EC2A1: Microeconomics II

Class 1: Exercise and Solution

Winter Term 2024

There are two groups of individuals in a country: “…sh & chip”1 producers
F , and co¤ee-shop baristas; B. There are 80 “…sh & chip” producers and
10 co¤ee-shop baristas. All individuals like to eat …sh & chips, x1 and drink
co¤ee x2 . They have identical preferences:
q
J
x1 + 2 xJ2

where J 2 fF; Bg. The prices of …sh & chips and co¤ee are p1 and p2 . Each
…sh & chip producer makes 1 portion of …sh and chips and each co¤ee barista
makes 1 cup of co¤ee. You can assume that non-satiation and convexity
hold, and you can focus on interior solutions. They sell their produce in a
competitive market.
1. Derive the demand functions for …sh & chips and co¤ee when prices
are …xed.
2. What is the equilibrium price ratio between …sh & chips and co¤ee
(hint, set p1 = 1 and solve for p2 ).
3. What are the utilities of each F and B individuals at this price ratio?
4. Now suppose that the country opens up to migration which results in
10 new …sh & chip producers and 20 new co¤ee-shop baristas moving to
the country (nobody leaves). The migrants have the same preferences
and are as productive as the existing producers, each making one unit
of output of their respective good. What is the new equilibrium price
ratio between …sh & chips and co¤ee? Explain your …nding intuitively.
1
You can view …sh & chips as a single good where the …sh and chips are mixed in …xed
(but beautifully optimal) proportions. Sadly, "mushy peas" are not in the model.

1
 5. How does the utility of type F and B individuals change after migration
compared to before? Explain you answer intuitively.
6. Why is it important to think about the impact of migration in general
equilibrium terms?
7. Does the framework help to think about gainers and losers as a conse-
quence of labour migration? Is the mechanism in the model realistic?
What does it leave out?

1 Solution
1. Set p1 = 1. Then substitute the budget constraint into the utility
function to get q
J J
m p2 x2 + 2 xJ2
Then
1
p2 = p
xJ2
so
1
xJ2 =
(p2 )2
Then
1
xJ1 = mJ p2 1 = mJ .
(p2 )2 p2
mF = 1 and mB = p2

2. Solve supply equals demand for good 2:

90
= 10
(p2 )2
then
p2 = 3.
3. Then utilities are
q
1 1 4
F : 1 p2 xF2 + 2 xF2 = 1 +2 =
q 3 3 3
10
B : 3 p 2 xB
2 +2 xB
2 = :
3

2
4. Now
120
= 30
(p2 )2
so
p2 = 2:
We have increased supply relative to demand so the price of co¤ee
has fallen relative to …sh & chips.
5. Utilities are
q
1 1 3 4
F : 1 p2 xF2 + 2 xF2 = 1 +2 = >
q 2 2 2 3
1 5 10
B : 2 p 2 xB
2 +2 xB
2 = 2+ = < :
2 2 3
So F has gained because the price of co¤ee has fallen and B has
a lower utility because she is a producer of co¤ee and bene…ts as
a consumer are lower than costs as a producer.
6. Point out that price changes determine the pattern of gainers and
losers. This matters to people who produce goods as well as those
who consume. You would not see this at all without a general
equilibrium approach.
7. For class discussion; take notes when you attend class. There
are no right or wrong answers here but in an exam question like
this, it is important to be re‡ective and intelligent showing that
you understand the role of a model. Here, that would mean
noting that by changing relative prices, migration a¤ects the whole
economy and of course this is a¤ected by the skill composition of
migrants. But migration is a much more complex issue than this
with political and social dimensions not just economics. And to
trace through the full general e¤ects across an economy with many
sectors and goods would require a lot of data. And the impact of
migration on wages and incomes is quite hard to pin down when
migrants ‡ow to particular destinations endogenously.