ECON131

Principles of Macroeconomics
Spring 2012, Problem Set 1
Suggested Answer

Prof. Hui He

Due on Feb. 3, 2012

Topic: Supply-Demand Framework

Question 2, 4, 5, 6, 7, and 8 on page 77-78 of the textbook.
Question 2 on page 77 (10 points)
Answer: The answers to all three parts are shown in Figure 1.
(a) Initially, the equilibrium price is $2.00, and the equilibrium quantity is 26,000
hamburgers, as shown by the intersection of D0 and S0.
(b) The decrease in the price of beef increases the supply of hamburgers, from S0
to S1. So the equilibrium price falls (for example, to $1.75), and the
equilibrium quantity rises (for example, to 30,000).
(c) Returning to the original supply curve, an increase in the price of pizza raises
the demand for hamburgers, to D1. This raises the price (for example, to
$2.25), and raises the quantity (for example, to 28,000).
FIGURE 1

Question 4 on page 77 (10 points)

Answer: The answers to all three parts are shown in Figure 2.
(a) In market equilibrium, the price is $65 and the quantity is 1,300, as shown by
the intersection of D and S0.
(b) When the price ceiling of $55 is imposed, the quantity sold falls to 700,
because this is all that sellers are willing to offer, even though buyers would
prefer to buy 2,300 books.
(c) When the efficiency of publishing improves, the supply curve will move out,
perhaps to S1. As shown, the price is still $55, the quantity has risen to 1,800,
and there is still a shortage. There are two other possibilities, however. Supply
could increase enough to intersect with demand at a price of $55, in which
case 2,300 books would be sold and the shortage would disappear. If the
increase in supply were even greater, the price ceiling would be ineffective,
the price would fall below $55 and the quantity sold would rise above 2,300.
FIGURE 2

Question 5 on page 78 (10 points)

Answer: The same diagram, Figure 3, can be used for all three cases, because they all
entail a decline in demand, from D0 to D1. Price falls from P0 to P1, and quantity falls
from Q0 to Q1.

(a) In a drought, people have less need for umbrellas, so demand falls.
(b) Popcorn is a complement for movie tickets, so when popcorn prices rise, the
demand for tickets falls.
(c) Coca-Cola is a substitute for coffee, so when the price of the soda falls, the
demand for coffee falls.
FIGURE 3

Question 6 on page 78 (10 points)

Answer: (a) As Figure 4 (b) shows, the supply of tapes falls from S0 to S1. This leads to
an increase in price to P1 and a reduction in quantity to Q1.
(b) In Figure 4 (a), the demand for CDs, a substitute for tapes, rises when the price of
tapes rises. Therefore there is both a higher price and a higher quantity of CDs.
FIGURE 4

Question 7 on page 78 (15 points)

Answer: (a) With a 50-cent tax per pound of beef, Table 2 in the text must be adjusted:
Price Paid by Consumers
(dollars per pound)
8.00
7.90
7.80
7.70
7.60
7.50
7.40

Price Received by Farmers

(dollars per pound)
7.50
7.40
7.30
7.20
7.10
7.00
6.90

Quantity Supplied
(pounds per year)
90
80
70
60
50
40
30

(b) Using the new Table 4-2, Figure 6 shows that the new supply curve, S1 lies
above the original curve, S0, by a distance of 50 cents at each output. The
new equilibrium price is approximately $7.55, and the new equilibrium
quantity is approximately 47 pounds.
FIGURE 5

(c) Yes, beef consumption falls by approximately 13 pounds.

(d) The equilibrium price rises by approximately 35 cents, which is less than the
tax.
(e) Consumers pay two thirds of the tax, since the price they pay has risen by 35
cents. Producers pay 30%, since the price they receive has fallen.
Question 8 on page 78 (15 points)
Answer: (a) In equilibrium, quantity demanded equals quantity supplied:
24,000 500P = 6,000 + 1,000P
1,500P = 18,000
P = 12
4

Substitute P = 12 in either the supply or the demand equation to derive Q =

18,000.
(b) If tourists like t-shirts less, the new demand curve might be Q = 21,000
500P. Using the same method as in part (a), in equilibrium, P = 10 and Q =
16,000.
(c) Opening of the new stores might lead to an increase in the supply curve to Q =
9000 + 1000P. Set equal to the original demand curve, and using the method
of part (a), this yields equilibrium price and quantity of P = 10 and Q = 19000.

Topic: An Introduction to Macroeconomics

Question 1, 2, 3 on page 102 of the textbook.
Question 1 on page 102 (10 points)
Answer: Microeconomist: (a) and (d); Macroeconomist: (b) and (c).
Question 2 on page 102 (10 points)
Answer: Figure 6 shows an economy with a fixed aggregate supply curve, and an
aggregate demand curve that shifts out each year, from D0 to D1 to D2, etc. Prices
would rise continuously, from P0 to P1 to P2, and production would increase, from
Y0 to Y1 to Y2.
FIGURE 6
Price Level

S
P2
P1
P0
D2
D1
D0
Y0

Y1

Y2

Domestic Product

Question 3 on page 102 (10 points)

Answer: (a) Raises GDP by $50,000.
(b) Raises GDP by $10,000.
(c) GDP does not rise, because there is no market transaction.
(d) GDP rises by $500,000, the value of the newly constructed house.

(e) GDP does not rise, because nothing new was produced.
(f) Raises GDP by $25,000.
(g) GDP actually falls by $100. The casino is selling gambling services to you,
which are measured by how much you lose. Winning $100 therefore reduces
sales of gambling services.
(h) GDP does not rise. Because nothing new is produced, capital gains and losses
do not count in GDP.
(i) GDP does not change because you did not produce a good or service.
(j) Raises GDP by $100.