Econ 100, Spring 2014 Exercise Set 5 PART 1: ELASTICITY

Econ 100, Spring 2014 Exercise Set 5 PART 1: ELASTICITY A decrease in supply will cause the largest increase in price when a. both supply and demand are inelastic. b. both supply and demand are elastic. c. demand is elastic and supply is inelastic. d. demand is inelastic and supply is elastic. Economists compute the price elasticity of demand as the a. percentage change in price divided by the percentage change in quantity demanded. b. change in quantity demanded divided by the change in the price. c. percentage change in quantity demanded divided by the percentage change in price. d. percentage change in quantity demanded divided by the percentage change in income. Your younger sister needs $50 to buy a new bike. She has opened a lemonade stand to make the money she needs. She currently is charging 25 cents per cup, but she wants to adjust her price to earn the $50 faster. If you know that the demand for lemonade is elastic, what is your advice to her? a. Leave the price at 25 cents and be patient. b. Raise the price to increase total revenue. c. Lower the price to increase total revenue. d. There isn t enough information given to answer this question. The price elasticity of demand for water is generally estimated to be about a. -2.00 b. -1.00 c. -0.50 d. 0 ANS C Suppose that when the price of corn is $2 per bushel, farmers can sell 10 million bushels. When the price of corn is $3 per bushel, farmers can sell 8 million bushels. Which of the following statements is true? a. The demand for corn is income inelastic, and so an increase in the price of corn will increase the total revenue of corn farmers. b. The demand for corn is income elastic, and so an increase in the price of corn will increase the total revenue of corn farmers. c. The demand for corn is price inelastic, and so an increase in the price of corn will increase the total revenue of corn farmers. d. The demand for corn is price elastic, and so an increase in the price of corn will increase the total revenue of corn farmers. ANS C When the rental price of DVD movies is $4, Denise rents five per month. When the price is $3, she rents nine per month. Denise s demand for DVD rentals at P = $4 is a. elastic and her demand curve would be relatively flat. b. elastic and her demand curve would be relatively steep. c. inelastic and her demand curve would be relatively flat. d. inelastic and her demand curve would be relatively steep. ANS A

Which of the following is not a determinant of the price elasticity of demand for a good? a. the time horizon b. the steepness or flatness of the supply curve for the good c. the definition of the market for the good d. the availability of substitutes for the good Other things equal, the demand for a good tends to be more inelastic, the a. fewer the available substitutes. b. longer the time period considered. c. more the good is considered a luxury good. d. more narrowly defined is the market for the good. Suppose that the price elasticity of supply of home cleaners is 1.5. If the price of home cleaners rises 5 per cent, the quantity supplied of home cleaners will a. decline 7.5 per cent. b. rise 7.5 per cent. c. rise 1.5 per cent. d. rise 0.3 per cent. ANS B Refer to the figure on the right. In this diagram, the price elasticity of supply at point B is a. 1.5 b. 0.33 c. 0.66 d. 1.33 ANS D Refer to the figure on the right. In this diagram, the price elasticity of supply at P = 150 is a. 1.5 b. 0.33 c. 0.66 d. 3.33 ANS A The government increases the tax on petrol to raise additional tax revenue. The tax will result in the greatest amount of tax revenue if the price elasticity of demand for petrol is a. 1.8 b. 1.4 c. 1.0 d. 0.5 ANS D

Consider a competitive market for which the quantities demanded and supplied (per year) at various prices are given as follows. Assume that both demand and supply are linear. Price ($) Quantity demanded (millions) 60 22 14 80 20 16 100 18 18 120 16 20 a. Calculate the price elasticity of demand at the equilibrium price. b. Calculate the price elasticity of supply at the equilibrium price. Quantity supplied (millions) ANS The equilibrium price is $100, the equilibrium quanity is 18 mill. a) The price elasticity of demand Ed = ( Qd/Qd)/( P/P) for P = 100, Ed = {(18 16)/18}/{(100 120)/100} = 5/9 b) The price elasticity of supply is ES = ( Qs/Qs)/( P/P) for P = 100, ES = {(18 20)/18}/{(100 120)/100} = 5/9 According to econometric estimates, the income elasticity of demand for automobiles in the United States of America is between 2.5 and 3.9. If average income rises by 5 percent, what effect will this have on the quantity of autos demanded? ANS Using the expression for income elasticity of demand (EI = percentage change in quantity demanded divided by the percentage change in income), Q/Q = EI ( I/I). With 2.5 EI 3.9, and I/I = 0.05: We have (2.5)(0.05) Q/Q (3.9)(0.05), so that 12.5% %( Q/Q) 19.5%. Rank the following according to elasticity from most elastic to least elastic demand: demand for red meat, demand for food, demand for lamb chops [kuzu pirzola]. ANS (most elastic) kuzu pirzola, red meat, food (least elastic) The demand for red meat is more inelastic than the demand for lamb chops because meat is a broad commodity category that includes lamb chops. Lamb chops have good substitutes: all other red meat. The substitutes for red meat (fish, chicken) are not as close substitutes. The least elastic is food because there really are very few substitutes for food.

Refer to Figure 5-2. Starting at P = $12, if we decrease price by 1%, a. total revenue will increase and demand is elastic at P = $18. b. total revenue will increase and demand is inelastic at P = $12. c. total revenue will decrease and demand is inelastic at P = 12. d. total revenue will decrease and demand is elastic At P = $12. Refer to Figure 5-2. Sellers total revenue will increase if the price is a. increased from $4 to $6. b. increased from $16 to $18. c. decreased from $8 to $6. d. All of the above are correct. Refer to Figure 5-2. Sellers total revenue will increase if the price is a. increased from $6 to $8. b. decreased from $18 to $16. c. decreased from $16 to $15. d. All of the above are correct. PART 2: CONSUMER SURPLUS, PRODUCER SURPLUS and the MARKET EFFICIENCY Table 7-1 BUYER WILLINGNESS TO PAY MIKE $50.00 SANDY $30.00 JONATHAN $20.00 HALEY $10.00 Refer to Table 7-1. If the table represents the willingness to pay of four buyers and the price of the product is $15, then who would be willing to purchase the product? a. Mike b. Mike and Sandy c. Mike, Sandy, and Jonathan d. Mike, Sandy, Jonathan, and Haley Refer to Table 7-1. If the table represents the willingness to pay of four buyers and the price of the product is $18, then their total consumer surplus is a. $38. b. $42. c. $46. d. $72.

Refer to Table 7-1. If the table represents the willingness to pay of four buyers and the price of the product is $30, then their total consumer surplus is a. $-10. b. $-6. c. $20. d. $30. A consumer s willingness to pay directly measures a. the extent to which advertising and other external forces have influenced the consumer s decisions regarding his or her purchases of goods and services. b. the cost of a good to the buyer. c. how much a buyer values a good. d. consumer surplus. Consumer surplus is a. the amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it. b. the amount a buyer is willing to pay for a good minus the cost of producing the good. c. the amount by which the quantity supplied of a good exceeds the quantity demanded of the good. d. a buyer s willingness to pay for a good plus the price of the good. If the cost of producing sofas decreases, then consumer surplus in the sofa market will a. increase. b. decrease. c. remain constant. d. increase for some buyers and decrease for other buyers. If the price of oak lumber increases, what happens to consumer surplus in the market for oak cabinets? a. It increases. b. It decreases. c. It will not change consumer surplus; only producer surplus changes. d. It depends on what event led to the increase in the price of oak lumber. Which of the following is not true when the price of a good or service falls? a. Buyers who were already buying the good or service are better off. b. Some new buyers, who are now willing to buy, enter the market. c. The total consumer surplus in the market increases. d. The total value of purchases before and after the price change is the same.

Refer to Figure 7-1. When the price is P 1, consumer surplus is a. A. b. A + B. c. A + B + C. d. A + B + D. Refer to Figure 7-1. When the price is P 2, consumer surplus is a. A. b. B. c. A + B. d. A + B + C. Refer to Figure 7-1. When the price rises from P 1 to P 2, consumer surplus a. increases by an amount equal to A. b. decreases by an amount equal to B + C. c. increases by an amount equal to B + C. d. decreases by an amount equal to C. Refer to Figure 7-1. Area C represents a. the decrease in consumer surplus that results from a downward-sloping demand curve. b. consumer surplus to new consumers who enter the market when the price falls from P 2 to P 1. c. the increase in producer surplus when quantity sold increases from Q 2 to Q 1. d. the decrease in consumer surplus to each consumer in the market when the price increases from P 1 to P 2. Refer to Figure 7-1. When the price rises from P1 to P2, which of the following statements is not true? a. The buyers who still buy the good are worse off because they now pay more. b. Some buyers leave the market because they are not willing to buy the good at the higher price. c. Buyers place a higher value on the good after the price increase. d. Consumer surplus in the market falls. A seller is willing to sell a product only if the seller receives a price that is at least as great as a. the seller s producer surplus. b. the sellers s cost of production. c. the seller s profit. d. the average willingness to pay of buyers of the product. Producer surplus is a. measured using the demand curve for a good. b. always a negative number for sellers in a competitive market. c. the amount a seller is paid minus the cost of production. d. the opportunity cost of production minus the cost of producing goods that go unsold.

Producer surplus measures a. the benefits to sellers of participating in a market. b. the costs to sellers of participating in a market. c. the price that buyers are willing to pay for sellers output of a good or service. d. the benefit to sellers of producing a greater quantity of a good or service than buyers demand. Refer to Figure 7-4. Which area represents producer surplus when the price is P 1? a. BCE b. ACF c. ABED d. DEF Refer to Figure 7-4. Which area represents producer surplus when the price is P 2? a. BCE b. ACF c. ABED d. AFEB Refer to Figure 7-4. Which area represents the increase in producer surplus when the price rises from P 1 to P 2? a. BCE b. ACF c. ABED d. AFEB Refer to Figure 7-4. When the price rises from P 1 to P 2, which area represents the increase in producer surplus to existing producers? a. BCE b. ACF c. DEF d. ABED Refer to Figure 7-4. Which area represents the increase in producer surplus when the price rises from P 1 to P 2 due to new producers entering the market? a. BCE b. ACF c. DEF d. AFEB

Table 7-4 SELLER COST DALE $1,500 JILL $1,200 DENISE $1,000 CATHERINE $750 JACKSON $500 Refer to Table 7-4. If the market price is $1,000, the producer surplus in the market is a. $700. b. $750. c. $2,250. d. $3,700. Refer to Table 7-4. If the market price is $1,100, the combined total cost of all participating sellers is a. $3,700. b. $2,700. c. $2,250. d. $1,500. Refer to Table 7-4. If the price is $1,000, a. Denise is an eager supplier. b. Catherine is an eager supplier. c. Dale s producer surplus is $500. d. All of the above are correct. Refer to Table 7-4. If the price is $775, who would be willing to supply the product? a. Dale and Jill b. Dale, Jill and Denise c. Denise, Catherine and Jackson d. Catherine and Jackson Refer to Table 7-4. Suppose each of the five sellers can supply at most one unit of the good; then the market quantity supplied is exactly 3 if the price is a. $670. b. $770. c. $970. d. $1,170. Refer to Figure 7-10. The equilibrium (market-clearing) price is a. P1. b. P2. c. P3. d. P4.

Refer to Figure 7-10. At the equilibrium, total consumer surplus is represented by the area a. A. b. A + B + C. c. D + E + F. d. A + B + C + D + E + F. Refer to Figure 7-10. At the market-clearing equilibrium, total producer surplus is represented by the area a. F. b. F + G. c. D + E + F. d. D + E + F + G + H. Refer to Figure 7-10. At the market-clearing equilibrium, total surplus is represented by the area a. A + B + C. b. A + B + D + F. c. A + B + C + D + E + F. d. A + B + C + D + E + F + G + H. Refer to Figure 7-10. When there is a minimum price of P3, total consumer surplus is represented by the area a. A. b. A + B + C. c. D + E + F. d. A + B + C + D + E + F. Refer to Figure 7-10. When there is a minimum price of P3, total producer surplus is represented by the area a. F. b. F + G. c. D + E + F. d. F + D + B. Refer to Figure 7-10. When there is a minimum price of P3, total surplus is represented by the area a. A + B + C. b. A + B + D + F. c. A + B + C + D + E + F. d. A + B + C + D + E + F + G + H. Refer to Figure 7-9. At the equilibrium price, consumer surplus is a. $480. b. $640. c. $1,120. Refer to Figure 7-9. At the equilibrium price, producer surplus is a. $480. b. $640.

c. $1,120. Refer to Figure 7-9. At the equilibrium price, total surplus is a. $480. b. $640. c. $1,120. Refer to Figure 7-9. At the maximum price of $8, consumer surplus is a. $480. b. $640. c. $680. Refer to Figure 7-9. At the maximum price of $8, producer surplus is a. $160. b. $640. c. $1,120. Refer to Figure 7-9. At the maximum price of $8, total surplus is a. $480. b. $840. c. $1,120.