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Economics: Supply and Demand and Price Elasticity

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1. Draw a circular-flow diagram. Identify the parts of the model that correspond to the flow of goods and services and the flow of dollars for each of the following activities. a. Sam pays a storekeeper $1 for a quart of milk.

b. Sally earns $4.50 per hour working at a fast food restaurant. c. Serena spends $7 to see a movie.

d. Stuart earns $10,000 from his 10 percent ownership of Acme Industrial.

2. What is a competitive market? Briefly describe a type of market that is not perfectly competitive.

3. What are the demand schedule and the demand curve and how are they related? Why does the demand curve slope downward?

4. Popeye’s income declines, and as a result, he buys more spinach. Is spinach an inferior or a normal good? What happens to Popeye’s demand curve for spinach?

5. What are the supply schedule and the supply curve and how are they related? Why does the supply curve slope upward?

6. Does a change in producers’ technology lead to a movement along the supply curve or a shift in the supply curve? Does a change in price lead to a movement along the supply curve or a shift in the supply curve?

7. Describe the role of prices in market economies.

8. List and explain the four determinants of the elasticity of demand.

9. How did elasticity help explain why drug interdiction could reduce the supply of drugs, yet possibly increase drug related crimes?

10. For each of the following pairs of goods, which good would you expect to have more elastic demand and why? a. Required textbooks or mystery novels

b. Beethoven recordings or classical music recordings in general c. Heating oil during the next six months or heating oil during the next five years d. Root beer or water

11. Suppose that business travelers and vacationers have the following demand for airline tickets from New York to Boston:



a. As the price of tickets rises from $200 to $250, what is the price elasticity of demand for: i) Business travelers?
ii) Vacationers?
Use the midpoint method in your calculations.
b. Why might vacationers have a different elasticity than business travelers?

12. The New York Times reported (Feb. 17, 1996,p. 25) that subway ridership declined after a fare increase: “There were nearly four million fewer riders in December 1995, the first full month after the price of a token increased 25 cents to $1.50, than in the previous December, a 4.3 percent decline.” a. Use these data to estimate the price elasticity of demand for subway rides. b. According to your estimate, what happens to the Transit Authority’s revenue when the fare rises? c. Why might your estimate of the elasticity be unreliable?

13. Two drivers–Tom and Jerry–each drive up to a gas station. Before looking at the price, each places an order. Tom says, “I’d like 10 gallons of gas.” Jerry says, “I’d like $10 worth of gas.” What is each driver’s price elasticity of demand?

14. Economists have observed that spending on restaurant meals declines more during economic downturns than does spending on food to be eaten at home. How might the concept of elasticity help to explain this phenomenon?

15. Consider public policy aimed at smoking.

a. Studies indicate that the price elasticity of demand for cigarettes is about 0.4. If a pack of cigarettes currently costs $2 and the government wants to reduce smoking by 20 percent, by how much should it increase the price? b. If the government permanently increases the price of cigarettes, will the policy have a larger effect on smoking one year from now or five years from now? c. Studies also find that teenagers have a higher price elasticity than do adults. Why might this be true?

16. Explain why the following might be true: A drought around the world raises the total revenue that farmers receive from the sale of grain, but a drought only in Kansas reduces the total revenue that Kansas farmers receive.

17. Consider a straight line demand curve which goes through the points (p=12.70, q=2200) and (p=12.50, q=2300). a. Calculate arc elasticity
b. At each of the two points calculate point elasticity
c. Calculate point elasticity at a price of 12.60.

18. Consider the demand curve P = 300 – .6Q. Calculate the elasticity of demand at P = 200.

19. “An increase in the demand for notebooks raises the quantity of notebooks demanded, but not the quantity supplied.” Is this statement true or false? Explain.

20. Consider the market for minivans. For each of the events listed here, identify which of the determinants of demand or supply are affected. Also indicate whether demand or supply is increased or decreased. Then show the effect on the price and quantity of minivans. a. People decide to have more children.

b. A strike by steelworkers raises steel prices.
c. Engineers develop new automated machinery for the production of minivans. d. The price of station wagons rises.
e. A stock-market crash lowers people’s wealth.

21. During the 1990s, technological advance reduced the cost of computer chips. How do you think this affected the market for computer for computers? For computer software? For typewriters?

22. Because bagels and cream cheese are often eaten together, they are complements. a. We observe that both the equilibrium price of cream cheese and the equilibrium quantity of bagels have risen. What could be responsible for this pattern–a fall in the price of flour or a fall in the price of milk? Illustrate and explain your answer. b. Suppose instead that the equilibrium price of cream cheese has risen but the equilibrium quantity of bagels has fallen. What could be responsible for this pattern–a rise in the price of flour or a rise in the price of milk? Illustrate and explain your answer.

23. An article in The New York Times described a successful marketing campaign by the French champagne industry. The article noted that “many executives felt giddy about the stratospheric champagne prices. But they also feared that such sharp price increases would cause demand to decline, which would then cause prices to plunge.” What mistake are the executives making in their analysis of the situation? Illustrate your answer with a graph.

24. Emily has decided always to spend one-third of her income on clothing. a.
What is her income elasticity of clothing demand?
b. What is her price elasticity of clothing demand?
c. If Emily’s tastes change and she decides to spend only one-fourth of her income on clothing, how does her demand curve change? What are her income elasticity and price elasticity now?

25. Pharmaceutical drugs have an inelastic demand, and computers have an elastic demand. Suppose that technological advance doubles the supply of both products (that is, the quantity supplied at each price is twice what it was). a. What happens to the equilibrium price and quantity in each market? b. Which product experiences a larger change in price?

c. Which product experiences a larger change in quantity?
d. What happens to total consumer spending on each product?

26. Because better weather makes farmland more productive, farmland in regions with good weather conditions is more expensive than farmland in regions with bad weather conditions. Over time, however, as advances in technology have made all farmland more productive, the price of farmland (adjusted for overall inflation) has fallen. Use the concept of elasticity to explain why productivity and farmland prices are positively related across space but negatively related over time.

27. From initial positions of equilibrium (in each case), indicate the effects of demand and supply changes (as indicated) on price and quantity. Separately graph the initial demand and supply curves, then the changed curves, and note the effects on price and quantity. Change ofresults inChange of

demandsupply pricequantity
e. ==

28. Changes in equilibrium price and quantity have been observed–what changes in supply and demand would account for these observed changes? ObservedCauses(s)
PriceQuantity SupplyDemand
a. + +
b. + –
c. – +
d. – –
29. Suppose that the demand for some product is highly (price) elastic, but not perfectly elastic, and that the supply is (price) inelastic, but not perfectly inelastic. If supply decreases, what will happen to total expenditures (revenues) on the product? Illustrate using demand and supply curves.

30. Suppose the market demand for pizza is given by [pic] and the market supply for pizza is given by [pic], where P=price (per pizza). a. Graph the demand supply schedules for pizza using $5 through $15 as the value of P. b. In equilibrium, how many pizzas would be sold and at what price? c. What would happen if suppliers set the price of pizza at $15? Explain the market adjustment process. d. Suppose the price of hamburgers, a substitute for pizza, doubles. This leads a doubling of the demand for pizza (at each price consumers demand twice as much pizza as before). Write the equation for the new market demand for pizza. e. Find the new equilibrium price and quantity of pizza.

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