Basic Micro: The population of Berkeley is roughly 100,000—and the average Berke

Question

Basic Micro: The population of Berkeley is roughly 100,000—and the average Berkeley resident buys one latte a day at an average price per latte of $4.

1. Suppose that the maximum willingness-to-pay for a latte in Berkeley is $14 and that the daily demand for lattes is linear—a straight line. What is the equation for the demand curve?

2. Suppose that it is easy and cheap to open a cafe to make lattes, so that there are no fixed costs, and there are neither increasing nor decreasing returns to scale. What do you think the supply curve for lattes would be?

3. What is the equilibrium price? What is the equilibrium quantity?

4. What is the consumer, producer, and total surplus?

5. What is the contribution of the latte business in Berkeley to GDP?

6. Suppose the city of Berkeley grants a monopoly right to sell lattes and all drinks that are close substitutes for lattes to a single monopoly—the Berkeley Monopoly Cooperative. What price would it set for lattes? How many would it sell? How much consumer and producer surplus would be generated?

Explanation / Answer

(1) Form of linear demand:

P = a - bQ

When Q = 0, P = 14

14 = a - 0

a = 14

When Q = 100,000, P = 4

4 = a - (b x 100,000)

4 = 14 - 100,000b

100,000b = 10

b = 10 / 100,000 = 0.0001

Demand curve is:

P = 14 - 0.0001Q

(2)

Supply curve will be its marginal (variable) cost, which will be an upward rising stratight line with no vertical intercept (i.e. starting from origin).

(3) & onward: Questions cannot be answered unless Average cost/Total cost/Marginal cost or the supply function are given.

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