Download Elasticity FRQs answers

AP Economics:
Elasticity FRQ s
October 2016
Elasticity FRQs
1. Assume that bread and butter are complementary goods. The government begins to
subsidize the production of wheat, which is an input in the production of bread.
(a) For each of the following markets, draw correctly labeled supply and demand graphs and
show the effect of the subsidy on the equilibrium price and quantity in the short run.
(need correctly labeled supply and demand graphs for all three:)
(i) the wheat market
rightward shift of the supply curve for the wheat market with price decreasing and
quantity increasing
(ii) the bread market
rightward shift of the supply curve for the bread market with price decreasing and
quantity increasing
(iii) the butter market
rightward shift of the demand curve for the butter market with price increasing and
quantity increasing
(b) If the demand for bread is price elastic, how will total revenues for the bread producers
change as a result of the government subsidy? total revenue will increase
(Notice this is the Total Revenue test in reverse – they tell you DB is elastic then ask you how
TR will change…Mr. B)
2. Utility and price elasticity of demand are important concepts in explaining consumer
behavior.
(a) Define marginal utility
extra satisfaction received from consuming another unit of a good or service
(b) The table below shows the quantities, prices, and marginal utilities of two goods,
fudge and coffee, which Mandy purchases:
Quantity of purchase
Price per pound
Marginal utility of last
pound
Fudge
10 pounds
$2
12
Coffee
7 pounds
$4
20
Mandy spends all her money and buys only these two goods. In order to maximize
her utility, should Mandy purchase more fudge and less coffee, purchase more coffee
and less fudge, or maintain her current consumption? Explain.
more fudge, less coffee: MU/$ for fudge is greater than MU/$ for coffee
(Notice this is the MU table turned sideways, and you need to complete it by adding a MU
per $ row, which would show MU/$ for Fudge is 6 and MU/$ for Coffee is 5).
(c) Assume that consumers always buy 20 units of good R each month regardless of its
price.
(i)
What is the numerical value of the price elasticity of demand for good R?
Zero – perfectly inelastic
(ii) If the government implements a per-unit tax of $2 on good R, how much of the
tax will the seller pay?
seller will pay none of the tax (or perfectly inelastic buyer will pay all of the tax)
3. Sasha is a utility-maximizing consumer who spends all of her income on peanuts and
bananas, both of which are normal goods.
(a) Assume that the last unit of peanuts consumed increased Sasha's total utility from 40
utils to 48 utils and that the last unit of bananas consumed increased her total utility
from 52 utils to 56 utils.
(i) If the price of a unit of peanuts is $ 1 and Sasha is maximizing utility, calculate
the price of a unit of bananas. MU of peanuts is 48-40 = 8, and price is $1, so
MU/$peanuts = 8. MU of bananas are 56-52 = 4 and we know MU/$bananas is also 8.
So price of last banana = 4/8 or $.50; or, at a price of $.50, MU/$ = 4/.50 = 8.
(ii) If the price of a unit of peanuts increases and the price of a unit of bananas
remains unchanged from the price you determined in part (a)(i), how will Sasha's
purchase of peanuts change? Sasha will purchase fewer peanuts (if Ppeanuts
increases, MU/$ decreases and becomes lower than MU/$ for bananas).
(b) Assume that the cross-price elasticity of demand between peanuts and bananas is
positive. A widespread disease has destroyed the banana crop. What will happen to the
equilibrium price and quantity of peanuts in the short run? Explain. Equilibrium price
and quantity will both increase. Peanuts and bananas are substitutes (they have a
positive cross-elasticity); a decease in the supply of bananas causes an increase in the
price of bananas, which causes demand for peanuts to increase.
(c) Assume that the price of bananas increases.
(i) Will the substitution effect increase, decrease, or have no effect on the quantity
of bananas demanded? Decrease
(ii) What happens to Sasha's real income? Decrease (the income effect – inflation
in prices reduces Sasha’s real income)
4. The graph below illustrates the market for calculators. S denotes the current supply curve,
and D denotes the demand curve.
(a) Calculate the producer surplus before the tax. $135 ( ½ x $3 x 90)
(b) Now assume a per-unit tax of $2 is imposed whose impact is shown in the graph
above.
(i)
Calculate the amount of tax revenue $120 ($2 x 60)
(ii)
What is the after-tax price that the sellers now keep? $4
(iii)
Calculate the producer surplus after the tax. $60 (½ x $2 x 60)
(c) Is the demand price elastic, inelastic, or unit elastic between the prices of $5 and $6?
Explain. Demand is price elastic as it is >1 using midpoint calculation formula.
Ed = (30/75) / (1/5.5) = 2.2 (the Coefficient test)
OR
Demand is price elastic as Total Revenue increases from $360 ($6 x 60 units) to $450 ($5 x 90
units) as price decreases from $6 to $5 (The Total Revenue test)
(c) Assuming no externalities, how does the tax affect allocative efficiency? Explain.
Allocation is no longer efficient because of the loss of surplus (creation of deadweight
loss)
5. The diagram above shows the domestic supply and demand for good X in the country
of Placonia.
(a) Assume the government of Placonia imposes a tariff of good X, increasing the price from
PW to Pt. Using the labels in the graph, indicate the change in each of the following in
Placonia:
(i) consumer surplus
consumer surplus decreases from PwNH to PtMH, or a decrease ofMNPwPt
(CS is the area above price but below the demand curve)
(ii) producer surplus
producer surplus increases by JKPtPW
(and PS is the area below price but above the supply curve)
(d) Indicate how employment in the domestic industry that produces good X is
affected by the tariff. employment increases because of increased domestic
production