Download ECON 300 – Spring 2005 In-Class Exercise 2 Eric Jacobson 1

ECON 300 – Spring 2005
In-Class Exercise 2
Eric Jacobson
1.
Consider the demand curve Q=100 – 50P.
a. Draw the demand curve and indicate which portion is elastic, which portion is
inelastic, and which portion is unit elastic.
The demand curve is a straight line, going from (P=$2, Q=0) to (P=$0, Q=100).
The point of unit elasticity comes at (P=$1, Q=50). The elastic portion is to
the left of that point, where P increases and Q decreases, while the inelastic
portion is to the right of that point, where P decreases and Q increases.
b. If the price is $1.50, could sellers increase revenue by changing the price?
Answer without making additional calculations. Explain your answer.
Since we know that total revenue peaks at the unit elastic point, we don’t need
to do any calculations – the price of $1.50 is in the elastic portion, so moving
towards unit elasticity (dropping price, raising quantity) will increase total
revenue.
c. Suppose there is a parallel increase in demand. At a price of $1.50, will
elasticity of demand change as a result of the shift? Explain. At Q=75, will price
elasticity of demand change as a result of the shift? Explain.
If the demand curve were to shift outward, it would maintain the same slope.
We also, know, thanks to some rearranging of variable, that the elasticity of
demand is equal to [ (P/Q) * (the inverse of the slope of the demand curve) ].
Since P is constant ($1.50) and the slope is constant, the only thing that
changes is Q… as it increases due to the outward shift, the elasticity of
demand will decrease.
At Q=75, similar logic can be used. The elasticity of demand will increase as P
increases, thanks to the outward shift in demand.
2. Answer based on your understanding of elasticity of demand.
a. An improvement in farm technology definitely is beneficial to consumers but
could be bad for farmers. Explain.
A technological improvement will expand supply, causing price to drop and
quantity to increase (both great for consumers). However, if demand is
inelastic at all, the falling price will cause a drop in total revenue for the
farmers.
b.If you expected a long period of declining GDP, what kind of companies would
you choose to invest in?
You should invest in companies with a low income elasticity of demand, or
even negative income elasticities, since high income elasticities magnify
changes in Y. An example of a product with low income elasticity would be
asthma medication – people would purchase it at similar rates no matter
how poor the economy performs. An example of a product with negative
income elasticity might be gruel (or Easy Mac) – if people are poorer, they
might actually be inclined to purchase more of it.
3. This question asks you to draw indifference curves representing the situations below.
Not all of these indifference curves will have the standard downward-sloping, convex
shape that frequently is shown in the text. For each situation draw a set of
indifference curves clearly indicating (with subscripts and an arrow) the direction of
increasing utility. Always label the Y-axis as quantity of hamburgers.
a. Difficult. Chris has convex indifference curves for two goods he likes –
hamburgers and grilled chicken. He likes grilled chicken much more than
hamburgers (but likes both kinds of food.) Contrast this to Webber’s IC’s.
Webber also has convex indifference curves and likes hamburgers and grilled
chicken, but he likes hamburgers much more than grilled chicken. Hint:
contrast Chris and Webber’s marginal rates of substitution at different points on
the Y-axis.
While Chris’ graph is convex and more vertical (you’d have to trade him
many hamburgers for him to give up a grilled chicken), Webber’s graph
will also be convex, but more horizontal (you’d have to trade him many
grilled chickens for him to give up a hamburger).
b.P&R Ch 3, Exercise 2, Part b
Jane’s preference is completely to hamburgers – she dislikes soft drinks to
the point of pouring them out. Her indifference curves are therefore
horizontal lines – you literally couldn’t get her to trade a hamburger for a
soft drink, even if you offered her an unlimited amount.
c. P&R Ch 3, Exercise 2, Part c
Bob dislikes soft drinks relative to hamburgers, but will drink them to be
polite. His indifference curve will be convex and upsloping, as the soft
drinks will decrease in utility as the number of them increases. Moving to
the LEFT, indifference curve utility INCREASES. This is the “weird case”
compared, because utility typically decreases as one moves to the left
(closer to the orgin.)
d.P&R Ch 3, Exercise 2, Part d
Molly insists on consuming one soft drink for every two hamburgers she eats
– they are therefore perfect complements for her, in the sense that she can’t
have one without the other. The graph should reflect this, with right angle
curves extending (with corners where multiples of two hamburgers
intersect with multiples of one soft drink).
4.
Extra credit Jeopardy “question.” Harvey Rosen, Greg Mankiw
Harvey Rosen was chosen to replace Greg Mankiw as the Chairman of the
Council of Economic Advisors (CEA).