Eco 301 Name_______________________________ Problem Set 2 16 September 2009 Frank, chapter 2 1. Use a labor market supply and demand model to answer the following questions. a) From an equilibrium position a minimum wage is set above the going wage. Sketch graph this possibility and show 1) the amount of new entrants into the labor market, and 2) the number of workers laid-off from their jobs. Wage Supply min. wage A C D E G F Demand Labor laid off new entrants b) Is society better or worse off because of the new minimum wage law? Since both a yes or no could be correct here you must explain your reasoning, perhaps with graphic support. The workers who retain their jobs get (A) more income, but the workers laid off now have no income and those who are new in the labor market but not employed also are frustrated. The more elastic is the demand and supply of labor, the worse the problem. 2. A public official once tried to calm public fears concerning a supply induced spike in gasoline prices by saying, “The high price will reduce demand and therefore price will soon fall again.” What is wrong with this statement? This statement confuses a change in quantity demanded with a change in demand. The reason prices rose was because supply shifted left which cause the quantity demanded to change to the new equilibrium price. The higher price will not shift demand left so that price can fall. Other factors that shift demand left could come into play or the supply could shift right again for some reason, but they are the only thing , short of price ceilings, that can lower the price of gasoline. 3. On the graph below, graph the story on the first page of Chapter 2 in your text. Begin from the initial market equilibrium price and quantity shown below. Price Supply Quantity a. Next, illustrate the OPEC embargo by shifting one of the graph’s functions. B H Demandb. Show a price ceiling that is imposed, and illustrate the quantity of gasoline that will exchange in the market. (Assume that the ceiling is set at the original equilibrium price.) c. At this quantity, is the benefit of the last unit of oil consumed greater than or less than the cost of producing that oil? d. In order to show the benefit lost from the price ceiling, shade in the area where the unrealized benefits would have exceeded the costs. The market supply shifts left, as shown in the sketch below. A price ceiling at (p) will cut production back to point (b). The benefit of the last unit of oil is greater than the cost of producing it by the vertical distance cd. The triangle dca is lost net benefit (deadweight loss) from the price ceiling. Price S’ c a S d p Demand b Quantity 4. The market for DVDs has supply and demand curves given by P' = 2QS and P = 42 — Qd, respectively. a. How many units will be traded at a price of $35? At a price of $14? Which participants will be dissatisfied at these prices? At prices of 35 and 14, there will be 7 DVDs traded in the market. At P=35, sellers are dissatisfied. At P=14, buyers are dissatisfied. b. What quantity of DVDs at what price will be sold in equilibrium? The supply and demand curves, shown in the diagram, intersect at P=28, Q=14 c. What is the total revenue from DVD sales? Total revenue is (28)(14) = 3925. The chart below shows the value placed on a particular airplane flight by 10 different individuals. Person Number Value of the Flight ($) 1 100 2 50 3 70 4 40 5 120 6 80 7 95 8 55 9 115 10 90 The ticket price was only $40, so all 10 people buy tickets. The plane holds only 7 people. All show up in the order they are listed. Letters (a) through (d) below show four methods of solving the seat scarcity problem. Fill in the amount of consumer benefit the plane ride generates. a. A first-come-first-served method provides __555___value. b. Random lottery method that picks 1, 3, 4, 5, 7, 9, 10 provides __630____value. c. A method that offers a $60 cash rebate to anyone who gives up a seat provides _ 670____value. d. A method in which an airline official interviews the people and excludes numbers 6, 7, and 8, who are flying for nonessential purposes, provides __585___ value. e. Which method is preferred from an efficiency standpoint? Explain. Method c is preferred because it supplies the most value. f. Are there ever circumstances where method d would be preferred? Yes, but only if society had an agreed upon definition of what is nonessential and if those with essential purposes were unable to express their need due to low income. g. If numbers 5 and 9 knew that a first-come-first-served method would be used, can you explain why they might have come to the airport so late? Fliers 5 and 9 may have a very high opportunity cost of time and they are willing to absorb some risk of being bumped, as long as the expected value of the loss is less than their time cost of waiting in line. h. What would happen if either methods a, b, or c were used but the ticket holders were allowed to sell their tickets to someone else? If a market for tickets was allowed, the people with the top seven values would fly because they would buy the top seven places in line from those who would get more benefit from the money than the plane trip. This assumes that transaction costs are relatively low.i. Does this suggest that some restrictions on markets need not be inefficient if voluntary exchange is allowed? If market restrictions are imposed and secondary markets evolve to deal with the inefficiencies, it is accurate to say that efficiency can result if the negotiation costs in the secondary market are not too high. One important point to keep in mind is that a demand curve shows what consumers are willing and able to pay for a given quantity of goods or services. A low-income person is thought to prefer leisure more than plane rides if he is able to pay only $40 for a