Daniel l. Rubinfeld

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58 Part 1 Introduction: Markets and Prices a. Assuming, as before, that the equilibrium price and quantity are P* = 75 cents per pound and Q* 75 million metric tons per year, derive the linear demand curve consistent with the smaller elasticity. b. Using this demand curve, recalculate the effect of a 20-percent decline in copper demand on the price of copper. 8. Example 2.8 analyzes the world oil market. Using the data given in that example: a. Show that the short-run demand and competitive supply curves are indeed given by D = 24.,08 - 0.06P Sc = 11.74 + 0.07P b. Show that the long-run demand and competitive supply curves are indeed given by D = 32.18 - 051P Sc = 7.78 + 0.29P c. During the late 1990s, Saudi Arabia accounted for 3 billion barrels per year of OPEC's production. Suppose that war or revolution caused Saudi Arabia to stop producing oil. Use the model above to calculate what would happen to the price of oil in the short run and the long run if OPEC's production were to drop by 3 billion barrels per year, 9. Refer to Example 2.9, which analyzes the effects of price conh'ols on natural gas. a. Using the data in the example, show that the following supply and demand curves did indeed describe the market in 1975: Supply: Q = 14 + 2Pc + 0.25Po Demand: Q - 5P c + 3.75P 0, where Pc and Po are the prices of natural gas and oil, respectively Also verify that if the price of oil is $8.00, these curves imply a free-market price of $2.00 for natural gas. b. Suppose the regulated price of gas in 1975 had been $150 per thousand cubic feet instead of $1.00. How much excess demand would there have been c. Suppose that the market for natural gas had /lot been regulated. If the price of oil had increased from $8.00 to $16,00, what would have happened to the free market price of natural gas *10. The table below shows the retail price and sales for instant coffee and roasted coffee for 1997 and 1998, a. Using this data alone, estimate the short-run price elasticity of demand for roasted coffee, Also, derive a linear demand curve for roasted coffee, b. Now estimate the short-run price elasticity of demand for instant coffee. Derive a linear demand curve for instant coffee, c. Which coffee has the higher short-run price elasticity of demand Why do you think this is the case RETAIL PRICE OF SALES OF RETAIL PRICE OF SALES OF INSTANT COFFEE INSTANT COFFEE ROASTEO COFFEE ROASTED COFFEE YEAR ($/LB) (MILLION LBS) ($/LB) (MillION LBS) 1997 10.35 75 4.11 820 1998 10.48 70 3.76 850 PART 2 presents the theoretical core of microeconomics. Chapters 3 and 4 explain the principles underlying consumer demand. We see how consumers make consumption decisions, how their preferences and budget constraints determine their demands for various goods, and why different goods have different demand characteristics. Chapter 5 contains more advanced material that shows how to analyze consumer choice under lmcertainty. We explain why people usually dislike risky situations, and show how they can reduce risk, and how they choose among risky alternatives. Chapters 6 and 7 develop the theory of the firm. We see how firms combine inputs, such as capital, labor, and raw materials, to produce goods and services in a way that minimizes the costs of production. We also see how a firm's costs depend on its rate of production and production experience. Chapter 8 then shows how firms choose profit-maximizing rates of production. We also see how the production decisions of individual firms combine to determine the competitive market supply curve and its characteristics. Chapter 9 applies supply and demand curves to the analysis of competitive markets. We show how government policies, such as price controls, quotas, taxes, and subsidies, can have wide-ranging effects on consumers and producers and explain how supply-demand analysis can be used to evaluate these effects.
few years ago, General Mills decided to introduce a new product. The new brand, Apple-Cinnamon Cheerios, offered a sweetened and more flavorful variant on General Mills' classic Cheerios product. But before Apple-Cinnamon Cheerios could be extensively marketed, the company had to resolve an important problem: How high a price shollid it charge No matter how good the cereal was, its profitability would be affected considerably by the company's pricing decision. Knowing that consumers would pay more for a new product with added ingredients was not enough. The question was how milch more. General Mills, therefore, had to conduct a careful analysis of consumer preferences to determine the demand for Apple-CiImamon Cheerios. General Mills' problem in determining consumer preferences mirrors the more complex problem faced by the U.s. Congress in evaluating the federal Food Stamps program. The goal of the program is to give to low-income households coupons that can be exchanged for food. But there has always been a problem in the program's design that complicates its assessment: To what extent do food stamps provide people with more food, as opposed to simply subsidizing the purchase of food that they would have bought anyway In other words, has the program turned out to be little more than an income supplement that people spend largely on nonfood items instead of a solution to the nutritional problems of the poor As in the cereal example, an analysis of consumer behavior is needed. In this case, the federal govermnent must determine how spending on food, as opposed to spending on other goods, is affected by changing income levels and prices. Solving these two problems-one involving corporate policy and the other public policy-requires an understanding of the theory of consumer behavior: the explanation of how consumers allocate incomes to the purchase of different goods and services. Consumer Behavior How can a consumer with a limited income decide which goods and services to buy This is a fundamental issue in microeconomics-one that we address in this chapter and the next We will see how consumers allocate their incomes across goods and explain how these allocation decisions determine
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Daniel l. Rubinfeld

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