Fall 2011

INTRODUCTION TO MICROECONOMICS: A MATHEMATICAL APPROACH

ECONOMICS A04H
Prof. Gordon Cleveland (sections L01 and L02)

COURSE HANDBOOK AND STUDY AIDS

Michael Krashinsky, Gordon Cleveland

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TABLE OF CONTENTS ECMA04H

(This entire handbook is downloadable, in sections, from the UTSC Blackboard site associated with this course)
BASIC COURSE INFORMATION SURVIVAL GUIDE SCHEDULE OF IMPORTANT DATES READING LIST AND COURSE OUTLINE TUTORIAL QUESTIONS (ANSWERS HANDED OUT AT WEEKLY TUTORIALS) PAGE 2 PAGE 8 PAGE 13 PAGE 14 PAGE 17

STUDY QUESTIONS AND STUDY OBJECTIVES FOR EACH WEEK OF THE COURSE (ANSWERS INCLUDED) PAGE 31

University of Toronto at Scarborough September 2011

ECOA04H Introduction to Microeconomics: A Mathematical Approach

There are three sections of this course taught by two different professors: Professor Gordon Cleveland teaches the L01 section on Monday and Wednesday 2:00 p.m. 3:30 p.m. in IC130 (the big lecture theatre in the new Instructional Centre). He also teaches the L02 section on Monday and Wednesday 3:30 p.m. 5:00 p.m. in IC130. Professor Parkinson teaches the L03 section of the course from 11:00 a.m. to 12:30 p.m. on Tuesday and Thursday in IC130. Professor Clevelands office is on the 2nd floor of the Instructional Centre in IC282. His office hours are on Mondays and Wednesdays from 1 p.m.- 2 p.m., but he may have extra time on Wednesday mornings if you want to book an appointment. Professor Parkinsons office is on the 2nd floor of the Instructional Centre in IC284. His office hours are on Tuesdays and Thursdays from 1 p.m. 2 p.m. each week. There are six teaching assistants for this course. They will lead the weekly tutorials and they have office hours each week to help you. Teaching Assistants have 24 hours of office hours per week in one of the T.A. Offices (there are three Teaching Assistant offices located together on the second floor of the Instructional Centre - IC221, IC223 and IC225). Check the notices outside these offices to find the T.A. you are looking for. Materials related to this course are available on the Blackboard site related to this course. Go to https://portal.utoronto.ca to log in and find the information for this course. You will find there various study aids and information (including tests and test answers from previous years) relevant to students in all sections of this course. Prof. Clevelands office phone is 416-287-7317, and he can be reached by e-mail at cleveland@utsc.utoronto.ca. Prof. Parkinsons office phone is 416-287-7339 and his email address is parkinson@utsc.utoronto.ca. E-mail is good for simple questions, but complex questions requiring explanation should be asked in person (or try consulting one of the Teaching Assistants during the TA office hours in IC221, IC223 or IC225). This version of Part 1 of the handbook applies only to sections L01 and L02 of the course (the sections taught by Prof. Cleveland). It describes the readings you should be doing in the textbook each week, and it gives you mathematical problems to do that are based on the material covered in class that week. You should be doing those questions and checking your answers each week. There will be common term exams and final exams across all the sections in this course. The teaching assistants have regular office hours in the Economics TA Office, located on the second floor of the Instructional Centre in IC221, IC223 and IC225. Plan now to go and talk to them about any problems you are having with the course material. Their office hours can be found on the doors of the T.A. offices, and on the course Blackboard site, and you will meet them at the weekly tutorials held for this course. 2

This course is a half-credit course, which together with ECMA06H, makes up the mathematical (i.e., using calculus) stream of introductory economics and is directed primarily at students interested in specialist programs like the B.B.A. or specialist or major programs in Economics. Before you take either ECMB02H or ECMB06H, (which are the intermediate level courses in microeconomics and macroeconomics), you must complete both ECMA04H and ECMA06H and you must complete MATA32H and MATA33H, or the equivalent material in other calculus courses at university level (for instance, you could do MATA30H and one of MATA35H, MATA36H or MATA37H, instead). Note that if you are interested in a career in Economics, you should definitely do MATA30H plus one of MATA35/A36/A37, plus several more math courses (more calculus and matrix algebra, and perhaps real analysis) during your undergraduate program, as well as taking advanced courses in microeconomics (ECMC13 or ECO325), macroeconomics (ECMC14 or ECO326) and econometrics (ECM. The natural progression in the Management program would suggest that you complete MATA32 and MATA33 at the same time that you are taking ECMA04 and ECMA06 in first year (and preprogram students should be aware that they MUST complete both half-courses in calculus before they can be admitted to the BBA). The Canadian economy is relatively complex: this course gradually builds our knowledge of concepts and tools of analysis that allow us to understand the economy, as well as to pass the course. The course requires steady work on problems, reading and thinking about concepts, and learning how to prepare for testing. It is not a course that can be crammed into a couple of weeks of preparation before exams. 1. CLASSES: There are three hours of lectures each week. Because our text does not use calculus and is not mathematically-oriented, we will be introducing extra mathematical material in class that is not in your textbook. Problem-solving concepts will also be introduced and discussed in your tutorial sessions. That being the case, you should plan on attending all classes and tutorials, concentrating in class, and taking proper notes. You are responsible for what is discussed in class. If you miss a class, you are responsible for finding out what was covered (since the classes are taped and made available on the web, this should not be too difficult) The classes are large - up to 350 students in a classroom - so noise in class can be a serious problem. Please do not talk in class. If you want to talk to your neighbour, the class and the professor would appreciate it if you both left the class. Of course, you should turn off your cell phones and other noisy devices while in the classroom. 2. VIDEO VERSION OF THE CLASS: You can access streaming video versions of the weekly lectures through the Blackboard site for this course. You can play the lectures at home or on the on-campus computers if you miss a class. 3. PROBLEM SETS: You are expected to work your way through the problem sets (study questions) in this Handbook during the term. There are a number of questions assigned for each week. You should do them faithfully and carefully (perhaps working with a study group of your fellow students). Answers to all of 3

the problems are provided in the Handbook, and the Teaching Assistants are happy to explain further any answers you do not fully understand. Naturally, since the answers are provided, you are not expected to hand in your answers for marking) 4. EXAMS AND GRADING: Your grade is determined on the basis of two tests during the term (each worth 25%) and a final exam in the final exam period worth 50%. Your marks will be posted on the intranet. If you miss either or both of the two tests during the term, your marks will be adjusted to put the weight on the final exam. You do not need to present a doctors note or excuse, and there are no make-up tests for students who miss term tests. On the other hand, if you miss the final exam, you will have to apply (on ROSI) to write a deferred exam. Please note that deferred exams will not necessarily take the same multiplechoice form as the exam written in December, and the exam may be designed by a different instructor (who is teaching the class in the term when you write the deferred exam). We want to encourage you to write the term tests, so we will reward you for doing so. If you write the term tests and the final exam and your mark on the final is higher than on one or both term tests, we will replace the lower term test mark with the mark you received on the final exam. This means that there is no penalty for trying a term test, even if you think you are not fully ready. Our intention is not to delay the point at which you begin to take this course seriously. You should do that now. Our intention is, however, to provide a small safety net for students in first year as they begin to learn how to do this challenging subject.

The final exam for all students will be a three-hour exam and will take place in the final exam period, between Wednesday, December 7th and Tuesday, December 20th, 2011 The two mid-term tests will each be held in a 2 hour test period outside of class time. Later in the term, you can check the Blackboard site for information on where to write these tests. The dates and times will be announced in class and shown on the Blackboard site.

The mid-term tests will be made up entirely of "objective" questions (mathematical problems or questions about economic concepts and graphs in the multiple choice form). The final exam will include many multiple-choice questions, but also questions where you must provide a written or graphical answer. The exact design of each test will be discussed in class prior to its taking place. Check the Blackboard site for this course for sample tests and exams from previous years. 5. CALCULATORS: The following simple calculators are recommended (there may be additional letters added at the end on the version you buy, but that does not make any difference). SHARP EL-531 SHARP EL-509 4

TEXAS INSTRUMENTS TI-30 TEXAS INSTRUMENTS TI-34II Explorer Plus or TI-32 CASIO fx-65 or fx-280 You may buy other types of calculators and use them for this course, but you should avoid any that have considerable storage capacity for text, or those that have large screens and sophisticated graphing capabilities, because these calculators can be confiscated during an exam or test. 6. TUTORIALS: Tutorials will be held 11 times this term, led by senior undergraduate students, or graduate students. There are no tutorials in the first week; these will begin in the second full week of classes (the week that begins on September 19th). We have prepared special problems/questions which will be dealt with in these tutorials; these tutorial questions are included in this Handbook. The answers will be taken up by your teaching assistants (TAs) at the weekly tutorials; a copy of the correct answers will either be available on the Blackboard site or will be handed out at the end of the tutorial. Tutorials will parallel the material that we are doing in class, at about the same time. These tutorials are an excellent source of supplemental help in this difficult course. 7. DROPPING OUT OF ECMA04H : Sorry to bring up this painful subject so early in your career in economics, but if you are not doing well in economics, you may decide to drop out of ECMA04H. Dropping a course is unfortunate, but it is not a shameful act; under certain circumstances, it is the wisest course of action. The drop date is Wednesday, November 18th. By that time, you will have written at least one mid-term test and received 25% of your marks in this course. If, at that stage, it is clear you cannot handle the material (given the rest of your academic load), you are better to drop the course and take it again another term, rather than see it through to the bitter end. ECMA04H will be offered again in the summer term, so you can take it at that time to catch up. You are permitted to take ECMA06H without having previously taken ECMA04H, so dropping out of ECMA04 now does not mean that you must drop ECMA06 from next terms course schedule. Of course, ECMA04H is also offered each fall, and ECMA06H is also offered in the summer term. 8. OFFICE HOURS: My office hours have been provided above and will be announced in class. I am happy to see you to talk about any problems you may be having in the course. Although there are a lot more students than there are office hours (there are over 900 students in the three sections of this course), you will often find me available, especially if you are willing to wait a few minutes. In fact, there are many office hours when there is no wait at all. However, right before each test or exam, there is likely to be a line up. This suggests the obvious: don't wait until right before tests to see me about problems (and of course I am not likely to be sympathetic to a student who comes in a day or two before the test to announce that he or she does not understand the past two months worth of material!). If you find the line-ups too long, you may find it easier to resolve some problems by speaking with the tutorial leaders (tutorials are led by teaching assistants - TAs - who are senior undergraduates or graduate students). And, of course, e-mail is another possibility for relatively simple questions. 5

9. BOOKS: It is recommended that you purchase this textbook and follow the recommended readings each week that are outlined in this Course Handbook. This textbook cannot substitute for the lectures, the tutorials, and regular work on the problems that are assigned in this Handbook. The textbook does not use calculus. While it provides important discussion of the economic theory you are expected to learn in this course, it is not sufficient to prepare you for writing the problem-based questions on your tests and exams this year. Therefore, purchase of this textbook is recommended, but not required. The textbook is: entitled Principles of Microeconomics 5th Canadian edition. It was written by Gregory Mankiw from Harvard University and Ronald Kneebone and Kenneth McKenzie from the University of Calgary. It is published in paperback by Nelson Education Ltd and costs about $93 in the UTSC bookstore. You can also rent it from the UTSC bookstore (a cheaper option inquire at the bookstore), or you can rent online access to the textbook (for about $56) from Course Smart (www.coursesmart.com). If you are going to use a course smart book, make sure you get the right one (many books have similar names). You may want to use the ISBN numbers of our text in the search engine on that site (ISBN-13: 978-0-17-650241-6 ISBN-10: 0-17-650241-6). The rest of this handbook, available soon on Blackboard, is an absolutely vital part of this course!! I strongly recommend that you download it and PRINT IT as soon as sections become available. Students in past years have also found past exams extremely useful for review purposes. A (nearly) full set of tests, exams, and answers to the tests and exam questions, is available on the Blackboard site for this course. 10. CHEATING: Cheating debases the learning process and is immoral. Furthermore, it violates the rules of the University and, if detected, will have serious consequences. Any student caught engaging in such activities will be subject to academic discipline ranging from a mark of zero on the assignment, test or examination to dismissal from the university as outlined in the academic handbook. Any student abetting or otherwise assisting in such misconduct will also be subject to academic penalties. Even more to the point, the Department of Management takes it very seriously, and will pursue any case to the limit. I routinely take a variety of measures calculated to make cheating difficult and to catch offenders (some you will know about; others are kept secret). The point is simple: students who do not cheat should know that they are not disadvantaged by their honesty. Each year, a couple of students are caught cheating and get a mark of zero, and a notation on their transcript. You have now been warned. 11. EXTRA HELP: Students who are having trouble should make sure that they work through the problem set questions (and answers) and tutorial questions and answers carefully. Teaching assistants are available at various hours during the week to provide assistance in explaining these answers, and the appropriate techniques for answering questions. Each T.A. will have four hours of office hours per week, in the Economics T.A. offices on the 2nd floor of the 6

Instructional Centre (IC-221, IC223, IC-225). Several independent operators have been posting ads around campus offering special tutoring for which you are asked to pay. These sessions are not sanctioned by the University and we have no information about whether they are of any value. Caveat emptor Let the buyer beware. The Department of Management, in collaboration with the UTSC library, will be providing academic research support in the IC Building. To refine your research skills or to learn more about various scholarly resources, please contact the Librarian for Management and Economics students. Lola Rudin, Subject Librarian, Management and Economics Room IC375 Office hours: Monday & Thursday, 1:00 3:00pm or by appointment Email: lrudin@utsc.utoronto.ca Web: http://guides.library.utoronto.ca/utsc_mgmt The English Language Development Centre (ELDC) helps students develop the critical thinking, vocabulary and academic communication skills essential for achieving academic and professional success. Personalized support includes: RWE (for academic writing); Communication Cafs (oral); Discussion SkillBuilding Cafs; Vocabulary Cafs; seminars/workshops; personal ELD consultations; drop-in sessions. http://ctl.utsc.utoronto.ca/eld/ The Writing Centre (TWC) offers invaluable services to students (learn to become a better writer!) and offers many different kinds of help: drop-in sessions, individual consultations, workshops, clinics, and online writing handouts. http://ctl.utsc.utoronto.ca/twc/ 12. ACCESSABILITY STATEMENT: Students with diverse learning styles and needs are welcome in this course. In particular, if you have a disability/health consideration that may require accommodations, please feel free to approach me and/or the AccessAbility Services Office as soon as possible. I will work with you and AccessAbility Services to ensure you can achieve your learning goals in this course. Enquiries are confidential. The UTSC AccessAbility Services staff (located in S302) are available by appointment to assess specific needs, provide referrals and arrange appropriate accommodations (416) 287-7560 or ability@utsc.utoronto.ca.

Survival Guide for Introductory Economics (and your first year at Scarborough College) Some advice from Professor Michael Krashinsky, former Chair of the Department of Management
I have taught the introductory course at Scarborough at various times over the past 38 years. Certain patterns have emerged that make it possible to tell you about what seems to produce success and failure in this course. Some of these observations will be useful in your other courses. My suggestions apply to everyone, but might be particularly useful to first year students. 1. Keep up: University courses tend to be cumulative, so that not falling behind is critical. If you are up-to-date in your work, my lectures will make more sense and reinforce what you are studying. On the other hand, if you fall behind, the lectures will not make sense and you will fall further behind. The pace in university is likely a good deal faster than what you have been used to, so your experience in high school (that you can fall behind "x" weeks and be able to catch up) is probably misleading. To keep up. you will have to ... 2. Expect to work regularly at home: In most university courses, you are expected to work regularly on the course material outside the classroom. Again, this is likely quite different from your high school experience. Quite aside from your problem set assignments, you have an automatic assignment after each lecture. That is, I expect you to go over your lecture notes and the related reading and get the material clear in your head before the next lecture. Most students do not do this, which is one reason why ... 3. Marks tend to be significantly lower in university: The average first year student in Management arrives from high school with an average mark of well over 80% (on the best 6 courses, including English). Our experience over the past few years suggests that about 15-20% of the students registering in this course will drop out of this course before it ends. Another 20-25% will either fail the course or receive Ds. Since I regard D as an unacceptable grade for a student, only slightly more that half the students starting this course will receive good grades. Clearly, many students do not do as well as their high school marks might suggest. The median mark at the University for students tends to be around 70. If the average student coming into Management has an 85% coming out of high school, then the median student sees his or her mark drop by 15 percentage points. Of course, some individuals (the ones who work very hard) find their marks do not fall at all, but clearly more is expected of you here than in high school. This is not to scare you off university, because... 4. Everyone we accept to university is capable of doing well: The work in this course is not overwhelming or too hard. However you will have to work very seriously. As I have suggested, your experience in high school is likely to be a bad guide to how you must work in university. You will have to work more on your own, you will have to plan lots of time out of class to review your notes, to read your text, to do sample problems. The bottom line is that you should ... 8

5. Expect to work harder than you did in high school: We expect a minimum of ten hours a week of work in the course, including your time in class. If you are taking five courses, all of which expect this work level, that amounts to 50 hours a week of work on academic subjects. That is real work, not work while watching television or a party going on in the background or while you are earning money at a job. In fact, ... 6. You should NOT go to school full time AND hold a demanding job: No one can work 30-40 hours a week at a job and 50 hours a week at learning university-level material. Yet every year I meet large numbers of students trying to do just that. It may be that their high school experience has taught them that combining work and school is quite reasonable. It is a serious mistake to extend that experience to university. The work here is at a higher level and the pace is such that what you did in high school is not enough. You CANNOT work full time and go to school full time. Several years ago, I had a student in a fourth year seminar who was earning an "A" in the course. I was surprised, because his average mark over the previous three years had been a "C+" (and my course was hard, so that a student earning an "A" in it could have done as well in any other course). When I asked the student about this, he told me frankly that this year he did not have a part-time job. In each previous year of University, he had had a job that required 20 hours a week, and he told me that he accepted the lower marks because he needed the money to operate his car. I felt his choice was strange (in the long run, his lower marks would cost him a lot more money than he was earning, not to mention the fact that the extra money he would later earn could buy him a lot better car than he was driving!), but at least he knew the choice he was making. Many first year students do not know that working at a job during term will cost them marks, will mean their income is lower in the future, and in many cases will result in them not surviving first year. If we believe that the student mentioned above is typical, then we can figure out what a full time job will cost you. Working 30+ hours a week will mean that: an excellent ("A") student will get average ("C" to "C+") grades a bright ("B") student will get below-average ("D" to "C-") grades a good ("C") student will fail or barely pass. If you have such a job, I can hear your objections now. Let's deal with them in turn: "I'm not typical. I can work and still study, since my job is boring and doesn't take that much out of me." - You're wrong. Boring work is the worst of all in terms of destroying the urge to study (since, let's face it, studying for most people is not something we look forward to, so motivating ourselves to study is next to impossible after a boring job). And you may not be typical, but don't kid yourself. "You're wrong about supporting a car. I work to support myself. Without the money I earn, I couldn't stay in school." - This is a tougher objection. I don't know your personal financial situation, nor can I judge what pressures you face. If you truly need to work to stay in school, then you still have to face the cost of work in terms of your grades. If you must work, then accept reality and go to school part time. Or work full time and save up to go to school. Or borrow the money somehow, or apply for a bursary, or cut your budget to the bone. But for goodness sake don't try to combine 30 hours a week of work with a full time course load. Because the inevitable result is the worst of both worlds: wasted effort, low grades, and a year down the drain. 9

 "What about self-reliance and all those movies about kids working their way through school." - Most people are not movie heroes! I admit that there are in this world some fantastically motivated people who can manage it all. After all, there are 168 hours in a week, and even subtracting 50 or so for sleep, there are enough hours for school and even a full time job ... if you are Superman or Superwoman, that is. Most of us aren't, which is why so many of the students who started the introductory course last year did not finish it or, if they did finish it, did not receive acceptable grades. I don't doubt your motivation at the beginning of the term. But the movie picture of the dedicated student living in poverty and coping is not the story I see in my classes! "I'm different. It won't happen to me." - Yes it will. 7. High school economics is not university economics: Another reason for the lower marks in university is that what you are expected to be able to do at the end of the course, and what you are expected to know for exams, differs between high school and university, even when the material covered is not much different. In past years, I have had some students who even used the same economics text in their grade 13 economics course as I used in first year. The students were sure they knew what they needed to know even before the course started. Most of them were supremely surprised after the first test. One student came to me and said: "I had seen all the material before, but you really expected us to be able to solve problems and know what was going on. In high school, the questions were more general. We never had to be able to solve problems involving the detail that you expect." Precisely. I won't ask you, for example, vague questions about why perfect competition works, but rather will ask detailed questions about how it works. Your high school training won't hurt you, but don't expect it to carry you any distance. By the way, this same phenomenon applies in your other courses. The math people say that their students do best when totally new material is introduced, since the students work hard to overcome their lack of knowledge. When high school material is reintroduced more rigorously, students relax, figuring that they know what is going on. Inevitably, they don't. All this is a good reason why ... 8. A little bit of fear wouldn't hurt: The purpose of all these warnings is not to scare you out of university. There is the classic story of the dean calling all the students together in a first assembly and saying "Look to your left; look to your right; one of you won't be here in six months." That is not a bad summary of what happens in this course. But the reason is not that one-third of the students can't handle the work. As mentioned earlier, everyone accepted here is capable of doing the work. Thus the issue is how to get you to do the work you are capable of. One way is to make you a little afraid at the beginning so that you work hard and do not fail out before you discover just what is required to do well in university. The key lies within yourself, because ... 9. University is a very impersonal place: You hardly need to be told this, as you sit in classes with 300-500 students. But the anonymity means that if you don't do the "right" amount of homework, if you skip classes, if you don't do the sample problems - in summary, if you don't follow all my advice - it will seem that nothing bad happens. No one yells at you, no note goes home to parents, no one, it seems, even notices. Even if you fail the first exam, nothing seems to happen. You can drift (and party) for the entire year failing all your courses and no one will say anything to you. How can they, when they don't know your name? 10

The danger in first year is worsened by the fact that you will get little feedback on how you are really doing in the course until it is too late to do much about it. That is because there is a lot of weight on exams in university, with little for problem sets and nothing (at least in this course) for class participation, oral presentations, and so on. There is only one way to deal with this problem. Work hard, keep up-to-date, work with other students, and ... 10. When you are having trouble, get help quickly: Your professor has office hours. There are lots of students, but you will be amazed at how accessible they are in office hours that are not right before an exam or a problem set due date. If you prepare for seeing them (by writing down specific questions, and working on problems you are having trouble with), they can make very effective use of your time and their time. Also, there are teaching assistants (t.a.'s) who can help and who are even more available. But you will have to take the vital first step by coming in to see us. Don't worry that your professor will be angry if you are not understanding things. What makes professors angry (and frustrated) is the students who drift along not understanding things and then write exams that reflect that lack of understanding! Finally, 11. Enjoy University! This sounds like the parent telling a teenager not to do this, not to do that, not to do the other thing, and above all to have fun! But the point is that if you work hard and keep up with your course work and avoid "part time" jobs that chew up all your available time for thinking, university will be a very rewarding time for you. You'll learn more about yourself and about the world around you, and you may even get a job at the end of it all. Maybe even more importantly, if you fall behind and do badly in your courses, you won't enjoy university, and if you are not having much fun, you are unlikely to stay here very long. And that would defeat the whole purpose of coming here in the first place. Enjoying university also means that you should take courses because you are interested in them and because they stimulate you. All too often, students take Economics even though they don't like it and are bored in class, because they (or, even worse, their parents) believe that "practical" courses like Economics are what lead to good jobs. This is a bad strategy. For one thing, if you don't like what you are studying here, you are unlikely to do very well. A's and B's in Political Science or Psychology or History on a resume look far more impressive than C's, D's and F's in Economics. And in any case, getting a job is, I hope, not all that university will be about for you. On this last point, I rather like a quote from Thomas Jefferson's Principles of Education for the American People: "It is the objective of higher education To form the statesmen, legislators, and judges upon whom public prosperity and individual happiness are so much to depend; To harmonize and promote the interests of agriculture, manufacturing and commerce, and by well-informed views of political economy to give free scope to the public industry; To develop the reasoning faculties of our youth, enlarge their minds, cultivate 11

their morals, and instill in them precepts of virtue and order; To enlighten them with mathematical and physical sciences, which advance the arts and administer to the health, the subsistence, and the comforts of human life; and, finally, To form them to habits of reflection and correct action rendering them examples of virtue to others and of happiness within themselves." All that having been said, let's get down to the course!

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SCHEDULE OF IMPORTANT DATES ECMA04H

Week 1 Monday, September 12 - first day of classes in the L01 and L02 sections of this course; there are no tutorials in this week (Week 1). Go to your assigned tutorials in Week2. Wednesday, September 21 - last day to add/change courses Monday, October 10 - Thanksgiving, no classes on this day Wed Oct 19 or Fri Oct 21 - possible days for first test Wed Nov 16 or Fri Nov 18 - possible days for second test Wednesday, November 16 - last day to drop course without academic penalty (removed from transcript) Thursday, December 1st - last day of classes for sections L01 and L02 of this course (replacement class for Thanksgiving, at your regular time)

Week 2 Week 5 Week 6 Week 10 Week 10 Week 12

Wednesday, December 7 to Tuesday, December 20 - FINAL EXAM PERIOD - exam may come at any time in the exam period. Note - There will be tutorials in ECMA04Y in all weeks except week 1. In other words, the tutorials start in the week beginning on September 19th. (Note: there are tutorials even on weeks when mid-term tests are scheduled)

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READING LIST AND COURSE OUTLINE

(dates shown below are applicable only to L01 and L02 sections) Week 1 (Sept 12, Sept 14) Topics: Definition of economics. Definition of microeconomics and macroeconomics. The role of scarcity of economic resources and of choice. Opportunity cost defined and explained. The production possibilities model as a way of thinking about scarcity, choice and opportunity cost. Seven of the ten key principles of economics discussed. Recommended Reading: Chapter 1 Ten Principles of Economics (pp. 3-13) and Chapter 2 Thinking Like An Economist read section entitled Our Second Model: The Production Possibilities Frontier (pp. 26-30). Week 2 (Sept 19, Sept 21) Topics: The market model in general. How markets allocate resources through buying and selling of goods and services. Shifts in demand and shifts in supply and how they affect equilibrium price and quantity traded. The key role of prices in allocating resources to different uses. Judgement of the allocative function of free markets. Recommended Reading: Chapter 4 The Market Forces of Supply and Demand (pp. 6990), part of Chapter 6 Supply, Demand and Government Policies (pp. 119-131 on price ceilings and price floors) and look at the Appendix to Chapter 2 Graphing: A Brief Review (pp. 42-50) especially consider the difference between moving along a curve and shifting a curve. Week 3 (Sept 26, Sept 28) Topics: The theory of consumer demand for goods and services. Utility, total utility, marginal utility, and the optimal purchase rule; how these concepts help us understand the negative slope of demand curves. The Law of Demand. Individual and market demand; shifting of demand curves and moving along them. The concepts of consumer surplus and of producer surplus algebraically and graphically. Market efficiency and the maximization of consumer surplus and producer surplus. Recommended Reading: Chapter 7 Consumers, Producers and the Efficiency of Markets (special focus on part of chapter on consumer surplus) Week 4 (Oct 3, Oct 5) Topics: Measuring and understanding the elasticity of demand and of supply. How a sales tax will affect a market. The importance of the elasticity of demand and supply in determining the incidence and excess burden of a sales tax. Review of the concepts of consumer surplus and producer surplus. Price ceilings, price floors and the allocative functions of markets. Recommended Reading: Elasticity and Its Application (pp. 95-115) and part of Chapter 6 Supply, Demand and Government Policies (pp. 131-138 on excise taxes and elasticity) and Chapter 8 The Costs of Taxation (pp. 165-177). Also read SUPPLEMENT A (available on Blackboard site) on excise taxes and elasticity. 14

Week 5 (Oct 10 is Thanksgiving holiday, Oct 12) Topics: Production and Productivity. How all production processes are characterized by diminishing marginal returns to additional use of some variable input, when one input is fixed in amount. This gives us diminishing marginal product (and diminishing average product), and explains the costs of production in the short run. Recommended Reading: part of Chapter 13 The Costs of Production (pp. 269-275). Week 6 (Oct 17, Oct 19) Topics: The typical shapes of a firms cost curves. Use of fixed and variable inputs determine short run costs, based on diminishing marginal product and rising marginal cost. The distinction between the short run and long run costs. Definition, description and explanation of total, average and marginal costs in the short run. The importance of marginal costs to decision-making. The envelope theorem and the relationship between short-run and long-run costs. The long run average cost curve (LAC or LRAC) as an envelope of the short run average cost curves. Economies of scale, diseconomies of scale, and minimum efficient scale. Recommended Reading: second part of Chapter 13 The Costs of Production (pp. 275286). Week 7 (Oct 24, Oct 26) and Week 8 (Oct 31, Nov 2) Topics: Economic models often assume that a market is "perfectly competitive". Perfect competition is defined, the demand situation facing a perfectly competitive firm is clarified, and we figure out how a perfectly competitive firm will make supply decisions which will maximize its profit (in the short run). Assuming all firms have similar costs, we derive the implications of perfect competition for the supply of goods to the market as a whole (the industry supply curve in the short run). Demand and supply across the whole market will determine the price, which then has feedback effects on the behaviour of the individual firm. Entry and exit of firms give us the long run supply curve of the perfectly competitive industry as a whole. We discuss the characteristics of long run equilibrium in a perfectly competitive market. How a perfectly competitive market allocates resources in the short run and in the long run and maximizes the sum of consumer and producer surplusthe invisible hand at work. Recommended Reading: Chapter 14 Firms in Competitive Markets (pp. 291-309). Week 9 (Nov 7, Nov 9) Topics: The polar opposite of a perfectly competitive market is a monopolistic one. Monopoly is defined, the demand situation facing a monopolistic firm is clarified, and we examine how a monopoly will make price and output decisions to maximize profits. Taking the point of view of society as a whole (and using the concepts of consumer surplus and producer surplus), we can compare the results of business decisions made in perfectly competitive and monopolistic market structures. This economic theory is the foundation of public policies towards a number of important industries. Public policy may strive to regulate the behaviour of industries that do not operate in the public interest; we discuss the pros and cons of these regulatory efforts. Recommended Reading: parts of Chapter 15 Monopoly (pp. 313-328 and pp. 334-339) 15

Week 10 (Nov 14, Nov 16) Topics: Much of the Canadian economy is neither perfectly competitive, nor monopolistic. The rest of the Canadian economy can be better understood with models that emphasize strategic behaviour with uncertain outcomes. We briefly mention monopolistic competition (product differentiation) and then focus our attention on oligopolistic industries. Game theory, especially the prisoners dilemma, can be used to understand decision-making of firms in an oligopoly. We compare the gain to society from oligopoly, with the gain to society from monopoly and perfect competition, and discuss public policy that can improve public results from oligopolistic industries. Recommended Reading: Chapter 17 Oligopoly (pp. 365-386). Also read Supplement B: The Prisoners Dilemma and Applications to Duopoly which you can download from the Blackboard site for this course. LAST DATE TO DROP COURSE WITHOUT ACADEMIC PENALTY IS WEDNESDAY NOVEMBER 16th Week 11 (Nov 21, Nov 23) Topics: So far in this course, it may seem that governments play a minor role in the economy; in fact, the role of governments, through taxation, laws, regulations, and direct expenditures is very large. All too briefly, we examine two major classes of arguments that suggest that a market economy may not work well and that we may benefit from an important degree of government intervention into the economy. The first of these is the case of public goods goods that are consumed collectively, rather than individually, and where excluding additional consumers is infeasible. The second of these is externalities; goods that are consumed by individuals, but where there are effects on others. Pollution is one main example of an externality - a problem that a purely private market economy may not be able to solve; we analyze this problem in theory and look at alternative forms of government intervention which may help to control pollution. Recommended Reading: Chapter 10 Externalities (pp. 205-224) and Chapter 11 (Public Goods and Common Resources (pp. 229-242) Week 12 (Nov 28, Nov 30 and also Thursday, December 1st replacing Thanksgiving Monday) Topics: The rationale for trade between countries is frequently misunderstood. We focus on the importance of comparative advantage in determining what each country will specialize in producing and trading with others. In simplified models, it is shown that all countries can be made better off by international trade. In other models, we examine the overall economic cost to a country that decides to ignore these benefits and protect its own markets with tariffs or quotas. We also examine situations under which protectionism can make good economic sense. Recommended Reading: Chapter 3 Interdependence and the Gains from Trade (pp. 51-63) and Chapter 9 Application: International Trade (pp. 181-199).

16

TUTORIALS
Your tutorials are scheduled on the same day each week (different days for different students). Tutorial questions are printed below. There are no tutorials in Week 1 **************************************************************** ECM A04H TUTORIAL #1 (WEEK 2)
1. 2. 3. 4. What is the opportunity cost to you of going to Economics class? What is the opportunity cost to you of getting a university education? What is the opportunity cost to you of taking a part-time job during the school year? Assume that Jane lives in a single-person economy and is only able to produce juice (Y) and nuts (X). Her Production Possibilities Frontier for one month's production can be described by the function: Y = 400 - 30X - X2 0 X10

(a) What is the maximum amount of juice (in litres) that she could produce? What is the maximum amount of nuts (in kilos) that she could produce? (b) Why do we restrict X to lie in the interval (0,10) when we write the PPF as a function? (c) Is the point (5, 100) [i.e., X=5, Y=100] an efficient amount of production for Jane? Why or why not? (d) Sketch the PPF. Divide the diagram into three sets, as follows: points that are attainable but inefficient; points that are attainable and efficient; points that are unattainable. (e) What is the opportunity cost of nuts at (4, 264)? What is the opportunity cost of juice at the same point? Repeat both questions at (8,96). How are these costs related to calculus concepts that you have learned? How are they related to geometric properties of the graph that you have sketched? (f) What is the value of the second derivative of the Production Possibilities Frontier (i.e., d2Y/dX2)? What does the sign (i.e., positive or negative) of this derivative imply, economically speaking? How do we interpret a PPF that is linear, compared to one that is bowed (i.e., curved) outwards? (g) Imagine now that Jane has a utility function (a function that expresses her evaluation of X and Y (nuts and juice). Lets say that this utility function is: U 17

= 80X + 2Y. This utility function tells us that every kilo of nuts gives Jane 80 units of utility (joy or satisfaction), whereas each litre of juice gives her 2 units of utility. (The odd thing about this utility function is that these valuations of X and Y dont depend on how much juice or nuts Jane already has, but we will ignore this unrealistic feature and enjoy the simple mathematical form of a linear utility function.). Given the PPF (which tells us how much juice and nuts can be produced) and her utility function (which tells us the amount of joy she will get from different combinations of juice and nuts), how much of each do you think she will decide to consume?

18

1(a)

Draw a graph depicting supply and demand curves in the market for tomatoes. What would happen to the prevailing price and quantity traded if family incomes were suddenly to rise? Show the changes on the graph. Does your answer to (a) depend on whether tomatoes are considered to be "inferior"? Show the effect of a rise in incomes if tomatoes are an inferior good. The following changes will either cause (i) a change in quantity demanded, (ii) a change in demand, (iii) a change in quantity supplied, or (iv) a change in supply. Indicate which description applies to each of the following, and also whether the equilibrium price and the equilibrium quantity will rise or fall: the effect of a shift to the right of the supply curve of margarine on the margarine market the effect of a fall in the price of margarine on the butter market the effect on the aluminum market of a subsidy which lowers the price of electricity (note: aluminum smelters use a lot of electricity). the effect of a shift to the left in the supply curve of oats on the oat market the effect of a rise in autoworker wages on the market for cars. The demand for strawberries can be represented by: P = 10 - .6Q, 0 Q 16.66 where P is the price in dollars per pint and Q is thousands of pints sold per week. The supply of strawberries in the off-season can be represented by: P = -2 + .4Q, Q 5 Determine the equilibrium price and quantity in the off-season. At this equilibrium quantity, what is the extra cost (measured along the supply curve) of supplying an extra unit of strawberries (i.e., the opportunity cost). At this same quantity, what is the extra value to consumers of an extra unit of strawberries (measured along the demand curve). Assume that in the strawberry season, the supply curve shifts to: P = -2 + .2Q, Q 10 Determine the new equilibrium price and quantity. Draw the change in supply on a graph and show the new equilibrium price and quantity.

ECMA04H TUTORIAL #2 (WEEK 3) QUESTIONS

(b) 2.

(a) (b) (c) (d) (e) 3(a)

(b)

4.

In the market for apartments in Prince George, British Columbia, demand is given by: 19

P = 100 - Q and supply is given by: P = 20 + .25Q where Q is the number of apartments rented and P is the rental price per day. (a) What is the equilibrium price and equilibrium quantity of apartments traded? (b) If the city council of Prince George decides to enforce a price ceiling of $30 per day, and this price ceiling is effective, how many apartments will be rented? (c) Given the number of apartments from answer (b), what price would renters be willing to pay, at the margin, for apartments? If price/rent controls forbid renters from paying the price they are willing to pay, what form might these extra payments take? (d) What is the amount of excess demand or excess supply of apartments at the controlled price?

20

ECONOMICS A04H TUTORIAL #3 (WEEK 4) QUESTIONS

1. You have the following utility function for roller coaster rides (where utility is measured in dollars, and X refers to the quantity of roller coaster rides): U = 10X1/2 a) Derive the demand curve for roller coaster rides and determine how many rides are purchased when the price per ride is $1. What is the marginal utility of an extra ride when X = 25, when X = 16, when X = 9, when X = 4? b) What is the consumer surplus when the price per ride is $1? Explain what consumer surplus is, in plain English. How does the amount of consumer surplus you receive affect your decision to buy a certain quantity of rides if the price rises? c) Suppose that the amusement park operator offers a day pass for $40 which allows you to take all the rides you can manage for the entry fee of $40. You determine that there is enough time during the day for 50 rides. Should you buy the pass, or continue to pay by the ride? What is the most you would pay for the pass? d) Ignore the day pass. If the price per ride rises to $1.25, how many rides are purchased and what is the consumer surplus. What impact has the price increase had on the amount spent on rides? e) Elasticity of demand measures the sensitivity of quantity demanded to changes in price along a demand curve (e.g., when the supply curve shifts but demand remains the same). When the price per ride is $1, determine the elasticity of demand. Is your result consistent with the answer to the final question in part d?

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ECOA04H TUTORIAL #4 (WEEK 5) QUESTIONS

1.

The demand and supply of gazebos are given by the following equations: demand: P = 110 - 0.5Q supply: p = 54 + 0.2Q where Q = quantity and P = price in dollars. Compute equilibrium price and quantity. Suppose that a tax of $7 per gazebo is placed on consumers. How are demand and supply affected? Determine the new equilibrium price paid by buyers and equilibrium quantity. Who bears the burden of the tax? Draw this graph. Now suppose that the government removes the tax on consumers and replaces it with a $7 gazebo tax on the sellers of gazebos. How are the curves affected? Draw the graph for this new situation. Demonstrate that there is no change in the economic incidence of the tax (even though the statutory incidence of the tax has changed). Determine the elasticities of supply and demand at the initial equilibrium point (prior to the tax). How are these elasticities related to the economic incidence of the tax? Now the demand for gazebos changes to P= 82 - 0.15Q. Repeat parts (a), (b) and (d) of the previous question.

(a) (b)

(c)

(d)

2.

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ECMA04H TUTORIAL #5 (WEEK 6) QUESTIONS

1.

An industry has the following demand curve: P = 500 - 10Q. Any amount of output can be supplied at a price of $100 per unit. A $50 tax is placed on the sale of this output. Compute government revenue, excess burden, the cost to taxpayers of the tax, and the cost to taxpayers per dollar of revenue raised. A firm employs 34 units of capital (fixed in the short run) and has the following short run production function: Units of labour used per day Output per day 11.3 15 12.0 16 12.8 17 13.7 18 14.7 19 15.8 20

2.

The price of capital is $2 per unit and the price of labour is $20 per unit. The production function can also be written as L = 0.05Q2 - 0.85Q + 12.8 for Q 15 a) Derive a table for the AP (average product) and MP (marginal product) of labour, without calculus. What is the relationship between the maximum AP and the MP? Is the pattern of (eventually) declining average product and marginal product normal or abnormal in the production of goods and services? Without calculus, construct a table showing TVC (total variable cost), TFC (total fixed cost), TC (total cost), AVC (average variable cost), AFC (average fixed cost), AC (average cost), and MC (marginal cost). Is AVC minimized where AP is maximized? Explain. Derive an expression for AVC, AC, and MC, using calculus where appropriate. Find the minimum value of AVC and AC. Show that MC passes through both minimum points. Explain why this happens.

b)

c)

23

ECMA04H TUTORIAL #6 (WEEK 7) QUESTIONS

1.

A firm in a perfectly competitive constant cost industry in the short run has fixed costs of $240, and total costs given by: TC = 3q2 + 10q + 432 q 4 where q is output of the firm. Demand for the output of this industry is given by: P = 154 - 0.06Q where Q is industry output. Form an expression for AC, AVC, and MC for this firm. Where is AC minimized? Where is AVC minimized? In a perfectly competitive industry, it is assumed there are so many firms that no individual firm has any control over the price; price is a constant from the point of view of the individual firm. Form an expression for the profits earned by this firm if the price in the short run is P0. Maximize this expression, and show that the result is the same as setting price = marginal cost. Form an expression for the supply curve of this firm. Suppose in the short run that there are 60 identical firms in the industry. The industry supply curve is the sum of the quantities supplied by each individual firm. Find the industry supply curve and then calculate the equilibrium price and output in this industry in the short run. How much profit does each firm earn? Repeat part (c) when the number of firms in the industry is 100, 200, and 300.

a) b)

c)

d)

24

ECONOMICS A04H TUTORIAL #7 (WEEK 8) QUESTIONS

1.

A constant cost industry is one that has a horizontal long run industry supply curve. We continue to use the firm in the perfectly competitive constant cost industry from last week's tutorial. This firm had fixed costs of $240, and total costs of: TC = 3q + 10q + 432 q 4 where q is output of the firm.

Demand for the output of this industry is given by: P = 154 - 0.06Q where Q is industry output.

Initially there are 100 firms, each producing 12 units of output, and price is $82 and profits are zero. Assume that this size of plant generates the minimum long run average costs, so that this situation is also a long run equilibrium. a) b) c) Explain why this is a long run equilibrium. Suppose that demand increases to P = 178 - 0.06Q. What will happen in the long run and the short run? Return demand to the original level and return to the initial equilibrium. Now suppose that the government imposes a tax of $12 per unit sold on every firm in the industry. What will happen in the short and long run and who will bear the tax in each case? Return demand to the original level and remove the tax. Now a new technology is developed which can produce output at a minimum AC of $64 when the firm produces 25 units (this is the new minimum LRAC [or LAC]). What will happen in the long run?

d)

25

ECMA04H TUTORIAL #8 (WEEK 9) QUESTIONS

1. We continue to use the cost data from the firm in the previous tutorials. Now, however, there is a single (monopoly) firm in the industry. This firm had fixed costs of $240, and total costs of: TC = 3q + 10q + 432 q 4 a) where q is output of the firm.

Suppose that the demand for the output of this industry is given by: P = 120 - 2Q where Q is industry output.

How much output will the firm produce and what price will it charge? What profits will the firm earn? b) c) d) Now the firm faces demand of Now the firm faces demand of P = 90 - 2Q. Repeat part a. P = 70 - 2Q. Repeat part a.

For each of the answers to (a), (b), and (c), what is the elasticity of demand at the equilibrium quantity? Is demand elastic, inelastic or unit elastic? Are you surprised?

2. (a) (b)

Imagine that a tax of $10 per unit is levied on the monopoly firm in each of the three cases from Question 1. By how much will the market price paid by buyers (including the consumers share of the tax) rise in each case? How much is the buyers share and the sellers share of the tax in each case?

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ECMA04H TUTORIAL #9 (WEEK 10) QUESTIONS

1. Output in an industry can be produced most efficiently in plants producing q = 5 with LRAC (also known as LAC) = $12. Demand in the industry is given by P = 32 0.1Q. Determine long run output and price and number of firms in a competitive industry (assume that each firm operates only one plant). What is the overall benefit to society from the production of the good? What is the overall cost to society from the production of the good? What is the (net) gain to society (G.T.S.) from the production of this good? Now a single firm monopolizes the industry and bars entry by other firms. Determine long run price and output, the number of plants operated by the firm, and the firm's profits. What is the gain to society (G.T.S.) from the production of the good? What is the efficiency loss due to monopoly?

a)

b)

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ECMA04H TUTORIAL #10 (WEEK 11) QUESTIONS

1. 2. (This question is being changed. The replacement will appear later this term. Watch for the replacement version of the tutorial on Blackboard). In a small and isolated community, there are 20 consumers, each of whom have the following utility for mosquito control during the summer: U = 20X - 0.5X2 where X is the amount of mosquito control purchased in aggregate by members of the community, and U is the utility measured in dollars for each individual when X units of mosquito control are purchased (that is, all members of the community derive benefit from mosquito control, whether or not they actually purchase it themselves). Mosquito control costs $100 per unit. (a) Explain why no individual acting alone will purchase any units of mosquito control. (b) Add up the individual utilities to obtain the aggregate utility obtained by the community from the purchase of mosquito control. If the community acts together, how much mosquito control will the community demand at a price of $100? If each individual pays 1/20 of the cost per unit for mosquito control, show that each individual will be made better off by acting collectively, rather than individually. (c) Explain in words why the market fails to come up with the optimal solution in this case. (d) In real life, will the community ever act to overcome this market failure? When is this likely to occur? When is this unlikely to occur?

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ECMA04H TUTORIAL #11 (WEEK 12) QUESTIONS

1. In Canada, the production of 1 unit of both grain and clothing each require 1 unit of labour; in the U.S.S.R., 1 unit of grain is produced by 10 units of labour and 1 unit of clothing by 4 units of labour. Canada has 20 units of labour; the U.S.S.R. has 160 units of labour. Derive the PPF of each country and indicate what each will produce and consume given autarchy. What is the relative price of the goods in each country under autarchy? Which country has an absolute and comparative advantage in each good? Under free trade, who will export what? If both economies are decentralized, what mechanism will lead to this result? If we call PG/C the number of units of C that trade internationally for 1 unit of G (thus PG/C is the relative price of G), what can we say in general about the value of PG/C after trade begins? Show that each country is made better off by trade. Do this by means of an invented example, and by drawing Production Possibilities Frontiers and Consumption Possibilities Frontiers for each country. (Can you also show this indirectly by showing that there are efficiency losses due to imposing tariffs on trade?) A country consumes wheat, some of which is produced domestically and some of which is imported. The domestic Demand and Supply curves are given by: domestic Demand: P = 100 - Q domestic Supply: P = 10 + Q Wheat is also available for unlimited import at a price of $20 per unit. In the absence of any government interference, how much wheat will be produced, imported and consumed in the country? Suppose now that a 50% tariff is placed on the importing of wheat. How much wheat will be produced, imported and consumed in the country? We want to measure the inefficiency of the tariff. To do this, we must compare the net benefit to society with and without the tariff. Without the tariff, the net benefit is just the sum of producers' and consumers' surpluses. With the tariff, we must also include any revenues earned by the government from tariff revenue (which could be used to benefit residents of the country). In each case, derive net benefit. What is the loss associated with the tariff?

a)

b)

c)

2.

a. b. c.

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STUDY OBJECTIVES AND STUDY QUESTIONS

Week 1 (Sept 12, Sept 14) Topics: Definition of economics. Definition of microeconomics and macroeconomics. The role of scarcity of economic resources and of choice. Opportunity cost defined and explained. The production possibilities model as a way of thinking about scarcity, choice and opportunity cost. Seven of the ten key principles of economics discussed. Recommended Reading: Chapter 1 Ten Principles of Economics (pp. 3-13) and Chapter 2 Thinking Like An Economist read section entitled Our Second Model: The Production Possibilities Frontier (pp. 26-30). Study Objectives 1. To learn and comprehend the definition of economics. 2. To learn the meaning of opportunity cost and to be able to apply this analytical concept in explaining economic behaviour. 3. To determine the specific meaning of the opportunity cost concept in the context of a Production Possibilities model of an economy; to be able to calculate opportunity cost mathematically. 4. To understand the meaning of concepts such as scarcity, efficiency, inefficiency, growth, opportunity cost tradeoffs, attainable and unattainable regions, within the context of a simple Production Possibilities model of the economy. 5. To begin to grasp the role of markets in making economic decisions in a market economy. 6. To distinguish clearly between the types of questions and issues addressed by microeconomics and macroeconomics.

30

Study Questions 1-3 An economy can produce two goods, X and Y. The equation of the Production Possibilities Frontier for this economy is given by: Y = 144 - 10X - X2, 0 X 8, Y 0 Questions 1, 2 and 3 concern this economy. 1. When the economy is producing 8 units of X and 0 units of Y, what is the opportunity cost of Y? (A) 0 units of Y per unit of X. (B) 14 units of Y per unit of X. (C) 26 units of Y per unit of X. (D) 69 units of Y per unit of X. (E) 90 units of Y per unit of X. (F) 100 units of Y per unit of X. (G) 102 units of Y per unit of X. (H) 130 units of Y per unit of X. (I) 144 units of Y per unit of X. (J) 1/144 units of X per unit of Y. (K) 1/102 units of X per unit of Y. (L) 1/90 units of X per unit of Y. (M) 1/69 units of X per unit of Y. (N) 1/36 units of X per unit of Y. (O) 1/26 units of X per unit of Y. (P) 1/14 units of X per unit of Y. (Q) 0 units of X per unit of Y. (R) none of the above 2. When the economy is producing 7 units of X and 20 units of Y, what is the opportunity cost of X? (A) 0 units of Y per unit of X. (B) 14 units of Y per unit of X. (C) 26 units of Y per unit of X. (D) 69 units of Y per unit of X. (E) 90 units of Y per unit of X. (F) 100 units of Y per unit of X. (G) 102 units of Y per unit of X. (H) 130 units of Y per unit of X. (I) 144 units of Y per unit of X. (J) 1/144 units of X per unit of Y. (K) 1/102 units of X per unit of Y. (L) 1/90 units of X per unit of Y. (M) 1/69 units of X per unit of Y. (N) 1/36 units of X per unit of Y. (O) 1/26 units of X per unit of Y. (P) 1/14 units of X per unit of Y. (Q) 0 units of X per unit of Y. (R) none of the above We can tell that this economy has increasing opportunity costs because: (A) d2Y/dX2 > 0 (B) dY/dX < 0 (C) d2Y/dX2 < 0 (D) dY/dX > 0 (E) all of the above (F) none of the above (G) this economy does not have increasing costs.

3.

31

4. An economy can produce two goods, X and Y. The equation of the production possibilities frontier for this economy is given by the following equation: Y = 36 - 0.25(X+1)2 a) for 0X11

a government official tells you that he hopes that the economy will produce 4 units of X and 31 units of Y. Is this a reasonable or unreasonable estimate, and why? when the economy is producing 9 units of X efficiently, what is the opportunity cost (measured in units of Y given up) of getting a small amount more of X? What is the general formula for measuring the opportunity cost of X in this economy? Calculate the opportunity cost of X, when X = 1. Calculate the opportunity cost of X when X = 10. Explain, in an economic sense, why there is a difference in the opportunity cost measured at different places along the PPF. How would you determine using calculus whether or not a PPF demonstrated increasing costs?

b) c) d) e) f) g)

32

ANSWERS TO STUDY QUESTIONS: WEEK 1

1. The correct multiple choice answer is (O). If Y = 144 - 10X - X2, then dy/dx = -10 2X. By the inverse function rule, dx/dy = 1/(-10 -2X). The opportunity cost of Y is -dx/dy, which is 1/(10 + 2X). The point X=8, Y=0 is on the production possibilities frontier, because it satisfies the equation of the PPF. Therefore, the opportunity cost of Y is 1/(10 + 16) = 1/26 units of X per unit of Y. The correct answer is (A). Normally, the opportunity cost of X is given as -dy/dx. However, the point X=7, Y=20 lies inside the PPF, which we can confirm by substituting for X in the equation Y = 144 - 10X - X2. Along the PPF, when X = 7, Y = 25. Inside the PPF, the opportunity cost of X is zero, because no units of Y need be given up to obtain more X. The correct answer is (C). When the second derivative is negative, the PPF curve has a bowed-out shape (concave to the origin). In this case, the opportunity cost of X increases as more X is produced, or the opportunity cost of Y increases as more Y is produced. This kind of economy is said to have increasing costs.

2.

3.

4. (a) If X = 4, then the maximum amount of Y that can be produced is Y = 36 - 0.25(4 + 1)2 = 29.75. The estimate by the government official is therefore in the unattainable region and therefore unreasonable. (b) The opportunity cost of X is -(dY/dX). Call Z = (X + 1), then use the chain rule to find opportunity cost: -(dY/dX) = -(dY/dZ x dZ/dX). Since dY/dZ = -0.5Z and dZ/dX = 1, -(dY/dX) = -[-0.5(X + 1)] = 0.5X + 0.5. When we evaluate this expression at X = 9, we find the opportunity cost of X is 0.5(9) + 0.5 = 5. The general formula for measuring the opportunity cost of X is -(dY/dX). When X = 1, the opportunity cost of X is 0.5(1) + 0.5 = 1. When X = 10, the opportunity cost of X is 0.5(10) + 0.5 = 5.5. If the second derivative is negative, it tells us that opportunity costs vary along the PPF because there are increasing costs of producing X as more of it is produced (and increasing costs of producing Y, as more of Y is produced). In other words, more units of Y have to be given up to get an extra unit of X as the amount of X produced increases. Increasing costs are a reflection of the imperfect substitutability of resources in different uses (resources are somewhat specialized, rather than being all-purpose). A linear PPF would imply that resources are perfectly substitutable for one another at some rate. Check the second derivative of the PPF function. The second derivative (d2Y/dX2) tells us how the slope of the PPF changes as X increases. To show that the opportunity cost of X is increasing, we must show that the second derivative of the PPF function is negative. For the particular PPF analyzed in this question, 33

(c) (d) (e) (f)

(g)

dY/dX = -0.5X - 0.5. Therefore, d2Y/dX2 = -0.5, which is negative for all values of X. Therefore costs are increasing in X. (We could, of course, look at dX/dY [the opportunity cost of Y] and d2X/dY2 [the second derivative of X, with respect to Y] to show that costs are also increasing in Y).

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