Economics 1001 Assignment 1 Solution

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ECON1001: Introduction to Economics I

Problem Set I

1. You have planned to spend 9 days in Vienna during this Christmas and New Year season. You have reserved a round-trip ticket to Vienna, which would cost you $8000. You have also bought the ticket to Vienna Philharmonic’s New Year Concert, which cost you $200. You have wanted to attend the New Year concert for a long time and you are willing to pay $1000 to see it. Tickets to the concerts are nonrefundable and you cannot resell them. You just learned that all your finals would be done by Dec 15. If you leave for Vienna and come back by Christmas, the round trip tickets will cost you only $7100. You can change the dates of your plane tickets without any fees. (So tickets cost $8000 if you go later and $7100 if you go earlier.) You can also change the dates of your hotel bookings without any fees. Other than price differences in plane tickets, the only consequence from going early is that you will not be able to attend the New Year concert. Given the above information, what is the surplus you get from going on the trip early?

Ans: (10 marks)

900 – 1000 = -100

2. In Hong Kong, ferries to Lamma Island are operated by Hong Kong and Kowloon Ferry Holdings Limited. Ferry fares are subject to government regulation. Suppose ferry fare without government intervention would be $18 on weekdays, but they cost $14.5 currently because of price ceiling imposed by the government. Is the following statement correct or not? Use no more than 3 sentences to explain.

“We can apply the model for perfectly competitive markets. The model predicts that more ferry rides will be taken if the government lifts this price ceiling because the government is currently imposing a price ceiling below equilibrium price, which causes shortage"

Ans: (10 marks)

No. According to the information given, all ferries to Lamma are operated by one company. Therefore, this is not a perfectly competitive market, and we can’t apply the supply demand model to this situation.

3. Suppose crude oil market is perfectly competitive. Suppose member countries of OPEC, an organization of several oil exporting countries, have agreed to reduce their production by a total of 1 million barrels a year. For example, if they would produce a total of 10 million barrels a year without the agreement, they will now produce only 9 million with the agreement. a. What is the effect on world oil price if OPEC can carry out this agreement? Use ONE diagram of supply and demand curves to illustrate. Show the graph clearly with proper labels. No explanation is required.

Ans: (5 marks)

[pic]

b. Suppose in the short run, own-price elasticity of demand for oil is -0.2. Currently oil price is USD$100 per barrel and 10 million barrels are traded a year. Assume that oil production is perfectly inelastic in the short run. What do you expect the world oil price to be in the short run after OPEC reduces production by 1 million barrels/year? Ans: (5 marks)

[pic]
Given that price elasticity of demand = -0.2
Where price elasticity of demand = (ΔQ/Q)/(ΔP/P)
So -0.2 = (ΔQ/Q) / (ΔP/P)
-0.2 = (-1million/10 million) / (ΔP/100).
So ΔP=50%*100 = $50

c. Do you expect total expenditure on oil to increase or decrease after OPEC carries out this agreement? Ans: (5 marks)

The price elasticity of demand is -0.2, so demand is inelastic at the original equilibrium. After OPEC carries out the agreement, equilibrium price level increases, from part (c). Therefore, the total expenditure will increase. [pic]

d. Compare the effect on oil price in the short run and in the long run. Which is bigger? Use ONE diagram of supply and demand curves to support your answer. Ans: (10 marks)
There are three...
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