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Chapter 4 Working with Supply and Demand
CHAPTER 4
WORKING WITH SUPPLY AND DEMAND
ANSWERS TO EVEN-NUMBERED ONLINE REVIEW QUESTIONS
2.a.
Q0 is initial quantity demanded
Q1 is new quantity demanded
P0 is the initial price
P1 is the new price
b.By taking an average of new and old (i.e., the midpoint between the new and old values), we get the same value for elasticity whether we’re moving up or down along any given segment of a demand curve.
c.A price elasticity of 0.4 means that, for every 1% change in price, quantity demanded declines by 0.4%. Equivalently, a 10% price increase should lead to a 4% decline in quantity demanded, assuming the elasticity remains at around 0.4 over the entire range being examined.
4.Examples of goods with almost perfectly inelastic demand include such things as insulin to a diabetic (an absolute necessity for a patient with that condition, and a drug for which virtually no substitutes are available). Very broadly defined necessities, like housing or food, would also have near-perfectly inelastic demand over some range of prices.
Very narrowly defined products, or goods for which close or exact substitutes exist, are candidates for perfectly elastic demand curves. A particular farmer’s wheat, for example, is usually indistinguishable from wheat grown on another farm. Many raw materials share this characteristic. For example, the demand for a particular producer’s crude oil (of a particular grade) is likely to be very elastic—oil is oil, and one producer’s is as good as another’s.
6.Short-run elasticities are generally smaller (in absolute value) than long-run elasticities because, over a longer time horizon, consumers have greater ability to adjust their behavior and find substitutes for a good.
8.a.Canned spaghetti: inferior good—as incomes rise people could afford ingredients for homemade spaghetti.
b.Vacuum cleaners: normal good. (Most individual households would have an income elasticity of zero—they would buy just one vacuum cleaner once their income reaches a certain level, and then buy no more as income rises. However, classifying goods as normal or inferior depends on market income elasticities. As average income in a market rises, more households will decide to own vacuum cleaners or to replace old ones, so we expect a positive income elasticity.)
c.Used books: inferior good—as incomes rise people buy new books instead.
d.Computer software: normal good—as incomes rise people tend to buy more computer software programs.
10.a.Negative; high. These two goods are clearly complements. A rise in the price of one should lead to a significant decline in quantity demanded of the other.
b.Positive; low to moderate. In fact, antibiotics are used to treat infections, while decongestants are used to treat symptoms of viral infections (colds, flu). But much of the public erroneously believes that antibiotics—which require a doctor’s prescription in the United States—can help cure the flu. Therefore, a rise in the price of antibiotics might make people less likely to visit the doctor when they have the flu, and more likely to buy over-the-counter decongestants.
- Negative; low to moderate. The relationship between gasoline and auto repairs is derived from the relation between gas and cars, and cars and auto repairs. An increase in gas prices could be expected to reduce demand for cars (or at least certain kinds of cars), which would, in turn, reduce demand for auto repairs.
12.If supply is perfectly elastic and demand is perfectly inelastic, the burden of an excise tax would fall completely on buyers. If the situation were reversed, the burden would fall completely on sellers.
EVEN-NUMBERED PROBLEM SET
2.a.There is excess demand equal to 250 units (600 – 350).
b.Only 350 apartments will be rented.
c.Since the price ceiling is non-binding, the market will move to equilibrium, where 400 apartments will be rented. There will be neither excess supply nor excess demand.
4. In order for the $60 per unit tax to be divided equally between buyers and sellers, the price paid by buyers would have to be $30 higher than it was originally and the after-tax price received by sellers would have to be $30 lower. That is, the new price paid by consumers would have to be $300 + $30 = $330 and the price received by sellers would have to be $300 - 30 = $270. From the diagram, however, it’s clear that at $330 per ticket, consumers would want to purchase more than 7.5 million tickets per year while at $270 per ticket (after taxes), sellers would want to offer fewer than 7.5 million tickets. Therefore, with an equal split of the tax, the market could not be in equilibrium.
6. When an (effective) price ceiling is imposed, quantity demanded exceeds quantity supplied at that ceiling price. To prevent black-market activity, the government would have to somehow make up for the shortage. It could do this by obtaining the needed units (housing units, in the case of rent control) and selling them at the ceiling price
Opinions may vary, but this seems a very inefficient way of enforcing the ceiling. The government would find that the cost of producing the extra units is more than the revenue they would generate.
8. In Chapter 4, we learned that about 25 percent of the world’s oil is produced in the Persian Gulf. If half the Gulf’s capacity was wiped out, that would amount to a 12.5 percent drop in production. In the long run, with a long-run demand elasticity of 0.4, the price would have to rise by 12.5/0.4 = 31.25 percent. From an initial price of $60 per barrel, the price would rise by 0.3125 x 60 = $18.75per barrel to a new price of $78.75/barrel.
10.a.It is not a straight line demand curve since quantity demanded does not fall by the same amountsfollowing repeated price rises by a fixed amount.
- Demand is elastic for this price change.
c.Demand is elastic for this price change.
d.There must be good substitutes available for rosebushes from a particular nursery (either other types of plants or rosebushes from that nursery’s competitors), given that over this range of prices, it is unlikely that rosebushes make up a significant share of a household’s budget.
12.a.More elastic.
b.Quantity demanded will fall by 2,190 bottles. To find this answer, first use the mid-point rule to calculate that the price of Pepsi increased by 10.5%. Then, substitute this value and the value of the price elasticity of demand into the equation for price elasticity of demand, and solve for the change in quantity demanded:
2.08 = x 10.5%
x = 21.9%.
Finally, multiply the initial number of bottles of Pepsi demanded by this price elasticity of demand to find the change in quantity demanded:
Change in quantity demanded = 21.9% × 10,000 = 2,190
c.The price of ground beef will have to increase by 4.9%. Find this by substituting what is known into the equation for price elasticity of demand and solving for x:
1.02 = 5% x
x = 4.9%
MORE CHALLENGING QUESTION
14.Either the supply of PCs in Europe is perfectly inelastic, or the demand for PCs in Europe is perfectly elastic. Neither of these statements is likely to be true, or even close to true.