Intermediate Microeconomic Theory (3550)

Homework Assignment 1 - Answers

Due: Thursday, September 4, 2008
Please answer clearly, concisely and in complete sentences. Remember your work must be
legible to receive credit.
This homework assignment is based on Chapter 1 of the course textbook, Price Theory.
(The following scenario applies to questions 1 through 3.) Professor Daynard of Northwestern University
wants for smokers or their families to win liability verdicts or settlements that will raise the price
of cigarettes. The basic premise of his campaign: Cigarettes cause cancer, and the tobacco
industry knows it. When smokers suffer from tobacco-related illnesses, it is the fault of the
industry, not of the smokers. Sometimes people who do not recognize him offer him a cigarette.
He always takes the cigarette and throws it away. This happens ten times a year, and he figures
that this way there are ten fewer cigarettes for other people to smoke.
1.

How does Professor Daynards policy affect the demand and supply curves for cigarettes?
The demand curve for cigarettes shifts right by 10 cigarettes per year.

2.

How does Mr. Kings policy affect the equilibrium quantity of cigarettes?
The equilibrium quantity of cigarettes increases by less than ten per year.

3.

Is Professor Daynard correct in believing that he reduces the number of cigarettes that
other people smoke? Is he correct in believing that he reduces it by ten per year? How do
you know?
The number of cigarettes smoked by others is equal to the new equilibrium quantity
minus the ten that are thrown away. Thus, he is correct in believing he reduces the
number of cigarettes that other people smoke, but incorrect in believing that he reduces
that number by ten per year.

4.

If we observe that fewer cars are being purchased this year than last year, then we should
expect the price of cars to fall. Is this statement true or false? Explain how you know.
False. We know only that the quantity has decreased. This might equally well be caused
by a decrease in demand (in which case price must fall) or by a decrease in supply (in
which case the price must rise).

5.

Mathematically, how does the equilibrium price of beef vary as the price of cows changes
if the variables that affect demand are held constant at their typical values?
Qd = 286 20p
Qs = 178 + 40p 60pc

Hint: First solve for the equilibrium price of beef in terms of the price of cows. Then show how
the equilibrium price of beef varies with the price of cows.
The demand function doesnt depend on the price of cows. We have to use the supply
function to see how equilibrium changes.
The equilibrium is determined by equating the right-hand sides of the demand and supply
equations:
286 20p = 178 + 40p 60pc
Rearranging terms, we find that 60p = 108 + 60pc.
Dividing both sides by 60, we have an expression for the equilibrium price of processed
beef as a function of the price of cows: p = 1.8 + pc.
We know from our above equation (p = 1.8 + pc) that p = pc.
Any increase in the price of cows causes an equal increase in the price of processed beef.
We can find the equilibrium quantity as a function of the price of cows by substituting
this expression for the equilibrium price into the demand equation (or the supply
equation).
Q = 286 20p
Q = 286 20 (1.8 + pc)
Q = 250 - 20pc
6.

Explain and illustrate with a graph the potential effect(s) of making it more difficult to
remove child safety caps on medicines.
According to a 1984 paper by Viscusi in the American Economic Review, when child
safety caps on medicines are made more difficult to remove, sufficiently many people
stop using the caps at all so that there is an increase in the number of accidental
poisonings.

Probability of accidental
poisoning.

Quantity of easyopening medicine bottles

(i.e. non childproof medicine caps)

(The following scenario applies to questions 7 through 9.) Suppose that an excise tax of 50 cents apiece is
imposed on oranges. The original supply and demand curves are given as follows:
Q = 1000 - 200P and
Q = 800P.
7.

What are the equations for the new supply and demand curves?
The excise tax adds 50 cents to every orange sold. The supply curve therefore must be
changed by 50 cents. To most easily see this, convert Q = 800P to the inverse P =
1/800Q. Subtracting 50 cents from the price of each orange gives the new equation: P - .5
= 1/800Q, or solving for the supply curve again (as opposed to the inverse): 800P 400 =
Q. This is the new supply curve. The demand curve remains the same.

8.

What is the new equilibrium price and quantity of oranges?

The new price is obtained by equating the new supply curve with the initial demand
curve. 800P 400 = 1000 200P. This simplifies to P = $1.40. When the price is $1.40,
consumers demand Q = 1000 200($1.40) = 720 oranges per day.

9.

What is the new post tax price from the suppliers point of view?
Although oranges now have a price of $1.40 each, suppliers receive 50 cents less per
orange, or 90 cents each.

10.

Evaluate the following argument. In the cities, there are more medical services provided
than there are in rural areas. Nevertheless, the price of medical services is higher in the
cities. This indicates that our simple supply and demand graphs do not apply to markets
for things like medical care.
This statement is not true. We are given information on supply of medical services in
urban versus rural areas and also on the price of medical services in urban and rural
markets. We are not given information on demand. It is feasible for the supply of medical
services to be lower in rural areas and also for demand to be lower, which would result in
a lower price in rural areas. You might graph this result to clarify it for yourself if needed.