Chap 7:

At Equilibrium

-In the graph, the equilibrium point is where the supply curve (S) intersects the demand curve
(D). This point is at a price of $24 and a quantity of 40 units.
Producer surplus is the area above the equilibrium price and below the supply curve. In this
graph, it's a triangle with a base of 40 units and a height of $8. The area of the triangle is
(1/2)40$8 = $160.
-Consumer surplus is the area below the equilibrium price and above the demand curve. In this
graph, it's a triangle with a base of 40 units and a height of $16. The area of the triangle is
(1/2)40$16 = $320.
-Total surplus is the sum of producer surplus and consumer surplus. In this case, total surplus is
$160 + $320 = $480.
Price Ceiling of $16

-A price ceiling is a government-imposed maximum price that a good or service can be sold for.
In this case, the price ceiling of $16 is below the equilibrium price of $24. This means the price
ceiling will be binding, because the market price will be forced down to the price ceiling.
-At the price ceiling of $16, quantity supplied will be 24 units according to the supply curve.
However, quantity demanded will be 64 units according to the demand curve. This creates a
shortage of 40 units (64 units demanded - 24 units supplied).
-Producer surplus becomes zero because the price ceiling prevents producers from selling at a
higher price.
-Consumer surplus becomes the area below the demand curve and above the price ceiling line.
This is a rectangle with a base of 24 units and a height of $8. The area is 24*$8 = $192.
-Total surplus under the price ceiling is $192 (consumer surplus only) because producer surplus
is zero.
Price Floor of $40

-A price floor is a government-imposed minimum price that a good or service can be sold for.
In this case, the price floor of $40 is above the equilibrium price of $24. This means the price
floor will not be binding, because the market price will be higher than the price floor anyway.
-The equilibrium price and quantities remain the same ($24 and 40 units) because the price
floor is not binding.
-Producer surplus remains $160 and consumer surplus remains $320 because the market
reaches equilibrium at the original price.
Total surplus remains $480 (producer surplus + consumer surplus) because there is no change
from the equilibrium.
Question 1: Chap 21
Part a: Budget Constraint and Indifference Curve

Diagram:

Create a graph with two axes:

Horizontal Axis: Label it "Dining Hall Meals" and represent the number of meals eaten at the
dining hall.
Vertical Axis: Label it "Package Soup" and represent the number of packages of soup
consumed.
Plot the Budget Constraint:

Cost per Dining Hall Meal: $6

Weekly Food Budget: $60
Calculate the maximum Package Soup affordable: Divide the budget by the cost per package
soup ($60 / $1.50) = 40 packages.
Plot two points:
On the horizontal axis, mark the point representing the maximum dining hall meals affordable
(10 meals - $60 divided by $6 per meal).
On the vertical axis, mark the point representing the maximum package soup affordable (40
packages).
Connect these points with a straight line. This line represents the budget constraint, showing the
trade-off between dining hall meals and package soup given the student's budget.
Plot the Indifference Curve (Assuming Equal Spending):

Choose an indifference level: This represents a level of satisfaction the student has with
different combinations of dining hall meals and package soup.
Start from a point on the budget constraint: Since equal spending is assumed, choose a point
roughly in the middle of the budget line.
Move along a curve: While maintaining the same level of satisfaction, adjust the quantities of
dining hall meals and package soup (e.g., decrease dining hall meals and increase package
soup). This curve represents the indifference curve, showing combinations that provide the
same level of satisfaction.
Label the intersection point of the indifference curve and budget constraint as Point A (optimal
choice with equal spending).
Part b: Price Change and New Optimum

Analysis:

The price of package soup increases from $1.50 to $2. This effectively reduces the purchasing
power for package soup.
Diagram (using the same axes from part a):

Shift the Budget Constraint:

Maintain the point representing the maximum dining hall meals affordable (10 meals).
Recalculate the maximum package soup affordable with the new price ($60 / $2) = 30
packages.
Mark the new point on the vertical axis representing 30 packages of soup.
Draw a new budget constraint line parallel to the original one, but intersecting the vertical axis at
the new point (representing the reduced purchasing power for soup).
New Optimum:

Due to the price change and the assumed 30% spending on dining hall meals, the student will
likely consume fewer packages of soup and more dining hall meals.
Locate a new indifference curve that is tangent to the new budget constraint, reflecting a new
level of satisfaction after the price change and spending shift. This indifference curve will likely
be steeper than the original one (more sensitive to the price increase).
Label the intersection point of the new indifference curve and the new budget constraint as
Point B (new optimal choice).
Quantity of Package Soup Consumed:

As a result of the price change, the student will likely consume less package soup. This can be
observed by comparing Point A and Point B on the diagram. Point B will be located at a lower
level on the vertical axis (representing fewer packages of soup) compared to Point A.

Question 2: Chap 21

Part (a): Both Products are Normal Goods

Effect on Maya’s Budget Constraint
When the price of coffee increases due to the frost in Brazil, Maya’s budget constraint will shift.
Here’s how to visualize it:

Initial Budget Constraint: Assume Maya's initial budget constraint is represented by line BC1,
where she can purchase quantities of coffee (C) and croissants (K).

New Budget Constraint: After the increase in coffee prices, the new budget constraint will be
represented by line BC2. Since coffee is now more expensive, Maya can afford less coffee if
she spends all her income on coffee, thus the intercept on the coffee axis will shift inward.

Diagram 1: Budget Constraint Change

Effect on Optimal Consumption Bundle Assuming SE > IE for Croissants
Since both goods are normal and the substitution effect (SE) outweighs the income effect (IE)
for croissants, the following changes occur:

Substitution Effect: As the price of coffee rises, Maya will substitute coffee with more croissants
because croissants are relatively cheaper now.

Income Effect: The increase in the price of coffee effectively reduces Maya’s real income,
leading her to consume less of both normal goods.

Diagram 2: Indifference Curve with SE > IE for Croissants

 I
1: Initial indifference curve before the price change.
I2: New indifference curve after the price change.
Point A: Initial optimal bundle.
Point B: New optimal bundle.
Maya moves from point A (on BC1 and I1) to point B (on BC2 and I2), indicating an increase in
croissants and a decrease in coffee consumption.

Part (b): Coffee is an Inferior Good

Effect on Maya’s Budget Constraint
The budget constraint shifts similarly as in part (a) due to the increased price of coffee.

Diagram 3: Budget Constraint Change (same as Diagram 1)

Effect on Optimal Consumption Bundle Assuming IE > SE for Coffee
Since coffee is an inferior good and the income effect (IE) outweighs the substitution effect (SE),
Maya’s consumption pattern will change as follows:

Substitution Effect: As the price of coffee rises, Maya will substitute coffee with more croissants.

Income Effect: The reduction in real income will lead her to consume more of the inferior good
(coffee) because she can’t afford as many croissants.

Diagram 4: Indifference Curve with IE > SE for Coffee

I1: Initial indifference curve before the price change.
I2: New indifference curve after the price change.
Point A: Initial optimal bundle.
Point B: New optimal bundle.
Maya moves from point A (on BC1 and I1) to point B (on BC2 and I2), indicating an increase in
coffee consumption (due to the strong income effect making her buy more of the inferior good)
and a decrease in croissant consumption.

Summary of Effects
Normal Goods: SE > IE for croissants leads to more croissants and less coffee.
Inferior Goods: IE > SE for coffee leads to more coffee and fewer croissants.
In both cases, the diagrams show the impact on Maya’s consumption choices due to the change
in the price of coffee, reflected in the shift of the budget constraint and changes in the optimal
consumption bundle.