1.  Over the past 30 years, technological advances have reduced the cost of computer chips. How do you think this has affected the market for computers? For computer software? For typewriters?  Illustrate your answer with graphs.

Technological advances that reduce the cost of producing computer chips represent a decline in an input price for producing a computer. The result is a shift to the right in the supply of computers, as shown in Figure. The equilibrium price falls and the equilibrium quantity rises, as the figure shows.

Because computer software is a complement to computers, the lower equilibrium price of computers increases the demand for software. As Figure below shows, the result is a rise in both the equilibrium price and quantity of software.

            Because typewriters are substitutes for computers, the lower equilibrium price of computers reduces the demand for typewriters. As Figure below shows, the result is a decline in both the equilibrium price and quantity of typewriters.

2.  Using supply-and-demand diagrams, show the effect of the following events on the market for sweatshirts.  Yes, I want graphs.

a.       A hurricane in South Carolina damages the cotton crop.

b.       The price of leather jacket falls.

c.       All colleges require morning exercise in appropriate attire.

d.       New knitting machines are invented.

      a.   When a hurricane in South Carolina damages the cotton crop, it raises input prices for producing sweatshirts. As a result, the supply of sweatshirts shifts to the left, as shown in Figure. The new equilibrium price is higher and the new equilibrium quantity of sweatshirts is lower.

b.   A decline in the price of leather jackets leads more people to buy leather jackets, reducing the demand for sweatshirts. The result, shown in Figure, is a decline in both the equilibrium price and quantity of sweatshirts.

c.    The effects of colleges requiring students to engage in morning exercise in appropriate attire raises the demand for sweatshirts, as shown in Figure. The result is an increase in both the equilibrium price and quantity of sweatshirts.

d.   The invention of new knitting machines increases the supply of sweatshirts. As Figure shows, the result is a reduction in the equilibrium price and an increase in the equilibrium quantity of sweatshirts.

3.  The market for pizza has the following demand and supply schedules:

a.       Graph the demand and supply curves. What is the equilibrium price and quantity in this market?  Why  yes!  Graph paper would make it look professional.

b.       If the actual price in the market were above the equilibrium price, what would drive the market toward equilibrium?

c.       If the actual price in this market were below the equilibrium price, what would drive the market toward the equilibrium?

      Quantity supplied equals quantity demanded at a price of $6 and quantity of 81 pizzas. If the price were greater than $6, quantity supplied would exceed quantity demanded, so suppliers would reduce the price to gain sales. If the price were less than $6, quantity demanded would exceed quantity supplied, so suppliers could raise the price without losing sales. In both cases, the price would continue to adjust until it reached $6, the only price at which there is neither a surplus nor a shortage.

4.  Because bagels and cream cheese are often eaten together, they are complements.  Again, graphs.

a.       We observe that both the equilibrium price of cream cheese and the equilibrium quantity of bagels have risen. What could be responsible for this pattern- a fall in the price of flour or a fall in the price of milk? Illustrate and explain your answer.

b.       Suppose instead that the equilibrium price of cream cheese has risen but the equilibrium quantity of bagel has fallen. What could be responsible for this pattern- a rise in the price of flour or a rise in the price of milk? Illustrate and explain your answer.

      a.   Because flour is an ingredient in bagels, a decline in the price of flour would shift the supply curve for bagels to the right. The result, shown in Figure, would be a fall in the price of bagels and a rise in the equilibrium quantity of bagels.

      Because cream cheese is a complement to bagels, the fall in the equilibrium price of bagels increases the demand for cream cheese, as shown in Figure below. The result is a rise in both the equilibrium price and quantity of cream cheese. So, a fall in the price of flour indeed raises both the equilibrium price of cream cheese and the equilibrium quantity of bagels.

      What happens if the price of milk falls? Because milk is an ingredient in cream cheese, the fall in the price of milk leads to an increase in the supply of cream cheese. This leads to a decrease in the price of cream cheese, rather than a rise in the price of cream cheese. So a fall in the price of milk could not have been responsible for the pattern observed.

b.   In part (a), we found that a fall in the price of flour led to a rise in the price of cream cheese and a rise in the equilibrium quantity of bagels. If the price of flour rose, the opposite would be true; it would lead to a fall in the price of cream cheese and a fall in the equilibrium quantity of bagels. Because the question says the equilibrium price of cream cheese has risen, it could not have been caused by a rise in the price of flour.

What happens if the price of milk rises? From part (a), we found that a fall in the price of milk caused a decline in the price of cream cheese, so a rise in the price of milk would cause a rise in the price of cream cheese. Because bagels and cream cheese are complements, the rise in the price of cream cheese would reduce the demand for bagels, as Figure below shows. The result is a decline in the equilibrium quantity of bagels. So a rise in the price of milk does cause both a rise in the price of cream cheese and a decline in the equilibrium quantity of bagels.

5.  Suppose that the price of basketball tickets at your college is determined by market forces. Currently, the demand and supply schedules are as follows:

a.       Draw the demand and supply curves. What is unusual about this supply curve? Why might this be true?

b.       What are the equilibrium price and quantity of tickets?

c.       Your college plans to increase total enrollment next year by 5,000 students. The additional students will have the following demand schedule:

 Now add the old demand schedule and the demand schedule for the new students to calculate the new demand schedule for the entire college. What will be the new equilibrium price and quantity?

      a.   As Figure below shows, the supply curve is vertical. The constant quantity supplied makes sense because the basketball arena has a fixed number of seats at any price.

b.   Quantity supplied equals quantity demanded at a price of $8. The equilibrium quantity is 8,000 tickets.

c.   

      The new equilibrium price will be $12, which equates quantity demanded to quantity supplied. The equilibrium quantity remains 8,000 tickets.

6. The government has decided the free-market price of cheese is too low.

a.       Suppose the government imposes a binding price floor in the cheese market. Draw a supply-and-demand diagram to show the effect of this policy on the price of cheese and quantity of cheese sold. Is there a shortage or a surplus of cheese?

b.       Producers of cheese complain that the price floor has reduced their total revenue. Is this possible? Explain.

c.       In response to the cheese producers’ complaints, the government agrees to purchase all the surplus cheese at the price floor. Compared to the basic price floor, who benefits from this new policy? Who loses?

a.   The imposition of a binding price floor in the cheese market is shown in Figure 4. In the absence of the price floor, the price would be P₁ and the quantity would be Q₁. With the floor set at P_f, which is greater than P₁, the quantity demanded is Q₂, while quantity supplied is Q₃, so there is a surplus of cheese in the amount Q₃ – Q₂.

b.   The farmers’ complaint that their total revenue has declined is correct if demand is elastic. With elastic demand, the percentage decline in quantity would exceed the percentage rise in price, so total revenue would decline.

c.    If the government purchases all the surplus cheese at the price floor, producers benefit and taxpayers lose. Producers would produce quantity Q₃ of cheese, and their total revenue would increase substantially. However, consumers would buy only quantity Q₂ of cheese, so they are in the same position as before. Taxpayers lose because they would be financing the purchase of the surplus cheese through higher taxes.

7.  A recent study found that the demand and supply for Frisbees are as follows:

a.       What are the equilibrium price and quantity of Frisbees?  I always want graphs.

b.       Frisbee manufacturers persuade the government that Frisbee production improves scientists’ understanding of aerodynamics and thus is important for national security. A concerned Congress votes to impose a price floor of $2 above the equilibrium price. What is the new market price? How many Frisbees are sold?

c.       Irate college students march on Washington and demand a reduction in the price of Frisbees. An even more concerned Congress votes to repeal the price floor and impose a price ceiling $1 below the former price floor. What is the new market price? How many Frisbees are sold?

      a.   The equilibrium price of Frisbees is $8 and the equilibrium quantity is six million Frisbees.

b.   With a price floor of $10, the new market price is $10 because the price floor is binding. At that price, only two million Frisbees are sold, because that is the quantity demanded.

c.    If there’s a price ceiling of $9, it has no effect, because the market equilibrium price is $8, which is below the ceiling. So the market price is $8 and the quantity sold is six million Frisbees.

8.  Suppose the federal government requires beer drinkers to pay a $2 tax on each case of beer purchased. (In fact, both federal and state governments impose beer taxes of some sort.)

a.       Draw a supply-and-demand diagram of the market for beer without the tax. Show the price paid by consumers, the price received by producers and the quantity of beer sold. What is the difference between the price paid by consumers and the price received by producers?

b.       Now draw a supply-and-demand diagram for the beer market with the tax. Show the price paid by consumers, the price received by producers and the quantity of beer sold. What is the difference between the price paid by consumers and the price received by producers? Has the quantity of beer sold increased or decreased?

a.   Figure below shows the market for beer without the tax. The equilibrium price is P₁ and the equilibrium quantity is Q₁. The price paid by consumers is the same as the price received by producers.

b.   When the tax is imposed, it drives a wedge of $2 between supply and demand, as shown in Figure 6. The price paid by consumers is P₂, while the price received by producers is
P₂ ­– $2. The quantity of beer sold declines to Q₂.

9.Explain how buyer’s willingness to pay, consumer surplus and the demand curve are related.

      The price a buyer is willing to pay,  consumer surplus, and the demand curve are all closely related. The height of the demand curve represents the willingness to pay of the buyers. Consumer surplus is the area below the demand curve and above the price, which equals the price that each buyer is willing to pay minus the price actually paid.

10.  Explain how seller’s costs, producer surplus, and the supply curve are related.

      Sellers' costs, producer surplus, and the supply curve are all closely related. The height of the supply curve represents the costs of the sellers. Producer surplus is the area below the price and above the supply curve, which equals the price received minus each seller's costs of producing the good.

11.  In a supply-and-demand diagram, show producer and consumer surplus in the market equilibrium.

12.  What is efficiency? Is it the only goal of economic policymakers?

An allocation of resources is efficient if it maximizes total surplus, the sum of consumer surplus and producer surplus. But efficiency may not be the only goal of economic policymakers; they may also be concerned about equity¾the fairness of the distribution of well-being.

13.  Name two types of market failure. Explain why each may cause market outcomes to be inefficient .

Two types of market failure are market power and externalities. Market power may cause market outcomes to be inefficient because firms may cause price and quantity to differ from the levels they would be under perfect competition, which keeps total surplus from being maximized. Externalities are side effects that are not taken into account by buyers and sellers. As a result, the free market does not maximize total surplus.