Introductory Microeconomics: Problem Set 1

1. The demand curve for a good is given by QD = 20-2P; the supply curve is QS = ½P.

1. Find the equilibrium price and quantity in this market.
2. What is the total consumer surplus? (For present purposes it is enough to know that this is the area under the demand curve and above the equilibrium price.)
3. Suppose the government imposes a quantity tax on producers of 5 per unit. Find the equilibrium prices that producers receive and consumers pay, and the changes in consumer and producer surplus. Who is affected more by the tax? Why?
4. Explain why the equilibrium with the tax is inefficient. Calculate the deadweight loss.
5. Suppose instead that the government imposes a price ceiling of 4. What will be the effect? How does this outcome differ from the equilibrium with the tax?

2. Explain the nature of the opportunity costs of the following activities:

1. Attending a lecture.
2. Spending time on a train.
3. Extracting oil from underground.
4. (Popularised by Robert Frank) You won a free ticket to see an Eric Clapton concert (which has no resale value). Bob Dylan is performing on the same night and is your next-best alternative activity. Tickets to see Dylan cost £40. On any given day, you would be willing to pay up to £50 to see Dylan. Assume there are no other costs of seeing either performer. What is the opportunity cost of seeing Eric Clapton? £0, £10, £40, or £50?

3. Consider a linear demand curve: QD = a - bp.

1. Draw a diagram illustrating how the elasticity of demand varies along the demand curve (quantity on the horizontal axis, price on the positive part of the vertical axis, price elasticity on the negative part of the vertical axis).
2. Indicate the point at which the elasticity is equal to minus one.
3. Provide some economic intuition (a story) for why the elasticity might vary in this way with respect to price and quantity.

4. Suppose that inverse supply is given by p = -10 + 0.5qs.

1. What could be the economic interpretation of the negative intercept?
2. Supposing that suppliers could costlessly dispose (a "free disposal" assumption) of unwanted units what would the supply curve look like?
3. If the price is 10, what is the producer surplus assuming free disposal?
4. What is the change in the producer surplus if the price increases to 11? Provide an economic intuition (a story) for this change.

5. Come up with three examples for non-linear demand or supply functions and provide an economic rationale ("story") for why the markets you choose exhibit these characteristics.