Your Federal Quarterly Tax Payments are due April 15th

# HOMEWORK EXERCISE #3 Free Market Versus Benevolent Dictatorship by xtw17906

VIEWS: 45 PAGES: 3

• pg 1
```									 Principles of Macroeconomics (Econ 1)              Signature:
Drake University, Fall 2009
William M. Boal                                Printed name:

HOMEWORK EXERCISE #3
"Free Market Versus Benevolent Dictatorship"
Due September 15, 2009
INSTRUCTIONS: Use the following information to answer all questions on this exercise. Suppose a market
(similar to the pit market experiment we did in class) consists of five buyers and five sellers of a particular good
(like tee-shirts or pocket calculators). Each buyer wants to buy at most one unit. The buyers value the good at the
following amounts.
Buyer                   Ann               Bob              Carol              David               Emily
Value                   \$20               \$15                \$12               \$11                  \$9

Each seller wants to sell at most one unit. The costs to the sellers of providing the good are the following amounts.
Seller                   Ken              Laura               Mike              Naomi              Oscar
Cost                      \$2                \$3                  \$4                \$9                \$11

Trades are conducted under the following rules. Each person can buy or sell only one unit of the good. Earnings (or
gains from trade) for each buyer equal the buyer's value of the good minus the price paid. Earnings (or gains from
trade) for each seller equal the price received minus the seller's cost of the good. Earnings of buyers or sellers who

(1) [Free market: 44 pts] Assume the buyers and sellers meet in a free market and negotiate their own deals to their
individual best advantage. Assume that, with some experience, buyers and sellers are able to avoid rip-offs, and all
sales are made at the same price.

a.   First, analyze supply. [8 pts]
How many sellers would want to sell a unit if the price were below \$2?

How many sellers would want to sell a unit if the price were exactly
\$2? [Hint: The answer depends on whether someone were willing to
sell for zero earnings.]                                                                  or
How many sellers would want to sell a unit if the price were more than
\$2 but less than \$3?
How many sellers would want to sell a unit if the price were exactly
\$3? [Hint: The answer depends on whether someone were willing to
sell for zero earnings.]                                                                  or
b.   Next, analyze demand. [8 pts]
How many buyers would want to buy a unit if the price were above
\$20?
How many buyers would want to buy a unit if the price were exactly
\$20? [Hint: The answer depends on whether someone were willing to
How many buyers would want to buy a unit if the price were less than
\$20 but more than \$15?
How many buyers would want to buy a unit if the price were exactly
\$15? [Hint: The answer depends on whether someone were willing to
Principles of Macroeconomics (Econ 1)                                                    Homework Assignment #3
Drake University, Fall 2009                                                                          Page 2 of 3

c.   Next, draw the complete demand and supply curves for this market in the graph below. Be careful to draw
the stairsteps correctly, using your answers to parts (a) and (b) to start. Label the demand curve “D” and
the supply curve “S”. [12 pts]

\$21
\$20
\$19
\$18
\$17
\$16
\$15
\$14
\$13
\$12
Price

\$11
\$10
\$9
\$8
\$7
\$6
\$5
\$4
\$3
\$2
\$1
\$0
0            1              2              3              4           5              6
Quantity

d.   Finally, describe market equilibrium. [16 pts]
To the nearest whole dollar, what will be the equilibrium price? [Hint:   \$
At what price will the number of sellers who want to sell equal exactly
How many sellers will choose to sell?

Compute the total earnings (or gains from trade) for all these sellers.    \$

Compute the total earnings (or gains from trade) for all these buyers.     \$

Give the name(s) of any seller(s) who will choose not to sell.

Compute the combined total earnings (or gains from trade) of all           \$
Principles of Macroeconomics (Econ 1)                                                    Homework Assignment #3
Drake University, Fall 2009                                                                          Page 3 of 3

(2) [Benevolent dictatorship: 44 pts] Alternatively, working with the same information given on page one of this
assignment, assume you are a benevolent dictator.
a. Give the definition of "benevolent." [4 pts]

Because you are a dictator, you can dictate who trades with whom at what price. You can also dictate who is not
permitted to trade. Because you are benevolent, your objective is to maximize total earnings (or gains from trade)
of all buyers and sellers combined. But remember, each person can buy or sell only one unit of the good.

Work out trading assignments to maximize total earnings and report your assignments below. [Hint: In deciding
who should be permitted to trade, you may want to give priority to buyers or sellers with the largest potential
earnings at any given price. You probably should use pencil for this section!]

b.   Trades assigned by the benevolent dictator (use as many rows as needed).
\$                     \$                  \$
\$                     \$                  \$
\$                     \$                  \$
\$                     \$                  \$
\$                     \$                  \$
c. Give the names of buyers not permitted to trade (if any).

d. Give the names of sellers not permitted to trade (if any).

e. Compute combined total earnings of all buyers and sellers that are        \$

(3) [Comparison: 12 pts] Answer the following questions. Full credit requires good grammar and accurate spelling.
Answers that are identical or nearly identical to another student’s will receive zero points.
a. Which system—the free market or the benevolent dictatorship--requires someone to know other people’s

b. Which system—the free market or the benevolent dictatorship--can potentially produce more equal earnings?