CHAPTER 2

THE BASICS OF SUPPLY AND DEMAND

MICROECONOMICS, 8 TH EDITION
ROBERT S. PINDYCK AND DANIEL RUBENFELD

Demand and Supply

Questions

1. Define demand. Define supply

2. List non price factors that influence demand and
supply
3. In defining demand and supply, why do you think
economists focus on price while holding constant
other factors that might have an impact on the
behavior of buyers and sellers?
4. The law of demand and the law of supply
5. Movement along the demand and the supply
6. Shift the demand curve and supply curve
7. What is the market equilibrium and restriction of
market equilibrium?
8. Define consumer surplus
9. Define producer surplus
10.
Government controlled prices
What is the price ceilings?
What is the price floors?

Elasticity

1. Explain what an elasticity of demand represents and how it is

measured
2. Identify what factors determine whether demand is elastic or
inelastic
3. Factors affecting the own price elasticity of demand
4. Relation of elasticity and total revenue
5. Perfectly elastic demand
6. Perfectly inelastic of demand
7. Explain the meaning of cross price elasticity of demand
8. Explain the meaning of income elasticity of demand
9. Explain the meaning elasticity of supply
10.
Understand the distinction between arc elasticity and
point elasticity
Short Problems for elasticity.
1. (a) Would you expect the price elasticity of demand to be higher for
Chevrolet automobiles or for
automobiles in general ? Why ? (b)
Would you expect the price elasticity of demand for electricity for
resindential use to be higher or lower than for industrial use ? Why ? (c)
Would you expect the price elasticity of demand for electricity to be higher
or lower in the short run
as compared with the long run ? Why ?

2. Agricultural commodities are known to have a price inelastic demand

and to be necessities. How can this information allow us to explain why
the income of farmers falls (a) after a good harvest ? (b) In relation to the
incomes in other sectors of the economy ?

3. . Suppose that the cross-price elasticity of demand between McIntosh and

Golden Delicious apples is 0,8, between apples and apple juice is 0,5,
between apples and cheese is 0,4, and between apples and beer is 0,1.
What can you say about the relationship between each set of commodities
?

4. .A researcher estimated that the price elasticity of demand for automobiles

in the United States is 1.2, while the income elasticity of demand is 3.0.
Next year, U.S. automakers intend to increase the average price of
automobiles by 5 percent, and they expect consumers; disposable
income to rise by 3 percent. (a) If sales domestically produced
automobiles are 8 million this
year, how many automobiles do you
expect U.S. automakers to sell next year ? (b). By how
much should

domestic automakers increase the price of automobiles if they wish to

increase sales by 5 percent next year ?

5. The management of the Mini Mill Steel Company estimated the following
elasticities for a special type of steel : Ep = - 2, EI= 1, and Exy = 1,5,
where X refers to steel and Y to aluminum. Next year, the firm would like
to increase the price of the steel it sells by 6 percent. The management
forecasted that income will rise by 4 percent next year and that the price of
aluminum will fall by 2 percent. (a) If the sales this year are 1,200 tons of
the steel, how
many tons can the firm expect to sell next year ? (b)
By what percentage must the firm change the price of steel to keep its
sales at 1,200 tons next year ?

6. Suppose the own price elasticity of demand for good X is - 2, its income
elasticity is 3, its advertising elasticity is 4, and its cross price elasticity
of demand between it and good Y is 6. Determine how much the
consumption of this good will change if:
a. The price of good X increases by 5%
b. The price of good Y increases by 10%
c. Advertising decreases by 2 %
d. Income falls by 3%
7. The ACME Corporation determines that at current prices, the demand for its
computer chips has a price elasticity of - 2 in the short run. The price elasticity
of its disc drivers is 1.
a). If ACME decides to raise the price of both
products by 10%, what will happen to its sales? To its sales revenue? b) Can
you tell from the above information which product will generate more
revenue? If yes, which one?
8.

Integrating Problem
The research depertment of the Corn Flakes Corporation (CFC) estimated
the following regression for the demand of the cornflakes it sells :
Qx = 1.0 2.0 Px + 1.5I + 0.8Py 3.0 Pm + 1.0A
Where Qx = sales of CFC cornflakes, in millions of 1- ounce boxes per

year
Px = the price of CFC cornflakes, in dollars per 10 ounce box
I = personal disposable income, in trillions of dollars per year
Py = price of competitive brand of cornflakes, in dollars per 10
ounce box
Pm = price of milk, in dollars per quart
A = advertising expenditures of CFC cornflakes, in hundreds of
thousands of
dollars per year

This year, Px = $2, I=$4, Py = $2,50, Pm= $1, and A =$2. (a) Calculate the sales
of CFC cornflakes this year; (b) calculate the elasticity of sales with respect to
each variable in the demand function; (c) estimate the level of sales next year if
CFC reduces Px by 10 percent, increase advertising by 20 percent, I rises by 5
percent, Py is reduced by 10 percent, and Pm remains unchanged. (d) By how
much should CFC change its advertising if it wants its sales to be 30 percent
higher than this year ?

Questions for review - chapter2 (Pindyck)

1. Suppose that unusually hot weather causes the demand
curve for ice cream to shift to the right. Why will the price
of ice cream rise to a new market-clearing level?
2. If a 3-percent increase in the price of corn flakes causes a 6percent decline in the quantity demanded, what is the
elasticity of demand?
3. Explain the difference between a shift in the supply curve
and a movement along the supply curve.
4. Why do long-run elasticities of demand differ from short-run
elasticities? Consider two goods: paper towels and
televisions. Which is a durable good? Would you expect
the price elasticity of demand for paper towels to be larger
in the short run or in the long run? Why? What about the
price elasticity of demand for televisions?
5. Suppose the demand curve for a product is given by Q = 10
2P + PS, where P is the price of the product and P S is the
price of a substitute good. The price of the substitute good
is $2.00.
Suppose P = $1.00. What is the price elasticity of
demand?
What is the cross-price elasticity of
demand?
Suppose the price of the good, P, goes to $2.00. Now
what is the price elasticity of demand? What is the
cross-price elasticity of demand?
Exercises

1.

Refer to Example 2.5 (page 38) on the market for wheat. In

1998, the total demand for U.S. wheat was Q = 3244 283P
and the domestic supply was QS = 1944 + 207P. At the end
of 1998, both Brazil and Indonesia opened their wheat
markets to U.S. farmers. Suppose that these new markets
add 200 million bushels to U.S. wheat demand. What will be
the free-market price of wheat and what quantity will be
produced and sold by U.S. farmers?

2. Much of the demand for U.S. agricultural output has come

from other countries. In 1998, the total demand for wheat was
Q = 3244 283P. Of this, total domestic demand was QD =
1700 107P, and domestic supply was QS = 1944 + 207P.
Suppose the export demand for wheat falls by 40 percent.
a. U.S. farmers are concerned about this drop in export
demand. What happens to the free-market price of wheat in
the United States? Do the farmers have much reason to
worry?
b. Now suppose the U.S. government wants to buy enough
wheat to raise the price to $3.50 per bushel. With the drop
in export demand, how much wheat would the government
have to buy? How much would this cost the government?
3. In 1998, Americans smoked 470 billion cigarettes, or 23.5
billion packs of cigarettes. The average retail price was $2 per
pack. Statistical studies have shown that the price elasticity of
demand is 0.4, and the price elasticity of supply is 0.5. Using
this information, derive linear demand and supply curves for
the cigarette market.