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1) What has happened to the market for computers in
the last 30 years?
2) As the price of gasoline rises, what effect does this have
on the market for car tires:
What do we know about the computer market?
There’s a lot more of them now, and they’re cheaper.
Lower price and larger quantity would be caused by
an increase in supply.
Assume that gasoline and car tires are complements. As
the price of gasoline rises, then demand for car tires will
fall.
S
S1
S
P
2
P
1
P2
1
D1
P2
D2
D
2
Q Q
1
Q1 Q2
As we see in the graph, with the increase in supply,
price was driven down and quantity increased.
Supply could have increased from new technology,
cheaper resources (electronic parts became much
cheaper), or from more firms.
As we see in the graph, as the price of gasoline rises, the
demand for car tires falls. This makes the price and
quantity of car tires to decrease.
3) What would happen in the market of an inferior
good during a recession (recession is when the
economy experiences a drop in income)?
4) People love herbs, spices and seasonings. Explain why
Give an example of an inferior good: Top Ramen,
public busses, high mileage used cars, generic goods
or store brand goods, stuff at dollar-stores.
During a recession, demand for normal goods would
decrease as income falls. But demand for inferior
goods would increase during a recession as incomes
fell. People are poorer, so they demand more inferior
goods.
S
pepper is inexpensive and used a lot, and why saffron is
extremely expensive (more expensive than gold by
weight) and used rarely.
Pepper has a large quantity and small price. Saffon has a
small quantity and large price. This suggests differences
in supply, not demand. So I’ll draw the graph with a
single demand curve but two different supply curves.
Ssaffron
Spepper
PS
PP
D
P2
QS
P1
D2
D1
Q1 Q2
During a recession, the demand for inferior goods
rises. This makes the prices and quantity of inferior
goods to rise. This would be a good time to be a
producer in the inferior goods market.
QP
As we can see from the above graph, the price of saffron
is high, but quantity is small. And the price of pepper is
low, but the quantity is large. Differences in supply
explain this. It must be easier and cheaper to produce
pepper than saffron.
5) What is the elasticity of this supply curve:
S
6) In order to increase total box-office receipts, the makers
of the movie Transformers 2 increased the price of movie
tickets. However, after the price rise, total revenue
actually declined.
As price was increased, total revenue declined. This
happens if demand is elastic.
Give an example of a good that would have this
supply curve
There are three categories of goods that have a
perfectly inelastic supply:
1) “Land” is often analyzed using perfectly
inelastic supply. There’s a certain
amount available, and that amount is
fixed. This ignores things like landfill.
2) Dated goods from the past: 1963 Shelby
Cobra sports cars. 1974 Cabernet
Sauvignon wines. Mickey Mantle rookie
baseball cards. 19th Century antiques.
3) Any good if the time period is so short
that producers can’t adjust production at
all. Think of a fishing boat returning
with their catch of salmon. It doesn’t
matter the market price. The ship is
going to offer all the catch. This example
is called the “immediate run” which is a
time period much shorter than the “short
run”.
7) Grapefruit have inelastic demand. A freeze
destroys about one-fourth of the crop. Will this be a
good year or bad year for grapefruit farmers?
This will be a good year for grapefruit farmers. Look
at the following graph:
P2
P1
D
Q2
Q1
As seen in the above graph, the demand curve is drawn to
suggest demand is elastic. The initial price is P1 with an
initial TR of P1 * Q1 which is the area of the rectangle
shaded with the upward sloping lines.
After the price increase to P2, TR becomes P2 * Q2 which
is the area of the rectangle with the downward sloping
lines.
We can see the TR1 rectangle is much large than the TR2
rectangle, so TR fell as price was raised from P1 to P2.
8) Would Cruise Ship travel/vacations have elastic or
inelastic demand? Why? What does this mean?
Cruise ship travel would have elastic demand. See the
graph below. It shows an elastic demand. This means
that small changes in price, such as a price increase, would
result in a large quantity change.
P2
P1
P2
P1
D
D
¾ Q1
The demand curve is drawn to be inelastic as given in
the question. The initial quantity and price is Q1 and
Q2
Q1
Cruise ship travel would have elastic demand because:
1) there are close available substitutes. There are many
P1. Quantity is reduced by ¼ to ¾. The new price is
P2. Since demand is inelastic, price will rise more
than quantity fell. As price rises for an inelastic
good, TR will rise as can be seen in the TR
rectangles. The new rectangle given by the
downward sloping lines is much larger than the initial
TR. So after the loss of crops, firms are taking in
more TR. Since they also have less fruit to pick,
handle and ship, their profits should be significantly
higher. This is a good year for grapefruit growers. It
would be especially good is other growers lost more
than ¼ of their crop while you didn’t lose any.
other types of vacations one could take. If the market was
defined even more narrowly by looking at a specific cruise
line or cruise destination, demand would even more
elastic.
2) It takes a large fraction of most people’s budget.
Cruises are expensive, often thousands of dollars
3) Cruises are economic luxuries. Income elasticity is
probably greater than 1 which means people will spend a
lot more on cruises as their income increases. This also
makes demand elastic
4) The only question is what time period we’re talking
about. If people have plenty of time to adjust, for example
we’re looking at cruises leaving over the next 12 months,
then demand would be elastic. However, if we were to
restrict ourselves to cruises leaving next week where there
was little time to adjust, time would be very inelastic.