Download Econ160SQ2(Elasticity, PPF, Comparative Advantage)

Economics 160
Prof. E. McDevitt
STUDY QUESTIONS ON ELASTICITY
1. What does the elasticity of demand measure?
2. Assume that P1 = $100 and Q1 = 10,000. Price now increases to $115, and quantity demanded
falls to 9,500. Calculate the elasticity of demand.
3. Suppose the elasticity of demand for cigarettes is 1. The government desires to decrease the
quantity demanded for cigarettes from its current level of 1,000,000 packs per day to 800,000
packs per day. They will attempt to do this by increasing the tax on cigarettes, thereby causing
an increase in price. If the current price is $4 per pack, then price would have to increase to what
level to achieve the above drop in quantity demanded?
3. What is the relationship between P and TR when e <1? What is the relationship between P
and TR when e > 1? What is the relationship between P and TR when e =1?
4. Suppose CSUN is considering raising the tuition rate in order to increase total revenue. Would
raising tuition necessarily cause total revenue to rise? Explain your answer. Is it possible that
raising tuition could cause total revenue to fall? Explain.
5. What does it mean to say that demand is relatively elastic? ...relatively inelastic? Use a graph
to explain.
6. What are some of the determinants of the elasticity of demand? Would the elasticity of a
crowd’s demand for cold lemonade by affected by the proximity of a drinking fountain? Explain.
How does ignorance affect elasticities of demand?
7. Does a society’s transportation system in any way affect elasticities of demand?
8. Define and show on graph: perfectly inelastic demand curve and perfectly elastic demand
curve.
9. Suppose demand is perfectly elastic at a price of $5. (That is, the horizontal demand curve hits
the vertical axis at $5). What would happen to quantity demanded if the price was raised to
$5.01?
10. Assume that P1 = $8 and Q1S = 100,000. Price now falls to $6. At this lower price, quantity
supplied now equals 60,000. What is eS?
11. Suppose elasticity of supply equals 0.5. The current price is $1,000 and the current quantity
supplied is 1,000,000. If price rises to $1,100, what is the new quantity supplied? Show your
answer on a graph as well as providing numerical calculations.
12. What does it mean to say that supply is relatively elastic? ...relatively inelastic? Use a graph
to explain.
13. a.Under what circumstances will buyers bear the entire burden of a tax? b. Under what
circumstances will sellers bear the entire burden of a tax? Use supply and demand graphs to
show your answer.
14. Suppose harvest-time rains destroy a large quantity of strawberries. Do you think that the
total revenue received by strawberry producers will go up or down? Hint: your answer depends
upon the elasticity of demand. You should be able to explain why. Use a supply and demand
graph to explain your answer.
15. Consider the market for cigarettes in Brazil and the U.S. Suppose the supply curve is the
same in each country, but demand for cigarettes is more elastic in the US. The initial price and
quantity is the same in each country. Suppose each country imposes an excise tax of $1/unit on
cigarettes. Using a single supply and demand graph, compare the impact on price in each country.
Answers.
1. It measures how sensitive quantity demanded is to changes in price.
2. The elasticity formula is:
e = (percentage change in Q)/(percentage change in P) = (Q/Q1) / (P/P1).
Step one: Let us first calculate Q (which is read “change in quantity demanded”).
Q= 10,000-9,500= 500.
Step two: Next, divide this number by Q1 (the original quantity demanded). So we have
500/10,000 = 0.05 (or 5%). This tells us that quantity demanded has fallen by 5%.
Step three: Calculate P. Doing so, we get P = $115-$100=$15.
Step four: Divide P by P1. Doing this,we get $15/$100=0.15 (or 15%). That is, there has been
a 15% increase in price.
Step five: Divide the percentage change in Q by the percentage change in P.
e = 0.05/0.15 = 1/3.
3. Set up the problem as follows:
e = (Q/Q1) / (P/P1) = (200,000/ 1,000,000)/(P/P1)=1
= (0.20)/(P/P1) = 1.
This tells us that (P/P1 ) must be equal to 0.20 also. That is, the price must be increased by
20%. Since the original price of cigarettes was $4, the new price would have to be $4.80.
(Note: 20% of $4 is $0.80).
3b. When e <1 (that is, demand is inelastic), P and TR move in the same direction. In other
words, raising P will cause TR to increase and decreasing P will cause TR to fall.
When e>1 (that is, when demand is elastic), P and TR move in opposite directions. In other
words, an increase in P will cause TR to fall, and a decrease in P will cause TR to rise.
If e =1 (unit elastic), then a change in P will leave TR unchanged.
4. No. If the demand for schooling at CSUN is elastic (e>1), then raising tuition would cause TR
to fall. Explanation: If e = (Q/Q1) / (P/P1) >1, then it follows that the percentage change in Q
exceeds the percentage change in P. This means that, say, a 10% increase in P will cause Q to fall
by more than 10%. Since TR = P*Q, this would mean that TR has fallen. Intuitively, to say that
demand is elastic is to say that a relatively small increase in price will lead to a relatively large
drop in customers (students).
5. Relatively elastic means the demand curve is relatively flat, and relatively inelastic means the
curve is relatively steep. See Graphs.
6. Some of the determinants are (a) the number and knowledge of substitutes, (b) the time
interval that a consumer has to adjust to a given price change, and (c) the definition of a market.
The larger the number of substitutes available, the more elastic demand will be (that is,
consumers will be more responsive to a price change). Likewise, the longer the time interval a
consumer has to adjust to a price change, the more elastic demand will be. This is due to the fact
that the longer the time a consumer has to respond to a given price change, the greater the
number of substitutes a consumer will be able to find.
If a market is defined broadly—for example, the market the gasoline—then fewer the close
substitutes there are. And so demand would tend to be relatively inelastic. On the other hand, if
the market is defined narrowly—for example, the market for Exxon/Mobil gasoline—then the
greater the number of close substitutes there are. (Chevron gasoline, Union 76 gasoline, etc. are
very close substitutes for ExxonMobil gasoline). In this case, demand is more elastic.
7. The better the transportation system, and thus the cheaper transportation is, the greater the
number of substitutes available. If a person is restricted to a limited geographical area, then the
number of substitutes would be small in comparison to someone who was not restricted. The
greater the number of substitutes available, the more elastic demand will be.
8. See graphs.
9. It would fall to zero. Any price above $5 would cause quantity demanded to fall to zero if
demand was perfectly elastic.
10. The change in quantity supplied = 100,000-60,000=40,000. Dividing this by the original
quantity supplied gives us 40,000/100,000=0.40 (40%). The change in price = $8-$6=$2.
Dividing this number by the original price gives us $2/$8 =0.25 (25%). Thus:
eS = (0.40)/(0.25) = 1.6.
11. Set up as follows:
eS = (Qs/Q1s)/(P/P1)= (Qs/Q1s)/(0.10)=0.50.
It follows from this equation that (Qs/Q1s ) must be equal to 0.05 (5%). A 5% increase in
quantity supplied would make the new quantity supplied equal to 1,050,000.
(Note: 5% of 1,000,000 is 50,000).
12. Relatively elastic means relatively flat, and relatively inelastic means relatively steep. See
graphs.
13. See graphs and tables.
14. If the supply of strawberries falls (leftward shift in supply curve), then price will increase. If
demand for strawberries is inelastic (e<1) then TR will rise, but if the demand for strawberries is
elastic (e>1), then TR will fall. See graphs and the answer to question number (4).
Question 8.
P
Question 5.
P
Question 8.
P
Perfectly Inelastic
Perfectly Elastic
D
P1
P2
D
Delastic
Dinelastic
Q1 Q2inelas. Q2elas. Q
For a given change in price, from P1 to P2,
the increase in quantity demanded is greater
for elastic curve.
Q
Q
Question 13a.
P
Question 12.
Sinelastic
P
D
S2
$11
S1
P2
P1
Selastic
Vertical gap=$1
Q1Qinelastic Qelastic
P
$10
Quantity
Q
Quantity
For this problem it is assumed that
an excise tax of $1/unit is imposed on sellers.
Question 13a.
Table for 13a .Buyers bear entire burden
$11
S2
vertical gap=$1
$10
S1
D
Q2
Q1
Q
Before Tax After Tax
Buyers Pay $10
$11
.
Sellers receive net
price of $10
$11-$1=$10
Note: Sellers receive the same price before and
after tax, whereas buyers pay a price that is $1 higher.
Question 13b.
P
P
vertical gap=$1
Question 13b.
S1=S2
S2
S1
$10
D
$10
D
Q2
Q1
Q
Q
Quantity
P
Question 15
S2
PBrazil
PUS
P1
S1
DUS
DBrazil
Table for 13b. Sellers bear entire burden.
Before Tax After Tax
Buyers Pay
$10
$10
.
Sellers receive net
price of
$10 $10-$1=$9
Buyers pay the same price before and after the tax,
whereas sellers receive a net price that is $1 lower.
QUS QBrazil Q1 Quantity
Study Questions on PPF, Comparative Advantage
1. See Figure 1.
Figure 1: Fiji’s PPF
Y
200
Y1
X1= 20
50
X
a. Determine the opportunity cost of producing X in Fiji.
b. Find Y1.
2. See Figure two.
Z
Figure 2: Siberia’s PPF
10
9
7
4
1
2
3
4
X
Suppose Siberia is initially producing zero X and 10 units of Y. What is the opportunity of
producing the first unit of X? …of producing the second unit? ….third unit? …..fourth unit?
3. What factors cause the production-possibility frontier to shift?
4. Elizabeth and Stephanie have each been assigned 3 rooms to clean. Cleaning the floor and
dusting is required for each room. It takes Elizabeth 10 minutes to dust one room and 20 minutes
to clean the floor for one room. It takes Stephanie 25 minutes to dust one room and 25 minutes to
clean the floor for one room. Therefore, Elizabeth is currently spending 90 minutes to clean her
three rooms (90 minutes = 10 minutes * 3 rooms + 20 minutes* 3 rooms) and Stephanie is
currently spending 150 minutes to clean her three rooms.
a. Who has the comparative advantage in cleaning floors?
Who has the comparative advantage in dusting?
b. What sort of trades can they make that would reduce the time each spends on cleaning?
5. a. It takes Tom 10 hours to produce an X and 5 hours to produce a Y. It takes Maria 18 hours
to produce an X and 6 hours to produce a Y. Who has the absolute advantage in the production of
good X? Who has the absolute advantage in the production of good Y? Who has comparative
advantage in the production of good X? Who has the comparative advantage in the production of
good Y? Explain your answers.
b. Suppose Tom has 100 total hours available. He uses 50 hours to produce X and 50 hours to
produce Y. Maria has 90 total hours available, and she uses 72 hours to produce X and 18 hours
to produce Y. Given this information, fill in the table below.
X produced
Y produced
Tom
Maria
TOTAL
c. Now suppose each individual completely specializes in the good that he/she has a comparative
advantage in. Based on this assumption, fill in the table below.
X produced
Y produced
Tom
Maria
TOTAL
Compared to your answer for part (b), what has happened to the TOTAL production of of X and
Y?
6. Use the following information to answer the questions below:
U.S.
Great Britain (GB)
Soybean
2hrs.
8hrs.
Textiles
1hr.
2hrs.
Each number in the table represents the number of labor hours required to produce one unit of the
respective good. The U.S. has 8,000 labor hours available, and GB has 8,000 hours available.
a. Draw each country’s production possibility curve. What does the slope of the PPF represent?
b. Which country has the absolute advantage in the production of soybeans? ...in the production
of textiles? Explain.
c. Which country has the comparative advantage in the production of soybeans? ...in the
production of textiles? Explain.
d. Assume that the U.S. is initially producing and consuming 3000 units of soybeans and 2000
units of textiles, and G.B. is initially producing and consuming 600 units of soybeans and
.
units of textiles. Fill in the following table.
Before Specialization
Soybeans
Textiles
US
GB
TOTAL
e. Now assume that each country completely specializes in the good in which it has a
comparative advantage. Fill in the following table.
After Specialization, But Before Trade
Soybeans
Textiles
U.S.
G.B.
TOTAL
f. Assume that the price of wheat in terms of shoes is 3T per S (that is, it takes 3 units of textiles
to purchase one unit of soybeans), and at this price the U.S. desires to export 700S. Fill in the
table below showing production and consumption.
After Specialization and Trade
Soybeans
Textiles
U.S.
G.B.
TOTAL
g. Would trade take place at a price of 1T per S? Explain.
ANSWERS
Y
200
Fiji’s PPF
Y1
X1= 20
50
X
a. The opportunity cost of X in terms of Y is given by the slope of the PPF.
Slope = (rise/run) = 200/50 = 4. Therefore, the cost of producing 1 X is 4 Y.
b. If Fiji is producing 20 units of X ,and given that the opportunity cost of 1X is 4Y, then
Fiji must be giving up 20*4 = 80 units of Y. And so Y1 = 200-80= 120.
2. The opportunity cost of producing the first unit of X is 1Z (output of Z falls from 10 to 9 as
Siberia moves from zero X to 1 unit of X.) The opportunity cost of the second unit of X is 2Z
(output of Z falls from 9 to 7). The opportunity cost of the third unit of X is 3Z (output of Z falls
from 7 to 4). The opportunity cost of the fourth unit of X is 4Z (output of Z falls from 4 to 0).
3. Changes in technology, and changes in the amount of inputs available (land, labor and capital).
4. Elizabeth’s opportunity cost of cleaning one floor = (20 minutes/floor)/ (10 minutes/dusting)=
two dustings per floor. In other words, in the amount of time it takes Elizabeth to clean one floor
she could have dusted two rooms.
Stephanie’s opportunity cost of cleaning one floor = (25 minutes/floor)/ (25 minutes/dusting)=
one dusting per floor. In other words, in the amount of time it takes Stephanie to clean one floor
she could have dusted one room.
Since Stephanie has the lower opportunity cost of cleaning floors, she has the comparative
advantage in floors.
Elizabeth’s opportunity cost of dusting one room = (10 minutes/dusting)/ (20 minutes/floor)=
½ floor per dusting. In other words, in the amount of time it takes Elizabeth to dust one room
she could have cleaned ½ of a floor.
Stephanie’s opportunity cost of dusting one room = (25 minutes/dusting)/ (25 minutes/floor)=
one floor per dusting. In other words, in the amount of time it takes Stephanie to dust one room
she could have cleaned one floor.
Since Elizabeth has the lower opportunity cost of dusting, she has the comparative advantage in
dusting.
4b. Any “price” between 2D per F and 1D per F will make both better off. For example, suppose
they agree on a price of 1.5D per F. So Stephanie, who has the comparative advantage in floors,
might agree to take over two Elizabeth’s floors in return for Elizabeth dusting all three of
Stephanie’s rooms. So after this trade, Elizabeth does 6 dustings plus 1 floor and Stephanie does
5 floors and no dustings.
Time spent by each would now be:
For Elizabeth  (6 dustings*10 minutes/dusting ) + (1 floor*20 minutes/floor) = 80 minutes.
This saves Elizabeth 10 minutes (recall that before the trade it took Elizabeth 90 minutes to
complete her three rooms).
For Stephanie  (5 floors*25 minutes/floor) = 125 minutes. This saves Stephanie 25 minutes
(recall that before the trade it took Stephanie 150 minutes to complete her three rooms).
5a. Tom has the absolute advantage in the production of X since it takes him fewer hours to
produce one unit of X (10 hours versus 18 hours for Maria). Tom also has the absolute advantage
in the production of Y since it takes him fewer hours to produce one unit of Y (5 hours versus 6
hours for Maria).
Tom’s opportunity cost of producing one unit of X = (10 hours per X/5 hours per Y)=2Y per X.
Maria’s opportunity cost of producing one unit of X=(18 hours per X/6 hours per Y)=3Y per X.
Since Tom can produce a unit of X at a lower opportunity cost than Maria (2Y<3Y), we can
conclude that Tom has the comparative advantage in the production of X.
Tom’s opportunity cost of producing one unit of Y = (5 hrs. per Y/10 hours per X)=1/2X per Y.
Maria’s opportunity cost of producing one unit of Y=(6 hrs. per Y/18 hours per X)=1/3X per Y.
Since Maria can produce a unit of Y at a lower opportunity cost than Tom (1/3Y<1/2Y), we can
conclude that Maria has the comparative advantage in the production of Y.
5b.
X produced
Y produced
Tom
5
10
Maria
4
3
TOTAL 9
13
5c.
Tom
Maria
TOTAL
X produced
10
0
10
Y produced
0
15
15
6a.
T
8000
US PP Curve
T
GB PP Curve
4000
4000
S
1000
S
Slope of the US ppc = (8000/4000)= 2
Slope of GB ppc =4000/1000=4
This tells us that the opportunity cost of
This tells us that the opportunity cost of
producing one S is 2T in the US.
producing one S is 4T in GB.
6b. Absolute advantage in Soybeans—US since 2 hours < 8 hours.
Absolute advantage in Textiles---US since 1 hour < 2 hours.
6c. Cost of soybeans in the US= 2hrs.per soybean/1hr. per textile = 2T per unit of soybeans.
Cost of soybeans in GB = 8 hours per soybean/2 hours per textile=4T per unit of soybeans.
Therefore , the US has the comparative advantage in the production of soybeans.
The cost of textiles in the US = 1 hour per textile/2 hours per soybean= ½ S per unit of textiles.
The cost of textiles in GB = 2hours per textile/8 hours per soybean= ¼ S per unit of textiles.
So GB has the comparative advantage in the production of textiles.
6d.
Before Specialization
Soybeans
Textiles
US
3000
2000
GB
600
1600
TOTAL
3600
3600
6e. After Specialization, But Before Trade
Soybeans
Textiles
U.S.
4000
0
G.B.
0
4000
TOTAL
4000
4000
6f.
After Specialization and Trade
Soybeans
Textiles
U.S.
4000-700=3300
0+2100=2100
G.B.
0+700=700
4000-2100=1900
TOTAL
4000
4000
6g. No. The US can either produce their own T or trade for T. If it produces its own T, then it
gives up ½ S per T. This is below the price of 1S per T. Therefore it would be cheaper for the US
to produce their own T. So trade would not take place at this price.