1. Microeconomics Assignment 2 Spring 11
There are THREE questions in this assignment.
You may submit individual work or group work of no more than 3 persons from the
same class.
Answers (except diagrams), including student names, should be fully printed.
Due date: On or before 7 March 2011 (Monday) 5:00pm.
1. Pinnipeds are endangered species. Their body parts are used as aphrodisiacs
in Chinese medicines.
Suppose the market for the body parts of pinnipeds is a competitive market.
Past records show that whenever price rises by 10%, its production rises by
2%.
a. Recently, there is a rising cost of catching pinnipeds such that its price
increases by one-third of its increase in cost. What is the price
elasticity of demand for pinnipeds body parts? Show your calculation.
b. In the long run, what will happen to the market price and quantity sold
of pinnipeds body parts? Explain with the concept of price elasticity
of demand.
2. Terry has $1,000 to be spent on two goods – steaks (S) and chips (C). His
utility function is U = 100S0.6C0.4.
The price of steaks is $60 while the price of chips is $10. Chips are inferior
good to Terry.
a. Calculate the optimal consumption bundle for Terry.
b. Draw Terry’s budget line, with the units of steaks on the X-Axis.
Label his consumption bundle as “A”. Label the intercepts.
c. Suppose the price of steaks rises to $80 and the price of chips drops to
$5.
i. Draw the new budget line on the same diagram as in (b). Show
the new intercepts.
ii. Can Terry afford to buy back the original consumption bundle?
Explain briefly. Show your calculation when necessary.
iii. “Terry may consume fewer chips than before.” Do you agree?
Explain with the concepts of substitution and income effects.
d. Will your answer to (c)(iii) be different if chips are normal good to
Terry? Explain.
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2. Microeconomics Assignment 2 Spring 11
3. Suppose a printing firm has a production function of q = 60K0.6L0.2.
a. Find the marginal product of capital. Use it to explain whether the
printing firm is subject to the law of diminishing marginal returns.
b. Suppose both K and L expand by a multiple of α. Show the new
output level of this printing firm. Using the results to explain whether
the printing firm is facing a decreasing returns to scale.
c. “Decreasing returns to scale is the same as the law of diminishing
marginal returns.” Do you agree? Explain briefly.
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