Mine Zeynep Senses msenses@jhu.

edu BOB 707 Practice Problem Set Lecture 5 Questions 1, 2, 3, 4, 6 and 7 will be solved in tutorial on August 3rd 1. At the price of $100, tourists demand 267 airplane tickets. At the same price, business travelers demand 237. At the price $110, tourists demand 127 tickets and business travelers demand 127. Assuming that the demand curves of business travelers and tourists are both linear over this price range, what is the price elasticity of demand at the price $100? 2. The demand for drangles is given by D(p) = (p + 1)-2, where p is the price of drangles. If the price of drangles is $20, what is the price elasticity of demand for drangles? 3. The demand for voice mail is Q = 1,000 - 150P + 20I. Assume that per capita disposable income I is $900. At a price P of $40, what is the income elasticity of demand? 4. For the following production functions, determine whether they exhibit increasing, decreasing or constant returns to scale. Show your work. a) q = 2K + 10L b) q = L2 c) q = 100K + L d) q = K2L3 e) q = K0.1L0.2 f) any Cobb Douglas Function (q = KaLb) with i) a+b<1 ii) a+b=1 iii) a+b>1 5. A competitive firm produces output using three fixed factors and one variable factor. The firms short-run production function is q = 305x - 2x2, where x is the amount of variable factor used. The price of the output is $2 per unit and the price of the variable factor is $10 per unit. In the short run, how many units of x should the firm use? 6. A competitive firm uses a single input x to produce its output y. The firms production function is given by y = x3/2 for quantities of x between 0 and 4. For quantities of a greater than 4, the firms output is y = 4 + x. If the price of the output y is $1 and the price of the input x is $3, how much x should the firm use to maximize its profit? 7. Philip owns and operates a gas station. Philip works 40 hours a week managing the station but doesnt draw a salary. He could earn $800 a week doing the same work for Terrance. The station owes the bank $100,000 and Philip has invested $100,000 of his own money. If Philips accounting profits are $1,000 per week while the interest on his bank debt is $300 per week, what is the businesss economic profits?

Answers 1. -4.96 2. -1.90 3. 1.38 4. a) q = 2K + 10L 2aK + 10aL = a*(2K + 10L) = a*q => constant returns to scale b) q = L2 (aL)2 = a2L2 = a2q => increasing returns to scale c) q = 100K + L 100aK + aL = a*(100K + L) = a*q => constant returns to scale d) q = K2L3 (aK)2(aL)3 = a5q > aq => increasing returns to scale e) q = K0.1L0.2 (aK)0.1(aL)0.2 = a0.3q < aq => decreasing returns to scale f) for every c>1 i) (cK)a(cL)b = c(a+b)q < cq for every a+b<1 => decreasing ii) (cK)a(cL)b = c(a+b)q = cq for a+b = 1 => constant iii) (cK)a(cL)b = c(a+b)q > cq for every a+b>1 => increasing 5. 75 6. 0 7. -100/week