Homework Problem Set 1

Due on week 5 (7-11 Sep)

Each student is required to prepare a typed or clearly handwritten answer to be submitted at the beginning of your designated tutorial.
1. Kevin is considering leaving his current job, which pays $50,000 per
year, to start a new company that manufactures a line of special pens
for personal digital assistants. He expects the annual overhead costs
and operating expenses to amount to $3,200,000.
a. What is his opportunity costs, if Kevin decides to embark on his
new venture?
b. How much revenue would he need in order to earn positive accounting profits? Positive economic profits?
2. The daily demand for Invigorated PED shoes is estimated to be:
Qdx = 100 3Px + 4Py 0.01M + 2Ax
where Ax represents the amount of advertising spent on shoes(X), Px
is the price of good X, Py is the price of good Y, and M is average
income. Suppose good X sells at $25 a pair, good Y sells at $35, the
company utilizes 50 units of advertising, and average consumer income
is $20,000.
a. Is Y a substitute or complement for good X?
b. Is X an inferior or normal good?
c. Determine the inverse demand function for good X.
d. Calculate and interpret the own price, cross price, and income
elasticity of demand.
3. Indicate how each of the following events will shift the demand curve
for the Ford Taurus(a midsize car):
1

a. GM introduces a new line of small, fuel-efficient cars;

b. Following an agreement between the US and Japan, Japanese car
manufacturers will reduce their exports of medium sized car to
the US;
c. The cost of steel increases.
4. A consumer is thinking of spending his income I on two goods X and
Y , with the market price Px , Py respectively. For the following two
scenarios, derive the demand function for good X(in functional form,
not graphically):

a. U (x, y) = 11x + 11y

b. U (x, y) = min(3x, 2y)
5. Jenny consumes two goods, X and Y. Her utility function is given by
the expression U = 3XY 2 . (M Ux = 3Y 2 and M Uy = 6XY .) The
current market price for X is $10, while the market price for Y is $5.
Jennys current income is $500.
a. Sketch a set of two indifference curves for Jenny in her consumption of X and Y. Explain how you determine the indifference
curves.
b. Determine the consumer equilibrium: the X and Y combination
that maximizes Jennys utility, given her budget constraint.
c. Calculate the impact on Jennys optimum basket of an increase
in the price of X to $15. What would happen to her utility as a
result of the price increase?
6. Assume your demand for Pepsi is given by the inverse demand function
P = 12 2Q. Compare the following two options: purchase with unit
price $4 per bottle, or a package deal $18 for 5 bottles. Calculate the
consumer surplus for the two options. Which option should a rational
consumer choose? [For calculation purpose, assume that the demand
is continuous, i.e., consumers can purchase any positive number of
Pepsi, not limited to discrete numbers.]