Question 1) In the U.S. it is illegal to buy or sell heroin, yet there is still a market. Suppose the government's main goal is to decrease the amount of heroin consumed and proposes three solutions. For each of these, show what would happen to the market price and quantity for heroin. Briefly discuss your policy recommendation for the government by citing the costs/benefits of each. (For simplicity, assume that heroin sellers and heroin buyers are two separate groups of people)
a. Offer extensive drug rehabilitation programs free-of-charge to heroin users
b. Increase the minimum length of prison sentences for heroin sellers
c. Legalize the sale of heroin
Question 2) Suppose that the equilibrium price of lemons was $.79/lb and the price of limes was $.85/lb. Suppose the supply of lemons suddenly decreased and the price of limes increased (assume that nothing else happened to the lemon or lime market).
a. From the above information, are lemons and limes substitutes or complements? Explain.
b. What happened to the quantity of limes sold after the price change?
c. Do you think lime farmers were happy after this change? Why/why not?
d. Give an example of a good whose price would have likely fallen with the decrease in lemon supply. Why did you choose this good? (There are many appropriate answers for this)
Question 3) Graph the following demand curve and supply curves. Compute the equilibrium price and quantity. What is the amount of consumer surplus (note: the area of a triangle equals 1/2 * base * height)?
Demand curve: P = 20 - 4*Qd
Supply curve: P = 2 + 2*Qs