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PROBLEM SET NUMBER 1 ECON601

Handout on 25 January 2009 Answers Provided on 1 February 2009

1. A consumer exhibits a Utility Function U(X,Y) which has the following functional form, and income constraint (M): U = U(X,Y) = X Y I = X Px + Y Py a) In the space below, derive the Generalized Demand Curves for both X and Y:

b) What are the values of the X and Y, when the following conditions hold: =.4 and =.6 and Px = $3.00 and Py =$4.00 and I = $100

2. The example of a Households Demand for Clean Air is as indicated below. This question has 3 parts: a, b, and c.
$2000

Price

$1000

Demand (D)
5

Pollution reduction level

If the value per unit of pollution reduction is represented by Prices on the y-axis, and the Quantity of Pollution Reduction is depicted on the x-axis, answer the following questions: a) What is the total value that the Household places on 5 units of pollution reduction?

b) How much does the Household actually pay for 5 units of pollution reduction?

c) What is the net-value of the 5-units of pollution reduction to Household?

3. Given the following linear demand curve for good X:

P( x) = b Where, X = level of output b = y-intercept a = x-intercept a) Derive the Total Revenue Function

b X a

b) Derive the Marginal Revenue Function

c) Graphically show the relationship between the Total Revenue Function and the Linear Demand Curve, highlighting the various areas of Elastic, Unitary Elastic, and Inelastic demand.

4. Demand and supply elasticities can assist business and policy makers in answering important questions of public policy. For example, would selling oil from the Arctic National Wildlife Refuge (ANWR) in the US State of Alaska substantially affect the price of oil? In other words, what would be the effect of ANWR on the world equilibrium price of oil, given the following information:

The original world equilibrium price is $50.00 and the Quantity Demand at that
price is 82 (in millions of barrels of oil);

At the original world price and quantity the Elasticity of Demand = -0.4 Daily ANWR production would be .8 (million barrels of oil per day)

1. Solve for the equation of the long-run linear Consumer Demand Curve, for the pre-ANWR output and price:

The original Elasticity of Supply = .30

2. Solve for the equation of the long-run linear Supply Curve, for the pre-ANWR output and price:

3. Determine the post-ANWR long-run Supply Curve (hint: notice that the slope of the original Supply Curve does not change, and the original Demand Curve does not change position. What is occurring here is a Change in Supply): 4. Utilizing the original Demand Curve, and the post-ANWR Supply Curve determined the post-ANWR Market Equilibrium Price: 5. Substitute the new Equilibrium Price into the Demand Curve or the post-ANWR Supply Curve, the new post-ANWR Equilibrium Output Level can be determined. This difference between this Output Level and the Original Output Level of (82 million barrels of oil per day). The answer to this question will assist you in answering the original question: would selling oil from the Arctic National Wildlife Refuge (ANWR) in the US State of Alaska substantially affect the price of oil?

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