Homework 2-

1. Fundamentals of Supply and Demand:

Assume there is a downward sloping demand curve and an upward sloping supply curve for Frosted Flakes.  In the following scenarios, explain whether there will be a shift in demand, a shift in supply, a movement along the demand curve, or a movement along the supply curve.  If there is a shift, state the direction of the shift (e.g., demand shifts to the left or demand shifts to the right), and finally, identify the effect of the event on the equilibrium quantity and equilibrium price in the market.

a. The temperature drastically drops, and consumers begin to eat more oatmeal and less cereal. 

b. The price of Cinnamon Toast Crunch, a substitute for Frosted Flakes increases.

c. The price of milled corn, the number one ingredient in Frosted Flakes decreases. 

d. The National Cancer Foundation finds that sugar consumption is a direct cause of pancreatic cancer, and sugar is an ingredient in Frosted Flakes. Assume that this change does not alter producers' decisions about producing Frosted Flakes nor their input costs.

e. The price of Frosted Flakes increases due to the imposition of an effective price floor in this market.

f. There is a national shortage of cardboard boxes, which are used in packaging Frosted Flakes. 

g. Cows throughout the United States contract a rare disease carried by mosquitoes.  This makes all domestic milk unsafe to drink, and milk is considered a complement to Frosted Flakes.

h. The price of Frosted Flakes decreases due to the imposition of an effective price ceiling in this market.  

2. Price Intervention:

The government institutes a price support program for farmers producing corn.  In order to raise farm revenue, the government will establish a price floor in the market for corn and buy any excess supply of corn and store it in Lakota, ND at $2/lb.  The government sets the price floor at P_floor = $10/lb. of corn.  The supply and demand schedules for corn are as follows:               

Q_Supply = (P-4)/2                

Q_Demand = (16-P)/4           

a. Calculate the equilibrium price and quantity without the price floor, and plot the demand and supply curves in a graph. In your graph mark the initial equilibrium price and quantity. On your graph identify the y-intercept and x-intercept for the demand curve and the y-intercept for the supply curve.  

b. Suppose the government institutes the price floor of $10/lb of corn. How many units of corn will be supplied with this program? How many units of corn will be demanded by consumers with this program? How many units of corn will the government purchase with this program? What is the cost to the government, net of storage costs, for this program? What is the total cost to the government, including storage costs, for this program? In your graph shade the area that represents the cost to the government net of storage costs.

c. Calculate the cost to consumers with the price floor.  Shade this area on the graph in part a.) in a different color.

d. Now, using the same demand and supply schedules, draw a new graph where the government uses a price subsidy program instead of a price floor program.  There is no longer a cost for storage, and the guarantee price equals the floor price, P_guarantee = $10.  How many units of corn will be supplied with this program? How many units of corn will be demanded by consumers with this program? How many units of corn will the government purchase with this program? What is the total cost to the government for this program? Shade the area that represents the total cost to the government for this program on your new graph. Calculate the cost to consumers with the price subsidy program. Shade this area on your new graph and label it clearly.

3. Market Demand Curve:

Let Sue's demand curve for shoes be Q=6-2P and Jackie's demand curve is Q=10-2P.  The market supply curve for shoes is given by Q=4P-4.  (Hint: in this problem it's okay if your equilibrium quantity and equilibrium price calculations do not result in a whole number!)

a. Graph Sue's demand curve and Jackie's demand curve on separate graphs.  Graph the market supply curve on each of the separate graphs.

b. Suppose Jackie is the only consumer of shoes. Calculate the equilibrium price and quantity for Jackie given this assumption.

c. Now on a new graph, graph the market demand curve for shoes by horizontally summing Sue and Jackie's demand curves.

d. What is the market demand function for shoes if Jackie and Sue are the only consumers of shoes in this market?  What is the equilibrium price and quantity in the market for shoes?

4. Comparative Advantage-

In one day in country A, it takes 20 workers to produce a flat screen TV and 5 workers to produce an iPod. In one day in country B, it takes 10 workers to produce a flat screen TV and 5 workers to produce an iPod. Both countries have 100 workers available each day.

a. Draw the PPF of each country for one day's worth of production. Use a separate graph for each country. In your graphs measure flat screen TVs on the horizontal axis and iPods on the vertical axis. Carefully label each graph with the respective country's name. Label the horizontal and vertical axis as well.

b. Which country has an absolute advantage in flat screen TV production?

c. Which country has an absolute advantage in producing iPods?

d. What is the opportunity cost of producing a flat screen TV in country A?

e. What is the opportunity cost of producing a flat screen TV in country B?

f. What is the opportunity cost of producing an iPod in country A?

g. What is the opportunity cost of producing an iPod in country B?

h. Which country has a comparative advantage in flat screen TV production?

i. Which country has a comparative advantage in producing iPods?

j. Suppose the countries trade with each other.  What is the range of possible flat screen TV prices (in terms of iPods)?

k. Draw the combined PPF of these two countries in a graph with iPods measured on the vertical axis and flat screen TVs measured on the horizontal axis.

5. Excise Tax:

The supply and demand schedules for peanut butter are given by the following equations:        

Q_Supply = (P-4)/2                

Q_Demand = (16-P)/4

a. Draw  a graph of the supply and demand curves in this market.  On the graph mark the market equilibrium price and quantity, as well as the areas for consumer surplus and producer surplus.

b. Calculate the value of consumer surplus and producer surplus for peanut butter.

c. Now suppose that the government decides to implement an excise tax on producers of $3 per jar of peanut butter. What happens to the equilibrium quantity and price in this market?  Draw a new graph of the market for peanut butter. In this new graph include the original demand and supply curves, and the new supply curve S2. In your graph label the areas that correspond to government tax revenue with the excise tax, consumer surplus with the excise tax, producer surplus with the excise tax, and deadweight loss with the excise tax.

d. Given the tax described in part (c), calculate the value of the consumer surplus with the excise tax, producer surplus with the excise tax, government revenue, and the deadweight loss due to the tax.