ECON10004 Introductory Microeconomics

August 29

PART 1. The Big Bang Theory [50 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
SHELDON 2 1
LEONARD 1/2 2
1.1. What is the maximum number of meals Sheldon can produce in 12 hours? What is the maximum
number of laundry baskets Sheldon can complete in 12 hours? (5 points)
1.2. Plot in a graph: Sheldon’s production possibility frontier. (5 points)
1.3: Plot in a graph: Leonard’s production possibility frontier. (5 points)
1.4. What is Sheldon’s opportunity cost of one meal (in terms of baskets given up)? What is his
opportunity cost of one basket (in terms of meals given up)? (5 points)
1.5. Does Leonard have an absolute advantage in producing both meals and baskets? Explain your
answer. (5 points)
1.6. Who has a comparative advantage in cooking? Explain your answer. (5 points)
1.7. Suppose each person has 12 hours for the two tasks in a week, and suppose both Sheldon and
Leonard each spend 6 hours on cooking and 6 hours on laundry. Consider an offer from Leonard to
Sheldon: do 3 baskets of laundry for me each week, and I’ll cook you 2 meals. Can you find a production
plan such that the offer benefits both Leonard and Sheldon? 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. (10 points)
1.8. Consider the same setup in 1.7. Consider another offer from Leonard to Sheldon: do 1 basket of
laundry for me each week, and I’ll cook you 3 meals. Can you find a production plan such that the offer
benefits both Leonard and Sheldon? Explain your answer. (10 points)

PART 2. Timber Crunch [50 points]
The demand and the supply of timber for construction in Australia are given by
Q D =120 – 20P
Q S = 40P
We assume the market is perfectly competitive.
2.1. Compute the equilibrium price P CE and quantity Q CE . (5 points)
2.2. Plot on a graph: the demand curve, the supply curve, and the equilibrium price and quantity. (5
points)
2.3: Calculate the price elasticity of demand and price elasticity of supply at the equilibrium price and
quantity. (5 points)
2.4. Calculate the producer surplus and consumer surplus in the equilibrium and illustrate them in a
graph. (5 points)
2.5. Due to Covid lockdowns, interstate transportation becomes difficult. Meanwhile, construction work
is viewed as essential and therefore not affected by lockdowns. Use a demand and supply graph to
explain how the lockdowns affect the equilibrium price and quantity. (5 points)
2.6. After the equilibrium change in 2.5, the government introduces tax benefits for house renovation to
stimulate the economy. As a result, there is an increase in construction projects. How do the tax benefits
change the equilibrium in the timber market? (5 points)
2.7. Bushfires are more likely to happen in summer. If a bushfire happens again in the coming summer,
how would you expect it to affect the timber market? (5 points)
2.8. Consider the setup in 2.1-2.4, and suppose the government introduces a subsidy of t=1 dollar to
the buyers for every unit of timber purchased. Calculate the new equilibrium quantity, and use a demand
and supply graph to explain how the subsidy affects the equilibrium price and quantity. (5 points)
2.9. Calculate the deadweight loss caused by the subsidy in 2.8. (5 points)
2.10. Given the subsidy in 2.8, calculate and illustrate in a graph the consumer surplus, producer surplus
and subsidy expenditure. (5 points)