Download Chapter 4 Working with Supply and Demand

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 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-the-counter 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:
-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.
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.