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Tabassum A-1 ECON 1006

ASSIGNMENT # 1
Microeconomics - ECON 1006 – Summer 2024
Faculty of Business & Economics- Algoma U
Due Date: Check the Course Outline

INSTRUCTIONS (Please read)

- Complete all the parts to all questions and follow the organization suggested by each question.
- You may draw the graphs with a pencil but you must draw them within the answers (DO NOT
attach the graphs on separate papers at the end, I will not mark those);
- All the text including mathematical part must be typed (Hand written assignments will receive
a grade of zero).
- The assignment must be submitted using the group’s page and must be submitted as a single
document - MS Word format ONLY.
- If a question is found to be copied from an internet source, it will receive a zero grade. If it is
copied from another group, both groups will receive a grade of zero.
- Note the submission time on the link and submit before the link is expired. No other mode of
submission will be graded.
- Assignment must be completed in groups (absolutely no individual assignments).
- If a group member does not participate in the group work, report the name in the comments
section on the group assignment submission link and that member will receive zero for not
cooperating with the group.
- The link will allow the submission only once, hence you must make sure that the assignment
is complete and you are submitting the correct document. No assignment in part or whole will
be graded if submitted by email.
- Write to the point answers to the question and explain only where needed. Do not draw
multiple graphs when you can show the work on a single graph. (Check for my instructions
within the question, “do not draw a new graph”.
- Assignment will be graded out of 100 marks and it is worth 10% of your overall grade.
- Answer each question and related parts right after the question and not at the end of this
document.
- Download this document and save it as your Group # and Section and complete the
assignment on this same document.

QUESTION 1 – (15 mark @ 5 marks each part) – Chapter 2

Suppose there are two countries: Canada and Japan, each producing 2 goods: cars and wheat. The
only input they have is labor. Suppose both countries have 10 million workers. A Canadian
worker can produce 10 tonnes of wheat per year or 4 cars. A Japanese worker can produce either
5 tonnes of wheat or 4 cars.

a. Construct a table of output per worker from the information in the question. Which country has
absolute advantage in Wheat? Cars? Explain why? Use the above information to draw the
*/*PPF of each country separately. If each country chooses to remain self-sufficient and
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devotes half its labor towards each good, how much of each good will be produced. Show
this point on the PPF graph.
Solution-
Table of output per worker
(wheat in tones)
Countries Cars Wheat
Canada 4 10
Japan 4 5

Absolute advantage is the ability to produce a good using fewer input than another producer. In
our example above, since labor is the only input, neither of the countries are having an absolute
advantage in producing cars because producing a car requires the same amount of labor for both
countries. However, Canada has an absolute advantage in producing wheat because it requires
less labor to produce 1 tonne of wheat in comparison to Japan. Each labor can produce 10 tonnes
of wheat in Canada whereas, in Japan, each labor can produce 5 tonnes of wheat.

According to our production possibility frontier graph, if each country chooses to remain
selfsufficient and devotes half its labor towards each goods, then each labor would be able to
produce 2 cars and 5 tones of wheat in Canada. In Japan, each labor would be able to produce 2
cars and 2.5 tones of wheat. In total, Canada will produce 20 million cars and 50 million tons of
wheat whereas, Japan will produce 20 million cars and 25 million tons of wheat.
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b. Construct a table to show the opportunity cost of each country for each of the goods they
produce. Which country has comparative advantage in Wheat? Cars? Explain Why?

Solution-

Opportunity cost table

Countries 1 Car 1 tons of wheat
Canada 10/4 = 2.5 tons of wheat 4/10 = 0.4 car
Japan 5/4 = 1.25 tons of wheat 4/5 = 0.8 car

Comparative advantage is the ability to produce a good at a lower opportunity cost than another
producer. In our table above, Japan has a comparative advantage over Canada in cars as the
opportunity cost of producing 1 car is 1.25 tonnes of wheat which is better than Canada which is
producing 1 car at the opportunity cost of 2.5 tonnes of wheat. On the other hand, Canada has
comparative advantage in terms of production of wheat as the opportunity cost for Canada to
produce one tonne of wheat is .4 car unlike Japan whose opportunity cost is 0.8 car to produce
the same.

c. Starting from the situation of no trade in part a) and using the opportunity cost table in part
b), what price of wheat and cars will make trade beneficial for both countries? Explain as
much as possible and you can give a range of prices if it is not possible to give the exact
price.

Solution: According to tables mentioned, it is clear that Canada undoubtedly, has a comparative
advantage in producing wheat and Japan has a comparative advantage in producing cars. Now
suppose both the countries decided to trade in a way that both get their consumption outside their
production capacity. As Canada produces wheat at a lower opportunity cost, it will produce more
wheat and Japan will produce more cars because it has a comparative advantage in that.

If Canada starts producing 10 tonnes of wheat and 0 cars and, on the other hand, Japan will
produce 0 ton of wheat and 4 cars, in this case both will be better off and trade profitably.

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Canada will trade 3 tons of wheat for 2 cars and Japan will trade 2 cars for 3 tons of wheat. After
the trade, both countries will be benefitted.

Consumption without
trade
Countries Cars Wheat
Canada 2 5
Japan 2 2.5

Consumption with trade

Countries Cars Wheat
Canada 2 7
Japan 2 3

QUESTION 2– (20 marks) – Chapter 3

Explain each of the following statements using supply-and-demand diagrams and three steps
method you have learned in class. (Marks will be deducted if steps are not explained in detail)

a. [5 marks] When a cold snap hits Florida, the price of orange juice rises in supermarkets
throughout Canada.

Solution (a) STEP 1- When a cold snap hits Florida, crops of oranges are destroyed, this
results in reduction of supply of oranges which is an input in production of orange juice,
as orange juice is produced with orange, this eventually affects orange juice supply.

STEP 2- A cold reduces the number of oranges supplied, this results in reduction of
quantity supplied of orange juice, as the reduction in quantity supplied of orange juice is
not due to price rather it is due to reduction of quantity supplied of oranges(input), So,
the SUPPLY CURVE will shift and as it is reduction in quantity supplied of orange juice,
the shift will be towards left.

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STEP 3- INITIAL EQUILIBRIUM- E1 is the old equilibrium with the initial supply
curve (S1) and demand curve (D1), the initial price (P1) and quantity (Q1).

NEW EQUILIBRIUM- As the Supply curve shifts leftwards, the new supply curve
supply curve is S2 , the equilibrium is at E2 where the new supply curve intersects the
demand curve, P2 is the new equilibrium price which is higher than the initial price and
Q2 is new quantity.

b. [5 marks] When the weather turns cold in Canada every Winter, the prices of hotel rooms
in Caribbean resorts rise.

STEP 1: The Caribbean places have warm weather and when weather turns cold in
Canada, more Canadian seeks warmer places. Due to this, demand for hotel rooms in
Caribbean resorts increases.

STEP 2: As the demand of hotel rooms in Caribbean resorts increases not due to price
rather change in weather conditions in Canada, the demand curve will shift and as the
demand increases, the curve will shift towards right.

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STEP 3: INITIAL EQUILLIBRIUM – E1 is the old equilibrium with the initial supply
curve (S1) and demand curve (D1), the initial price (P1) and quantity (Q1).

NEW EQUILIBRIUM – As the demand curve shifts towards right, the new demand
curve is D2 and E2 is the new equilibrium where the new demand curve intersects the
supply curve, P2 is the new price which is higher than the initial price showing rise in
prices of hotel from P1 to P2, Q2 is the new quantity.

[10 marks] When a war breaks out in the Middle East, the price of gasoline rises in
Canada, while the price of a used SUV falls. (2 diagrams for this part; one for each
market; gasoline, SUVs).

Solution- Part I: GASOLINE MARKET

STEP 1: Middle East is the supplier of Oil to Canada and when a war breaks out in
Middle east, the quantity supplied for oil reduces, an input used to produce Gasoline, this
eventually impacts the Supply of Gasoline in Canada.

STEP 2: As supply of oil reduces, this leads to reduce is Gasoline supply. As, the
reduction in supply of Gasoline is not due to its own price, this leads to shift in SUPPLY
CURVE, due to reduction, the supply curve will shift leftwards.

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STEP 3: INITIAL EQUILLIBRIUM: E1 is the old equilibrium with the initial supply
curve (S1) and demand curve (D1), the initial price (P1) and quantity (Q1).

NEW EQUILLIBRIUM: As the supply curve shifts towards left, the new Supply curve
is S2 and E2 is the new equilibrium where the new supply curve intersects the demand
curve D1, P2 is the new price which is higher than the initial price showing rise in prices
of Gasoline from P1 to P2, Q2 in the new quantity.

Part II- USED SUVs MARKET

STEP 1- Used SUVs consumes more Gasoline in comparison with the new ones and as
the price of Gasoline rises which is a complementary substance of Used SUVs, the
demand of it gets impacted.

STEP 2- Due to increase in Gasoline prices, a complement to Used SUVs, its demand
falls. As the demand of Used SUV’s falls not due to its own price rather it is due to
Gasoline price, the demand curve will shift and as the demand is reducing, it will shift
towards left.

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STEP 3 – INITIAL EQUILLIBRIUM - E1 is the old equilibrium with the initial supply
curve (S1) and demand curve (D1), the initial price (P1) and quantity (Q1).

NEW EQUILIBRIUM- As the demand curve shifts towards left, the new Demand curve
is D2 and E2 is the new equilibrium where the supply curve S1 intersects new demand
curve, P2 is the new price which is lower than the initial one (P1) which reflects
reduction in Used SUV’s price (P1 to P2) and Q2 is new quantity.

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QUESTION 3 - (20 marks @ 5 marks for each part) Chapter 4

One of the largest changes in the economy over the past several decades is that technological
advances have reduced the cost of making computers.

a Draw a supply-and-demand diagram to show what happened to price, quantity, consumer

surplus, and producer surplus in the market for computers.

Solution:
The supply curve shifts rightward, reducing the price and increasing the quantity of
computers. Consumer surplus increases, and producer surplus decreases

Consumer
surplus

Producer
surplus

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Explanation of the diagram

 Initial supply curve(S1) and Demand curve (D) intersect at initial equilibrium.
 New Supply Curve (S2) shifts to the right side due to technological advances.
 Consumer Surplus increases because the price of computers declines and quantity
increases
 Producer surplus decreases due to a reduction in price

In summary, the technological advances that reduce the cost of producing computers lead to a
lower price, higher quantity, increased consumer surplus, and potentially increased or altered

producer surplus depending on market conditions.

b Several decades ago, students used typewriters to prepare papers for their classes; today they use
computers. Does that make computers and typewriters complements or substitutes? Use a
supply-and-demand diagram to show what happens to price, quantity, consumer surplus, and
producer surplus in the market for typewriters. Describe what has happened to producer surplus
in the typewriter market over the last several decades.

Solution:
For the question of whether computers and typewriters are complements or substitutes, one is
asking about the nature of the relationship in the sense of how consumers perceive their
atomicity. Having said that, on a general level computers are kind of like typewriters: they are
used to produce papers and documents. And so, they are interchangeable. The need for
typewriters has been on the decrease as computers have been easier and are now widespread due
to their functionality and ease of use

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Substitute goods are those goods which are used in place of each other. Typewriters and

computers serve the same purpose and can be used in place of each other.

Consumer

surplus

Producer
surplus

 Demand curve shifts leftwards to D2 (from D1)

 Equilibrium decreases to E1
 Equilibrium price falls to Pe1
 CS reduced (blue area)
 PS declines (red area)

As a result of lower demand for typewriters from the popularity of computers, the equilibrium
price and quantity have decreased and with it consumer surplus and producer surplus in the
typewriter market

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The introduction of new technology in computers changed the market for typewriters because
they are substitutes because a computer can be used in place of a typewriter, as computers
became cheaper and more widely distributed the demand for typewriters dropped
This scenario can be illustrated with a supply and demand diagram for the typewriter market.

c Are computers and software complements or substitutes? Draw a supply-and-demand diagram to

show what happened to price, quantity, consumer surplus, and producer surplus in the market for
software. Describe what has happened to producer surplus for software producers.

Solution:

Complementary goods are those goods that are used together. Software is required for
computer operations, so both are complementary goods.
Because computers are becoming cheaper and more widely used, the demand for software is
greater, and the prices and quantities of software are larger, increasing both the consumer
and producer surplus in the software market.

This can be illustrated with a supply-and-demand diagram market. Computers and software
are generally considered complements because the use of software is directly tied to the use
of computers, for the software market.

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C.S

P.S

 The Demand for software increases Demand curve shifts rightwards to D1

 Equilibrium Quantity increases to Qe
 Equilibrium price rise to Pe
 CS decrease (consumer surplus)
 PS increase(producer surplus)

During the last several years, producers' surplus in the software market has tended to increase.

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d Does this analysis help explain why software producer Bill Gates is one of the world's richest
men?
Solution
Yes, this analysis helps explain why Bill Gates is one of the most successful businessmen
and richest individuals in the world.

Bill Gates is the protagonist in the software market. He is the co-founder of Microsoft with
the demand for computers increasing, the demand for software is on the rise, which has
made Bill Gates one of the world's richest men.

A simple revenue analysis based on the law of demand and supply will reveal that the price
of Computer Software has seen a substantial reduction and that it is this reduced price of
software that has stimulated the demand for software, which is incontestably the economic
advantage of a frictionless market. It played perfectly into Microsoft's hands under Bill
Gates. This gave the company market power, and it was, because of the thereby increased
producer surplus.

QUESTION 4 – (15 Marks) – Chapter 5

Every year at the beginning of flu season, many people, including the elderly, get a flu shot to
reduce their chances of contracting the flu. One result is that people who do not get a flu shot are
less likely to contract the flu.

a. What type of externality (negative or positive) arises from getting a flu shot?

Solution: Receiving a flu shot produces a positive externality. Flu shot not only shields a
person from being sick, but it also slows down the transmission of the illness across the
population. This benefits those who do not get the flu shot by reducing their risk of
exposure to the flu virus.
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b. Draw a graph to show the market of flu shots with the market equilibrium quantity and
price.

Solution: Graph of market for flu shots:

o X-axis- quantity of flu shots o Y-axis- price of flu shots o Demand curve (D)-
downward sloping, showing the decrease in price of flu shots and increase in
quantity demanded
o Supply curve (S)- upward sloping

Equilibrium: o The point where the demand and supply curve intersect with
each other is the market equilibrium.

c. Now on the same diagram that you drew in part b) show the effect of this externality by
drawing and labeling the additional curves to show the efficient quantity of flu shots.
Also show the area that represents the deadweight loss in this market.

Solution: o Social Benefit Curve (MSB): This marginal social benefit curve is above
the demand curve (D) because receiving a flu shot offers extra advantages to society
that people do not consider when choosing whether to get vaccinated.

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o Efficient Quantity: The point on supply curve where the MSB curve intersects is

the efficient quantity or Q2 because it takes positive externality into account, this

number is larger than the market equilibrium quantity Q1 as shown in the above

diagram.

Deadweight loss: The area between the MSB and demand curve from Q1 to Q2.

This is known as the deadweight loss due to under consumption of flu shots in the

pressure of positive externality as shown in the above diagram

QUESTION 5 – (15 Marks) – Chapter 6

Pharmaceutical drugs have an inelastic demand and cars have an elastic demand. Suppose that
technological advance happened in both markets.

a. Draw the demand and supply diagrams for each market separately and show using the three
steps what happens to price and quantity due to shift in the supply curve.

Solution : Pharmaceutical Drugs (Inelastic Demand):

Step 1: Start with the initial equilibrium where demand (D) intersects supply (S) at point E1,
determining the initial price (P1) and quantity (Q1).

Step 2: Due to technological advancement, the supply curve shifts to the right (S1). This
increases the quantity supplied at any given price.

Step 3: The new equilibrium is reached at point E2, where the new supply curve (S1) intersects
the original demand curve (D). This results in a higher quantity (Q2) and a lower price (P2).

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Cars (Elastic Demand):

Step 1: Again, start with the initial equilibrium where demand (D) intersects supply (S) at point
E1, determining the initial price (P1) and quantity (Q1).
Step 2: With technological advancement, the supply curve shifts to the right (S1), increasing the
quantity supplied at any given price.

Step 3: However, in this case, due to the elastic nature of demand, the increase in quantity
supplied leads to a proportionally larger decrease in price. The new equilibrium is reached at
point E2, where the new supply curve (S1) intersects the original demand curve (D), resulting in
a significantly higher quantity (Q2) and a lower price (P2).

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b. Which product experiences a greater change in price? Why? Which product experiences a
greater change in quantity? Why? Explain using the concept of elasticity.

Solution: In this scenario, cars experience a greater change in price compared to

pharmaceutical drugs. This is because cars have an elastic demand, meaning that consumers
are more responsive to changes in price. When the supply increases due to technological
advancement, the price decreases more significantly to accommodate the higher quantity
demanded.

Conversely, pharmaceutical drugs have an inelastic demand, meaning that consumers are less
responsive to changes in price. Therefore, the change in price for pharmaceutical drugs will
be less significant compared to cars.
Regarding the change in quantity, cars also experience a greater change. Again, this is due to
their elastic demand. When the supply increases, the decrease in price stimulates a
proportionally larger increase in quantity demanded. Conversely, for pharmaceutical drugs
with an inelastic demand, the increase in supply leads to a relatively smaller increase in
quantity demanded.

c. What happens to the total consumer spending on both products? Use the concept of total
revenue with relation to elasticity and explain.

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Solution: Total consumer spending depends on the change in price and quantity demanded.

For cars, despite the decrease in price, the increase in quantity demanded is significant due
to their elastic demand. This results in an overall increase in total consumer spending
because the decrease in price is not sufficient to offset the increase in quantity.

For pharmaceutical drugs, although the decrease in price is less significant due to their
inelastic demand, the increase in quantity demanded is relatively smaller. Therefore, the
overall effect on total consumer spending might not be as pronounced compared to cars.

In elastic demand scenarios, when price decreases, the increase in quantity demanded is
proportionally larger, leading to an increase in total revenue (and total consumer spending).
In inelastic demand scenarios, when price decreases, the increase in quantity demanded is
proportionally smaller, potentially leading to a decrease in total revenue (and total consumer
spending).

QUESTION 6 – (15 Marks) – Chapter 7

Canada produces beef and also imports beef from other countries.
a. Draw a graph showing the demand and supply of beef in Canada. Assume that Canada can
import as much as it wants at the world price of beef without causing the world price of beef
to increase. Be sure to indicate on the graph the quantity of beef imported.

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Solution:

BEFORE TRADE AFTER TRADE CHANGE

CONSUMER A A+B+D + B, + D
SURPLUS
PRODUCER B+C C -B
SURPLUS
TOTAL SURPLUS A+ B + C A + B + C+ D +D

AREA D REPRESENTS INCREASE IN TOTAL SURPLUS AND GAINS FROM

IMPORT OF BEEF

o Prior to trade, the consumer surplus was fewer which is shown as Area A and producer
surplus was B+ C and the price in the market was equilibrium price.
o However, when the nation starts import of Beef due to the world price being lower than
the Equilibrium price, certain changes arrive in surplus.
o Area D in the diagram reflects the import, after trade, consumer surplus becomes Area
A+B+C that means consumer surplus increased by Area B+ D.
o When it comes to Producer surplus, after trade only Area C is Producer Surplus, that
means with the import, producer loses area B.
o Total surplus after trades becomes A+B+C+D, that means there is an increase in total
surplus with import which is area D

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b. Now show on your graph the effect of Canada imposing a tariff on beef. Be sure to indicate
on your graph the quantity of beef sold by Canadian producers before and after the tariff is
imposed, the quantity of beef imported before and after the tariff, and the price of beef in
Canada before and after the tariff.

Solution:

o Before Tariff was imposed on Beef when the country could do import as much as
they can, the price on which the import is done is the world price and the quantity of
import before tariff is imposed is from Q1 to Q4.
o Consumer surplus before tariff is, Area A+B+C+D+E+F as per the diagram,
however, Producer surplus is only area G that means Domestic suppliers are willing
to produce till Q1 due to less surplus.
o There is no Government revenue prior to tariff and total surplus is A+B+C+D+E+F.

BEFORE TARIFF AFTER TARIFF CHANGE

CONSUMER A+B+C+D+E+F A+B -C, -D, -E, -F
SURPLUS
PRODUCER G C+G +C
SURPLUS
GOVERNMENT None E +E
REVENUE

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TOTAL SURPLUS A+B+C+D+E+F+G A+B+C+E+G - (D + F)

THE AREA D AND F REPRESENTS WEIGHT LOSS
FALL IN TOTAL SURPLUS DUE TO
DEAD

c. Discuss who benefits and who loses when Canada imposes a tariff on beef.

o When Government imposes tariff on beef import to support Domestic suppliers, the
price increases and market comes near to Equilibrium which was prior to trade,
however, the amount of import decreases and comes between Q2 and Q3.
o Now, Domestic Suppliers are willing to produce more, the domestic quantity
supplied increases from Q1 to Q2.
o Producer surplus increases to Area G and C so they are benefitted, however,
Consumer surplus falls to Area A+ B, so they lose. o With the imposition of tariff,
Government also earns reflected from the area E, government is also benefitted.
o Total surplus falls by an amount equal to area D + F and becomes A+B+C+E+G o
The area D and F represents DEAD LOSS WEIGHT, the former is due to
overproduction and the later is due to underconsumption.

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