ECON 0100: Introduction to Microeconomic Theory Short Answer Assignment #1 Solution Set Chapter 3 1. a. See graph below: b. Pat's opportunity cost of making a pizza is one-half gallon of root beer, because she could brew one-half gallon in the time (two hours) it takes her to make a pizza. Pat has an absolute advantage in making pizza because she can make one in two hours, while it takes Kris four hours. Kris' opportunity cost of making a pizza is two-thirds gallon of root beer, because she could brew two-thirds of a gallon in the time (four hours) it takes her to make a pizza. Because Pat's opportunity cost of making pizza is less than Kris', Pat has a comparative advantage in making pizza. c. Because Pat has a comparative advantage in making pizza, she will make pizza and exchange it for root beer that Kris makes. d. For Kris the opportunity cost of making a pizza has changed from 2/3 to 1/6 of a gallon of root beer - since 1/6<1/2, Kris now has the comparative advantage in pizza production and should produce pizza and trade for root beer. Pizzas Root Beer 6 12 6 4 Pat’s PPF Kris’ PPF2. a. Reduced police efforts would lead to an increase in the supply of drugs. The factor category that changes supply is “the price of factors of production” because lower police enforcement reduces the risk/cost of selling illicit drugs. As seen below, this would cause the equilibrium price of drugs to fall and the equilibrium quantity of drugs to rise. On the other hand, cutbacks in education efforts would lead to a rise in the demand for drugs. The factor category that changes demand is “preferences” because not knowing the downside of illicit drug use will lead people to prefer to use drugs more than the otherwise would. This would push the equilibrium price and quantity up, as shown below. b. A fall in the equilibrium price would lead us to believe the first hypothesis. If the equilibrium price rose, we would believe the second hypothesis. P P* P** Q Q* Q** Market for Illegal Drugs D S P P* P** Q Q* Q** Market for Illegal Drugs D S S’ D’3. a. If quantity demanded falls by 4.3% when price rises by [(1.50-1.25)/1.33]*100=18.2%, the price elasticity of demand is 4.3/18.2 ≈ 0.237, which is fairly inelastic. b. Because the demand is inelastic, the Transit Authority's revenue rises when the fare rises. c. The elasticity estimate might be unreliable because it is only the first month after the fare increase the little time has elapsed since the price change. As time goes by, people may switch to other means of transportation in response to the price increase. So the elasticity may be larger in the long run than it is in the short