ECO 213 (BS ACF 2K15 [A and B])

Assignment 1

Due Date: 25th March 2016 by 12 PM

Instructor: Zainab Vohra

Submission Instructions:

1. You need to submit your assignment in hard copy (it could be hand written or typed) in
Muhammad Ali Kiani’s office (Room 108) in NBS ground floor.
2. Late assignments will not be accepted.
3. Your assignment should be your individual work.
4. The assignment solutions will be posted by Friday 25th March 11.59pm

Question 1

The following table shows the average retail price of butter and the Consumer Price Index from 1980 to

2000, scaled so that the CPI = 100i n 1980.

Year 1980 1985 1990 1995 2000

CPI 100 130.58 158.56 184.95 208.98
Retail price of 1.88 2.12 1.99 1.61 2.52
butter

a) Calculate the real price of butter in 1980 dollars. Has the real price increased/ decreased/ stayed
the same from 1980to 2000?
b) What is the percentage in the real price of butter from 1980 to 2000?

Question 2
The table below shows the retail price and sales for instant coffee and roasted coffee for 1997and 1998.

Year Retail Price of Sales of Instant Retail price of Sales of roasted

Instant Coffee Coffee roasted coffee coffee
1997 10.35 75 4.11 820
1998 10.48 70 3.67 850

a) Using these data alone, estimate the short-run price elasticity of demand for roasted coffee.
Derive a linear demand curve for roasted coffee. (Assume the long run for the coffee market is 3
years)
b) Using these data alone, estimate the short-run price elasticity of demand for roasted coffee.
Derive a linear demand curve for roasted coffee. (Assume the long run for the coffee market is 3
years)
 c) Calculate the cross elasticity of demand for roasted coffee and instant coffee. Are roasted coffee
and instant substitutes or complements?

Question 3
Much of the demand for U.S. agricultural output has come from other countries. In 1998, the total
demand for wheat was Q = 3244 - 283P. Of this, total domestic demand was QD = 1700 - 107P, and
domestic supply was Qs = 1944 + 207P. Suppose the export demand for wheat falls by 40 percent.
a) U.S. farmers are concerned about this drop in export demand. What happens to the free-market
price of wheat in the United States? Do farmers have much reason to worry?
b) Now suppose the US government wants to buy enough wheat to raise the price to $3.50 per
bushel. With the drop in export demand, how much wheat would the government have to buy?
How much would this cost the government?

Question 4
What are the four basic assumptions about individual preferences? Explain the meaning of each.

Question 5
Brenda wants to buy a new car and has a budget of $25,000. She has just found a magazine that assigns
each car an index for styling and an index for gas mileage. Each index runs from 1 to 10, with 10
representing either the most styling or the best gas mileage. While looking at the list of cars, Brenda
observes that on average, as the style index increases by one unit, the price of the car increases by $5000.
She also observes that as the gas-mileage index rises by one unit, the price of the car increases by $2500.
a) Illustrate the various combinations of style (S) and gas mileage (G) that Brenda could select with
her $25,000budget. Place gas mileage on the horizontal axis.
b) Suppose Brenda's preferences are such that she always receives three times as much satisfaction
from an extra unit of styling as she does from gas mileage. What type of car will Brenda choose?
c) Suppose that Brenda's marginal rate of substitution (of gas mileage for styling) is equal to
S/(4G).What value of each index would she like to have in her car?
d) Suppose that Brenda's marginal rate of substitution (of gas mileage for styling) is equal to (3S)/G.
What value of each index would she like to have in her car?

Question 6
Connie has a monthly income of $200that she allocates among two goods: meat and potatoes.
a) Suppose meat costs $4 per pound and potatoes $2 per pound. Draw her budget constraint.
b) Suppose also that her utility function is given by the equation U(M, P) = 2M + P. What
combination of meat and potatoes should she buy to maximize her utility? (Hint: Meat and
potatoes are perfect substitutes.)
c) Connie's supermarket has a special promotion. If she buys 20 pounds of potatoes (at $2 per
pound), she gets the next 10 pounds for free. This offer applies only to the first 20 pounds she
buys. All potatoes in excess of the first 20 pounds (excluding bonus potatoes) are still $2 per
pound. Draw her budget constraint.
 d) An outbreak of potato rot raises the price of potatoes to $4 per pound. The supermarket ends its
promotion. What does her budget constraint look like now? What combination of meat and
potatoes maximizes her utility?

Question 7

a) Orange juice and apple juice are known to be perfect substitutes. Draw the appropriate price-
consumption curve (for a variable price of orange juice) and income-consumption curve.
b) b. Left shoes and right shoes are perfect complements. Draw the appropriate price-consumption
and income-consumption curves.

Note: Draw the price-consumption and income-consumption curves on separate indifference maps

Question 8
Maurice has the following utility function:

U(X, Y) = 20X + 80Y – X2 – 2Y2

where X is his consumption of CDs with a price of $1and Y is his consumption of movie videos, with a
rental price of $2.He plans to spend $41 on both forms of entertainment. Determine the number of CDs
and video rentals that will maximize Maurice's utility.

Question 9

Suppose a chair manufacturer is producing in the short run (with its existing plant and equipment). The
manufacturer has observed the following levels of production corresponding to different numbers of
workers:

Number of Workers Number of chairs

1 10
2 18
3 24
4 28
5 30
6 28
7 25

a) Calculate the marginal and average product of labor for this production function. Plot the total
product, marginal product and average product on a graph.
b) Does this production function exhibit diminishing returns to labor? Explain.
c) Explain intuitively what might cause the marginal product of labor to become negative.
Question 10
Do the following functions exhibit increasing, constant, or decreasing returns to scale?What happens to
the marginal product of each individual factor as that factor is increased and the other factor held
constant?
a. q = 3L + 2K
b. q = (2L + 2K)1/2
c. q = 3LK2
d. q = Ll/2Kl/2
e. q=4Ll/2+4K

Question 11

The short-run cost function of a company is given by the equation TC = 200 + 55q, where TC is the total
cost and q is the total quantity of output, both measured in thousands.

a. What is the company's fixed cost?

b. If the company produced 100,000 units of goods, what would be its average variable cost?
c. What would be its marginal cost of production?
d. What would be its average fixed cost?
e. Suppose the company borrows money and expands its factory. Its fixed cost rises by $50,000, but its
variable cost falls to $45,000 per 1000 units. The cost of interest (i) also enters into the equation.
Each 1-point increase in the interest rate raises cost by $3000. Write the new cost equation.

Question 12

A chair manufacturer hires its assembly-line labor for $30 an hour and calculates that the rental cost of its
machinery is $15 per hour. Suppose that a chair can be produced using 4 hours of labor or machinery in
any combination. If the firm is currently using 3 hours of labor for each hour of machine time, is it
minimizing its costs of production? If so, why? If not, how can it improve the situation? Graphically
illustrate the isoquant and the two isocost lines for the current combination of labor and capital and for the
optimal combination of labor and capital.

Question 13
A computer company's cost function, which relates its average cost of production AC to its cumulative
output in thousands of computers Q and its plant size in terms of thousands of computers produced per
year q (within the production range of 10,000 to 50,000 computers),is given by

AC = 10 - 0.lQ + 0.3q

a. Is there a learning-curve effect?

b. Are there economies or diseconomies of scale?
c. During its existence, the firm has produced a total of 40,000 computers and is producing 10,000
computers this year. Next year it plans to increase production to 12,000 computers. Will its average cost
of production increase or decrease? Explain.
Question 14

Because industry X is characterized by perfect competition, every firm in the industry is earning zero
economic profit. If the product price falls, no firm can survive. Do you agree or disagree? Discuss.

Question 15
A sales tax of $1 per unit of output is placed on a particular firm whose product sells for $5 in a
competitive industry with many firms.
a. How will this tax affect the cost curves for the firm?
b. What will happen to the firm's price, output, and profit?
c. Will there be entry or exit in the industry?

Question 16
Suppose you are the manager of a watchmaking firm operating in a competitive market. Your cost of
production is given by C = 200 + 2q2, where q is the level of output and C is total cost. (The marginal
cost of production is 4q; the fixed cost is $200.)
a) If the price of watches is $100, how many watches should you produce to maximize profit?
b) b. What will the profit level be?
c) c. At what minimum price will the firm produce a positive output?

Question 17
The demand for labor by an industry is given by the curve L = 1200 - 10w, where L is the labor demanded
per day and w is the wage rate. The supply curve is given by L = 20w. What is the equilibrium wage rate
and quantity of labor hired? What is the economic rent earned by workers?

Question 18
Using the same information as in Exercise 8, suppose now that the only labor available is controlled by a
monopolistic labor union that wishes to maximize the rent earned by union members. What will be the
quantity of labor employed and the wage rate? How does your answer compare with your answer to the
previous questions?
Discuss. (Hint: The union's marginal revenue curve is given by MR = 120 - 0.2L.)

Question 19
A firm uses a single input, labor, to produce output q according to the production function q = 8.√L.
The commodity sells for $150 per unit and the wage rate is $75 per hour.
a) Find the profit-maximizing quantity of L.
b) Find the profit-maximizing quantity of q.
c) What is the maximum profit?
d) Suppose now that the firm is taxed $30 per unit of output and that the wage rate is subsidized at a
rate of $15 per hour. Assume that the firm is a price taker, so the price of the product remains at
$150. Find the new profit-maximizing levels of L, q, and profit.
e) Now suppose that the firm is required to pay a 20 percent tax on its profits. Find the new profit
maximizing levels of L, q, and profit.