Principles of Economics Recitation 6

Columbia University

October 23, 2017

(Columbia University) Recitation 6 October 23, 2017 1 / 14

Midterm Overview

The midterm was tough!

Don’t forget to read the questions carefully and answer every single
one. Many missed points because they forgot about small parts of the
question.
Always do an intuition check of your ”story” before you dive in to do
calculations/draw graphs.
Think of the midterm as a diagnostic of your understanding. The
final counts for a lot more. If you are confused or lost, come to office
hours (and not just the day before the final!)

(Columbia University) Recitation 6 October 23, 2017 2 / 14

Question 1: Definitions

Omitted variable: Something that has been left out of a study that,
if included would explain why two variables that are in the study are
correlated.
Perfectly elastic demand curve: a very small increase in price
causes consumers to stop using goods that have perfectly elastic
demand
Willingness to pay: the highest price that a buyer is willing to pay
for an extra unit of a good.
Common mistake: don’t forget that it is the highest amount for an
additional unit

(Columbia University) Recitation 6 October 23, 2017 3 / 14

Question 1: Definitions

Excess supply: when the market price is above the competitive

equilibrium price, quantity supplied exceeds quantity demanded,
creating excess supply.
Common mistake: don’t forget to mention what’s happening with
prices to cause excess supply
Fixed factor of production: an input that cannot be changed in the
short run
Common mistake: key difference between fixed and variable is the time
horizon - short run

(Columbia University) Recitation 6 October 23, 2017 4 / 14

Question 2: Elasticity

A slump in the energy industry leads residents of Houston to experience a

10% drop in incomes. The income elasticity of demand for housing is
estimated to be 0.5. By how much will the quantity of housing demanded
in Houston change? Is housing a normal or inferior good? Explain your
reasoning.

(Columbia University) Recitation 6 October 23, 2017 5 / 14

Question 2: Elasticity

A slump in the energy industry leads residents of Houston to experience a

10% drop in incomes. The income elasticity of demand for housing is
estimated to be 0.5. By how much will the quantity of housing demanded
in Houston change? Is housing a normal or inferior good? Explain your
reasoning.

Answer:
%∆qd %∆qd
εincome = %∆income =⇒ 0.5 = −10%
=⇒ %∆qd = −5%

Common mistake: don’t forget to mention the direction of the change.

Since 0 < εincome < 1, housing is a normal good. Intuitively, your demand
for housing increases as you get richer, but doesn’t increase so much that
it is considered a ”luxury” good (ε > 1)

(Columbia University) Recitation 6 October 23, 2017 5 / 14

Question 3: Sunk Cost

Should the dairy farming cooperative sell locally or in NYC?

1000 gallons of milk per day
Local price: $4/gallon
NYC price: $7/gallon
Cost of transporting to NYC: $500/day
Cost of one-time ”freak accident” transporting to NYC: $3300

Answer:
1 Calculate normal profits from selling locally vs. selling in NYC
2 Consider the ”freak accident” cost

(Columbia University) Recitation 6 October 23, 2017 6 / 14

Question 3: Profit and Sunk Cost

The payment of $3,300 is a one time sunk cost. They should expect to
make more money by selling in NYC for all subsequent weeks, therefore
they should continue to sell in NYC.

So, you should tell the farmers, “Don’t cry over spilled milk.”

(Columbia University) Recitation 6 October 23, 2017 7 / 14

Question 4: Supply and Demand

Using two supply/demand diagrams analyze the effect of especially good

weather for the growing of peanuts on the price and quantity sold of jelly.
Explain the logic clearly and label the diagrams carefully. Would the
results differ if the good weather had been accurately forecast months in
advance? Using your graphs (or a new one) illustrate a possible outcome if
the weather is forecast.
Answer:
1 Identify relationship between peanut butter and jelly
2 Draw supply and demand diagrams
3 Draw effect of good peanut weather on S&D diagrams
4 Draw effect of well-forecasted good peanut weather on S&D diagrams

(Columbia University) Recitation 6 October 23, 2017 8 / 14

Question 4: Supply and Demand

Peanut butter and jelly are complements.

Good peanut weather

(Columbia University) Recitation 6 October 23, 2017 9 / 14

Question 4: Supply and Demand

Well-forecasted good peanut weather

Common mistakes:
Forecasts should make you think about what happens in the long-run,
like firm entry/exit
The peanut and jelly markets need to be on separate graphs
Label! Axes, eq’m quantity and prices, graph title
(Columbia University) Recitation 6 October 23, 2017 10 / 14
Question 5: Budget Set

Nigel is a single parent with two children. Nigel currently chooses to work
30 hours a week (out of 50 possible hours). Nigel receives a wage rate of
$5 per hour.
1 Budget set and budget line
2 $50 per week welfare program if he works at least 10 hours per week.
New budget constraint, and what happens to hours worked?
3 Wage support program that increases his hourly wage rate. How will
his work decision be affected, and under which program is Nigel likely
to work more hours?

(Columbia University) Recitation 6 October 23, 2017 11 / 14

Question 5: Budget Set
Answer:

Common mistakes:
Answer all the questions. Most people forgot to shade the budget set
(just like on the quiz!)
Budget line intercepts are determined by how much money he could
make if he worked 0 or 50 hours. Not by the 30 hours he works now.
Discontinuity at 40 hours of leisure
(Columbia University) Recitation 6 October 23, 2017 12 / 14
Question 6: Costs and Long Run
Senior daycare center Longevity. Daily fixed cost of rent: $500. Market
price per day: $138

1 How many seniors served per day?

2 Is market in LR equilibrium?
3 Effect of aging population in short run and long run?
(Columbia University) Recitation 6 October 23, 2017 13 / 14
Question 6: Costs and Long Run
Answer:
Firm continues to serve until MR ≥ MC , so it will serve 6 people.
It is in LR equilibrium because in the long run, MR = MC = ATC
Aging effect:

(Columbia University) Recitation 6 October 23, 2017 14 / 14