Wednesday, September 15, 2010

Quiz 1

Most students lost points on numbers 2 and 3. Here are some thoughts I had while grading the quizzes.

#1 Identify the flaw in this analysis: ”If more Americans go on a low-carb diet, the demand for bread will fall. The decrease in the demand for bread will cause the price of bread to fall. The lower the price, however, will then increase the demand. In the new equilibrium, Americans might end up consuming more bread than they did initially.”

A lot of people are going around and around with this problem. Demand decreases because of people's preferences. The result is a new equilibrium where price and quantity have declined. The lower price is the result of a change in one of the determinants of demand (preferences). End of story. A lower price does not in turn increase demand.

A common mistake is to assume those not on the low-carb diet will increase their consumption and demand will increase. At the original equilibrium, stores will realize fewer people buying bread. A surplus will emerge. Stores/bakeries must lower prices to sell the excess bread. 

#2 Consider the following events: Scientists reveal that consumption of oranges decreases the risk of diabetes and, at the same time, farmers use a new fertilizer that makes orange trees more productive. Illustrate and explain what effect these changes have on the equilibrium price and quantity of oranges.

(This problem is similar to the last five problems in the practice set supply and demand)

Demand will shift to the right (increase) causing price and quantity to increase. Supply will shift to the right (increase) causing price to decrease and quantity to increase. In the end we know quantity will increase but the effect on price is indeterminate. 

Common mistakes were saying price stayed the same or having a definitive answer. There were a handful of answers that incorrectly shifted supply (an increase is a rightward/downward shift). Finally, a few people forgot to illustrate the effects. 

#3 Residents of your city are charged a fixed weekly fee of $6 for garbage collection. They are allowed to put out as many cans as they wish. The average household disposes of three cans of garbage per week under this plan. Now suppose that your city changes to a tag system. Each can of garbage to be collected must have a tag affixed to it. The tags cost $2 each and are not reusable. What effect do you think the introduction of
the tag system will have on the total quantity of garbage collected in your city?

(This problem is similar to our discussion on overeating at all-you-can-eat buffets. Also see the practice set on the introductory material).

In the first case, the cost is $6 per week no matter how many cans you put out, so the cost of disposing of an extra can of garbage is $0. Under the tag system, the cost of putting out an extra can is $2, regardless of the number of the cans. Since the marginal cost of putting out cans is higher under the tag system, we would expect this system to reduce the number of cans collected.

You need to have mentioned marginal cost in your answer or have some reference to it. Most students discussed that on average the quantity won't change because those that original consumed more than 3 cans would decrease their waste while those that consumed less than 3 cans would increase their waste. The key to getting credit for this problem is recognizing the price per can has increased from $0 to $2.

#4 What’s the best way to think about the rise in oil prices in the last 10 years, as China and India have become richer: was it a rise in demand, a fall in demand, a rise in supply, or a fall in supply? Why?

China and India represent more buyers in the market. As the number of buyers increase demand will shift to the right, causing quantity and price to increase. 

A lot of people fell into the trap that as China and India increased their demand for oil, the supply must have fallen. My guess is you're thinking of oil being in fixed supply, but you need to think about the market. Was less oil supplied to the market? No, their might be less oil in the ground, but this doesn't mean supply fell.

No comments:

Post a Comment