FRAMINGHAM STATE COLLEGE PRINCIPLES OF MICROECONOMICS PROBLEM SET NUMBER 3

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1 FRAMINGHAM STATE COLLEGE PRINCIPLES OF MICROECONOMICS PROBLEM SET NUMBER 3 My Name is? Text Chapter 4: Pages 86 and 87 in the Text. 1. Explain each of the following statements using supply-and-demand diagrams. a. When a cold snap hits Florida, the price of orange juice rises in supermarkets throughout the country. Cold weather damages the orange crop, reducing the supply of oranges. This can be seen in Figure 1 as a shift to the left in the supply curve for oranges. The new equilibrium price is higher than the old equilibrium price. Figure 1 b. When the weather turns warm in New England every summer, the prices of hotel rooms in Caribbean resorts plummet. People often travel to the Caribbean from New England to escape cold weather, so demand for Caribbean hotel rooms is high in the winter. In the summer, fewer people travel to the Caribbean, since northern climes are more pleasant. The result, as shown in Figure 2, is a shift to the left in the demand curve. The equilibrium price of Caribbean hotel rooms is thus lower in the summer than in the winter, as the figure shows. Principles of Microeconomics 1 Problem Set Number 3

2 Figure 2 c. When a war breaks out in the Middle East, the price of gasoline rises, while the price of a used Cadillac falls. When a war breaks out in the Middle East, many markets are affected. Since much oil production takes place there, the war disrupts oil supplies, shifting the supply curve for gasoline to the left, as shown in Figure 3. The result is a rise in the equilibrium price of gasoline. With a higher price for gasoline, the cost of operating a gasguzzling automobile, like a Cadillac, will increase. As a result, the demand for used Cadillacs will decline, as people in the market for cars will not find Cadillacs as attractive. In addition, some people who already own Cadillacs will try to sell them. The result is that the demand curve for used Cadillacs shifts to the left, while the supply curve shifts to the right, as shown in Figure 4. The result is a decline in the equilibrium price of used Cadillacs. Figure 3 Figure 4 Principles of Microeconomics 2 Problem Set Number 3

3 6. Suppose that in the year 2005 the number of births is temporarily high. How does this baby boom affect the price of baby-sitting services in 2010 and 2020? (Hint: 5-year-olds need baby-sitters, whereas 15-year-olds can be baby-sitters.) Demonstrate what happens using a supply and demand diagram for 2010 and 2020, A temporarily high birth rate in the year 2005 leads to opposite effects on the price of babysitting services in the years 2010 and In the year 2010, there are more 5-year olds who need sitters, so the demand for babysitting services rises, as shown in Figure 5. The result is a higher price for babysitting services in However, in the year 2020, the increased number of 15-year olds shifts the supply of babysitting services to the right, as shown in Figure 6. The result is a decline in the price of babysitting services. Figure 5 Figure 6 Principles of Microeconomics 3 Problem Set Number 3

4 8. The case study presented in the chapter discussed cigarette taxes as a way to reduce smoking. Now think about the markets for other tobacco products such as cigars and chewing tobacco. a. Are these goods substitutes or complements for cigarettes? Cigars and chewing tobacco are substitutes for cigarettes, since a higher price for cigarettes would increase the demand for cigars and chewing tobacco. b. Using a supply-and-demand diagram, show what happens in the markets for cigars and chewing tobacco if the tax on cigarettes is increased. An increase in the tax on cigarettes leads to increased demand for cigars and chewing tobacco. The result, as shown in Figure 25 for cigars, is a rise in both the equilibrium price and quantity of cigars and chewing tobacco. c. If policymakers wanted to reduce total tobacco consumption, what policies could they combine with the cigarette tax? The results in part (b) showed that a tax on cigarettes leads people to substitute cigars and chewing tobacco for cigarettes when the tax on cigarettes rises. To reduce total tobacco usage, policymakers might also want to increase the tax on cigars and chewing tobacco, or pursue some type of public education program. Principles of Microeconomics 4 Problem Set Number 3

5 9. The market for pizza has the following demand and supply schedules: Price Quantity Quantity Supplied Demanded $ Graph the demand and supply curves. What is the equilibrium price and quantity in this market? If the actual price in this market were above the equilibrium price, what would drive the market toward the equilibrium? If the actual price in this market were below the equilibrium price, what would drive the market toward the equilibrium? Quantity supplied equals quantity demanded at a price of $6 and quantity of 81 pizzas (Figure 7). If price were greater than $6, quantity supplied would exceed quantity demanded, so suppliers would reduce their price to gain sales. If price were less than $6, quantity demanded would exceed quantity supplied, so suppliers could raise their price without losing sales. In both cases, the price would continue to adjust until it reached $6, the only price at which there is neither a surplus nor a shortage. Figure 7 Principles of Microeconomics 5 Problem Set Number 3

6 11. Suppose that the price of basketball tickets at your college is determined by market forces. Currently, the demand and supply schedules are as follows: Price Quantity Quantity Supplied Demanded $4 10,000 8, ,000 8, ,000 8, ,000 8, ,000 8,000 a. Draw the demand and supply curves. What is unusual about this supply curve? Why might this be true? As Figure 8 shows, the supply curve is vertical. The constant quantity supplied makes sense because the basketball arena has a fixed number of seats no matter what the price. Figure 8 b. What are the equilibrium price and quantity of tickets? Quantity supplied equals quantity demanded at a price of $8. The equilibrium quantity is 8,000 tickets. Principles of Microeconomics 6 Problem Set Number 3

7 c. Your college plans to increase total enrollment next year by 5,000 students. The additional students will have the following demand schedule: Price Quantity Demanded $4 4, , , , Now add the old demand schedule and the demand schedule for the new students to calculate the new demand schedule for the entire college. What will be the new equilibrium price and quantity? Price Quantity Demanded Quantity Supplied $ 4 14,000 8, ,000 8, ,000 8, ,000 8, ,000 8,000 The new equilibrium price will be $12, which equates quantity demanded to quantity supplied. The equilibrium quantity is 8,000 tickets. Principles of Microeconomics 7 Problem Set Number 3