EC101 Problem Set 1

Chapter 1
1. Opportunity Cost Suppose you are deciding how to spend your time on a Saturday
afternoon. You can either: (1) go to the beach with your friends, (2) compete in a chess
tournament, or (3) get a head start on your calculus homework.

(i.) What is the opportunity cost of getting a head start on your calculus homework?

The opportunity cost is missing out on beach day with my friends and having a great time or
competing in a chess tournament and possibly winning.

(ii.) What is the opportunity cost of going to the beach with your friends?
Similarly the opportunity cost would be not getting the experience of a chess tournament that i
could possibly learn from and win or not having a head start on my homework which could pile
the work for last minute that will end up stressing me out.

2. Thinking at the Margin Suppose that you are in charge of selling tickets for an up-
coming concert in your town. The total cost of the concert to the town is $80000, and
the arena in which it is held has 1000 seats (you can sell up to 1000 tickets). Please
answer the following questions and explain your thinking.

(i.) What is the average cost of a seat in this arena to the town?

Ar Cost $50 000

$50
= , =

1
,
000

(ii.) Suppose you have only sold 900 tickets, the show is about to start, and there are no
more buyers at your ticket window. What is the marginal cost to the town of letting
your best friend join the audience (take a seat) for free? What is the marginal cost
to the town of letting them join for $50?

The marginal cost of letting my friend join for free is $0 since I’m not really spending any additional
money and the crowd doesn’t have to pay anything more as well.
IfI charge my friend $50, there will not be a difference in the cost but now there will be an
additional 50 in the revenue.
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 (iii.) Are there any scenarios in which it makes sense to sell a ticket for less than the
average cost? Are there any scenarios in which it makes sense to sell a ticket for
more than the average cost?

Like in the case of airplanes if there are unsold seats or people who are not attending the concert
it is a good idea to sell tickets at a lower price so as not to face a loss. Also lower costs might
incentivize buyers to purchase more tickets. If the demand is high however and there are a lot of
last minute buyers, increasing the average cost makes a lot of sense because we will increase the
revenue.
Chapter 2
3. Production Possibilities The following graph is Country A’s Production Possibilities
Frontier (PPF) for laptops and cappuccinos.

iV
QR-- =

constant opportunity cost

1

Il
Q -
/ 1 I

- country
Becomes more
efficient
" at
producing laptops
-

III

if becomes
I
-
New ppF country
·

less
efficient in Laptop production
Inefficient and more efficient with
Cappucinos
!

(i.) On the graph, mark a point/allocation that is feasible but inefficient for Country
A to produce. ↑
(ii.) Suppose Country A becomes more efficient at producing laptops and remains just
as efficient at producing cappuccinos. Draw and mark a new possible PPF.
↑

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 (iii.) Suppose Country A becomes more efficient at producing cappuccinos and less effi-
cient at producing laptops. Draw and mark a new possible PPF. ↑
(iv.) Draw Country A’s PPF for laptops and cappuccinos when the opportunity cost of
producing laptops (in terms of cappuccinos) is constant.
↑

Chapter 3
4. Comparative Advantage & Gains from Trade Part 1 Suppose Company A and
Company B are both producers of just hats and scarves. Read the table labels carefully.

of 1 hat
Opportunity cost

Company & 2 3
= =

Company B
=: &
· Scarves/HAT
(i.) Which company has a comparative advantage in the production of hats? Why?
of lesser opportunity cost
Company A has
comp arative advantage because

5186/7
(ii.) What is a possible number of scarves per hat at which both companies will agree
to trade? Why?

5) trade price - P 0 875

<
< < ; P 0 625 < .
= .

(iii.) Suppose Company A resides in an area that was recently struck with a hurricane
and now only has the resources to produce 3 hats in 1 hour. After this event, which
company has a comparative advantage in the production of hats? Why?

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New opportunity of 3 Scare
a
cost CompanyA
=

scarves/flat
3

6/
5) 6 < 6/7 opportunity cost of company A to produce
hats is still lower than B So A has the comparative advantage

(iv.) After the hurricane, what is a possible number of scarves per hat at which both
companies will agree to trade? Why?

p =
312426/7
(v.) Draw Company B’s hourly PPF for hats and scarves. Clearly label your axes.

Scarves.

O
35 Hats
5. Comparative Advantage & Gains from Trade Part 2 Suppose Company C and
Company D are both producers of just wax candles and LED candles. Read the table
labels carefully.

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 (i.) Which company has an absolute advantage in the production of wax candles?
Which company has an absolute advantage in the production of LED candles?

Wax Candles: Company D has the absolute advantage because the produce the same amount in half the time.

LED candles: Company C has the absolute advantage because they take less time to produce 10 units.

(ii.) Which company has a comparative advantage in the production of LED candles?
Why?
cost of LED 20/3
Company C :

Opportunity 10 =

: "

Company 5/2
.

D
=
: a

D has the comparative advantage due to lower opportunity cost .

(iii.) Is there mutually beneficial trade when the price of 1 wax candle is 0.5 LED can-
dles? Why or why not?

(iv.) Is there mutually beneficial trade when the price of 5 wax candles is 3.5 LED
candles? Why or why not?

Chapter 4
6. Demand, Supply, & Equilibrium Consider the market for pizza.

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 F
T #
-
"
p
-Y 92 9
q

For each of the following scenarios, describe the e↵ect on demand, supply, equilibrium
quantity demanded, and equilibrium price in the market for pizza.

(i.) There is a global shortage of active dry yeast.

There will not be any change in Pizza demand because of shortage of dry yeast as consumers are not the ones
making it. The supply however will decrease because yeast is a major ingredient in pizza. The equilibrium quantity
demanded will also decrease because the supply line is decreasing and supply is reduced. The equilibrium price
however will increase because the demand is higher than supply.
(ii.) The CDC releases a statement that pizza consumption reduces the probability of
catching COVID.
The demand will increase no doubt. The supply remains the same. The equilibrium quantity will increase
because of the increasing demand curve to catch up with the increasing demand. The equilibrium price will
increase as well because the demand is higher.

(iii.) Everybody in the economy gets promoted at work with a 10% raise in salary.
The demand will increase because people will have more money to spend on Pizza. In the short term there will not
be any changes on the supply. The equilibrium quantitiy will increase because of the increase in demand and well
as the equilibrium price.

(iv.) A new innovation increases the average yield of tomatoes per plant.
The demand will stay the same but the supply will increase because tomatoes are an important ingredient for
making pizza. The equilibrium quantity will increase as a result of higher supply but the price will decrease as there
is now more pizza than the consumers want and consumers have the upper hand and in order to keep their salws
up shops will lower their prices.

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 (v.) Holding all else fixed, the market price of pizza decreases by $5.
The demand will no doubt increase because customers will be incenttivized to buy pizza at a lesser price.
But the supply will probably decrease as shops might not want to sell a lot of pizza at a low price
considering the supply incredients price as not changed. The equilibrium quantity will depend on the
demand and supply relationship. if the demand keeps increasing and the supply keeps decresing the
equilibrium quantity will decrese as well. The equilibrium price on the other hand, its given that its
decreasing.

7. Complementary & Substitute Goods Consider the markets for jackets, sweatshirts,
peanut butter, and jelly.

(i.) Suppose that the price of peanuts rise due to a shortage in crops. What is the e↵ect
on the equilibrium price peanut butter? What is the corresponding e↵ect on the
quantity demanded for jelly? Show your answers using demand & supply graphs.
Price
5 When there is a decrease in the supply
&
If the supply shortage
persists and
price doesn't

....
1) the eg price will increase
---

the demand for

.

down
ii) the eg quantity will
decrease go -
instead
.

will increase
Quantity iii) The demand will increase Jelly
(ii.) Create a short story/argument for jelly being (i.) a normal good, and (ii.) an
inferior good. You can answer via graphs, words, or both.
Let’s say that I got a promotion at work. I have more spare money to buy things that I like so I will
spend more money on PB and jelly and make more sandwiches. This will drive up the jelly demand.
This is an example of jelly as a normal good. As an inferior good we can think of my promotion again.
If I have more money I would start buying more expensive and healthy fruits and would avoid cheaper
and more available options like jelly. Hence, my promotion will decrease your jelly demand.

↑
(iii.) Suppose the supply for sweatshirts increased. What is the e↵ect on equilibrium
price and quantity of jackets?
Sweatshirt
Dice If the supply increases:
i) the equilibrium price will decrease because
S the supply is more than the demand
ii) the equilibrium quantity will increase due to

antity
the increase in supply.

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