Problem Set # 1

This problem set is due Thursday, February 15, at the beginning of the class period. Problem sets done on notebook paper or unstapled will not be accepted. Late problem sets are unacceptable also.

1. In a simplified economy, imagine that there is only one scarce input, R2D2 (some type of robot), and only two outputs, pearls and jam. The following tables show how many pearls and how many bottles of jam can be produced daily with different quantities of R2D2s.

a) If there were only 500 R2D2s available in the economy, derive a table showing the maximum amount of pearls that can be produced for different levels of jam production.

b) Compute the opportunity costs of a bottle of Jam for each level of production.

c) Use the data in part a) to draw a production possibilities frontier (PPF).

d) Suppose that this nation is ruled by a dictator that puts a lot of emphasis on wearing pearls. Show a point on the PPF where this country is likely to be producing (Call it point X).

e) Suppose that this dictator changes his mind and puts jam consumption as the most important national goal. Where will this economy be producing on the PPF (Call it point Z) ?

2. Some members of the Clinton administration are discussing the possibility of imposing a price ceiling on Acetylsalicylic Acid (the chemical used in the production of Aspirin).

a) Draw a diagram showing the demand and supply of Acetylsalicylic Acid before the price ceiling is imposed.

b) Draw a diagram showing the demand and supply of Aspirin before the price ceiling on Acetylsalicylic Acid is imposed.

c) Draw a diagram showing the demand and supply of Motrin (a product that uses Ibuprophen as its main chemical instead of Acetylsalicylic Acid) before the price ceiling on Acetylsalicylic Acid is imposed.

d) How do your diagrams in parts a), b), and c) change when the Federal government imposes a price ceiling on Acetylsalicylic Acid at a level below the equilibrium price. Explain and illustrate graphically

3. The following equation represents the demand for beach balls in the South Padre Island area during Spring Break:

a) Make a demand schedule showing the quantities demanded corresponding to prices from $2 to $10 (using $2 intervals).

b) Graph the demand curve.

c) Calculate the price elasticity of demand if price increases from $2 to $4.

d) Calculate the price elasticity of demand if price falls from $8 to $10.

e) Suppose that the supply of beach balls is fixed at 1,100 units. What will the equilibrium market price be?

f) Assume that the demand for beach balls is now given by:

If supply is still fixed at 1,100 units and income is equal to $300, what would the equilibrium market price be? (Assume that beach balls are normal goods).

g) What would the equilibrium market price be if income declined to $100?

4. Bud Adams, the owner of the Houston Oilers has just signed a deal to move his NFL team from Houston, Texas, to Nashville, Tennessee. He is trying to set the price at which the tickets to the Oilers games will be sold. He calls and asks for your help. He provides you with the following information. The demand for Oilers tickets is given by the following schedule:

a) If the capacity of the Liberty Bowl (the Oilers' 1996 temporary home in Memphis, TN) is 45,000 and the number of tickets is limited to the number of seats, what price maximizes total receipts from ticket sales?

b) Starting in the 1997 season the Oilers will be moving their home games from the Liberty Bowl to the new Nashville Dome. If the capacity of the Nashville Dome is 65,000 and the number of tickets is limited to the number of seats, what price maximizes total receipts from ticket sales in the new stadium?

c) Use the elasticity of demand concept to explain your answers to parts a) and b).

You receive another call from the Oilers's owner telling you that, as usual, he made a mistake in the computation of the demand schedule for Oilers' tickets, the correct schedule is as follows:

d) Given the new information, what price maximizes total receipts from ticket sales in the Liberty Bowl?

e) Given the new information, what price maximizes total receipts from ticket sales in the Nashville Dome ?

f) Use the elasticity of demand concept to explain your answers to parts d) and e).