Download Selected Homework Answers from Chapter 3

Selected Homework Answers from Chapter 3
NOTE: To save on space, I have not given specific labels to my axis, but rather stuck
with just P and Q. Ideally, you should put specific labels. For example, the vertical axis in
question 4a should read “Price of Housing” and the horizontal axis label should read
“Quantity of Houses Sold”
4. For each of the following markets, indicate whether the stated change causes a shift in
the supply curve, a shift in the demand curve, a movement along the supply curve, and/or
a movement along the demand curve.
a. The housing market: Consumers’ incomes fall
Consumers’ income is one of the things we’ve learned will change demand, so we know
that we’ll have to see a shift in the demand
curve. As income has gone down, demand
Housing Market
decreases, and our demand curve shifts
inward.
P
S
But the story doesn’t end there . . . there’s
also been a change in quantity supplied.
Why a change in quantity supplied and not
supply? Because it’s due to a price change
caused by the decrease in demand.
P1
P2
D2
D1
Q2 Q1
Q
To put it another way, we’ve SHIFTED the
demand curve, and MOVED ALONG the
supply curve.
b. The tea market: The price of sugar goes down
Tea Market
P
S
P2
P1
D2
D1
Q1 Q2
Q
Sugar is a compliment to tea, and we’ve
seen that a decrease in the price of a
compliment for a good increase the demand
of that good. So a decrease in the price of
sugar will correspond to an increase in the
demand for tea. Again, this is a change that
is caused by something other than price, so it
is a SHIFT in the demand curve, and a
change in DEMAND.
Similar to last problem, we have a change in
the QUANTITY SUPPLIED caused by the
price change, and we move along the
already existent supply curve.
The coffee market: There is a freeze in Brazil that severely damages the coffee crop
A damaged coffee crop means that the cost
of producing coffee has increased, so this is
equivalent to a drop in SUPPLY (again, a
non-price related change, so it is a shift of
the curve). That drop in supply (shift
leftward of the supply curve) brings about a
higher price, and that higher price then
means that the QUANTITY DEMANDED
goes down.
Coffee Market
S2
P
S1
P2
P1
D
Q2 Q1
Q
This time, we have a SHIFT of the supply
curve, and a MOVEMENT ALONG the
demand curve.
c. The fast food market: The number of fast food restaurants in an area decreases
One of the things that brings about shifts in
the supply curve is a change in the number
of firms in the market. As the number of
firms has decreased, this is equivalent to a
leftward SHIFT of the supply curve. Just
like in the coffee example, a decrease in the
supply will drive up the price, resulting in a
decrease in QUANTITY DEMANDED.
Fast Food Market
S2
P
S1
P2
P1
Just like in part c, we have a SHIFT of the
supply curve, and a MOVEMENT ALONG
the demand curve.
D
Q2 Q1
Q
6. Consider the market for automatic teller machine services in a city. The price is the fee
for a cash withdrawal.
a. Sketch the demand curve and the supply curve for ATM transactions.
ATM Market
P
Been there, done that. This will look just
like all the other supply and demand graphs
we’ve drawn so far. On the price axis is the
price of withdrawing money, and on the
quantity axis is the number of ATMs people
use to get said money.
S
Pe
D
Qe
Q
b. How is the equilibrium price determined?
The price is determined by where supply meets demand. In the above graph, that’s at the
point labeled Pe.
c. If the town council imposes a ban on ATM fees, equivalent to a price ceiling in
this market, what happens to quantity supplied and quantity demanded?
ATM Market
P
S
Pe
This is the same as saying the price of using
ATMs is now zero due to the price ceiling
(call it Pc). At a price of zero, suppliers are
willing to provide Qs ATMs, but consumers
demand Qd. As Qd exceeds Qs, we have a
SHORTAGE.
Note there are some side effects here. For
example, there are some people out there
that would be willing to pay the equilibrium
Pf
Qe
Qd
Qs
price (Pe) to use an ATM. If the market were
Q
allowed to do its work, the equilibrium
shortage
quantity, Qe, would be reached with an
appropriate price (Pe). But now that
suppliers can’t charge money, some aren’t willing to provide the service. Now some
people that would have gladly paid the equilibrium price, and would have gotten to use
ATMs before no longer have the option to use the service.
D
d. Economists frequently argue against price controls because of the incentives they
give to suppliers. Explain why this interference in the market may produce bad
incentives.
As we just saw in part c, one of the results of this price control is the suppliers just stop
providing the service. Another possible side effect, however, is that banks may start
trying to find other ways to make revenue, since ATM fees are no longer allowed. For
example, they may start charging for other transactions, or reduce their offered interest
rate.
7. In 1991 the price of milk fell 30 percent. Senator Leahy of Vermont, a big milkproducing state, supported a law in the U.S. Congress to put a floor on the price. The
floor was $13.09 per hundred pounds of milk. The market price was $11.47.
a. Draw a supply and demand diagram. Explain the effects of the legislation. Would
the legislation cause a surplus or a shortage?
Milk Market
P
S
$13.09
$11.47
D
Pf
Qd
Qe
Qs
Q
Placing a minimum price on something is
creating a price floor (similar to the
minimum wage example Dr. Allen did in
class). And as we’ve learned, if the price
floor is above the equilibrium price, then the
result will be a surplus, which is exactly
what our graph shows. There is a greater
supply at $13.09 than there is demand at that
price, so the market won’t clear. If the
market were allowed to work itself out, milk
suppliers would realize that they were
building up inventory and lower the price to
get rid of the extra milk they have lying
around, until the market was back in
equilibrium again.
b. The dairy farmers supported the legislation, and consumer groups opposed it.
Why?
Why consumers opposed this change is obvious . . . higher prices are never a good thing
for something you want to buy. But according to our graph, there are some suppliers that
lose out too. After all, now there’s a bunch of milk that isn’t being sold lying around, and
that’s a big drain on revenue (not to mention the fact that a warehouse full of old milk
can’t smell too great). Why would milk producers see this as a good thing?
Our textbook mentions that, with agricultural price floors, the end result is that the
government usually buys up the surplus. So from the milk producer’s point of view, all of
the product they produce gets sold, and it sells at a higher price than before. You can see
why they would be in favor of situations like this.
8. Why is it necessary for people to stand in line for days before the sale of tickets to
concerts by the most famous performers? Is the price mechanism working properly? Why
are scalpers present on these occasions?
People have to wait in line for days because there is a shortage of tickets . . . supply is not
as great as demand. If a concert hall can only hold 80,000 people, and 150,000 people
want to see the concert, only those that get one of those 80,000 tickets actually gets to go.
And that means lining up ahead of time to make sure you aren’t the 80,001st guy in line.
The price mechanism isn’t working properly here. If the price mechanism WERE
working, then there would be exactly the same number of tickets supplied as there were
demanded. The price would keep going up until only 80,000 people were willing to pay
that price to see the concert. Since we have a shortage, there must be a price ceiling.
Scalpers pop up because the have the opportunity to make money in this situation. If they
manage to get a hold of a ticket for the selling price, they can sell it to someone for the
equilibrium price, making a nice little profit. This is why black markets tend to appear
when you have price ceilings.
14.
a. Straight-line demand and supply curves can be represented by linear algebraic
equations. Given the following algebraic expression for supply and demand,
calculate the equilibrium price and quantity by solving the two equations for P
and Q.
Qs = 5 + 2P
Qd = 9 – 2P
At equilibrium, Qs = Qd, or
5 + 2p = 9 – 2P.
Subtracting 5 and adding 2P to both sides gives
4P = 4 or P = 1
Plugging 1 in for P
Qs = 5 + 2(1) = 7
Qd = 9 – 2(1) = 7
b. For the equations defined in part a, show that when you substitute the equilibrium
price into either the supply or the demand equation, you get the same equilibrium
quantity.
See above.
c. Suppose that the demand curve shifts as a result of an increase in consumers’
incomes. The new demand equation is Q = 13 – 2P. Calculate the new
equilibrium price and quantity.
Qs = 5 + 2P
Qd = 13 – 2P
At equilibrium, Qs = Qd, or
5 + 2p = 13 – 2P.
Subtracting 5 from both sides and adding 2P to both sides gives
4P = 8 or P = 2
Plugging 1 in for P
Qs = 5 + 2(2) = 9
Qd = 13 – 2(2) = 9
We know our P is correct, as it results in “clearing” of the market.