surplus with the tariff, and the same deadweight loss as the deadweight loss with the tariff. How many units of bananas should the quota equal for this result? Explain your answer.

h. Trade has distributional consequences. Briefly summarize who wins and who loses when an economy opens to trade. Be specific in your answer.

2. Suppose there are two countries, Capriland and Melodia. Both countries produce two goods, pianos and cars. Furthermore, assume that both countries have linear production possibility frontiers (PPFs). The following table provides information about the amount of labor necessary to produce one piano or one car in each of these two countries. Assume that Capriland and Melodia both have a total of 120 hours of labor available to devote to the production of pianos and cars. (Hint: put pianos (P) on the vertical axis and cars (C) on the horizontal axis as your work the various parts of this problem.)

a. Given the above information, write an equation that represents Capriland's PPF. In your equation pianos should be abbreviated as P and cars should be abbreviated as C.

b. Suppose that the amount of labor available for the production of pianos and cars is now 60 hours. You are told that Melodia is currently producing on its PPF and Melodia is producing 3 cars. Calculate how many pianos Melodia is making.

c. Given the initial information about Capriland and Melodia, determine whether each of the following statements is true or false.

i. The opportunity cost of producing one more car for Melodia is greater than the opportunity cost of producing one more car for Capriland.

ii.The opportunity cost of producing one more piano for Capriland is greater than the opportunity cost of producing one more piano for Melodia.

d. Given the initial information about Capriland and Melodia, suppose these two countries decide to specialize and trade with one another. Find the acceptable range of prices in terms of cars that 10 pianos will trade for. Show your work. Make sure your answer is clearly labeled.

e. Given the initial information, which country has the comparative advantage in the production of cars?

f. Given the initial information, which country has the absolute advantage in the production of pianos?

g. Given the initial information, construct a PPF that illustrates the combined production possibility frontier for these two countries. If the PPF has different linear segments identify the coordinates of the endpoints for any segment. Label your graph carefully and completely. Measure pianos (P) on the vertical axis and cars (C) on the horizontal axis.

3. Suppose you are given the following information about the demand and supply in a market. Assume that both the demand and supply curves are linear. 

a. Write the equation for the market demand curve given the above information. In your equation represent price as P and the quantity demanded as Qd. Write your equation in slope intercept form.

b. Write the equation for the market supply curve given the above information. In your equation represent price as P and the quantity supplied as Qs. Write your equation in slope intercept form.

c. Given the above information, find the equilibrium price (Pe) and the equilibrium quantity (Qe) for this market.

d. When the market is in equilibrium, what is the value of consumer expenditure on this good?

e. When this market is in equilibrium, what is the value of consumer surplus?

f. When this market is in equilibrium what is the value of producer surplus?

g. Suppose the government sets a price floor equal to $70 in this market. Describe the effect of this price floor on the market. Be sure to comment on and quantify any surplus or shortage that occurs as a result of this price floor. In addition, be sure to comment on whether the price floor is effective or not.

h. Suppose the government sets a price ceiling equal to $30 in this market. Describe the effect of this price ceiling on the market. Be sure to comment on and quantify any surplus or short that occurs as a result of this price ceiling. In addition, be sure to comment on whether the price ceiling is effective or not.

4. Answer the next question based on the following information.

Suppose there are two consumers, Yi and Saad, in a market. Yi's demand curve is given by the equation Q = 50 - 2P while Saad's demand curve is given by the equation P = 100 - Q.

a. In the space below draw a graph that represents Yi's demand curve and a separate graph that represents Saad's demand curve. Label these two graphs clearly and completely.

b. In the space below draw a graph that represents the market demand curve. Label this graph clearly and completely. Make sure you identify the y-intercept and the x-intercept. If the demand curve has different linear segments, make sure you identify the coordinates of the endpoints of each segment.

c. Find the market demand curve and write it in slope intercept form. If there is more than one demand curve equation, identify the relevant range of prices that is applicable for each demand curve equation.

d. Suppose the market supply curve is given as Qs = 12P. Given this information and your previous work, how many units will Saad buy of the good and what price per unit will he pay?