## Homework Assignment 2

### What happens in the market for margarine when income rises?

1. In the mythical nation of Oz, gasoline used to sell for \$1 a gallon, and the natives purchased
100,000 gallons a week. Four years ago, the price rose to \$3 a gallon, and the natives reduced
their quantity demanded to 90,000 gallons a week. Calculate the price elasticity for this change.
Today, gas again sells for \$1 a gallon in Oz, but the natives are only buying 70,000 gallons a
week. What gives?
2. A question on an economics exam asks: What happens in the market for margarine when
income rises? Allison, an excellent student, shows the demand for margarine decreasing. Is she
necessarily wrong? Why or why not?
3. Suppose you are planning to open a lemonade stand. List separately all the explicit and
implicit costs that might be involved.
4. John is a well-known consultant who makes \$150 an hour and has all the work he can handle.
He has a big job in Washington DC, ten hours away. He can drive at a cost of \$80 round trip or
take a one-hour flight for \$300. Which is he likely to do? Are there circumstances that may lead
him to choose otherwise? (20 points)
5. The boss observes that her 10 workers produce 1,000 widgets a day. She concludes that she
can employ 20 workers and make 2,000 widgets; 30 to make 3,000; or 40 to make 4,000. Explain
why this observation is either correct or incorrect. (20 points)
6. Andy wants to maximize his grade-point average. Having spent six hours studying for his final
exam in economics, Andy calculates his grade and discovers that even with a perfect score on the
final, he will not pass the course. He decides to study two more hours so he will not have wasted
the first six hours. Is this a good decision? Why or why not?
7. The AB Manufacturing Company has hired an economist to evaluate its financial situation.
She explains to the board of directors that the company is making zero economic profit. Should
the company go out of business?
8. Tom, a math major, examines Jane’s economics class notes and observes that when price-
taking firms earn economic profit, they do not seem to produce a quantity that minimizes their
costs. Is he correct? Is there significance to this observation?
9. If a technological advance lowers a firm’s production costs, why do prices typically fall?
Shouldn’t the firm maintain the same price and earn economic profit?
10. If the demand for pizza falls, pizza suppliers will suffer economic losses, and some firms will leave the industry. Why is this considered good? Shouldn’t we feel sorry for these business

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