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ME Problem Set II

PGP 2017-19

1. Much of the demand for U.S. agricultural output has come from other countries. In 2014, 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 the farmers have much reason to worry?
(b) Now suppose the U.S. 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?

2. The director of a theater company in a small college town is considering changing the way
he prices tickets. He has hired an economic consulting firm to estimate the demand for
tickets. The firm has classified people who go the theater into two groups, and has come up
with two demand functions.The demand curves for the general public ( Qgp ) and students ( Qs )
are given below:
Qgp 500 5P
Qs 200 4P
(a) Graph the two demand curves on one graph, with P on the vertical axis and Q on the
horizontal axis. If the current price of tickets is $35, identify the quantity demanded by each
(b) Find the price elasticity of demand for each group at the current price and quantity.
(c) Is the director maximizing the revenue he collects from ticket sales by charging $35 for
each ticket? Explain.
(d) What price should he charge each group if he wants to maximize revenue collected from
ticket sales?

3. Suppose that the market for air travel between Chicago and Dallas is served by just two
airlines, United and American. An economist has studied this market and has estimated that
the demand curves for round-trip tickets for each airline are as follows: QdU = 10,000
100PU + 99PA (Uniteds demand) QdA = 10,000 100PA + 99PU (Americans demand) where
PU is the price charged by United, and PA is the price charged by American.
(a) Suppose that both American and United charge a price of $300 each for a round-trip ticket
between Chicago and Dallas. What is the price elasticity of demand for United flights
between Chicago and Dallas?
(b) What is the market-level price elasticity of demand for air travel between Chicago and
Dallas when both airlines charge a price of $300?

4. Ms.Pampered consumes only two goods, pizza (P) and burgers (H) and considers them to
be perfect substitutes, as shown by her utility function: U(P, H) = P + 4H. The price of pizza
is $3 and the price of burgers is $6, and Ms.Pampereds monthly income is $300. Knowing
that she likes pizza, her grandmother gives her a birthday gift certificate of $60 redeemable
only at Pizza Hut. Though Ms. Pampered is happy to get this gift, her grandmother did not
realize that she could have made her exactly as happy by spending far less than she did. How
much would she have needed to give her in cash to make her just as well off as with the gift

5. In February 2011, there was an unexpected temporary surge in the demand for notebook
hard drives, increasing the monthly demand for hard drives by 25 percent at any possible
price. As a result of this, the price of notebook hard drives increased by $5 per megabyte by
the end of February. This surge in demand ended in March 2011, and the price of notebook
hard drives fell back to its level just before the demand surge occurred.
Later that year, in August 2011, an increase in the demand for notebook computers occured,
increasing the monthly demand for hard drives by 25 percent per month at any possible price.
Nine months later, the price of notebook hard drives had increased, by $1 per unit.
In both circumstances, the market experienced a shift in demand of exactly the same
magnitude. Yet, the change in the equilibrium price appears to have been different. Why?

6. . A recent study by Web Mystery Shoppers International indicates that holiday gift cards are
becoming increasingly popular at online retailers. Two years ago, online shoppers had to really
hunt at most e-retailers sites to purchase a gift certificate, but today it is easier to purchase gift
cards online than at traditional retail outlets. Do you think online gift cards are merely a fad?

7. Robinson Crusoe lives alone on a deserted island. He can spend his time gathering coconuts
or bananas. He has 16 hours available each day and can gather 4 coconuts in an hour or 8
bananas in an hour. Draw Robinson's budget constraint. Given that Robinson's Marginal
Utility of bananas is always 25 and his Marginal utility of coconuts is always 100, what is his
optimal consumption?
One day an individual from a neighbouring island arrives by boat and offers to exchange any
number of fruits at a rate of 1 coconut for 1 banana. Draw Robinson's budget constraint at this
exchange rate assuming he will now spend all his time gathering bananas. Is Robinson better
off? What does he consume?

8. Bobby is a college student who has $500 of income to spend each semester on books
and pizzas. The price of a pizza is $10 and the price of a book is $50. Draw Bobby's
budget constraint.
Now, suppose Bobby's parents buy her a $300 gift certificate each semester that can
only be used to buy books. (Bobby thinks her parents are crazy!!! They always make
sure that Bobby lives a miserable life with books only!!) But eventually Bobby could
find herself better-off with those gift certificates. Why?

9. Your preferences over pizza (x) and other goods (y) are given by U(x, y) = xy, with
associated marginal utilities MUx = y and MUy = x. Your income is $120.
a) Calculate your optimal basket when Px = 4 and Py = 1.
b) Calculate h income and substitution effects of a decrease in the price of food to $3.

10. If consumers do not buy less of a commodity when their incomes rise, they will
surely buy less when the price of the commodity rises. Why?