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Assignment II (10%) (Due date: Same day of midterm II)

Instructions: • This is a group assignment (3 students) • This assignment is subject to deduction for late submission (5% each day after the due day). • Type your assignment and deliver a hard copy to your instructor. • Answer the following 12 problems:

(I) Consider the market for milk in Saskatchewan. If p is the price of milk (cents per liter) and Q is the quantity of litres (in millions per month), suppose that the demand and supply curves for milk are given by:

Demand: p = 225 -15QD Supply: p = 25 + 35QS

a. Assuming there is no government intervention in this market, what is the equilibrium price and quantity?

b. Now suppose the government guarantees milk producers a price of $2 per litre and promises to buy any amount of milk that the producers cannot sell. What are the quantity demanded and quantity supplied at this guaranteed price?

c. How much milk would the government by buying (per month) with this system of price support?

d. Who pays for the milk that the government buys? Who is helped by this policy and who is harmed?

(II) This question is related to the use of output quotas in the milk market in the previous question. Suppose the government used a quota system instead of direct price supports to assist milk producers. In particular, it issued quotas to existing milk producers for 1.67 million liters of milk per month.

a. If milk production is exactly equal to the amount of quotas issued, what price do consumers pay for milk?

b. Compared with the direct price controls in the previous question, whose income is higher under the quota system? Whose is lower?

(III) Consider a simple demand-and supply model of a competitive labour market in a small town. The demand and supply curves for labour are given by

Demand: w = 18 – 3LD Supply : w = 3 + 2LS

where w is the wage ($ per hour) and L is the number of hours of employment (measured in thousands of hours per month).

a. Plot the demand and supply curve in a graph.

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b. Solve for the equilibrium level of w and L in the case of no government intervention. c. Now suppose that the town council imposes a minimum wage equal to $10 per hour. What is

the new level of employment? d. Identify in your diagram the area that is the deadweight loss. Compute its size, measured in

thousands of dollars per month.

(IV) The table below shows how Brett’s utility increases as the number of avocados he consumes (per month) increases. Brett’s utility is measured in utils, a name that economists invented to described units of utility.

Avocados Total Utility (in utils) Marginal Utility (in utils)

Zero 0

First 100

Second 185

Third 245

Fourth 285

Fifth 315

Sixth 335

Seventh 345

Eighth 350

a. Plot Brett’s total Utility on a scale diagram, with utils on the vertical axis and the number of avocados (per month) on the horizontal axis.

b. Compute the marginal utility for each avocado and fill in the table. c. Plot the marginal utility on a scale diagram, with utils on the vertical axis and the number of

avocados (per month) on the horizontal axis. d. Explain why it is reasonable that Brett’s utility increases by smaller and smaller amounts for

each successive avocado consumed.

(V) Sally consumes only two goods, shoes and “everything else”. For five different shopping trips (each with different prices), the price and Sally’s marginal utilities are shown below.

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Marginal Utility (Shoes)

Price in $ (Shoes) Marginal Utility (Everything Else)

Price in $ (Everything Else)

Trip 1 125 250 50 100

Trip 2 100 200 50 100

Trip 3 75 150 50 100

Trip 4 50 100 50 100

Trip 5 25 50 50 100

a. Is Sally maximizing her total utility on each shopping trip? Explain why or why not b. Using what you have learned in chapter 5 about marginal utility, explain how the number of

shoes consumed is changing as their price changes. c. Can you detect the shape of Sally’s demand curve for shoes from the data shown in the

table?

(VI) In what situations do the substitution effect and the income effect work in the same direction to produce a downward-sloping demand curve? In what situations do they have opposing effects?

(VII) Consider the revenues and costs in 2013 for Spruce Decor Inc., an Alberta-based furniture company entirely owned by Mr. Harold Buford.

Furniture Sales $645000

Catalogue Sales $12000

Labour Costs $325000

Material Costs $157000

Advertising Costs $28000

Debt- Service Costs $32000

a. What would accounts determine Spruce Decor’s profits to be in 2013? b. Suppose Mr. Buford has $400000 of capital invested in Spruce Decor. Also suppose that

equally risky enterprise earn a 16% rate of return on capital. What is the opportunity cost for Mr. Buford’s capital?

c. What are the economic profits for Spruce Decor in 2013?

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d. If Spruce Decor’s economic profits were typical of furniture makers in 2013, what would you expect to happen in this industry? Explain.

(VIII) Consider an example of a production function that relates the monthly production of widgets to the monthly use of capital and labour services. Suppose the production function takes the following specific algebraic form:

Q = K*L – (0.1)*L2 where Q is the output of widgets, K is the input of capital services, and L is the input of labour services.

a. Suppose that, in the short run, K is constant and equal to 10. Fill in the following table.

K L Q

10 5

10 10

10 15

10 20

10 25

10 30

10 40

10 50

b. Using the values from the table, plot the values of Q and L on a scale diagram, with Q on the vertical axis and L on the horizontal axis. (This is analogous to the TP curve) c. Now suppose that K increases to 20 because the firm increases the size of its widget factory. Re-compute the values of Q for each of the alternative values of L. Plot the values of Q and L on the same diagram as in part (b). d. Explain why an increase in K increases the level of Q (for any given level of L).

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(IX) The following table shows how the total output of skates (per month) changes when the quantity of the variable input (labour) changes. The firm’s amount of capital is fixed.

Hours of labour (per month)

Pairs of Skates (per month)

Average Product (AP) Marginal Product (MP)

100 200 ? ————?——————

—————?—————-

—————?—————-

—————?—————-

—————?—————-

—————?—————-

—————?—————-

120 260 ?

140 350 ?

160 580 ?

180 720 ?

200 780 ?

220 800 ?

240 810 ?

a. Compute the average product of labour for each level of output and fill in the table. Plot the AP curve on a scale diagram.

b. Compute the marginal product of labour for each interval (that is, between 100 and 120 hours, between 120 and 140 hours, and so on). Fill in the table and plot the MP curve on the same diagram.

c. Is the “law of diminishing returns satisfied? Explain. d. Explain the relationship between the marginal product of labour and the average

product of labour.

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(X) Consider the table below, which shows the total fixed costs (TFC) and total variable costs (TVC) for producing speciality bicycles in a small factory with a fixed amount of capital.

Output per year (thousands of

bicycles)

TFC (thousands of $)

TVC (thousands of $)

AFC (thousands of $)

AVC (thousands of $)

ATC (thousands of $)

1 200 40

2 200 70

3 200 105

4 200 120

5 200 135

6 200 155

7 200 185

8 200 230

9 200 290

10 200 350

11 200 425

a. Compute average fixed costs (AFC) for each level of output. b. Compute average variable costs (AVC) for each level of output. c. Compute average total costs (ATC) for each level of output. d. Plot the AFC, AVC, and ATC curves on a scale diagram with dollars on the vertical

axis and the level of output on the horizontal axis.

(XI) Each of the following is a means of increasing productivity . Discuss which groups in a society might oppose each one. a. A labour-saving invention that permits all goods to be manufactured with less labour

than before. b. The removal of all government production safety rules. c. A reduction in corporate income taxes. d. A reduction in the stringency of environmental standards for new factories.

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(XII) (a) Explain the difference between diseconomies of scale and diminishing marginal product of the variable factor. Why is one a short-run concept and the other a long-run concept? (b) Explain the difference between economies of scale and spreading overhead. Why is one a short-run concept and the other a long-run concept?

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