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10 Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises
Chapter 4 Working with Supply and Demand
Review Questions
2. a. %Q 
Q1  Q0 
 Q1  Q0 
 2 
; %P 
 P1  P0 
 P1  P0 
 2 
, where
Q0 is initial quantity demanded
Q1 is new quantity demanded
P0 is the initial price
P1 is the new price
b. By taking an average of new and old (i.e., the midpoint between the new and old values), we
get the same value for elasticity whether we’re moving up or down along any given segment
of a demand curve.
c. A price elasticity of –0.4 means that, for every 1% change in price, quantity demanded
declines by 0.4%. Equivalently, a 10% price increase should lead to a 4% decline in quantity
demanded, assuming the elasticity remains at around –0.4 over the entire range being
examined.
4.
Examples of goods with almost perfectly inelastic demand include such things as insulin to a
diabetic (an absolute necessity for a patient with that condition, and a drug for which virtually no
substitutes are available). Very broadly defined necessities, like housing or food, would also
have near-perfectly inelastic demand over some range of prices.
Very narrowly defined products, or goods for which close or exact substitutes exist, are
candidates for perfectly elastic demand curves. A particular farmer’s wheat, for example, is
usually indistinguishable from wheat grown on another farm. Many raw materials share this
characteristic. For example, the demand curve for a particular producer’s crude oil (of a
particular grade) is likely to be very elastic—oil is oil, and one producer’s is as good as
another’s.
6.
Short-run elasticities are generally smaller (in absolute value) than long-run elasticities because,
over a longer time horizon, consumers have greater ability to adjust their behavior and find
substitutes for a good.
8. a. Canned spaghetti: inferior good—as incomes rise people could afford ingredients for
homemade spaghetti.
b. Vacuum cleaners: normal good. (Most individual households would have an income
elasticity of zero—they would buy just one vacuum cleaner once their income reaches a
certain level, and then buy no more as income rises. However, classifying goods as normal or
inferior depends on market income elasticities. As average income in a market rises, more
households will decide to own vacuum cleaners or to replace old ones, so we expect a
positive income elasticity.)
c. Used books: inferior good—as incomes rise people buy new books instead.
d. Computer software: normal good—as incomes rise people tend to buy more computer
software programs.
10. a. Negative; high. These two goods are clearly complements. A rise in the price of one should
lead to a significant decline in quantity demanded of the other.
b. Positive; low to moderate. In fact, antibiotics are used to treat infections, while
decongestants are used to treat symptoms of viral infections (colds, flu). But much of the
public erroneously believes that antibiotics—which require a doctor’s prescription in the
Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises
11
United States—can help cure the flu. Therefore, a rise in the price of antibiotics might make
people less likely to visit the doctor when they have the flu, and more likely to buy over-thecounter decongestants.
c. Negative; low to moderate. The relationship between gasoline and auto repairs is derived
from the relation between gas and cars, and cars and auto repairs. An increase in gas prices
could be expected to reduce demand for cars (or at least certain kinds of cars), which would,
in turn, reduce demand for auto repairs.
12. If supply is perfectly elastic and demand is perfectly inelastic, the burden of an excise tax would
fall completely on buyers. If the situation were reversed, the burden would fall completely on
sellers.
Problems and Exercises
2.
a. There is excess demand equal to 250 units (600 – 350).
b. Only 350 apartments will be rented.
c. Since the price ceiling is non-binding, the market will move to equilibrium, where 400
apartments will be rented. There will be neither excess supply nor excess demand.
4. a. It is not a straight line demand curve since quantity demanded does not fall by a fixed
amount as price rises by a fixed amount.
b. Demand is elastic for this price change.
230  150
3 4

 230  150   3  4 

 

2

  2 
80 1


190 3.5
 1.47
E
c. Demand is elastic for this price change.
150  90
54

 150  90   5  4 

 

2

  2 
60 1


120 4.5
 2.25
E
d. There must be good substitutes available for rosebushes from Rosie’s Nursery (either other
types of plants or rosebushes from Rosie’s competitors), given that over this range of prices,
it is unlikely that rosebushes make up a significant share of a household’s budget.
6.
a. More elastic.
b. Quantity demanded will fall by 2,190 bottles. To find this answer, first use the mid-point rule
to calculate that the price of Pepsi increased by 10.5%. Then, substitute this value and the
value of the price elasticity of demand into the equation for price elasticity of demand, and
solve for the change in quantity demanded:
12 Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises
-2.08 = x  10.5%
x = -21.9%.
Finally, multiply the initial number of bottles of Pepsi demanded by this price elasticity of
demand to find the change in quantity demanded:
Change in quantity demanded = –21.9% × 10,000 = –2,190
c. The price of ground beef will have to increase by 4.9%. Find this by substituting what is
known into the equation for price elasticity of demand and solving for x:
–1.02 = –5%  x
x = 4.9%
8.
a.
3500  1000
2 1

 3500  1000   2  1 

 

2

  2 
2500 1


2250 1.5
 1.66
E AB 
b. These two goods are substitutes: a 1% increase in the price of good A causes a 1.66%
increase in the quantity of good B demanded.
10.
a. If the price of food increases by 2%, the quantity of entertainment demanded will decrease
by 1.44%.
b. If the price of natural gas falls by 3%, the quantity of electricity demanded will fall by 0.6%.
c. The quantity of ground beef demanded will increase by 1.2%.
12.
a. Doctors will charge $100 per examination.
b. After deducting their insurance reimbursement, patients will pay $50 per examination.
Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises
13
14. Either the supply of PCs in Europe is perfectly inelastic, or the demand for PCs in Europe is
perfectly elastic. Neither of these statements is likely to be true, or even close to true.
Challenge Questions
2.
a. Doctors will charge $250 per examination.
b. After deducting their insurance reimbursement, patients will pay $25 per examination.
c. The total revenue of doctors will be $25,000,000 = $250 x 100,000.
d. The total net expenditures of patients will be $50,000 = $50 x 100,000. Compared to the
original situation in Figure 14, the total net expenditures of patients is the same, but the total
revenue of doctors will increase by $20,000,000.
Economic Applications Exercises
2. a. Since many people are opting to stay at home instead of going to see baseball games, it can be
inferred that people are price sensitive, that is, price elastic. Elasticity should be greater than 1.
b. Assuming that elasticity is greater than 1, a reduction in ticket prices will increase quantity
demanded by a greater percentage, causing revenues to increase.
Chapter 5 Consumer Choice
Review Questions
2.
4.
A change in income will shift the budget line in a parallel fashion—increases in income shift the
budget line upward to the right, decreases shift it downward to the left. Changes in income alone
will not affect the budget line’s slope.
A change in one or both prices will rotate the budget line and change its slope. For example,
a decrease in the price of the good measured on the horizontal axis will cause a rotation of the
budget line around its vertical intercept; the rotation will result in a horizontal intercept farther to
the right.
[Using the Marginal Utility Approach] The law of diminishing marginal utility states that
marginal utility declines as more of a good is consumed. It is a reasonable assumption for most
14 Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises
goods: The more of a good one consumes, the less additional satisfaction is derived from each
additional unit.
There are, indeed, exceptions to the law. One example might be found among collectors. As
the collection becomes more complete, the marginal utility of additional paintings might actually
increase.
Marginal utility would be negative for any good that a consumer dislikes. An additional unit
consumed in this case would decrease utility. One example is garbage.
6.
The statement makes an error. Rationality does not mean that individuals make choices that are
“sensible” to others. Preferences are called rational if (1) they satisfy the logical consistency
requirement detailed in question 5, and if (2) the consumer can compare any two combinations of
goods and state either that he/she is indifferent between them or that he/she prefers one of them.
8.
A change in the price of one good relative to another gives rise to the substitution effect—the
tendency of consumers to substitute more of the good made relatively cheaper by the price
decline for the good that is now relatively more expensive. Hence, the substitution effect always
works to increase the quantity demanded of a good whose price has decreased. In this sense, the
substitution effect is always consistent with the law of demand.
The income effect is the change in quantity demanded that arises because of the change in
purchasing power caused by a price change. For example, if the price of a good declines, a given
income will “go farther”—as if the consumer has more income.
Any given price change sets in motion both income and substitution effects. If a good is
normal, these effects reinforce each other to increase quantity demanded, in the case of a price
decrease, or decrease quantity demanded when price increases. When a good is inferior, the
income and substitution effects work in opposite directions. The question then becomes, Which
effect is stronger? If the substitution effect dominates, the law of demand will still hold; but if the
income effect is stronger, a price increase will actually cause quantity demanded to increase, in
violation of the law of demand.
10.
The market demand curve for a particular good is found as the horizontal sum of the demand
curves of all consumers in the market for the good. Each individual demand is found by varying
the price of the good and observing how the optimal quantity of a good changes as the
consumer’s budget line rotates outward or inward.
Problems and Exercises
2.
[Using the Marginal Utility Approach] No, he is not maximizing utility. For each dollar spent on
novels, Parvez gets 5 units of utility; for each dollar’s worth of CDs, only 4. He should spend
less of his budget on CDs and more on novels. As he does so, the marginal utility of CDs will
rise and the marginal utility of novels will fall, until the ratio of marginal utility to price is the
same for both goods.
4.
a. Recall that the market demand curve is simply the horizontal sum (summed over quantities at
each price) of the individual demand curves. In this case, then, the market demand schedule
is:
Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises
15
Price
$5.00
$4.00
$3.00
D
$2.00
$1.00
3
5
7
9
Quantity
Price
Qty. Demanded
$5.00
$4.50
$4.00
$3.50
3
5
7
9
b. The three consumers have different demand schedules because they have different
preferences for the cereal.
6.
An increase in income always decreases demand for an inferior good. Hence, the demand curve
would behave as below, with new (post-income increase) demand shown by D2.
Price
S1
P1
P2
D1
D2
Q2
8.
Q1
Quantity
False. The price increase generates both income and substitution effects. With an inferior good,
both effects work against each other. While it is possible for the income effect to dominate (in
which case the good would, indeed, violate the law of demand), this would be extremely rare.
More commonly, the substitution effect dominates, so the good would obey the law of demand.
16 Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises
10. [Using the Indifference Curve Approach]
Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises
12.
17
[Using the Marginal Utility Approach]
Income = $300 per month|
Concerts at $30 each
Movies at $10 each
(1)
(2)
(3)
(4)
(5)
(6)
Number of
Marginal
Marginal
Number of
Marginal
Marginal
Concerts per
Utility from
Utility per
Movies per
Utility
Utility per
Month
Last Concert
Dollar Spent
Month
from Last
Dollar
on Last
Movie
Spent on
Concert
Last Movie
1
450
15
27
150
15
2
390
13
24
175
17.5
3
300
10
21
200
20
4
225
7.5
18
225
22.5
5
180
6
15
250
25
6
150
5
12
275
27.5
7
90
3
9
300
30
8
75
2.5
6
325
32.5
9
60
2
3
350
35
Max’s utility maximizing combination is 1 concert and 27 movies. This corresponds to point H”
in Figure 5.
14.
[Using the Indifference Curve Approach]
a.
The original equilibrium is at point A.
b. The new budget line is BL2. The new tangency must occur at a point where Rafaella is
consuming MORE THAN 4 pounds of chicken, and LESS than 10 eggs, for instance, at point
B.
18 Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises
16.
Income = $150 per month
Number of
concerts per
month
3
4
5
6
7
8
9
10
Concerts at $5 each
Marginal
Marginal
utility from
utility per
last concert
dollar spent
on last
concert
600
120
450
90
360
72
300
60
180
36
150
30
100
20
67.5
13.50
Number of
movies per
month
12
11
10
Movies at $10 each
Marginal
Marginal
utility from
utility per
last movie
dollar spent
on last movie
100
120
135
10
12
13.50
From this table, the marginal utility per dollar spent on last concert is equal to the marginal
utility per dollar spend on the last movie when Max consumes 10 concerts and 10 movies per
month. This does, indeed, demonstrate that point K on Figure 6 is optimal.
Challenge Questions
2.
Nothing would happen to consumer choices in this situation. If prices alone were increasing, then
the budget line would shift towards the origin. However, in this example, wages are increasing by
enough to keep the combination of goods and services the consumer can afford unchanged.
4.
[Using the Indifference Curve Approach]
Economic Applications Exercises
2. Answers may vary.