ADDITIONAL EXERCISES

1. If your goal is to minimize the deadweight loss from a tax, would you tax goods for which
demand is elastic or goods for which demand is inelastic, everything else being equal?
Explain using a diagram.

Answer: For fixed tax wedge, the change in quantity is much lower when the
demand is less elastic (more vertical). This generates a smaller deadweight loss
(DWL) triangle, as shown.

1. The following diagram shows the effect of a $4 tax.

2. Complete the table using the letters to denote the area of each region.
Answer:
a. See Table. The deadweight loss is the difference in social surplus: E + F. This represents
unrealized gains from trade.
No Subsidy With Tax

Consumer Surplus A+B+E A

Producer Surplus C+D+F D

Government Tax Revenue 0 B+C

Social (Total) Surplus A+B+C+D+E+F A+B+C+D

3. Suppose that, at your firm, the relationship between output produced and the number of workers you
hire is as follows:
Total
Labor Product
0 0
1 12
2 23
3 32
4 38
5 42
6 45
a. Find the marginal product of labor for each worker.
b. Is the relationship between output and labor consistent with the Law of Diminishing Returns?

Column (3) in the following table shows the marginal product of labor. The marginal product of labor
is the increase in output from hiring one more worker. So, for example, the marginal product of the
second worker is 23 – 12 = 9. The value of the marginal product of labor equals the price of output
times the marginal product of labor. We showed that the marginal product of the second worker is 9.
If the price of output is $9 then the value of the marginal product of the second worker is $9 x 9 =
$81.
 (1) (2) (3) (4) (5)
Labor Total Marginal Value of the Marginal Product Value of the Marginal
Product Product (Price = $9) Product
(Price = $3)
0 0 -- -- --
1 12 12 $108 $36
2 23 11 99 33
3 32 9 81 27
4 38 6 54 18
5 42 4 36 12
6 45 3 27 9
c. The law of diminishing returns says that the marginal product of labor becomes smaller as the
number of workers increases. This is true in this example. The marginal product of labor, for
example, of the first worker is 12 but the marginal product of the sixth worker is just 3.

4. New York decides to reduce the consumption of sugary soda by imposing a minimum price of $2.50
per soda. The current equilibrium price is $1.50. Sketch the supply and demand for soda and show the
effect of this policy. Clearly label the excess supply in your diagram.
Answer:
5. Consider the following demand schedule:
Price Quantity
$9 52
$11 48
$13 40
a. Use the midpoint formula to calculate the elasticity of demand (i) when price rises from (i) $9 to
$11 and (ii) when price rises from $11 to $13.
b. When price rises from $9 to $11, does expenditure rise, fall, or remain constant? What about
when price rises from $11 to $13?
c. Why should you have anticipated your answers to (b) once you had answered part (a)?
Answer:
a. Using the midpoint rule, the elasticities are:
Percentage change in Price = (11-9)/10 = 20%
Percentage change in Quantity = (52-48)/50 = 8%
Price Elasticity of Demand = 8%/20% = 0.4

1. The following tables show a small firm’s long-run average cost of manufacturing a good at two
different plants:
Plant 1
Quantity Total Average Cost Marginal Cost
Cost
1 50
2 106
3 164
4 224
5 287
6 355
7 430
8 520
9 618

Plant 2
Quantity Total Cost Average Cost Marginal Cost
1 20
2 52
3 90
 4 130
5 175
6 227
7 285
8 345
9 407

a. Complete the third and fourth columns of each table.

Answer:
a.
Plant 1
Quantity Total Cost Average Cost Marginal Cost
1 50 50.00 50
2 106 53.00 56
3 164 54.67 58
4 224 56.00 60
5 287 57.40 63
6 355 59.17 68
7 430 61.43 75
8 520 65.00 90
9 618 68.67 98

Plant 2
Quantity Total Cost Average Cost Marginal Cost
1 20 20.00 20
2 52 26.00 32
3 90 30.00 38
4 130 32.50 40
5 175 35.00 45
6 227 37.83 52
7 285 40.71 58
8 345 43.13 60
9 407 45.22 62