Logistics recap:

-     please submit your assignment via the LMS subject page;

-     the assignment is due by 6:00pm on August 30;

-     after submitted your assignment, please keep a local copy;

-     there is a maximum limit of 1000 words (not including diagrams);

-     answer all questions;

-     a maximum of 100 points are awarded according to the quality of the answers.

PART 1. The Big Bang Theory [30 points]

Consider Example 1 in Lecture 2. Assume the hours needed to cook a meal or finish a basket of laundry are different, and they are described below:

1 MEAL                          1 BASKET

1.1. What is Sheldon’s opportunity cost of one meal (in terms of baskets given up)? What is Leonard’s opportunity cost of one meal (in terms of baskets given up)? (4 points)

1.2. Who has an absolute advantage in doing laundry, and who has a comparative advantage in doing laundry? Explain your answer. (4 points)

1.3. Suppose each person has 12 hours for the two tasks in a week, and suppose Sheldon and Leonard each spend 6 hours on cooking and 6 hours on laundry. If they can trade meals at a price of 0.75 (baskets for each meal), are they willing to trade one meal (for 0.75 baskets of laundry)? Hint: you need to specify how they would adjust their time between the two tasks if they are going to trade one meal, and compare to the case without trade. Assume a person is willing to trade only when he would end up with no fewer meals and no fewer baskets. (7 points)

1.4. Consider the setup in 1.3. Consider an offer from Leonard to Sheldon: cook x meals for me each week, and I’ll do y baskets of laundry for you, where x and y do not need to be integers. Can you find such an offer and a production plan such that the offer benefits both? Hint: For a production plan, you need to specify how each person divides his 12 hours between the two tasks. The offer benefits Sheldon (or Leonard) when it results in no fewer meals and no fewer baskets for him. (7 points)

1.5. Suppose they got a new laundry machine, and they can reduce the time of each basket by 30 minutes. What are the new opportunity costs of a meal? Explain how the new machine affects their opportunity costs differently (or the same). (4 points)

1.6. Suppose the new machine reduces the time of each basket by x hours for each of them. We know the value of x is between 0 and 1, but we do not know the exact value of x. Can you still tell who has the comparative advantage in doing laundry? Explain your answer. (4 points)

PART 2. Logger Strike [36 points]

The demand and the supply of timber for construction in Australia are given by

QD =100 – 20P

QS = 5P

We assume the market is perfectly competitive.

2.1. Compute the equilibrium price PCE  and quantity QCE. (4 points)

2.2. Plot on a graph: the demand curve, the supply curve, and the equilibrium price and quantity. (4 points)

2.3: Calculate the price elasticity of demand and price elasticity of supply at the equilibrium price and quantity. (4 points)

2.4. Calculate the producer surplus and consumer surplus in the equilibrium and illustrate them in a graph. (4 points)

2.5. Suppose there are many construction companies collapsed (and left the market), use a demand and supply graph to explain how the collapse affects the equilibrium price and quantity. (4 points)

2.6. Consider the setup in 2.1-2.4, and suppose there is a strike of loggers, which change the supply to QS = 4P. Calculate the new equilibrium quantity and use a demand and supply graph to explain how the strike affects the equilibrium price and quantity. (4 points)

2.7. Calculate the change in the consumer surplus caused by the strike in 2.6. (4 points)

2.8. After the strike in 2.6, suppose the government subsidizes the buyers s dollars for every unit they purchase. Write the price paid by consumers in the equilibrium as a function of s. Would the government be able to use the subsidy to achieve the surplus before the strike, which is computed in 2.4. If no, explain why. If yes, what should be the value of s? (8 points)