PIE

 PPF
 Supply Demand
 Tax Incidence
 Elasticity
 Elasticy x CS

1. Opportunity Cost

Suppose that France and Germany both produce schnitzel and wise. The following table
shows combination of the goods that each country can produce in a day :

France
Wine (bottles) Schnitzel (pounds)
0 8
1 6
2 4
3 2
4 0
Germany
Wine (bottles) Schnitzel (pounds)
0 15
1 12
2 9
3 6
4 3
5 0

a. Who has a comparative advantage in producing wine? Who has a comparative advantage
in producing schnitzel?

Oppotunity cost Wine (1bottles) Schnitzel

(1pounds)
France 2 Schnitzel 1/2 Wine
Germany 3 Schnitzel 1/3 Wine
 - absolute advantage in producing wine : France
- absolute advantage in producing schnitzel : Germany
- comparative advantage in producing wine : Germany
- comparative advantage in producing schnitzel : France

When France produces 1 more bottle of wine, it produces 2 fewer pounds of schnitzel.
When Germany produces 1 more bottle of wine, it produces 3 fewer pounds of schnitzel.
Therefore, France’s opportunity cost of producing wine–2 pounds of schnitzel–is less than
Germany’s–3 pounds of schnitzel. When Germany produces 1 more pound of schnitzel, it
produces 0.33 fewer bottles of wine. When France produces 1 more pound of schnitzel, it
produces 0.50 fewer bottles of wine. Therefore, Germany’s opportunity cost of producing
schnitzel–0.33 bottles of wine–is less than that of France–0.50 bottles of wine. We can conclude
that Germany has the comparative advantage in making wine and that France has the
comparative advantage in making schnitzel.

b. Draw its PPF

2. Opportunity Cost

You have exams in economics and chemistry coming up, and you have 5 hours available
for studying. The following table shows the trade-offs you face in allocating the time will
spend studying for each subject :
 Hours Spent Studying Midterm Score
Choice Economics Chemistry Economics Chemistry
A 5 0 95 70
B 4 1 93 78
C 3 2 90 84
D 2 3 86 88
E 1 4 81 90
F 0 5 75 91

a. Draw its PPF

Use data in the table to draw a PPF.

Label the vertical axis ‘Score on economics exam’

Label the horizontal axis ‘Score on chemistry exam’.

Make sure to lavel the values where your PPF intersects the vertical and horizontal axes

Compresed axis
 If you spend all five hours studying for your economics exam, you will score a 95 on the
exam; therefore, your production possibilities frontier will intersect the vertical axis at 95.
If you spend all five hours studying for your chemistry exam, you will score a 91 on the
exam; therefore, your production possibilities frontier will intersect the horizontal axis at
91.

b. Label the points representing choice C and D. If you are at choice C, what is your
opportunity cost of increasing your chemistry score by 4 points?

C→D
 chemistry score +4 points
 economics score -4 points.
Therefore, the opportunity cost of increasing your chemistry score by four points
is the four point decline in your economics score

3. Tax Incidence
You are given the following information about the market for motorcycles.

Market Demand: P = 400 – 4Q

Market Supply: P = 4Q

a. Find the equilibrium price and quantity in this market

400 – 4Q = 4Q

8Q = 400

Q = 50 motorcycles

P = 4(50) = $200 per motorcycle

b. What is the value of consumer & producer surplus in this market?

CS = (1/2)($400/motorcycle – $200/motorcycle)(50 motorcycles) = $5000

 PS = (1/2)($200/motorcycle – $0/motorcycle)(50 motorcycles) = $5000

d. Suppose that the government decides to impose an excise tax of $80 per motorcycle on
producers in this market. What will be the number of motorcycles sold in this market
once this tax is imposed?

Psnew = 80 + 4Q.

80 + 4Q = 400 – 4Q

8Q = 320 , Q = 40 motorcycles.

e. Given the tax described in part (d), what will be the tax incidence on consumers?

To find the tax incidence we must first find the price consumers pay once the excise tax
is imposed.

When Q = 40 motorcycles, the price consumers pay is

P = 400 – 4Q

P = 400 – 4(40) = $240/motorcycle.

Excise tax raises the price to consumers from $200 to $240.

The consumer tax incidence can be calculated as the change in price times the number of
motorcycles sold once the tax is imposed.

CTI = ($240/motorcycle -$200/motorcycle)(40 motorcycles) = $1600.

4. Supply Demand + Tax

Consider an economy with the supply of soccer balls qs = 4p and the demand for soccer
balls given by qs = 270 – 5p.
 a) Calculate the equilibrium price and quantity.

Subtitute p = 30 →

b) Graph the supply and demand functions.

First we write both supply and demand having price on the left hand side,

c) Calculate both the consumer and producer surplus.

CS = 0.5 * (54 – 30) * 120 = 1440

PS = 0.5 * 30 * 120 = 1800

Now suppose the government imposes a sales tax, such that consumers much pay $5 to the
government each time they buy a soccer ball.

d) Calculate the new equilibrium price and quantity.

Now consumers pay $5 more for each unit of soccer ball that they purchase, there
fore new demand curve is:
 ( )

Supply is unchanged,

Equating new demand and supply,

e) Draw a graph marking the after tax consumer surplus and producer surplus as well as
the tax revenue

f) Calculate the consumer surplus and the producer surplus

CS = 0.5 * (54 – 32.22) * 108.88 – 1185.70

 PS = 0.5 * 27.22 * 108.88 = 1481.85

5. Elasticity of demand
If the price rises by 3 %, the quantity demanded falls by 1.5 %. Calculate the price
elasticity of demand.
e = - 1.5/3 = - 0.5 → 0.5

6. Elasticity of demand : Midpoint

If the price falls from 6 to 4, the quantity demanded rises from 8000 to 12000.
a. Calculate the price elasticity of demand by using midpoints.

% Change in quantity = =( = 4000/10000 = 2/5

)

% Change in price = =( = 2/5

)

e= = 1 (unitary)

b. What happens to turnover (Price * Quantity) due to the price change?

Before = P1*Q1 = 6*8000 = 48000
After = P2*Q2 = 4*12000 = 48000
Turnover unchanged
7. Elasticity of demand : indentify
Determine the price elasticity of demand in the special cases 1 to 3

1. e = 0 2. e = infinity 3. e = 1 (unitary)
8. Elasticity and tax incidence

Answer