ECO103 Problem Set 2

1. (3 points) Made the right way with fresh ingredients, Ratatouille (look it up!) is the best thing ever. Your friendElla Marija Lani Yelich-O’Connorhas abandoned her music career to open a bistro, which specializes in ratatouille and other French food, includingprofiterole. She has done some market research and finds that your neighbors value ratatouille dinners according to the following schedule:

Servings MU ratatouille
1 $27.50
2 $24.75
3 $21.88
4 $19.69
5 $18.04
6 $16.24
7 $14.61
8 $13.15
9 $11.84
10 $10.65
11 $9.59
12 $8.63
13 $7.77
14 $6.99

a. (1 points) Graph the demand curve for ratatouille. Does the demand curve have a positive or negative slope? Why?

b. (1 point) How many servings will Ella sell at $19.69? How many at $11.84?

c. (1 point) What will happen to the demand curve if a new study comes out showing eggplant and tomatoes (ingredients in ratatouille) are really good for you? What will happen to the demand curve if instead a study comes out showing Ella’sprofiterole desert causes heart attacks?

2. (3 points) Production. Ella makes ratatouille using equipment that she rents for $50 and eggplant, tomatoes, zucchinis, wine and other ingredients that cost $7.06 a serving. (Note that she signed a lease and pays the rent regardless of how many dinners she serves.) She hires workers at $25 each and finds that they produce servings according to the following schedule:

Servings Marginal Workers
1 0.30
2 0.33
3 0.36
4 0.40
5 0.44
6 0.48
7 0.53
8 0.58
9 0.64
10 0.71
11 0.78
12 0.86
13 0.94
14 1.04

a. (1 points) Calculate and graph the marginal cost of each serving. (Use a spreadsheet and show your calculations!) Why does the MC curve have the slope (up, down, or flat) that it does?

b. (2 points) Calculate and graph the marginal cost of each serving if workers become more productive so each slice can be made with only 80% as much labor. Show your calculations! Calculate and graph marginal cost if workers suffer a pay cut to $20/hour, with the old productivity.

3. (4 points) Perfect competition and equilibrium.

a. (1 point) Put the demand and supply curves together (at the original productivity and wages). Ella is a musician and never took Economics so she naively assumes that she is in a perfectly competitive market. How many servings will she sell? At what price?

b. (1 point) Draw the graph again and shade in the entire area of consumer surplus. Shade in the entire area of producer surplus.

(2 points) Calculate consumer surplus as the sum of the difference between the marginal utility and the price for each serving up to the last sold. Calculate producer surplus as the sum of the difference between price and marginal cost for each serving.

4. (4 points) Monopoly and equilibrium

a. (1 point) Ella gets smart and realizes that she is the only quality bistro around. Calculate the marginal revenue she gets for each additional serving as the change in total revenue (price times sales). Graph this. What is the new quantity of sales and the new price.

b. 1 point) Shade in the entire area of consumer surplus on your monopoly graph. Shade in the entire area of producer surplus

c. (1 point) Calculate total consumer and total producer surplus under the monopoly situation

d. (1 point) Compare the sum of consumer and producer surplus for the monopoly with the results for perfect competition. Which is better for consumers? Which is better for producers? Which is better for society? Explain

5. (2 points) Moving Equilibrium. Show the effect of each on the monopoly market equilibrium; you don’t need to have exact answers but explain the direction of change in the demand and/or marginal cost curves.

a. (0.5 points) Eggplant prices rise:

b. (0.5 points) There is good weather, and tomatoes are in abundant supply:

c. (0.5 points) Taylor Swift opens a restaurant across the street:

d. (0.5 points) A local restaurant reviewer praises the quality of Ella’s ratatouille:

6. (4 points) Why are CEOs paid so much? The ratio of CEO pay to the earnings of the average worker in their businesses has soared from around 38:1 in the early 1970s to over 700:1 today. Review the articles in Real World Micro on corporate behavior (especially 3.1, 4.3, 4.4), corporate governance (especially 2.5, 4.1), and consumer activism (especially 3.5, 3.6). What is the goal of corporate managers? Do they pursue the public good and the good of their workers and consumers? What other concerns do they have and are these goals consistent with pursuing the public good? What checks are there on their actions, including their salaries? Are these checks effective, and what might be done to make them more effective?