Introductory Economics
Eco 108
HW 5

1. Suppose that the government is considering changing a policy regarding gidgets. If it does, 100,000 people will lose their jobs in gidget factories in the United States. But, consumers of gidgets in the United States will each save $20 year. Assume that there are 250,000,000 consumers of gidgets in the U.S., and that those who lose their jobs were earning $30,000 a year. Is this a Pareto improving change? Why or why not? Is this a potentially Pareto improving change? Why or why not? What if the workers who lose their jobs were earning $55,000 a year?

2. Suppose that we have the following demand and supply curves,

   Qd = 50-P, Qs = 3P-6.

   • [a.] What is the equilibrium price? What is the equilibrium quantity? What is the consumer surplus? What is the producer surplus? What are the total gains from trade?

   • [b.] Suppose there is a decrease in demand, so that Q^d = 38-P. What is the new equilbrium price? What is the new equilibrium quantity? What is the new consumer surplus? What is the new producer surplus? What are the new total gains from trade?
   • [c.] What is the loss in total gains from trade as a result of this decrease in demand?

3. This question is about short run and long run industry equilibrium.

   • [a.] If firms in a perfectly competitive industry are making positive profits in the short run, what will happen? What assumption is important here?
   • [b.] In the long run what will be the profit of each firm in the industry?
   • [c.] Is it bad to be running a business that is earning zero economic profits? Why or why not?
   • [d.] This part consists of three different diagrams. First, draw a supply and demand curve for an industry, denote the equilibrium price by p^*. Second, draw a MC curve and a AC curve of a firm that will operate in this industry in the long run. Denote the equilibrium price, p^*, on your picture. Third, draw a MC and AC curve for a firm in this industry that will not operate in the long run. Denote the equilibrium price, p^*, on your picture.

4. Here's another shot at this question! Suppose that there are two goods, Coke and Pepsi. Coke costs $3.00 for a twelve pack and Pepsi costs $2.00 for a twelve pack. Sue's income is $6.

   • [a.] Graphically show Sue's budget set. Put Coke on the vertical axis.
   • [b.] Suppose Coke and Pepsi are perfect substitutes to Sue, what do her indifference curves look like? draw a few on the diagram you drew in part a.
   • [c.] When prices and income are as in part a, and preferences are as in part b, what is Sue's optimal choice of Coke and Pepsi? Denote this choice on your diagram from part a.

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