1. 1)
percentage change quantity supplied 2
a) Price elasticity of supply: n= n=( )=0.2
percentage change price 10
The unequally shared rise in cost can be calculated the same way as an unequally shared tax.
Therefore:
P n 1 0.2
Tax incidence: = => = e= -0.4
t (n−e) 3 (0.2−e)
The price elasticity of demand e is -0.4
b) As prices increase for pinniped parts, consumers will switch to substitutes. The quantity of
pinniped parts demanded will decrease which leads to an increase in the elasticity of demand which
will lead to a price drop of pinniped parts in the long run.
2. Ps=$60 Pc=$10; U=100S0.6C0.4; B=$1000
a)
MUs Ps
Consumption Equilibrium when =
MUc Pc
U=100S0.6C0.4
MUs = 0.6(100)S0.6-1C0.4 = 60S-0.4C0.4
MUc = 0.4(100)S0.6C0.4-1 = 40S0.6C-0.6
MUs Ps ((60S−0.4 )C 0.4 ) 60
Thus = = =
MUc Pc ((40S0.6 )C −0.6) 10
1.5S1C1 = 6
4S=C
Substitute 4S=C into Budget equation (Ps*S+Pc*C=B)
60*S+10*4S=1000
100S=1000
S=10 => C=4S = 4*10 = 40
The optimal consumption bundle for Terry is to buy 10 Steaks and 40 Chips
2. b)
c) I) see b)
II) Yes Terry can still afford to buy the original bundle of 10 Steak and 40 Chips:
80*(10)+5(40)=1000
III) As chips are an inferior good Terry may buy fewer chips according to the Giffen
paradox of the Law of demand. “If a good is an inferior good, a lower price may
result in a lower quantity demanded.”
d) If chips aren't an inferior good the demand will rise instead of decrease. When the price of steaks
rises, Terry will substitute steaks with chips according to the substitution effect. As Terry's income
is not effected by the rise in prices, the income effect will not apply and the substitution effect is the
sole effect. => Terry will buy more chips.
3. q=60K0.6L0.2
a)
MPk = 0.6(60)K0.6-1L0.2 = 36K-0.4L0.2
b) qa = 60(aK)0.6(aL)0.2
The production function follows the Cobb-Douglas format. Whenever a production function follows
the Cobb-Douglas format, the two indices for the two input variables demonstrate the returns to
scale condition of the production function. In this 0.6+0.2 = 0.8 > 1. As the sum of the two indices
is smaller 1 we can see that the printing company faces a decreasing return to scale.
c) I disagree. The principle of diminishing returns to inputs is when more on one input is added,
while other inputs are held constant, the marginal product of the input diminishes. Decreasing
returns to scale is when the a firm doubles its inputs, output increases by less than double. With
diminishing returns, only one input is being changed while holding the other is fixed. But for
decreasing returns, both inputs may change.