Principles of Economics II Microeconomics Homework #1: Ch 4~6 and Article Questions

Article Questions
Please download the associated article. Fare Hike... 1. Based on the article, are taxi fares more elastic or less elastic for drivers? Passengers? How do you know? Give at least 3 reasons. 2. If given a chance, do you think that cab drivers would have raised the amount that high? Why/not?

Chapter Questions
Ch 4 Questions: 1. Consider the market for eggs. For each of the events listed here, identify which of the determinants of demand or supply are affected. Also indicate whether supply or demand increases or decreases. Then draw a diagram to show the effect on the price and quantity of eggs. A. The price of grain that is fed to hens falls. B. The price of bacon falls. C. A new study is released that indicates that eating eggs is hazardous to ones health. D. The number of egg-producing farms falls. E. This weekend is the Easter holiday. 1. a. If the price of grain used to feed hens falls, the supply of eggs will rise. Demand will not be affected. The result is a fall in the price and an increase in the quantity sold, as Figure 12 shows. Figure 12

b. If the price of bacon falls, the demand for eggs will rise because eggs and bacon are complements. Supply will not be affected. The result is an increase in both the price of eggs and the quantity sold, as Figure 13 shows. Figure 13

c. A new study that indicates that eating eggs is hazardous to ones health will cause a decline in the demand for eggs. Supply is not affected. The result is a

decline in the price of eggs and a decrease in the quantity sold, as Figure 14 shows. Figure 14

d. If the number of egg-producing farms falls, the supply of eggs will decline. Demand is not affected. The equilibrium price of eggs will fall and quantity of eggs sold rises, as Figure 15 shows. Figure 15

e. During Easter weekend, the demand for eggs rises. Supply is not affected. As a result, both the equilibrium price and the equilibrium quantity rise, as Figure 13 shows. 2. Using supply and demand diagrams, show the effect of the following events on the market for personal computers. A. The price of computer chips falls. B. There is a rise in consumer incomes C. The price of computer software rises D. Universities require incoming freshmen to have their own personal computers. 2. a. If the price of computer chips falls, the cost of producing computers declines. As a result, the supply of computers shifts to the right, as shown in Figure 22. The new equilibrium price is lower and the new equilibrium quantity of computers is higher. Figure 22

b. A rise in consumer income leads more people to buy computers, increasing the demand. The result, shown in Figure 23, is a rise in both the equilibrium price and quantity of computers. Figure 23

c. If the price of computer software rises, the demand for computers will fall because computers and software are complements. This is shown in Figure 24. The result is a decrease in both the equilibrium price and quantity of computers. Figure 24

d. If universities require incoming freshmen to have their own personal computers, the demand for computers will rise. The result is a rise in equilibrium price and an increase in the equilibrium quantity of computers, as shown in Figure 23. 3. The market for hamburgers Price $1.00 1.25 1.50 1.75 2.00 2.25 has the following supply and demand schedule: Qty Demanded Qty Supplied 200 hamburgers 110 hamburgers 170 130 145 145 125 155 110 160 100 165

A.

Graph the demand and supply curves. What is the equilibrium price and quantity in this market? If the actual price in this market were above the equil. price, what would drive the market toward the equil.? If the actual price in this market were below the equil. price, what would drive the market toward the equil?

3. Quantity supplied equals quantity demanded at a price of $1.50 and quantity of 145 hamburgers (Figure 27). If the price were greater than $1.50, quantity supplied would exceed quantity demanded, so suppliers would reduce the price to gain sales. If the price were less than $1.50, quantity demanded would exceed quantity supplied, so suppliers could raise the price without losing sales. In both cases, the price would continue to adjust until it reached $1.50, the only price at which there is neither a surplus nor a shortage. Figure 27

Ch 5 Questions: 4. 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. Subway rides during the next 6 months or subway rides during the next 5 years. D. Root beer or water. 4. a. Mystery novels have more elastic demand than required textbooks, because mystery novels have close substitutes and are a luxury good, while required textbooks are a necessity with no close substitutes. If the price of mystery novels were to rise, readers could substitute other types of novels, or buy fewer novels altogether. But if the price of required textbooks were to rise, students would have little choice but to pay the higher price. Thus, the quantity demanded of required textbooks is less responsive to price than the quantity demanded of mystery novels. b. Beethoven recordings have more elastic demand than classical music recordings in general. Beethoven recordings are a narrower market than classical music recordings, so it is easy to find close substitutes for them. If the price of Beethoven recordings were to rise, people could substitute other classical recordings, like Mozart. But if the price of all classical recordings were to rise, substitution would be more difficult (a transition from classical music to rap is unlikely!). Thus, the quantity demanded of classical recordings is less responsive to price than the quantity demanded of Beethoven recordings. c. Subway rides during the next five years have more elastic demand than subway rides during the next six months. Goods have a more elastic demand over longer time horizons. If the fare for a subway ride was to rise temporarily, consumers could not switch to other forms of transportation without great expense or great inconvenience. But if the fare for a subway ride was to remain high for a long time, people would gradually switch to alternative forms of transportation. As a result, the quantity demanded of subway rides during the next six months will be less responsive to changes in the price than the quantity demanded of subway rides during the next five years. d. Root beer has more elastic demand than water. Root beer is a luxury with close substitutes, while water is a necessity with no close substitutes. If the price of water were to rise, consumers have little choice but to pay the higher price. But if the price of root beer were to rise, consumers could easily switch to other sodas. So the quantity demanded of root beer is more responsive to changes in price than the quantity demanded of water.

5. Suppose that business travelers and vacationers have the following demand for airline tickets from New York to Boston: Price Qty Demanded Qty Demanded (business) (Vacationers) $150 2,100 tickets 1,000 tickets 200 2,000 800 250 1,900 600 300 1,800 400 A. As the price of tickets rises from $200 to $250, what is the price elasticity of demand for (i) business travelers and (ii) vacationers? B. Why might vacationers have a different elasticity from business travelers? 5. a. For business travelers, the price elasticity of demand when the price of tickets rises from $200 to $250 is [(2,000 1,900)/1,950]/[(250 200)/225] = 0.05/0.22 = 0.23. For vacationers, the price elasticity of demand when the price of tickets rises from $200 to $250 is [(800 600)/700] / [(250 200)/225] = 0.29/0.22 = 1.32. b. The price elasticity of demand for vacationers is higher than the elasticity for business travelers because vacationers can choose more easily a different mode of transportation (like driving or taking the train). Business travelers are less likely to do so because time is more important to them and their schedules are less adaptable. 6. The New York Times reported that subway ridership declined after a fare increase:There were nearly 4 million fewer riders in Dec. 1995, the first full month after the price of a ticket increased 25 cents from $1.25 to $1.50 than in the previous Dec., a 4.3 percent decline. A. Use these data to estimate the price elasticity of demand for subway riders. B. According to your estimate, what happens to the Transit Authoritys revenue when the fare rises? C. Why might your estimate be unreliable? 6. a. If quantity demanded falls by 4.3% when price rises by 20% , the price elasticity of demand is 4.3/20 = 0.215, which is fairly inelastic. b. Because the demand is inelastic, the Transit Authoritys revenue rises when the fare rises. c. The elasticity estimate might be unreliable because it is only the first month after the fare increase. As time goes by, people may switch to other means of transportation in response to the price increase. So the elasticity may be larger in the long run than it is in the short run. Ch 6 Questions: 7. The government has decided that the free market price of cheese is too low. A. Suppose the government imposes a binding price floor in the cheese market. Draw a supply and demand diagram to show the effect of this policy on the price of cheese and the quantity of cheese sold. Is there a shortage or surplus of cheese? B. Farmers complain that the price floor has reduced their total revenue. Is this possible? Explain. C. In response to farmers complaints, the govt. agrees to purchase all of the surplus cheese at the price floor. Compared to the basic price floor, who benefits from this new policy? Who loses? 7. a. The imposition of a binding price floor in the cheese market is shown in Figure 3. In the absence of the price floor, the price would be P1 and the quantity would be Q1. With the floor set at P f, which is greater than P1, the quantity demanded is Q2, while quantity supplied is Q3, so there is a surplus of cheese in the amount Q3 Q2. b. The farmers complaint that their total revenue has declined is correct if demand is elastic. With elastic demand, the percentage decline in quantity would exceed the percentage rise in price, so total revenue would decline. c. If the government purchases all the surplus cheese at the price floor, producers benefit and taxpayers lose. Producers would produce quantity Q3 of cheese, and their total revenue would increase substantially. However, consumers would buy only quantity Q2 of cheese, so they are in the same position as before. Taxpayers lose because they would be financing the purchase of the surplus cheese through

higher taxes. Figure 3

8. Congress and the president decide that the US should reduce air pollution by reducing its use of gasoline. They impose a $0.50 tax for each gallon of gas sold. A. Should they impose this tax on producers or consumers? Explain with words and a diagram. B. If the demand for gas were more elastic, would this tax be more effective or less effective in reducing the quantity of gasoline consumed? Explain with both words and a diagram. C. Are consumers of gas helped or hurt by this tax? Why? D. Are workers in the oil industry helped or hurt by the tax? Why? 8. a. It does not matter whether the tax is imposed on producers or consumers the effect will be the same. With no tax, as shown in Figure 6, the demand curve is D1 and the supply curve is S1. If the tax is imposed on producers, the supply curve shifts up by the amount of the tax (50 cents) to S2. Then the equilibrium quantity is Q2, the price paid by consumers is P2, and the price received (after taxes are paid) by producers is P2 50 cents. If the tax is instead imposed on consumers, the demand curve shifts down by the amount of the tax (50 cents) to D2. The downward shift in the demand curve (when the tax is imposed on consumers) is exactly the same magnitude as the upward shift in the supply curve when the tax is imposed on producers. So again, the equilibrium quantity is Q2, the price paid by consumers is P2 (including the tax paid to the government), and the price received by producers is P2 50 cents. Figure 6

b. The more elastic the demand curve is, the more effective this tax will be in reducing the quantity of gasoline consumed. Greater elasticity of demand means

that quantity falls more in response to the rise in the price of gasoline. Figure 7 illustrates this result. Demand curve D1 represents an elastic demand curve, while demand curve D2 is more inelastic. The tax will cause a greater decline in the quantity sold when demand is elastic. Figure 7

c. The consumers of gasoline are hurt by the tax because they get less gasoline at a higher price. d. Workers in the oil industry are hurt by the tax as well. With a lower quantity of gasoline being produced, some workers may lose their jobs. With a lower price received by producers, wages of workers might decline.

When the supply and demand curves intersect, the market is in equilibrium. This is where the quantity demanded and quantity supplied are equal. The corresponding price is the equilibrium price or market-clearing price, the quantity is the equilibrium quantity. Putting the supply and demand curves from the previous sections together. These two curves will intersect at Price = $6, and Quantity = 20. In this market, the equilibrium price is $6 per unit, and equilibrium quantity is 20 units. At this price level, market is in equilibrium. Quantity supplied is equal to quantity demanded ( Qs = Qd). Market is clear.

Surplus and shortage: If the market price is above the equilibrium price, quantity supplied is greater than quantity demanded, creating a surplus. Market price will fall. Example: if you are the producer, you have a lot of excess inventory that cannot sell. Will you put them on sale? It is most likely yes. Once you lower the price of your product, your products quantity demanded will rise until equilibrium is reached. Therefore, surplus drives price down. If the market price is below the equilibrium price, quantity supplied is less than quantity demanded, creating a shortage. The market is not clear. It is in shortage. Market price will rise because of this shortage. Example: if you are the producer, your product is always out of stock. Will you raise the price to make more profit? Most for-profit firms will say yes. Once you raise the price of your product, your products quantity demanded will drop until equilibrium is reached. Therefore, shortage drives price up. If a surplus exist, price must fall in order to entice additional quantity demanded and reduce quantity supplied until the surplus is eliminated. If a shortage exists, price must rise in order to entice additional supply and reduce quantity demanded until the shortage is eliminated.

If the market price (P) is higher than $6 (where Qd = Qs), for example, P=8, Qs=30, and Qd=10. Since Qs>Qd, there are excess quantity supplied in the market, the market is not clear. Market is in surplus. THE PRICE WILL DROP BECAUSE OF THIS SURPLUS.

If the market price is lower than equilibrium price, $6, for example, P=4, Qs=10, and Qd=30. Since Qs<Qd, There are excess quanitty demanded in the market. Market is not clear. Market is in shortage. THE PRICE WILL RISE DUE TO THIS SHORTAGE.

Government regulations will create surpluses and shortages in the market. When a price ceiling is set, there will be a shortage. When there is a price floor, there will be a surplus. Price Floor: is legally imposed minimum price on the market. Transactions below this price is prohibited. Policy makers set floor price above the market equilibrium price which they believed is too low. Price floors are most often placed on markets for goods that are an important source of income for the sellers, such as labor market. Price floor generate surpluses on the market. Example: minimum wage. Price Ceiling: is legally imposed maximum price on the market. Transactions above this price is prohibited. Policy makers set ceiling price below the market equilibrium price which they believed is too high. Intention of price ceiling is keeping stuff affordable for poor people. Price ceiling generates shortages on the market. Example: Rent control.

Changes in equilibrium price and quantity:

Equilibrium price and quantity are determined by the intersection of supply and demand. A change in supply, or demand, or both, will necessarily change the equilibrium price, quantity or both. It is highly unlikely that the change in supply and demand perfectly offset one another so that equilibrium remains the same. Example: This example is based on the assumption of Ceteris Paribus. 1) If there is an exporter who is willing to export oranges from Florida to Asia, he will increase the demand for Floridas oranges. An increase in demand will create a shortage, which increases the equilibrium price and equilibrium quantity. 2) If there is an importer who is willing to import oranges from Mexico to Florida, he will increase the supply for Floridas oranges. An increase in supply will create a surplus, which lowers

the equilibrium price and increase the equilibrium quantity. 3) What will happen if the exporter and importer enter the Floridas orange market at the same time? From the above analysis, we can tell that equilibrium quantity will be higher. But the import and exporters impact on price is opposite. Therefore, the change in equilibrium price cannot be determined unless more details are provided. Detail information should include the exact quantity the exporter and importer is engaged in. By comparing the quantity between importer and exporter, we can determine who has more impact on the market. In the following table, an example of demand and supply increase is illustrated.

In this graph, supply is constant, demand increases. As the new demand curve (Demand 2) has shown, the new curve is located on the right hand side of the original demand curve. The new curve intersects the original supply curve at a new point. At this point, the equilibrium price (market price) is higher, and equilibrium quantity is higher also.

In this graph, demand is constant, and supply increases. As the new supply curve (SUPPLY 2) has shown, the new curve is located on the right side of the original supply curve. The new curve intersects the original demand curve at a new point. At this point, the equilibrium price (market price) is lower, and the equilibrium quantity is higher.

In this graph, the increased demand curve and increased supply were drawn together. The new intersection point is located on the right hand side of the original intersection point. This new equilibrium point indicated an equilibrium quantity which is higher than the original equilibrium quantity. The equilibrium price is also higher. It is because demand has increased relatively more than supply in this case.