Chapter 2: Answers to Questions and Problems

1. a. Since X is a normal good, an increase in income will lead to an increase in the demand for X (the demand curve for X will shift to the right). b. Since Y is an inferior good, a decrease in income will lead to an increase in the demand for good Y (the demand curve for Y will shift to the right). c. Since goods X and Y are substitutes, a decrease in the price of good Y will lead to a decrease in the demand for good X (the demand curve for X will shift to the left). d. No. The term inferior good! does not mean inferior "ualit#,! it simpl# means that income and consumption are inversel# related. $. a. The suppl# of good X will decrease (shift to the left). b. The suppl# of good X will decrease. %ore specificall#, the suppl# curve will shift verticall# up b# e&actl# '1 at each level of output. c. The suppl# of good X will decrease. %ore specificall#, the suppl# curve will rotate counter(cloc)wise. d. The suppl# curve for good X will increase (shift to the right). *. a. Qxs = +, + ,.+ ( +,, ) + ( *, ) = +,
s x

b. Notice that although , negative output is impossible. Thus, "uantit# supplied is .ero. c. To find the suppl# function, insert Pz = *, into the suppl# e"uation to obtain Qxs = +, + ,.+Px + ( *, ) = $,, + ,.+Px
Q = $,, + ,.+Px
s x

units. Q = +, + ,.+ ( +, ) + ( *, ) = 1-+

. Thus, the suppl# e"uation is

. To obtain the inverse suppl# e"uation, simpl# solve this P = /,, + $Qx s e"uation for Px to obtain x . The inverse suppl# function is graphed in 0igure $(1.

Price of X $1,600.0 $1,400.0 $1,200.0 $1,000.0 $800.0 $600.0 $400.0 $200.0 $0.0 0 100 200 300 400

500 Quantity of X

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Figure 2-1 /. a. 1ood Y is a substitute for X, while good 2 is a complement for X. b. X is a normal good. 1 1 1 d Qx = 1,$,, ( '/,31, ) + ( '+,3,,) 4( '3,) + ( '++,,,,) = +,,,, $ / 1, c. d. 0or the given income and prices of other goods, the demand function for good X 1 1 1 d Qx = 1, $,, Px + ( '+, 3,, ) 4 ( '3, ) + ( '++, ,,, ) , $ / 1, is which simplifies to . To find the inverse demand e"uation, solve for price to P = 1/, 31, $Qx d . obtain x The demand function is graphed in 0igure $($.
d Qx = -, /++ ,.+Px

Price of X $14,910 $11,928 $8,946 $5,964 $2,982 $0 0 1000 2000 3000 4000 5000 6000 7000 8000 Quantity of X Deman

Figure 2-2 +. a. Solve the demand function for Px to obtain the following inverse demand 1 Px = 11+ Qx d / function5 .

Q d = /6, / ( *+) = *$, b. Notice that when Px = '*+ , x units. 7lso, from part a, we )now the vertical intercept of the inverse demand e"uation is 11+. Thus, consumer ( .+) ( '11+ '*+) *$, = '1$,4,, ). surplus is '1$,4,, (computed as c. 8hen price decreases to '$+, "uantit# demanded increases to *6, units, so consumer surplus increases to '16,$,, (computed as ( .+) ( '11+ '$+) *6, = '16, $,, ). d. So long as the law of demand holds, a decrease in price leads to an increase in consumer surplus, and vice versa. 9n general, there is an inverse relationship between the price of a product and consumer surplus. 6. Page 2 Michael R. a!e

a. :"uating "uantit# supplied and "uantit# demanded #ields the e"uation 1 +, P = P 1, $ . Solving for P #ields the e"uilibrium price of '/, per unit. ;lugging this into the demand e"uation #ields the e"uilibrium "uanit# of 1, units Q d = +, ( /, ) = 1, (since "uantit# demanded at the e"uilibrium price is ). b. 7 price floor of '/$ is effective since it is above the e"uilibrium price of '/,. 7s a d result, "uantit# demanded will fall to 4 units Q = +, /$ = 4 , while "uantit#

amounting to 11 4 = * units. c. 7 price ceiling of '*, per unit is effective since it is below the e"uilibrium price of '/, per unit. 7s a result, "uantit# demand will increase to $, units Q d = +, *, = $, , while "uantit# supplied will decrease to + units

s 1 Q = ( /$ ) 1, = 11 $ . That is, firms produce supplied will increase to 11 units 11 units but consumers are willing and able to purchase onl# 4 units. Therefore, at d s a price floor of '/$, 4 units will be e&changed. Since Q < Q there is a surplus

s 1 Q = ( *, ) 1, = + $ . That is, while firms are willing to produce onl# + units consumers want to bu# $, units at the ceiling price. Therefore, at the price ceiling d s of '*,, onl# + units will available to purchase. Since Q > Q , there is a shortage

amounting to $, + = 1+ units. Since onl# + units are available at a price of '*,, the full economic price is the price such that "uantit# demanded e"uals the + F available units5 + = +, P . Solving #ields the full economic price of '/+. -.

d s a. The shortage is * units (since at a price of '6, Q Q = / 1 = * units). The full economic price is '1$. s d b. The surplus is 1.+ units (since at a price of '1$, Q Q = $.+ 1 = 1.+ units. The

cost to the government is '14 (computed as ('1$)(1.+) < '14).

1 c. The e&cise ta& shifts suppl# verticall# b# '6. Thus, the new suppl# curve is S and the e"uilibrium price increases to '1$. The price paid b# consumers is '1$ per unit, while the amount received b# producers is this '1$ minus the per unit ta&. Thus, producers receive '6 per unit. 7fter the ta&, the e"uilibrium "uantit# sold is 1 unit. .+ ( '1/ '1, ) $ = '/ d. 7t the e"uilibrium price of '1,, consumer surplus is . .+ ( '1, '$ ) $ = '4 ;roducer surplus is . e. No. 7t a price of '$ no output is produced.

4.

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1 1 1 Px = Px $ / $. a. :"uate "uantit# demanded and "uantit# supplied to obtain Solve this e"uation for Px to obtain the e"uilibrium price of Px = 1, . The e"uilibrium "uantit# is $ units (since at the e"uilibrium price "uantit# demanded 1 Q d = - ( 1, ) = $ $ is ). The e"uilibrium is shown in 0igure $(*. -

Price of X $20 $18 $16 $14 $12 $10 $8 $6 $4 $2 $0 0 1 2 3 4

Su!!"y

Deman 5 6 Quantity of X

Figure 2-" b. 7 '6 e&cise ta& shifts the suppl# curve up b# the amount of the ta&. %athematicall#, this means that the intercept of the inverse suppl# function S increases b# '6. =efore the ta&, the inverse suppl# function is P = $ + /Q . 7fter
s the ta& the inverse suppl# function is P = 4 + /Q , and the after ta& suppl# 1 Qs = P $ s Q / function (obtained b# solving for in terms of ;) is given b# . :"uating "uantit# demanded to after(ta& "uantit# supplied #ields 1 1 - P = P$ $ / . Solving for ; #ields the new e"uilibrium price of '1$. ;lugging this into the demand e"uation #ields the new e"uilibrium "uantit#, which is 1 unit. c. Since onl# one unit is sold after the ta& and the ta& rate is '6 per unit, total ta& revenue is onl# '6.

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7 technological brea)through that reduces production costs will lead to a rightward shift in the suppl# curve for >7% chips, resulting in a lower e"uilibrium price of >7% chips. 9f in addition, income increases, the demand for >7% chips will also increase since the# are a normal good. This increase in demand would tend to increase the price of >7% chips. The ultimate effect of both of these changes in suppl# and demand on the e"uilibrium price of >7% chips is indeterminate. ?epending on the relative magnitude of the increase in suppl# and demand, the price #ou will pa# for chips ma# rise or fall. The tariff reduces the suppl# of raw sugar, resulting in a higher e"uilibrium price of sugar. Since sugar is an input in ma)ing generic soft drin)s, this increase in input prices will decrease the suppl# of generic soft drin)s (putting upward pressure on the price of generic soft drin)s and tend to reduce "uantit#). @o)e and ;epsiAs advertising campaign will decrease the demand for generic soft drin)s (putting downward pressure on the price of generic soft drin)s and further reducing the "uantit#). 0or these reasons, the e"uilibrium "uantit# of generic soft drin)s sold will decrease. Bowever, the e"uilibrium price ma# rise or fall, depending on the relative magnitude of the shifts in demand and suppl#. No. this confuses a change in demand with a change in "uantit# demanded. Bigher cigarette prices will not reduce (shift to the left) the demand for cigarettes. To find the e"uilibrium price and "uantit#, e"uate "uantit# demanded and "uantit# supplied to obtain 1-+ P = $ P $,, . Solving #ields the new e"uilibrium price of d '1$+ per pint. The e"uilibrium "uantit# is +, units (since Q = 1-+ 1$+ = +, units 1 ( '1-+ '1$+) +, = '1,$+, at that price). @onsumer surplus is $ . ;roducer surplus is 1 ( '1$+ '1,,) +, = '6$+ $ . See 0igure $(/.

1,.

11. 1$.

Price

$200.0 $175.0 $150.0 $125.0 $100.0 $75.0 $50.0 $25.0 $0.0 0 10 20 30 40 50 60 Quantity Producer Surplus $625 Supply Demand Consumer Surplus $1!250

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Figure 2-# 1*. This decline represents a leftward shift in the suppl# curve for oil, and will result in an increase in the e"uilibrium price of crude oil. Since oil is an input in producing gasoline, this will decrease the suppl# of gasoline, resulting in a higher e"uilibrium price of gasoline and a lower e"uilibrium "uantit#. 0urthermore, the higher price of gasoline will increase the demand for substitutes, such as small cars. The e"uilibrium price of small cars is li)el# to increase, as is the e"uilibrium "uantit# of small cars. :"uating the initial "uantit# demanded and "uantit# supplied gives the e"uation5 $+, +P = / P 11, . Solving for price, we see that the initial e"uilibrium price is '/, per month. 8hen the ta& rate is reduced, e"uilibrium is determined b# the following e"uation5 $+, +P = /.1-1P 11, . Solving, we see that the new e"uilibrium price is about '*3.$+ per month. 9n other words, a t#pical subscriber would save about -+ cents (the difference between '/,.,, and '*3.$+). ?r# beans and rice are probabl# inferior goods. 9f so, an increase in income shifts demand for these goods to the left, resulting in a lower e"uilibrium price. Therefore, 1.>. ?r# 0oods will li)el# have to sell its products at a lower price. 0igure $(+ illustrates the relevant situation. The e"uilibrium price is '$.-+, but the ceiling price is ',.-+. Notice that, given the shortage of 1$ million transactions caused b# the ceiling price of ',.-+, the average consumer spends an e&tra 1$ minutes traveling to another 7T% machine. Since the opportunit# cost of time is '$, per hour, the non(pecuniar# price of an 7T% transaction is '/ (the '$, per hour wage times the fractional hour, 1$C6,, spent searching for another machine). Thus, the full economic price under the price ceiling is '/.-+ per transaction.

1/.

1+.

16.

(&$ )ee

Su!!"y

$4.75

$2.75 $0.75 S,orta+e - 12 $i""ion 4 16 Quantity #$i""ion% of &ran%action%'

*ei"in+ Price Deman

Figure 2-$

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The unusuall# cold temperatures have caused a decrease in the suppl# of grapes used to produce @hilean wine, resulting in higher prices. These grapes are an input in ma)ing wine, so the suppl# of @hilean wine decreases and its price increases. Since @alifornia and @hilean wines are substitutes, an increase in the price of @hilean wine will increase the demand for @alifornian wines causing an increase in both the price and "uantit# of @alifornian wines.

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