Introductory Microeconomics: Problem Set 1

  1. 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?

  2. 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.

  3. 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?

  4. The table below shows the unit labour requirements for four goods in two countries A and B. For our purposes we might wish to think of A as "the rest of the World" and B as some country of interest.

    5. ULRAB
    Rubber chickens (hrs/chicken)24
    Trousers (hrs/pair)22
    Poison gas (hrs/kg)43
    Beauty products (hrs/millihelen)32

    In the absence of trade, wages are £4/hr in A and £8 in B.

    1. For each good, calculate the ratio of the unit labour requirement in each country.
    2. What are the autarky prices of each good in each country?
    3. If the wage in A ("rest of the world") is fixed, in what direction must the wage in B change if the two countries open to free trade, in order for both countries to have something that they can export to the other?
    4. What are the highest and the lowest wages that can prevail in B with free trade, given the £4/hr wage in A?
    5. For which of the goods can you predict with certainty (given our assumptions) the pattern of trade, and what is it?
    6. Suppose that a free trade equilibrium is achieved with a £4/hr wage in A and a wage in B which is exactly at the mid-point of the range that you found on part (d). What will be the world prices of each good, and which country will export it?
    7. Suppose that workers in both countries work 40 hours per week, 50 weeks per year. Calculate their annual incomes in units of each good, both in autarky and free trade. In what sense, if any, have these workers gained from trade? Why (briefly) do workers in B appear to have gained, even though their wages are lower due to the effects of trade?
    8. What general lessons do you draw from this example?