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Economics for Business
Problem Set 2
Due Date: 29nd November, 2005
1. （1）What is the difference between a “change in demand” and a “change in quantity
demanded”? Graph your answer.
ANSWER:
A change in demand refers to a shift in the demand curve. A change in quantity demanded
refers to a movement along a fixed demand curve.
（2） For each of the following changes, determine whether there will be a movement along
the demand curve or a shift in the demand curve.
a. a change in the price of a related good
b. a change in tastes
c. a change in the number of buyers
d. a change in price
e. a change in expectations
f. a change in income
Answer: A change in price causes a change in quantity demanded. All of the other
changes listed shift the demand curve.
2. Consider the following pairs of goods. Which would you expect to have the more elastic
demand? Why?
a. water or diamonds
b. insulin or nasal decongestant spray
c. food in general or breakfast cereal
d. gasoline over the course of a week or gasoline over the course of a year
e. personal computers or IBM personal computers
ANSWER: a. Diamonds are luxuries, and water is a necessity. Therefore, diamonds have the
more elastic demand.
b. Insulin has no close substitutes, but decongestant spray does. Therefore, nasal
decongestant spray has the more elastic demand.
c. Breakfast cereal has more substitutes than does food in general. Therefore, breakfast
cereal has the more elastic demand.
d. The longer the time period, the more elastic demand is. Therefore, gasoline over the
course of a year has the more elastic demand.
e. There are more substitutes for IBM personal computers than there are for personal
computers. Therefore, IBM personal computers have the more elastic demand.
3. You own a small town movie theatre. You currently charge $5 per ticket for everyone who
comes to your movies. Your friend who took an economics course in college tells you that
there may be a way to increase your total revenue. Given the demand curves shown, answer
the following questions.
a.
b.
c.
d.
What is your current total revenue for both groups?
The elasticity of demand is more elastic in which market?
Which market has the more inelastic demand?
What is the elasticity of demand between the prices of $5 and $2 in the adult market? Is
this elastic or inelastic?
e. What is the elasticity of demand between $5 and $3 in the children’s market? Is this
elastic or inelastic?
f. Given the graphs and what your friend knows about economics, he recommends you
increase the price of adult tickets to $8 each and lower the price of a child’s ticket to $3.
How much could you increase total revenue if you take his advice?
ANSWER:
a. Total revenue from children’s tickets is $100 and from adult tickets is $250. Total
revenue from all sales would be $350.
b. the demand for children’s tickets is more elastic.
c. The adult ticket market has the more elastic demand.
d. The elasticity of demand between $5 and $2 is 0.26 or inelastic.
e. The elasticity of demand between $5 and $3 is 1.33 or elastic.
f. If price is increased to $8 for adult tickets (maximum for the graph) and price decreased
to $3 for child tickets (minimum for graph), total revenue would increase to $440 ($8 
40 + $3  40) or $90 more than before.
4. What are normal goods, inferior goods, and Giffen goods? Give an example of each good. Use
graph to explain income effect and substitution effects for these goods.
Answer: (1) We say a good is normal if the quantity demand rises as incomes rise and fall as
income falls. Example: xxx.
(2) We say a good is inferior good if the demand falls as incomes rise ( vice versa ). Example:
Fat oil, or any other correct example.
(3) We say a good is Giffen good if the demand rise as price rises. Potatoes.
See Fig. 2.6, 2.7 in page 58 and 59 for reference.
5. A real estate company runs business in two cities, A and B. In city A, research suggests that the
price elasticity is -0.8 and in city B -1.5. The company decided to revise house price downwards in
both cities by 10% this year. Comment on the decision. What alternative pricing strategy would
you suggest?
Answer: (1) The decision to cut price by 10% in both cities is not wise. As it did not consider the
different response of demand to price cut in two cities. (2) City A’s elasticity is low and city B’s is
high. So the company should cut less in city A and cut more in city B. Specifically, the company
should cut less than 10% in city A and more than 10% in city B.
6. Assume the demand for diamond is p  q
1 / 
,   0 . Calculate the elasticity. What did you
find? What is the meaning of  ?
q
p dq
p 
q
Answer: (1)  
 
  1 .
p
 1
q dp
q
q 
p

(2) This demand exhibits a constant elasticity. (3)  measures the elasticity level. Large
implies high elasticity. As this is the demand for diamond, we expect  to be relatively
large.