# PROBLEMS AND APPLICATIONS

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PROBLEMS AND APPLICATIONS

1. An improvement in technology lowers the cost of producing DVD recorders Explain what happens to consumer surplus in the market for DVD recorders. Illustrate your answers with ‘diagrams.

2. Suppose the demand for French bread rises. Explain what happens to producer surplus in the market for French bread. Explain what happens to producer surplus in the market for flour.Illustrate your answers with diagrams.

3. Regis is hungry for a snack. Here is the value he places on a cupcake.

Value of first cupcake \$5

Value of second cupcake \$4

Value of third cupcake \$3

Value of fourth cupcake \$

a. From this schedule, derive Regis’ demand schedule Graph his demand curve for cupcakes.
b. If the price of a cupcake is \$3.50, how many cupcakes does Regis buy? How much consumer surplus does Regis get from his purchase? Show his consumer surplus in your graph.

c. If price falls to \$2.50, how does quantity demanded change? How does Regis’ consumer
surplus change? Show these changes in your graph.

4. Kelly enjoys baking cupcakes and selling them. Because her kitchen space is limited, making large numbers of cupcakes is more costly than making small amounts. Here” is the cost she incurs to produce each cupcake .

Cost of first cupcake  \$1.
Cost of second cupcake  \$2.
Cost of third cupcake  \$3.
Cost of fourth cupcake  \$4.

a. From this schedule, derive Kelly’s supply schedule. Graph her supply curve for cupcakes.

b. If the price of a cupcake is \$3.50, how many cupcakes does Kelly produce and sell? How much producer surplus does Kelly get from these sales? Show her producer surplus in your graph.

c. If the price rises to \$4.50, how does quantity supplied change? How does Kelly’s producer surplus change? Show these changes in your graph.

5. Consider a market in which Regis from Problem 3 is the buyer and Kelly from Problem 4 is the seller.

a. Use Kelly’s supply schedule and Regis’ demand schedule to find the quantity supplied and quantity demanded at prices of \$2.50, \$3.50, and \$4.50. Which of these prices brings supply and demand into equilibrium?

b. What are consumer surplus, producer surplus, and total surplus in this equilibrium?

c. If Kelly produced and Regis consumed one fewer cupcake, what would happen to total surpus?

d. If Kelly produced and Regis consumed one additional cupcake, what would happen to total surplus?

6. The cost of producing stereo systems has fallen over the past several decades. Let’s consider some implications of this fact.

a. Draw a supply-and-demand diagram to show the effect of falling production costs on the and quantity of stereos sold.

b. In your diagram, show what happens to consumer surplus and producer surplus.

c. Suppose the supply of stereos is very elastic. Who benefits most from falling production costsconsumers or producers of stereos?

7. There are four consumers willing to pay the following amounts for haircuts.

Jerry: \$7 Oprah: \$2 Ellen: \$8 Phil: \$5

There are foue haircutting businesses with the following costs:

FirmA: \$3 Firm B: \$6 FirmC: \$4 Firm D: \$

Each firm has the’ capacity to produce only one haircut. For efficiency, how many haircuts should be given? Which businesses should cut hair and which consumers should have their hair cut How large is the maximum possible total surplus suppose a technological advance reduces the cost of making computers.

a. Draw a supply-and-demand diagram to show what happens to price, quantity, consumer surplus, and producer surplus in the market for computers.

b. Computers and adding machines are substitutes. Use a supply-and-demand diagram to show what happens to price, quantity, consumer surplus, and producer surplus in the market for adding machines, Should adding machine producers be happy or sad about the technological advance in computers?

c. Computers and .software are complements. Draw a supply-and-demand diagram to show what happens-to price, quantity, consumer surplus, and producer surplus in the market for software. Should software producers be happy or sad about the technological advance in computers?

d. Does this analysis help e~plain why software producer Bill Gates is one of the world’s richest men?

9. Consider how health insurance affects the quantity of healthcare services performed. Suppose that the typical medical procedure has a cost of \$100, yet a person with health insurance pays only \$20 ‘Jut of pocket. Her insurance company pays the remaining \$80. (The insurance company recoups the \$80 through premiums, but the premium a person pays does not depend on how many procedures that person chooses to under.)

a. Draw the demand curve in the market for medical care. (In your diagram, the horizontal axis should represent the number of medical procedures.) Show the quantity of procedures demanded if each procedure has a price of \$100. .

b. On your diagram, show the quantity of procedures demanded if consumers pay only \$20 per procedure. If the cost of each procedure to society is truly \$100, and if individuals have health 150 Economics Principles and Application sinsurance as just described, will the number of procedures performed maximize total surplus Explain.

c. Economists often blame the health insurance system for excessive use of medical care. Given your analysis, why might the use of care be viewed as “excessive”?

d. What sort of policies might prevent this excessive use?

10. Many parts of California experienced a severe drought in the late 1980s and early 1990s.

a. Draw a diagram of the water market to show the effects of the drought on the equilibrium price and quantity of water.

b. Many communities did not allow the price of water to change, however. What is the effect of this policy on the water market? Show on your diagram any surplus or shortage that arises.

c. A 1991 op-ed piece in The Wall Street Journal stated that “all Los Angeles residents are etc do
cut their water usage by 10 percent as of March 1 and another 5 percent starting May 1, based on their 1986 consumption levels.” The author criticized this policy on the grounds of both efficiency and equity, saying “not only does such a policy reward families who ‘wasted’ more water back in 1986, it does little to encourage consumers who could make more drastic reductions, [and] punishes consumers who cannot so readily reduce their water use.” In what way is the Los Angeles system for allocating water inefficient? In what way does the system seem unfair?

d. Suppose instead that Los Angeles allowed the price of water to increase until the quantity demanded equaled the quantity supplied. Would the resulting allocation of water “toner efficient? In your view, would it be fairer or less fair than the proportionate reductions in water use
mentioned in the newspaper article? What could be done to make the market solution fairer?

11 The supply and demand for ice cream cones are described by the following equations:

Supply:  {f = – 30 + 38P
Demand:  rJD = 90 – 2P

Q IS the quantity of ice cream cones per day, and P IS the price per cone (in dollars).

a. Graph the supply curve and the demand curve. What IS the equilibrium price and quantity?

b. Calculate consumer surplus, producer surplus, and total surplus at the equilibrium.

c. If a dictator who hated ice cream were to outlaw the sale of ice cream cones, who would bear the larger burden-the buyers or the sellers of ice cream cones?

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