Macro quiz.,
2. Assume Economy A produces physical text books. (15 points) a) In the space provided below graph the physical text book market demand and supply curves. Label the Demand curve D1, Supply curve $1, Equilibrium point El, Price Equilibrium P1, and Quantity Equilibrium Q1, both axis. (3 points) S2 P1 KEZ PZ Q, DZ Now assume that e-text book prices drop, (e-text are substitutes of physical text books) while paper (a resource for books) price also drops. b) In sentences, describe what will happen to market supply and market demand for physical text books. In the graph above, denote these changes if any with D2 for Demand curve two, 52 for Supply curve two, P2 for price equilibrium 2, EZ for equilibrium quantity, and Q2 for quantity equilibrium. (7 points) Enter cakes are a perfect substitute fore hardcovers. Therefore, with the double price drop, the market supply for E-textbooks 1 increases while hard-covers Videcloses In torn the market demand for e textbooks A increment and for hard-cortes, decrement. The changes are derided of the leftwend shift on De and the of c) In sentences, describe what will happen to price equilibrium and quantity equilibrium of physical text books with these changes. ( 5 points) V The price equilibrium will drop and the Most likely Also drop eventualy OR sing the denoted above. SameApplication 3: Agricultural Foodstuffs Assume the below is the market for agricultural foodstuff (corn, wheat, soybean, etc.): The areas are labeled by numbers (1, 2, 3, 4, 5). Price ($) Supply P1 2 P2 Demand $0 Q2 Q1 Q0 Quantity 10) At the equilibrium price, what areas (labeled by numbers) represent the consumer surplus? 11) At the equilibrium price, what areas represent the producer surplus? 12) At the equilibrium price, what areas represent the social surplus? 13) Suppose that a price floor is set at P1. How much do consumers purchase of the good (Q2, Q1, or Q0)? Is this more or less than at equilibrium? 14) At the price floor of P1, what areas represent the consumer surplus? 15) At the price floor of P1, what areas represent the producer surplus? 16) At the price floor of P1, what areas represent the social surplus? 17) At the price floor of P1, what areas represent the deadweight loss? 18) At the price floor of P1, is there a surplus or shortage of the foodstuffs? 19) As a result of the price floor, what area(s) represent the loss in consumer surplus? 20) What will the government have to do at the price floor at P1 in order to maintain the price floor?Application 4: Freeways What does a traffic jam on a route 1 have to do with supply and demand? There is a demand for driving on route 1 and a supply of space on route 1. The demand, however, fluctuates between the time of day or season in the year. Let's assume that the demand on the weekends is greater than the demand on weekdays. Let's assume that it costs $1 to drive on route 1 on the weekdays and costs $3 on the weekends. We then have the following: Toll ($) Supply of space on route 1 $3 Demand on weekdays for space on route 1 Demand on weekends for space on route 1 $1 $0 Q1 Q2 Freeway Space on Route 1 21) At $1 toll price, would there be congestion on weekdays, weekends, or both? Describe how this is shown on the graph above. 22) At $1, would the congestion represent a shortage or surplus? Why (explain by comparing the quantity demanded and the quantity supplied of space on route 1)? 23) At what price would eliminate the congestion on the weekends? 24) At what price(s) is there a surplus of route 1 freeway space on the weekends? 25) If the driving population increases in an area and the supply of freeway space remains constant, what will happen to freeway congestion? Explain what would change on the graph above by describing any shifts in the supply or demand curves.N Consider the following game. There is a population of people all with an initial wealth of $ 10,000. Each person faces a potential loss of $ 5,000. The population is made up of 75% of people of type 1 and 25% of people of type 2. Individuals of type I have a probability of loss of 20% while those of type 2 have a probability of loss of 10%. We assume that all individuals have identical Von Neumann Morgenstern2 type preferences represented by the following utility function : U(x) = Inx. a) What is the expectation of wealth for type 1 individuals? (2 points) b) What is the expectation of wealth for type 2 individuals? (2 points) c) What is the maximum price that a Type 1 consumer would pay for full insurance? (2 points) d) What is the maximum price that a Type 2 consumer would be willing to pay for full insurance? (2 points) Imagine an insurance company that cannot distinguish between the two types of consumers but who knows the probabilities of having a type 1 client and those of having a type 2 client. e) Suppose that this company decides to offer an insurance product whose price, actuarially fair3 in expiration, is equivalent to the average loss in this population. What is the price of this insurance? Will the Type 2 consumer agree to buy this insurance? (2 points) f) Now imagine that an insurance company offers insurance at a price equivalent to the actuarially fair price for type I individuals + an additional amount equivalent to 20% of the cost of risk for these individuals in order to cover their management costs and the firm's profit margin. What is the price of this insurance? (2 points) g) Would Type 1 and Type 2 individuals purchase this insurance? h) Suppose that the management costs of this insurance company are fixed and that it plans to increase its profits by offering a second product which consists in insuring 20% of the loss at a price of $ 110. Would Type 2 individuals buy this insurance? (2 points) i) Would Type 1 individuals prefer this second product to the first product offering full insurance but at a higher unit price? (2 points)2) Consider the following game. There is a population of people all with an initial wealth of $ 10,000. Each person faces a potential loss of $ 5,000. The population is made up of 75% of people of type 1 and 25% of people of type 2. Individuals of type I have a probability of loss of 20% while those of type 2 have a probability of loss of 10%. We assume that all individuals have identical Von Neumann Morgenstern2 type preferences represented by the following utility function : U(x) = Inx. a) What is the expectation of wealth for type 1 individuals? (2 points) b) What is the expectation of wealth for type 2 individuals? (2 points) c) What is the maximum price that a Type 1 consumer would pay for full insurance? (2 points) d) What is the maximum price that a Type 2 consumer would be willing to pay for full insurance? (2 points) Imagine an insurance company that cannot distinguish between the two types of consumers but who knows the probabilities of having a type 1 client and those of having a type 2 client. e) Suppose that this company decides to offer an insurance product whose price, actuarially fair3 in expiration, is equivalent to the average loss in this population. What is the price of this insurance? Will the Type 2 consumer agree to buy this insurance? (2 points) f) Now imagine that an insurance company offers insurance at a price equivalent to the actuarially fair price for type 1 individuals + an additional amount equivalent to 20% of the cost of risk for these individuals in order to cover their management costs and the firm's profit margin. What is the price of this insurance? (2 points) g) Would Type 1 and Type 2 individuals purchase this insurance? h) Suppose that the management costs of this insurance company are fixed and that it plans to increase its profits by offering a second product which consists in insuring 20% of the loss at a price of $ 110. Would Type 2 individuals buy this insurance? (2 points) i) Would Type 1 individuals prefer this second product to the first product offering full insurance but at a higher unit price? (2 points)
