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Q16 PS3 Jims preferences over cookies (x) and other goods (y) are given by U(x, y) =

xy with associated marginal utility functions MUx = y. and MUy = x. His income is \$20.
a) Find Jims demand schedule for x when price of y is Py = \$1.
b) Illustrate graphically the change in consumer surplus when the price of x increases from
\$1 to \$2.

a) Jims optimal basket is a solution to equations MUx / MUy = Px / Py and Px x + Py y = I.

Hence, we have y / x = Px and Px x + y = 20 with solution x = 10 / Px and y = 10. Demand
schedule for x is D(Px) = 10 / Px.

b)
Px

A B
\$2

\$1 C
D

5 10 x

The change in consumer surplus is area of region ABCD under the demand curve. The are of this
region can be computed by simple integration: [1,2] 10/p dp = 10 ln(2).

Q17 PS3 Suppose the market for rental cars has two segments, business travelers and
vacation travelers. The demand curve for rental cars by business travelers is Qb = 35
0.25P, where Qb is the quantity demanded by business travelers (in thousands of cars) when
the rental price is P dollars per day. No business customers will rent cars if the price
exceeds \$140 per day. The demand curve for rental cars by vacation travelers is Qv = 120
1.5P, where Qv is the quantity demanded by vacation travelers (in thousands of cars) when
the rental price is P dollars per day. No vacation customers will rent cars if the price
exceeds \$80 per day.
a) Fill in the table to find the quantities demanded in the market at each price.
b) Graph the demand curves for each segment, and draw the market demand curve for
rental cars.
c) Describe the market demand curve algebraically. In other words, show how the quantity
demanded in the market Qm depends on P. Make sure that your algebraic equation for the
market demand is consistent with your answers to parts (a) and (b).
d) If the price of a rental car is \$60, what is the consumer surplus in each market segment?

a)
Business (000 Vacation (000 Market Demand
Price (\$/day) cars/Week) cars/Week) (000 cars/Week)
100 10.0 - 10.0
90 12.5 - 12.5
80 15.0 - 15.0
70 17.5 15.0 32.5
60 20.0 30.0 50.0
50 22.5 45.0 67.5

b)

160
140
120
100 Vacation
Price

80
60 Market
40
20
0
- 50.0 100.0 150.0 200.0
1000 Cars/Week
c) For price greater than \$80, vacation travelers demand will be zero. So above P 80 ,
market demand is Qb 35 0.25P .
For price between \$0 and \$80, market demand is the sum of the vacation and business demand,
Qm Qb Qv , or
Qm 35 0.25P 120 1.5P
Qm 155 1.75P
Above a price of \$140, no purchases will be made so market demand is zero. In summary,
0, when P 140

Qm 35 0.25P, when 80 P 140
155 1.75P, when P 80

d)

160 CS=0.5(20)(80)
140
120 CS=800
100
Price

80
60
40
20
0
- 10.0 20.0 30.0 40.0

1000 Cars/Week

Vacation Demand

90 CS=0.5(30)(20)
80
70 CS=300
60
Price

50
40
30
20
10
0
- 50.0 100.0 150.0

1000 Cars/Week
Q1 PS4A producer operating in a perfectly competitive market has chosen his
output level tomaximize profit. At that output, his revenue and costs are as follows:
Revenue \$200
Variable costs \$120
Sunk fixed costs \$60
Nonsunk fixed costs \$40
Calculate his producer surplus and his profits. Which (if either) of these should he
use todetermine whether he should exit the market in the short run? Briefly
explain.

Producer surplus equals revenue less all non-sunk costs.

Thus:Producer surplus = 200 160 = 40
The non-sunk costs of 160 include the variable cost of 120 and the non-sunk fixed
cost of 40.
Profit = Revenue minus all costs = 200 120 60 40 = 20.
To decide whether to operate or shut down, the firm should look at producer
surplus (rather thanprofit).
Producer surplus (40) shows how much better off he would be operating (with a
profit =20) than shutting down (with a profit = 60).
So he should stay in business in the short run; hewill lose money, but not as much
as if her were to shut down.