Download Homework 1 Answers

HOMEWORK ASSIGNMENT 1
ANSWERS
4-1: What is the difference between a demand function and a demand curve?
A demand function is a mathematical representation of the relation between the quantity
demanded of a product and all factors that influence this demand. A demand curve pictures
how many units will be purchased at each possible price, holding all other factors fixed.
4-2: How will each of the following affect the position of the demand curve for videocassette recorders
(VCRs)?
a. An increase in the price of VCR tapes.
An increase in the price of VCR tapes will shift the demand curve for video recorders to the
left (demand will decrease since the price of a complement has increased).
b. A decrease in the price of VCRs.
A decrease in the price of VCR's does not shift the position of the demand curve. Rather it
results in an increase in the quantity demanded (movement along the curve).
c. An increase in per capita income.
An increase in personal income is likely to shift the demand curve for VCRs to the right
(VCRs are probably normal goods).
d. A decrease in the price of movie tickets.
The decline in movie ticket prices might shift the demand for VCRs to the left (demand will
decrease if movies and VCRs are substitutes).
4-3: If the demand for a product is inelastic, what will happen to total revenue if price is increased?
Explain.
The total revenue will increase. When demand is inelastic, a given percentage increase in
price corresponds to a smaller percentage decrease in quantity demanded. Thus total
revenue, which is equal to price times quantity, must increase.
4-4: What sign are the cross elasticities for substitute products? Explain.
The cross elasticities between substitutes are positive. Cross elasticities measure the
percentage change in the quantity demanded for a good given a percentage change in the
price of another good. When the price of a good increases, the demand for substitute
products increases.
4-5: Distinguish between normal and inferior goods.
The demand for normal goods increases with income, while the demand for inferior goods
decreases with income.
4-6: How can cross elasticities be used to help define the relevant firms in an industry?
Firms with high positive cross elasticities are strong substitutes and thus might be considered to be
competing in the same industry.
Part II. Elasticity
1. Yemayhem yoyos became exceedingly popular after the $2.00 price fell by a dime. At least, sales
rose from 110 to 118 units. What was the price elasticity of the product?
Answer: (8/114)/(-.10/1.95) = - 1.38
2. Persephone’s quality ping pong balls were moving slowly in February, but she found the secret of
boosting sales when she lowered the price from above the dollar barrier (at $1.05) to just below it (at
$.95). Sales jumped from 9,000 units to a more acceptable 11,000. Calculate the elasticity.
Answer: (2,000/10,000) / (-.1/1.00) = -2
3. The demand schedule for wax candles is as shown below. What is the price elasticity of demand
between $3 and $4? Assume the manager has been charging $3.00. Make the case for keeping that
price or changing the price to $4.00. If you choose to change, demonstrate the businessman’s
unfailing proof that the change is appropriate.
Px
Qx
$5.00
600
4.00
700
3.00
800
2.00
900
1.00
1,000
Answer: [(-100/750) / (1.00/3.50)] = -.465
4. When the price of Seedy’s CDs dropped from $10 to a mere $8, sales increased by a healthy 12%.
What was the elasticity of demand here?
Answer: (.12) / (-2/9) = -.545