Answer Key to HW 1 1. a. The opportunity cost is the value of Kevin’s next-best-alternative, in this case, staying at the current job. The value includes two parts: first he can now keep the costs associated with the new venture, $3,200,000; second he earns salary from current job, $50,000. Hence the opportunity cost is $3,250,000. b. The accounting cost is simply $3,200,000. In order to generate positive accounting profit, the revenue has to be more than $3,200,000. For positive economic costs, he needs to earn at least $3,250,000. 2. At the given prices, income and advertising input, the quantity demanded for good X is: Qx = 100 − 3 ∗ 25 + 4 ∗ 35 − 0.01 ∗ 20000 + 2 ∗ 50 = 65 EQx ,Px = ∆Qx /Qx ∆Qx Px 25 = × = −3 × = −1.15 ∆Px /Px ∆Px Qx 65

If Invigorated PED raises shoe prices, the percentage decline in the quantity demanded of its shoes will be greater in absolute value than the percentage rise in price. Consequently, demand is elastic. EQx ,Py = ∆Qx /Qx ∆Qx Py 35 = × =4× = 2.15 ∆Py /Py ∆Py Qx 65

Since the cross-price elasticity of demand is positive, good Y is a substitute for good X. QQx ,M = ∆Qx /Qx ∆Qx M 20000 = × = −0.01 × = −3.08 ∆M/M ∆M Qx 65

The income elasticity of demand for X is negative, so Invigorated PED’s shoes are inferior goods. The inverse demand function is as follows: 1 4 1 2 100 Px = − Qd + Py − M + Ax + x 3 3 300 3 3 3. a. shifts demand to the left: at a given price for the Ford Taurus, some of its potential buyers will now purchase the new model; b. shifts demand to the right: as the price of Japanese imports increases more people are willing to purchase US-made cars; 1

c. does not affect the demand curve. Factors affecting supply conditions (such as cost conditions) do not affect the desirability of the product (at the same price). Notice that the price of steel is something that would affect the cost of producing a Taurus. This would