Econ 172

Fall 2007

Homework 1 Due Wednesday September 5

1. Use supply-and-demand graphs to explain why parking is free at the suburban shopping mall but one typically must pay to park when shopping downtown.

In the suburban shopping mall, there are lots of parking spaces that are designed to be part of the mall (see graphs below). Demand is fairly small, only accounted for by shoppers and employees. Downtown has multiple uses and demand for parking is by people who shop, people who work downtown, and for people who live or visit others. Relative to supply, demand is high. So in the shopping mall, at a price of zero, quantity demanded is less than quantity supplied. Downtown, demand intersects supply at a positive price. Note that during the peak shopping season, Thanksgiving through Christmas, demand for parking at the mall (and downtown) is higher and sometimes you can’t find a parking spot. Question: Why doesn’t the mall charge for parking at that time so price performs its rationing function?

(Note that prices on the graph below are just made up)

2. During the winter of 1997-1998, the northeastern United States experienced warmer than usual conditions. The price of home heating oil was less than it was during the previous winter, but people bought less home heating oil. This contradicts the Law of Demand. True or false and why.

False. Temperature is one of the factors that can shift the entire demand curve. A warm winter means people will not buy as much heating oil at a given price as they would if the winter was colder. This statement confuses demand with quantity demanded. The demand curve shifted left, so quantity demanded and price fell. So the law of demand is not contradicted.

3. In the early 1990s the world price of coffee was high. Today it is much lower. Before 1994, Vietnam was a negligible producer of coffee. Today it produces 14 million pounds annually, second to Brazil’s 42 million pounds. Show what happened to the world coffee market using a supply and demand diagram.

The supply curve shifted right as Vietnam entered the world coffee market. This increased supply (shifted the curve to the right), pushing price down.

4. There is currently a big increase in the use of ethanol in the U.S. because of government mandates and subsidies for ethanol production. Nearly all methanol used in the U.S. comes from corn. Farmers are responding by planting much more acreage in corn. Trace out the impact of this ethanol boom (or boondoggle, as the case may be) on:

a. the market for soybeans.

Farmers are planting more acres in corn, and less in soybeans, so the supply curve for soybeans shifts left, raising the price and lowering quantity.

b. the price of products in the U.S. that are made from corn

Corn is an input into many products (corn flakes, corn sweetener used in soft drinks) and when its price rises, that means the cost of a factor of production rises, so we should expect to see the price of corn flakes and sodas rise.

c. the price of corn tortillas in Mexico, eaten by low income Mexicans, if Mexico imports corn.

Same answer as (b). The price of corn tortillas in Mexico rise. This hurts low income Mexicans, and there are a lot of them. According to The New York Times (Chasing a Dream Made of Waste, April 17, 2007) “But the more than six billion gallons of ethanol that will be produced this year have already helped push corn to its highest price in years, raising the cost of everything from tortillas to chicken feed. Poor people in Mexico have protested against the higher prices, and now China and India are starting to suffer from food inflation.”

d. the price of beef in the U.S., given that cow feed contains soybeans.

Also a shift leftward in supply, which means that the price of beef goes up.

5. Does a shift in the demand curve that raises price increase supply? Why or why not?

If the demand curve shifts and price goes up, that must mean that it has shifted to the right. That raises the quantity demanded and quantity supplied, but it has NO impact on the position of the supply curve itself. So quantity supplied rises, but supply remains constant.

6. In the U.S. the argument is usually made that (a) medical costs have risen dramatically in the past twenty years and (b) that more and more Americans have health insurance plans that pay most of their medical expenses.

Most media discussions of this say that (a) has caused (b). Use supply and demand analysis to show how (b) could have caused (a).

If Americans have health insurance plans that pay most of their medical expenses, that means that to them, the price is lower than it would be if they had to pay all of the costs. Along a demand curve, if the price falls, people will consume more. If they buy more medical care, then the total spending on medical care will generally go up.

In the text, chapter 2, answer questions 1, 4, 6, and 11 and problems 19, 21 and 22.

Questions:

1. When Japan banned US imports of US corn, the corn that used to be exported to Japan remained in the US; hence the supply of corn available in the US shifted to the right (it increased). This pushed the price down by 11.1%. The graph is identical to the one above (with different numbers).

4. When a freeze occurs in Florida, the US supply falls. The US price rises. More orange juice is sold by Brazilian firms since the higher US price gives them more of an incentive to sell their juice in the U.S. rather than in Brazil. Less juice is sold by American firms.

6. A usury law is a price ceiling on interest rates. If there is a price ceiling, then the price is set below the equilibrium price. Output is less than it would otherwise be and some people will not be able to get the amount of the good (in this case credit) as they would like to buy if the price was higher.

11. A crackdown on cocaine smuggline causes the supply curve to shift to the left, therefore raising price.

Problems

19. Qd = a – bP Qs = c + eP

At equilibrium Qd = Qs so a-bP = c+eP ; therefore

a-c = bP+eP and a-c = P(b+e) and P = (a-c)/(b+e)

Qd = a – b[(a-c)/(b+e)] = a- [(ba-bc)/(b+e)] = ab+ae – (ba-bc) = ae + bc

b+e b+e

and just to check that Qd = Qs

Qs = c+e[(a-c)/(b+e)] = cb+ce + ea-ec = cb + ea

b+e b+e

and from high school algebra you of course know that (ae+bc)/(b+e) = (cb+ea)/(b+e).