PROBLEM SET 1
1. This question is based on the article on the reading packet on the market for two trendy foods—kale and quinoa—and one more “mundane” crop—almonds.1 According to the article, while there are concerns about shortages of each of these three crops, the situation in each market is distinct.
a. Use supply and demand curves to summarize the market changes described in the article. (You should have three graphs: one for each product.)
b. Explain how your graphs capture the differences across these three markets that are described in the article. As part of your explanation, make sure to say how changes to demand and supply affect the equilibrium price and quantity in each market.
Kale: No changes in both supply and demand, so equilibrium price and quantity remains
Quinoa: Increase in demand, shifts equilibrium price higher to meet to the increased demand
Almond: supply decreases, drive up equilibrium price and reduces demand.
2. In the early 1990s, the toll on the Golden Gate Bridge was raised from $2 to $3. Following the toll increase, traffic fell by 5 percent. Prior to the toll increase, Stephen Leonoudakis, chairman of the bridge’s finance auditing committee, warned that the toll increase could cause toll revenues to decrease by several million dollars per year.
a. Estimate the point price elasticity of demand (starting from a price of $2). (Show the calculations leading to your answer).
Ep=Delta Q/Delta P= -5%/((3-2)/2)=-5%/0.5=-0.1
Not very elastic
b. Based on your estimate, can you say whether Leonoudakis’ prediction came true?
No. Traffic reduced at 10% of rate of price increase, so the overall revenue growth outpaced reduction of traffic.
c. In 2012, the toll on the bridge was $5 and the San Francisco Transportation Authority, which was facing a $66 million budget deficit over the next five years, was considering another $1 toll increase.2 Assuming that the estimate from part (a) is reasonably accurate, do you think that increasing the toll by another $1 would contribute to the goal of reducing the budget deficit?
Yes, it’s a 20% price increase, which would result in 2% of traffic loss. So the overall revenue will increase to help reducing the deficit.
3. On July 28, 2000 The Washington Post reported details of Bell Atlantic's rate plans for local telephone service in Northern Virginia. One plan (Plan A) offered by Bell Atlantic costs $0.10 (i.e., 10 cents) for every local call made (regardless of the duration of the call). Its other plan (Plan B) allows for unlimited number of local calls of any duration at a flat rate of $22 per month.
For the purposes of this question, suppose Jane has the following individual (inverse) demand curve for local phone calls:
P = 0.40 - 0.002Q,
Where Q = number of calls made per month, and P = price per call, in dollars.
a. Jane is currently subscribing to Plan A. How many calls does she place per month under this plan? What is her consumer surplus? Show your work and illustrate with a graph.
Jean’s consumer surplus= ½ x 150 x 0.3 = $22.5
b. Should Jane switch to Plan B? Show your calculations and illustrate with a graph.
No. See graph above. Jean’s current bill is 150 x 0.1= $15, Jean’s add’l demand is shown on attached graph as area “b” (b= 1/2 x (200-150) x 0.1 = $2.5. So the marginal demand for Jean is only $2.5, which is less than the delta of switching to plan B ($22-$15= $7)
c. Given your results above, why does Bell Atlantic offer both plans? Explain.
To capture more revenue, beyond the plan A can capture, with plan A using the current demand curve, number of calls can be made = 220, exceeds maximum demand along the demand curve (200).
4. The typical firm in a perfectly competitive market manufacturing an appliance part has long-run total cost of TC = 6q2 + 2400 and marginal cost of MC = 12q, where