1. Two friends, Rachel and Joey, enjoy baking bread and making apple pie. They are considering opening a bakery together. Rachel takes 2 hours to bake a loaf of bread and 1 hour to make a pie. Joey takes 4 hours to bake a loaf of bread and 4 hours to make a pie.
a. Draw production possibilities frontiers for Joey and Rachel.
b. What are Joey’s and Rachel’s opportunity costs of baking bread?
c. Who has the absolute advantage in making bread?
d. Who has the comparative advantage in making bread?
e. If Joey and Rachel both decide to open their bakery together and specialize to increase their joint production, what should Joey produce? What should Rachel produce?
f. Another option they’re considering is to each open separate bakeries. They could then either each split their time between making bread and pies, or they could each specialize and then trade with each other, so that their bakeries each offer both products. The price of a loaf of bread can be expressed in terms of an apple pie. If Joey and Rachel are specializing in production and decide to trade with each other, what range of ratios of bread and apple pie would allow both parties to benefit from trade?
g. They hire you as a business consultant and ask you to come up with a supplier agreement that makes them each equally better off. The question they ask you is to figure out how many pies and loaves of bread they should exchange with one another per day. (Think of a work day as being 8 hours long.)
2. Market surveys show that there are two types of consumers of avocado toast. The first type likes avocado toast and has a demand curve of
The second type is crazy about avocado toast and has a demand curve of
In the town of Pollakville, there are two consumers. Joel likes avocado toast, but Julia is crazy about avocado toast.
a. Plot Joel’s demand curve. Label axes and intercepts clearly.
b. Plot Julia’s demand curve. Label axes and intercepts clearly.
c. Using the individual demand curves above, derive the market demand for avocado toast in Pollakville. Plot the market demand curve. [HINT: Sum the two demand curves. Note that it may have two sections with different slopes.]
d. Suppose that the market supply for avocado toast in Pollakville is given by
Plot the supply curve on the same set of axes as the market demand curve.
e. Check your graph, then solve for the equilibrium price and quantity. How much does each consumer buy at the equilibrium?
f. Calculate the consumer surplus and show how you did so.
g. Calculate the producer surplus and show how you did so.
h. If the government imposes a $2 per unit tax on avocado toast, how will consumer surplus and producer surplus change? What is the tax revenue, and what is the size of the deadweight loss?
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