Problem Set 3. I. Problem 1. Explain each of the following statements using supply-and-demand diagrams.

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1 Problem Set 3 I. Problem 1. Explain each of the following statements using supply-and-demand diagrams. a) When the weather turns warm in New England every summer, the price of hotel rooms in Caribbean resorts plummets. Solution. b) When a war breaks out in the Middle East, the price of gasoline rises, and the price of a used Cadillac falls. Solution. 1

2 The price of gasoline rises because war negatively affects its supply. As the price of gasoline rises, the demand for used Cadillac s will decline and the demand for used Cadillacs will shift to the left. In addition, people who already own Cadillacs, will try to sell them and supply of Cadillacs will shift to the right. Overall, the price of Cadillacs will drop. Problem 2. 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 Solution: False. Problem 3. Consider the markets for DVD movies, TV screens, and tickets at movie theaters. a. For each pair, identify whether they are complements or substitutes: DVDs and TV screens Solution. complements DVDs and movie tickets Solution. substitutes TV screens and movie tickets Solution. substitutes b. Suppose a technological advance reduces the cost of manufacturing TV screens. Draw a diagram to show what happens in the market for TV screens. Solution. 2

3 c. Draw two more diagrams to show how the change in the market for TV screens affects the markets for DVDs and movie tickets. Solution. Problem 5. The market for pizza has the following demand and schedules a. Graph the demand and supply curves. What is the equilibrium price and quantity in this market? Solution. The equilibrium price is 6$ at which the quantity supplied equals to quantity demanded. 3

4 b. If the actual price in this market were above the equilibrium price, what would drive the market toward the equilibrium? Solution. If the price were above the equilibrium one, there would be a surplus in the market and firms would drop prices. c. If the actual price in this market were below the equilibrium price, what would drive the market toward the equilibrium? Solution. There would be a shortage and suppliers would increase the price. I. Multiple Choice Questions 1. In a market economy, supply and demand determine a. both the quantity of each good produced and the price at which it is sold. b. the quantity of each good produced but not the price at which it is sold. c. the price at which each good is sold but not the quantity of each good produced. d. neither the quantity of each good produced nor the price at which it is sold. Answer: a 2. In a competitive market, the quantity of a product produced and the price of the product are determined by a. a single buyer. b. a single seller. c. one buyer and one seller working together. d. all buyers and all sellers. 3. Assume Leo buys coffee beans in a competitive market. It follows that a. Leo has a limited number of sellers from which to buy coffee beans. b. Leo will negotiate with sellers whenever he buys coffee beans. 4

5 c. Leo can influence the price of coffee beans if he buys a large quantity of them. d. None of the above is correct. 4. Which of the following is not a reason perfect competition is a useful simplification, despite the diversity of market types we find in the world? a. Perfectly competitive markets are the easiest to analyze because everyone participating in the market takes the price as given by market conditions. b. Some degree of competition is present in most markets. c. There are many buyers and many sellers in all types of markets. d. Many of the lessons that we learn by studying supply and demand under perfect competition apply in more complicated markets as well. 5. A movement upward and to the left along a demand curve is called a(n) a. increase in demand. b. decrease in demand. c. decrease in quantity demanded. d. increase in quantity demanded. 6. A decrease in the price of a good will a. increase demand. b. decrease demand. c. increase quantity demanded. d. decrease quantity demanded. 7. The following table contains a demand schedule for a good. Price Demanded $ $20 Q1 If the law of demand applies to this good, then Q1 could be a. 0. b c d

6 Answer: a Figure 1 8. Refer to Figure 4-2. Suppose Phil and Miss Kay are the only consumers in the market. If the price is $6, then the market quantity demanded is a. 4 units. b. 6 units. c. 8 units. d. 12 units. 9. Which of the following would shift the demand curve for gasoline to the right? a. a decrease in the price of gasoline b. an increase in consumer income, assuming gasoline is a normal good c. an increase in the price of cars, a complement for gasoline d. a decrease in the expected future price of gasoline Answer: b 10. Suppose you like to make, from scratch, pies filled with banana cream and vanilla pudding. You notice that the price of bananas has increased. As a result, your demand for vanilla pudding would a. decrease. b. increase. c. be unaffected. d. There is insufficient information given to answer the question. Answer: a 11. Which of the following might cause the demand curve for an inferior good to shift to the left? 6

7 a. a decrease in income b. an increase in the price of a substitute c. an increase in the price of a complement d. None of the above is correct. 12. Elena loves orange juice. She reads in the newspaper that 20 percent of the Florida orange crop was destroyed by a late spring frost. Economists predict that the price of oranges will rise by 50 percent by the end of the year. As a result, Elena s demand for orange juice a. will increase but not until the end of the year. b. increases today. c. decreases as she looks for a substitute good. d. shifts left today. Answer: b Table 1 Firm X s Price Supplied Firm Y s Supplied $ $ $ $ $ $ Firm Z s Supplied 13. Refer to Table 1. If these are the only three sellers in the market, then the market quantity supplied at a price of $6 is a. 6 units. b. 12 units. c. 18 units. d. 24 units. 14. Which of the following might cause the supply curve for an inferior good to shift to the right? a. an increase in input prices b. a decrease in consumer income c. an improvement in production technology that makes production of the good more profitable d. a decrease in the number of sellers in the market 7

8 15. What would happen to the equilibrium price and quantity of lattés if coffee shops began using a machine that reduced the amount of labor necessary to produce them? a. Both the equilibrium price and quantity would increase. b. Both the equilibrium price and quantity would decrease. c. The equilibrium price would increase, and the equilibrium quantity would decrease. d. The equilibrium price would decrease, and the equilibrium quantity would increase. 16. Which of the following events would unambiguously cause an increase in the equilibrium price of cotton shirts? a. an increase in the price of wool shirts and a decrease in the price of raw cotton b. a decrease in the price of wool shirts and a decrease in the price of raw cotton c. an increase in the price of wool shirts and an increase in the price of raw cotton d. a decrease in the price of wool shirts and an increase in the price of raw cotton II. Table 2 Demanded (units) Price ($) Supplied (units) 1. Consider Table 2. What is the equilibrium price in this market? What is the equilibrium quantity in this market? At a price of $2, will there be a surplus or shortage of units in this market? If the supply curve shifts to the right, will the price in this market rise or fall? Answer: Equilibrium price=4$. At price 2 there is a shortage=40-15=25 units. If the supply curve shifts to the right, the market price will fall. 8