Conservation Strategy Fund Course Economie Tools for Ecosystem Conservation Microeconomics: Theory & Practice David W. Johnson Harvard University to Practice Problems Computers 1000 800 300 500 600 ¥ 700 675 Yes, it faces increasing opportunity costs of wine production. Opportunity cost of wine is the amount of computers you have to give up to get one more cask of wine.Where Opp cost of wine ‘Ato B | 200 comp /300 wine = 2/3 comp for 1 wine B to C | 200 comp/200 wine = I comp for I wine C10 D [200 comp / 100 wine = 2 comp for | wine DtoE | 200 comp/75 wine = 8/3 comp for I wine Eto F [200 comp/25 wine = 8 comp for 1 wine | In the A to B region, you have to give up 200 computers to get 300 casks of wine, or you have to give up 2/3 of a computer to get | more cask of wine, so the opportunity cost of one cask of wine in that region is 2/3 of a computer. Notice that as you increase production of wine (as you move from A to F), the opportunity cost of wine increases. b. Let's think about what would happen if you only wanted to produce computers. Then the bigger feet invention won’t have any elect on the total number of computers you can produce, which means that point A stays the same, Next, think about only producing wine. The big feet would allow you to produce more casks than before, so point F is moved to the right. At the other in between points, since you are producing some wine, the big feet would allow you to produce more than before, so those points move to the right also, Computers If Microgrigio annexes a nearby tropical island, and people from neighboring countries move to the island, it is clear they will be able to use the extra land and labor to produce more of each type of good. However, the information that the land is particularly well suited fo growing grapes suggests that the PPF will shift out proportionately more along the wine axis than along the computer axis. At any given level of computers produced, Microgrigio faces a LOWER marginal opportunity cost of wine because, say, they can bulldoze the Microsoft plant on the island and replace it with vineyards in that very fertile soil. Perhaps, then, as ‘you may already surmise, it might be efficient to put ONLY vineyards on the island and then build the necessary Microsoft plants ONLY on the mainland! Indeed! See new PPF below:Comeuct ers 1000 Foo Wine d) Two answers are proposed to this questions 1) Poor allocation of workers. Suppose that our economy consists of 3 agents. They happen to be named Bill Gates (computer wiz), Pat, and Ernest Gallo (wine buf?) (This is where our assumption of heterogeneous labor comes in). Now, rather than with our typical PPF, we have Bill Gates leaving computer production first, Pat leaves second, and Gallo leaves third. This also means that when we switch from producing wine to computers, Gallo leaves first, Pat second, and Gates third. This gives us a PPF that looks like the following: Bottles of Wine vs. Computers Computers Bottles of WineThis technology is inefficient because clearly, we'd be better off if Gates was the last person to leave the computer industry and if Gallo was the last to leave the wine industry. If this were the case, we'd have a “normal” PPF, Efficient Allocation of Workers (Extra Credit Answer!): Suppose our economy consists of the following three people: Bill Gates, Paul Allen, and Steve Wozniak You all should know who Gates and Allen are because they are among the richest people on the planet and they have buildings named after them on campus. Wozniak built the first Apple computer prototype... by himself. 1 will produce an economy with decreasing opportunity costs to computers. To formulate an example with decreasing opportunity costs to wine, switch the numbers and find the names of famous wine makers. Now, suppose that these three people have complementary production ability in terms of computers. Suppose that all three are pretty bad at making wine. In particular, regardless of which particular individual works, the economy produces on bottle of wine for each person placed in that sector. LE. if any one of the three makes wine, the economy has 1 bottle of wine. If two work to make wine, the economy has 2 bottles of wine. Also, suppose that if any one of the three makes computers, then the economy produces one computer. Now, if two work together to make computers, the economy has 3 computers. If all three of these technology titans work together to make computers, they will be able to produce 6 ‘computers for this economy. This means that optimal output is defined by the following table: Workers in Wine Workers in Computers Computers manufactured Bottles of wine 3 2 1 0 0 0 3 1 1 2 2 3 1 3 6 0 The opportunity cost of going from 0 to 1 computers is 1 bottle of wine per computer. The opportunity cost of going from 1 to 3 computers is 1/2 ofa bottle of wine per computer. The opportunity cost of going from 3 to 6 computers is 1/3 of a bottle of wine per computer. The PPF is:co a Bottles of Wine vs. Computers Computers Bottles of Wine Note: This example is completely efficient! It just relies on economies of scale. IF the company spends MORE than $50 in labor costs and time investigating the claim, it IS a sound business practice to just pay the claim up front. Why? Well, would YOU spend $75 in labor costs to SAVE your having to pay a $50 claim? | think not (OPPORTUNITY COSTS!!!) HOWEVER, over time, this company should indeed monitor HOW MANY $50 claims show up on a week basis......why? Well, if some enterprising (and dishonest) person figures out that $50 claims are paid immediately, this person will split up their fraudulent $1000 claim into 20 smaller $50 claims and then be quite happy to make $1000 illegally. By the way, this company was out of business when I returned the next summer, 0 pethaps this policy helped do them in, Really stupid practice, here. Sending a collection agent for a $10 unpaid bill? Only if that agent works for free, it would seem, Here, again, a solid opportunity cost argument carries the day To get the highest average grade, you want to maximize the total number of points in all three classes. There are only 6 hours, so you have to allocate your time in the way that will maximize your total number of points. Let's look at the marginal benefit of each hour of studying for the 3 subjects, for the first few hours. The marginal benefit is the number of extra points you gain from studying that subject for one more hour:Economics Math Stats Hours Marginal Benefit___ MB MB a 25 12 10. 2 20 - 10 5 _ ae 10 9 2 4 8 i 1 ‘So what are you going to do with the first hour? You get the highest point increase from spending that first hour on Econ, because 25 is higher than 12 or 10. What about the second hour? Again it’s econ, because 20 is still higher than 12 or 10. For the third hour, you want to spend it on Math, because the point increase is 12 compared to 10 for both econ and stats. For the 4", you can spend it on any of the 3, because the MB is 10 for all of them, For the 5" and 6", spend it on whichever you didn’t spend it on in the 4" or 5S" hours (for example. spent the 4"" on math, 5" on stats, and 6" on econ), Also, since the MB of studying economies goes down, it exhibits diminishing returns a. FALSE This question unfortunately deals with the semant of “demand” vs. “quantity demanded.” The true statement is that a decrease in supply results in a decrease in QUANTITY demanded. There is a movement along the demand curve. b. False. Suppose the stars are the observed equilibrium price and quantity. Then the positive correlation can be explained by a moving demand curve (also other explanations) ~ lad) (Sho YS a (aniss) Let’s look at which change has the effect that we want. a. A fall in price of flour makes bagels cheaper to make, so it shifts the supply eurve for bagels out. This results in an increase in the quantity demanded of bagels. / Since bagels and cream cheese are complements, this makes the demand for cream cheese rise, increasing the price of cream cheese. So this could be responsible for the increase in the equilibrium quantity of bagels and price of cream cheese. /¥) Cream Cheese & Bagels YF DI eG) FF Alogi A fall in the price of milk makes the supply curve for cream cheese shift out. This makes the price of cream cheese go down, and the quantity demanded go up. Since they are complements, this makes the demand for Bagels increase, and the quantity demanded increase. Since the price of cream cheese fell, this could not explain it. Cream Chee D2 s SI ae ph et 2 ¥ ot AN ph e \ Sek ; s\ a* & Vays) & GP GL bigls) | b. A rise in the price of flour makes bagels more expensive to make, so it shifts the supply curve for bagels in. This results in an decrease in the quantity demanded of awe bagels. Since bagels and cream cheese are complements, this makes the demand for \ cream cheese fall, decreasing the price of cream cheese. So this could not be w responsible for the decrease in the equilibrium quantity of bagels and increase in rice of cream cheese. ps . bi SN rH ge 4Cream Cheese | DI Hae OO A rise in Brie milk makes & supply elirve for cream chetse shitt in. This makes the price of cream cheese go up, and the quantity demanded go down. Since they are complements, this makes the demand for Bagels decrease, and the quantity demanded decreas is does explain the increase in the price of cream cheese and decrease in the quantity of bagels. \ i ) Cream Cheese Bagels© ‘One Car _ One Ton of 7 [us ~ 4 1/10 Japan 18 [ us See Figure 3. With 100 milion workers and 4 cars per worker, if either economy were devoted completely to cars, it could make 400 milion cars. Because a U.S. worker can produce 10 tons of grain, if the United States produced only grain it would produce 1,000 million tons. Because a Japanese worker can produce § tons of grain, if Japan produced only grain it would produce 500 million tons. These are the intercepts of the production possibilities frontiers shown in the figure. Note that because the trade-off between cars and grain is constant for both countries, the production possibilities frontiers are straight lines. Cars (millions) = 8 8 US. 500 1000 Grain (millions of tons) Figure 3 Because a U.S. worker produces either 4 cars or 10 tons of grain, the opportunity cost of one car is 2 1/2 tons of grain, which Is 10/4. Because a Japanese worker produces either 4 cars or § tons of grain, the opportunity cost of one car is 1 1/4 tons of grain, which is 5/4. Similarly, the U.S. opportunity cost of a ton of grain is 2/5 car (4 divided by 10) and the Japanese opportunity cost of a ton of grain is 4/5 car. This results in the following table: $$ ee ect [_ | One Car (in terms of tons of grain given up) terms of cars given up) 24/2 as "a 1/4 4/5‘Neither country has an absolute advantage in producing cars, because they are equally productive (the same output per worker); the United States has an absolute advantage in producing grain, because it is more productive (greater output per worker), Japan has a comparative advantage in producing cars, because it has a lower ‘opportunity cost in terms of grain given up. The United States has a comparative advantage in producing grain, because it has a lower opportunity cost in terms of cars given up, With half the workers in each country producing each of the goods, the United States ‘would produce 200 milion cars (50 milion workers times 4 cars each) and 500 milion tons of grain (50 million workers times 10 tons each), Japan would produce 200 milion ‘ars (50 million workers times 4 cars each) and 250 milion tons of grain (50 million workers times 5 tons each). From any situation with no trade, in which each country is producing some cars and some grain, suppose the United States changed one worker from producing cars to producing grain. That worker would produce 4 fewer cars and 10 additional tons of grain. Then suppose the United States offers to trade 7 tons of grain to Japan for 4 cars. The United States will do this because it values 4 cars at 10 tons of grain, so it will be better off if the trade goes through. Suppose Japan changes one worker from producing grain to producing cars. That worker would produce 4 more cars and 5 fewer tons of grain. Japan will take the trade because it values 4 cars at S tons of grain, so it will be better off. With the trade and the change of one worker in both the United States and Japan, each country gets the same amount of cars as before and both get additional tons of grain (3 for the United States and 2 for Japan). Thus, by trading and changing their production, both countries are better off, |fh, WeRD PPE. gs oll) Jy & we nye = | 00 ace vs J Snot 4000 Ts spe 4at9)os In this question, you want P* to FALL and Q* to stay the same. Thus, if you’re dealing with Sand D curves NEITHER of which are perfectly inelastic, you will need changes in Sand D that predict the same qualitative changes to P* BUT opposing qualitative changes to Q*. By that logic, then, we would want an DECREASE in demand (by itself putting downward pressure on both P* and Q*) and an INCREASE in supply (by itself putting downward pressure on P* but upward pressure on Q*), This combination could indeed result in a DECREASE in P* (via both forces) and NO CHANGE in Q* (if those forces balance in their effects on Q*). See Figure I below. s Now, allowing either S or D to be perfectly inelastic FIXES Q* because perfect inelasticity implies a vertical curve. Thus, if, for example, you decide to make S perfect inelastic, you will need a change in D to result in a FALL in P* -- well, we have such a change in D from above. So, the combination of perfectly inelastic $ with a DECREASE in D will deliver. See Figure I below. - SSimilar logic applies when we allow D to be perfectly inelastic. Then, we need the change in $ to deliver the FALL in P*. Thus, a perfectly inelastic D curve with an INCREASE in § is the last combination that will back out the data we observe. See Figure Ill below. p YA a, At the equilibrium, Quantity Demanded equals Quantity Supplied. So 4000 — 40P = 1000 + 60P 3000 = 100P P=30 now find Q: Q= 4000 — 4060 = 2800 100 30 1000 2800 4000Surplus of 1000 2400 3400 With the price floor of $40/sweatshirt, the new QD is: QD = 4000 — 40*40 = 2400 and the new QS is: QS = 1000 + 60*40 = 3400 so the surplus is 1000 sweatshirts. Since the council agreed to buy the surplus sweatshirts at $40 each, the cost of the policy to the council is $40/sweatshirt* 1000sweatshirts = $40,000! c. Consumer Expenditures = Price * QD old: $30*2800 = $84,000 new: $40*2400= $96,000 Since an increase in price causes consumer expenditures to rise, it means that Gemand is inelastic. Why? When P goes up, QD goes down, So if P*QD goes up ‘when P goes up, it means that the percentage increase in P must be greater than the percentage decrease in QD. if \°}. n?| >|"[o B | run JoaQ “loa? L Tack in cose Yow Wesel Dre Vad Re dye) #s Ses Joshry 2 ee ie @ Pr fours LVL Aya w midge Koesa. Solve for equilibrium by setting quantity demanded equal to quantity supplied. See belo Q= 20,000 ~ IP Qe = 10,000 + oP 20,000 - YP = 16,000 + NOP {0,000 = 2ooP Equilibrium price is $50 per ticket. Equilibrium quantity is 15,500 tickets. Q™ = 20,000 = 90(50) = 10,000 + \10 (Se) = b. With a price ceiling of $40 per ticket, the ceiling is binding, and the quantity demanded will be 16,400 tickets. However, the quantity supplied is only 14,400 tickets. A shortage of 2,000 Zickets now exists (so does the potential for an illegal secondary market). The policy decreases the number of people who attend the concerts, because only the short side of the market (the 14,400 tickets supplied) will be transacted. See graph below: POA) s _— £ 2,008 . shor tory ere 40With price pressure remaining at the ceiling price, this situation is not an equilibrium. Secondary, illegal markets (scalping) are bound to occur, likely resulting in prices far in excess of the “ceiling” price printed on the ticket. Thus, even as fewer Fanilows are admitted to the concert, some of them are likely to pay higher prices than those that would have occurred in a true equilibrium situation, c. If Zelda buys up all the tickets (14,400 @ $40 each), her costs are $576,000 (Zelda is rich to begin with....after all, she’s studied economies at Wellesley!). To find the single price she should charge for ALL the tickets, see where the quantity 14,400 hits the demand curve. Essentially, Zelda wants to see the maximum single price that can prevail in the market for her 14,400 tickets. This price is $62.22 (plug in 14,400 for Q in the demand curve and solve for just that price!). Her revenuc is thus $896,000, and her profit is therefore $320,000. Not bad for a day's work! s FST) Revenue: AReas A&B fa. $846, 000 Cost: AREA B $536,000 PRoiT : AREA D $320,000 Q Uiles) S40 4 EXTRA CREDIT: Forall those budding enthusiasts, it tums out that the point (14,400 , $62.22 ) on the demand curve is still a place where demand is inelastic’ Recall we can increase total revenue where demand is inelastic by raising price! If, therefore, we assume that Zelda need not sell ALL her tickets, we can make her profit increase! We need a bit of calculus to do it, but it can be shown that at a price of $11.11, Zelda can sell 10,000 tickets for arevenue of $LIILIILI1. Her profit then becomes $535,111. Quite a nice increase! This plan would entail Zelda’s destroying 4400 tickets, either by burying them, burying them, or using them to paper her bathroom wall. For those interested, [have included the diagram and the mathematics below. (Essentially, we're finding the unit elastic point on the demand curve here!) ‘Why doesn't Zelda just buy the 10,000 tickets to begin with and reduce her costs? Well, she must make sure NO ONE else has any tickets, because they might try to sell them for a lower price and spoil Zelda's plan. Thus, once she BECOMES a monopolist, her plan can be put into action,P($/4Kt) Full s REVENUE. Areas ALR $n CosT: AREAS BRC $546, 000 Profit: AREA A— AREA C #535, 141 “a ltets) {0,000 14,400 TR= P-Q’= P. [20,000 - oP] 7 20,000 P ~ qop? i = 20,000 ~ 18oP sey AGE) 4 Ly 0 = 20, 000-1807 ar 20,000 1000 _ Wy E98 + TG = a To fnd @, wie P= WG ins the soos darmnamd curve + Q™ = 20,000 — vo 26° = 10,000 Of, fv These Not comfortable with Jee catarbis, 4p Fre the ot mn the denn ave cone where Et -L, do: st: Ae oe APs “Wo & =) tas fut whuve a= 40P iF A? * J0,000- Gor ik wih caval ROP when, : oP = 20,000~40P => 180P = 20 oop = 20,000 P sro Pant Mave thon ane wey ty show. “the Proverbiaf co 7 iE( a. Setting quantity supplied equal to quantity demanded yields an equilibrium price (Va of $1 per gallon and an equilibrium quantity of $ million gallons per week. See diagram below Ss Pines the government taxes suppliers, the equilibrium price will RISE and the equilibrium quantity will fall. See calculations below. ‘The new equilibrium price (consumer's price) is $1.50 per gallon, and the new equilibrium quantity is $2.5 million gallons per week. After tax, the producers receive $.75 per gallon, so the consumers bear the greater burden of this tax ($.50 vs. $.25). The government collects revenue of S.75 on 2.5 million gallons for a total tax revenue of S1.875 million per week. See diagram below: rss ( qr: w-5P NS ope ites = 5? c. From above, it’s apparent that the consumer burden of this tax is greater than the producer burden. The producers have succeeded in “pushing” §.50 of this $.75 tax onto the consumers, so We should find that consumers have a less elastic demand curve than producers have a supply curve. Even though the producers are writing the check to the government for $.75 for each gallon they sell, they're “using” $.50 per gallon of the consumers’ money! See our calculations below to confirm that demand is relatively more inelastic than supply along the relevant portions of the curves, supporting our claim that the relatively more inelastic side of the market bears the greater burden of the tax: >, BoLS gee ca B[sts) [7 / | £( 542-5) Bene (16 —————. = is | in.45 5 (+15) £ (14.35)Equilibrium occurs where quantity supplied equals quantity demanded, thus where pire) 120-P a2" 30 PreSiomenter and Q* = 80 heaters neck s 40 ESS go lo a i) Jerry’s price ceiling reduces quantity supplied to 40 heaters/week but increases {quantity demanded to 100 heaters per week. Here, the short side of the market determines quantity transacted, so consumers will pay and solar heater ‘manufacturers will receive $20 cach for the 40 heaters supplied each week. Thus, at the very least, Jerry has forced 40 more heater consumers [from the equilibrium 80 in (a) to the 40 here] to be cold! Not to mention the somewhat odd assumption we're making that NO secondary market develops....Ceilings almost always restrict quantity supplied (at least those ceilings that bind!). ° fas) aa oe 7 (hss) c. With a $30/heater subsidy to consumers, find the new equilibrium price and quantity using inverse demand and supply curves, noting that this subsidy shifts the demand curve up by $30/heater: “New” Demand curve: P= 120-Q +30 Ola” Supply curve: %*QSolving yields 150-Q = %*Q 150=3/2*Q Qr=2/3 + 150= 100 Plugging this equilibrium quantity back into the original demand and supply curves yields the post subsidy prices to consumers and producers: P (consumers) = 120 - 100 = $20/heater P (producers) = ¥4 * (100) = $SO/heater —?> go 100 ofits) Sally's plan results in MORE warm souls, all of whom pay an after subsidy price ‘equal to the Mayor's ceiling price above....the difference? A true equilibrium here, with no pressure on price. TRUE, this plan costs the government $3000 ($30 per unit subsidy * 100 heaters transacted), but one should balance this cost against the economic and social costs of the unintended consequences of the Mayor’s plan from above Quickly, we can took atthe facts that the price to consumers falls by $2O/heater while the price to producers rises by $10/heater. Therefore, consumers receive the lion’s share (2/3) of the subsidy benefit Ahoy hus Tonge, than, : 5 as’ 9 ep. gee BO Bey 5s apo ch eal 5 ET ap get 2m 2 aw Demand 3s wl akvely me vnclaghe : PaJf, indeed, the more inelastic curve bears the relatively greater burden of any tax, it should follow that the more inelastic curve receives the relatively greater benefit of any subsidy. Our calculations bear this out -- demand is much more inelastic that supply here. Because demand is more inelastic than supply, any subsidy ‘equilibrium will produce a greater drop in price to consumers than it will an inerease in price to suppliers. Thus, consumers here enjoy the greater subsidy benefit. Synthesize this result with the tax case.