Problem Set 4

Econ 202 (03, 04, and 05) Spring 2003

(Dr. Tin-Chun Lin)
1.

In the graph shown, which of the demand curve is most elastic at point A?

D1
D2
D3
Q

2.

(A) D1.
(B) D2.
(C) D3.
(D) All of the demand curves shown are equally elastic at point A.
(Answer: (A))
In the graph shown above, a given increase in price would result in the largest increase in total revenue
on which demand curve?
(A) D1.
(B) D2.
(C) D3.
(D) It is impossible to answer the question with the information given.
(Answer: (C))

3.

(True or False) When the price elasticity of demand is less than 1, a decrease in price will increase total
revenue.
(Answer: False)

4.

(True or False) A linear demand curve becomes more elastic as price falls.

(Answer: False)

5. (True or False) If the price of a normal good increases, consumers total expense must increase.
(Answer: False)
6. (True or False) Both price ceilings and price floors are normally accompanied by shortages.
(Answer: False)
7.

(True or False) The elasticity of demand will be constant at all points along a down-ward sloping
straight-line demand curve.
(Answer: False)

8.

When policymakers use price ceilings or price floors,

(A) They are able to make everyone in the market better off.
(B) They obscure the signals that normally guide the allocation of societys resources.
(C) They improve the efficiency of resource allocation in society.
(D) All of the above.
(E) None of the above.
(Answer: (B))
Which of the following is the most correct statement about price controls?
(A)
Price controls never help those they are designed to help.
(B)
Price controls always help those they are designed to help.
(C)
Price controls always hurt those they are designed to help.
(D)
Price controls often hurt those they are designed to help.
(Answer:
(D))

9.

10 Workers with high skills and much experience are not affected by the minimum wage because,
(A) They belong to unions.
(B) They are not legally guaranteed the minimum wage.
(C) They generally earn wages less than the minimum wage.
(D) Their equilibrium wages are well above the minimum wage.
(Answer: (D))
11. Which of the following is not a result of an increase in the minimum wage?
(A) An increase in production.
(B) An increase in the number of teenagers unemployed.
(C) An increase in the number of teenagers who chose to look for jobs.
(D) An increase in the dropout rate from school.
(Answer: (A))
12. (True or False) Other factors held constant, if there are few close substitutes for a good, demand is
more elastic for it.
(Answer: False)
13. The following are the demand and supply schedules for chocolate brownies:
Price
Quantity demanded
Quantity supplied
(cents per brownie)
(millions per day)
(millions per day)
90
1
7
80
2
6
70
3
5
60
4
4
50
5
3
40
6
2
a. If there is no tax on brownies, what is their price and how many are produced and consumed?
(Answer: the equilibrium price is 60 cents per brownie, and the equilibrium quantity is 4 million.)
b. If a tax of 20 cents per brownie is introduced, what happens to the price of a brownie and the
number produced and consumed? (Answer: the tax raises the equilibrium price of brownies to 70
cents per brownie and lowers the quantity to 3 million.)
c. How much tax does the government collect and who pays it? (Answer: the government collects
$600,000 in tax revenue; consumers pay $300,000 of the tax in total; producers pay $300,000 of
the tax in total.)
14. Suppose that a 5 percent sales tax is levied on all goods and services.
a. Will this cause total spending on every good and service to increase? (Answer: only the demand is
inelastic (i.e. elasticity is less than 1 but larger than zero))
b. Will all prices rise by 5 percent as a result of tax? (Answer: when the demand is perfectly inelastic
(i.e. elasticity is equal to zero) or the supply is perfectly is perfectly elastic (i.e. elasticity equals
infinity.)
c. Is it possible that the burden of the tax be shared equally by all buyers and all sellers of every good
and services? (Answer: yes.)
15. 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. Use a supply-anddemand 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? (Answer: you can do it by yourself).
b. Farmers complain that the price floor has reduced their total revenue. Is this possible? Explain.
(Answer: 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. In response to farmer complaints, the government 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?
(Answer: producers benefit; taxpayers lose. Taxpayers lose because they would be financing the
purchase of the surplus cheese.)
16. If the government places a $500 tax on luxury cars, will the price paid by consumers rise by more than
$500, less than $500, or exactly $500? Explain. (Answer: If the government imposes a $500 tax on
luxury cars, the price paid by consumers will rise less than $500, in general. The burden of any tax is
shared by both producers and consumersthe price paid by consumers rises and the price received by
producers falls, with the difference between the two equal to the amount of the tax. The only exception

would be if the supply curve were perfectly elastic, in which case consumers would bear the full
burden of the tax and the price paid by consumers would rise by exactly $500.

ELASTICITY
Practice Problems -- Answer Key
Multiple choice questions.
1.The price elasticity of demand is:
a) the ratio of the percentage change in quantity demanded to the percentage change
in price.
b) the responsiveness of revenue to a change in quantity.
c) the ratio of the change in quantity demanded divided by the change in price.
d) the response of revenue to a change in price.
2.If demand is price elastic, then:
a) a rise in price will raise total revenue.
b) a fall in price will raise total revenue.
c) a fall in price will lower the quantity demanded.
d) a rise in price won't have any effect on total revenues.
3. Complementary goods have:
a) the same elasticities of demand.
b) very low price elasticities of demand.
c) negative cross price elasticities of demand with respect to each other.
d) positive income elasticities of demand.
4. The price elasticity of demand generally tends to be:
a) smaller in the long run than in the short run.
b) smaller in the short run than in the long run.
c) larger in the short run than in the long run.
d) unrelated to the length of time.
5. If the price elasticity of supply of doodads is 0.60 and the price increases by 3 percent,
then the quantity supplied of doodads will rise by
a) 0.60 percent.
b) 0.20 percent
c) 1.8 percent
d) 18 percent.
6. Suppose we know that the price elasticity of demand of good X is equal to -1.2. Then,
if its price will increase by 5%, we can predict with certainty that
a) quantity demanded of that good will increase.
b) the revenue of the firm producing that good will increase by 6%.
c) the revenue of the firm producing that good will decrease by 6%.
d) the quantity demanded of that good will decrease by 6%.
e) None of the above.

7. A 10% increase in the price of movie ticket in Westridge 8 leads to a 15% decrease in
the number of tickets sold, indicating the demand for movie ticket in Westridge 8 is:
a) elastic.
b) inelastic.
c) unit elastic.
d) Can not tell from the information given.
8. If the cross-price elasticity between two commodities is 1.5,
a) the two goods are luxury goods.
b) the two goods are complements.
c) the two goods are substitutes.
d) the two goods are normal goods.
True/False/Uncertain.
For each of the following statements, say whether it is true, false, or uncertain and
explain your answer.
1. It is reasonable to expect the cross price elasticity of demand for golf clubs and golf
balls to be positive.
Golf clubs and golf balls are complementary goods. This means that, as the price of golf
clubs increases (a positive change), the consumption of golf balls decreases (a negative
change). Cross price elasticity of demand is equal to the ratio of these changes and will
be negative. The statement is false.
2. If the demand is perfectly elastic, then a shift in the supply curve does not affect the
equilibrium price.

True, because a perfectly elastic demand

curve is horizontal. Therefore, no matter
what the shift is the equilibrium price will
always remain the same. (See graph.)

3. The demand curve for autos is more elastic than the demand curve for Fords.
False. A Ford can be substituted by a different model. It is not as easy to find a substitute
for a car in general. The more substitutes a good has, the more elastic is the demand for
that good. Therefore, demand for Fords is more elastic.
4. Suppose you own a "Here Comes the Sun" tanning salon and the demand curve for
your services is downward sloping. Further, suppose that a new tanning salon called

"Sunny Delight" opens two blocks away from your salon. Tell whether the following
three statements are true, false or uncertain and explain your answer.
a. The demand curve for your services shifts to the right.
This new salon is a substitute for your services. After it has appeared, your consumers
have more choice, and some of them will start using the new salon. So the demand for
your services will decrease, or shift to the left.
The statement is false.
b. The demand for your services becomes more elastic.
One of the factors determining the price elasticity of demand for the good is the number
of substitutes. More substitutes - more elastic demand.
The statement is true.
c. The cross-price elasticity of the demand for your services with respect to the price
charged by "Sunny Delight" is negative.
These two goods (services) are substitutes. The cross-price elasticity of substitutes is
positive, since as the price of one of them increases, the demand for (and therefore the
consumption of) the other one increases, too.
The statement is false.
Short Answer Question.
5. Initially Hans Johnson was the only consumer in the market for "Casa de Econ" beer,
produced by a small local brewery. When the price of "Casa de Econ" six-pack varies
between $10 and $20, the price elasticity of his individual demand is equal to negative 1.
Now imagine that Hans has been cloned 4 times, and now we have 5 identical consumers
in the market for "Casa de Econ". What will happen to the price elasticity of market
demand in the price range given above? Will the demand become more price elastic, less
price elastic, or will elasticity stay the same? Explain your answer.
Since elasticity deals with relative changes, it doesn't matter how many consumers we
have in the market as long as all of them are same. (If the quantity demanded for each of
them changes by 50%, that would mean the quantity demanded in the entire market will
change by 50%, too.) So the price elasticity of demand will stay the same.

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