EC 201 Student Name:

Cal Poly Pomona Class Meeting Time:

Spring, 2007

Dr. Bresnock

Homework Assignment 4 Answers (25 points)

Complete each statement or answer the question in the spaces provided.

(1)The price elasticity of demand for a new car model called Sputter is estimated to be equal to -.40. This means that a 1% increase in Sputter's price will result in a % .40 decrease (increase/decrease) in the number of Sputters demanded. Demand is therefore inelastic (elastic/unit elastic/inelastic). If the manufacturer wishes to raise total sales revenue from its Sputter model, it should raise (raise/lower) the price of the car.

(2)The quantity of Good A increases by 10% when Good B's price increases by 15%. The cross-price elasticity of demand is .66 . These two goods must therefore be substitutes (substitutes/complements/independent). Give an example of two goods of this type: the two goods are alternatives – consumer is indifferent between them, i.e. butter and margarine, Fiji and Aquafina water, etc.

(3)When Maria's income falls from $50,000 to $30,000, she increases purchases of Good A from 50 units a year to 100 units a year. The income elasticity of demand is therefore equal to -1.33 . For Maria, Good A is inferior (normal/neutral/inferior) because: Maria buys more of Good A as her income decreases and vice versa

(4)If the price is $50, 20 units are sold while at a price of $40, 25 units are sold, then the elasticity of demand for this good is -1.00 or unit elastic (elastic/unit elastic/inelastic) and a decrease in price will result in no change(increase/no change/decrease) in total revenue

(5)Consider the two goods – water and diamonds. Indicate what the likely elasticity case will be: elastic/greater than 1 (‌‌‌ |EP>1| ); unit elastic/equal to 1 ( |EP=1| ), inelastic/less than 1 ( |EP<1| ), or zero ( |EP=0| ):

(a)Price elasticity of demand for water: 1 or inelastic

(b)Price elasticity of demand for diamonds: 1 or elastic

(c)Income elasticity of demand for water: 0

(d)Income elasticity of demand for diamonds: 1 or elastic

(e)Cross price elasticity of demand between water and diamonds: 0

(f)Diamonds are most likely to be considered normal (normal/neutral/inferior) goods; water is most likely to be considered neutral (normal/ neutral/inferior); and water and diamonds would be unrelated (substitutes/complements/unrelated) goods

Now consider the market for pizza. Suppose that the market demand for pizza is given by the equation P = 40 – 4QD, and the market supply for pizza is given by the equation P = 10 + 2QS, where QD = quantity demanded, QS = quantity supplied, P = price consumers pay (per pizza) and the price producers receive (per pizza).

(1)Graph the supply and demand schedules for pizza and indicate the equilibrium price and quantity. (Your answer must contain your complete algebraic solution). Calculate the consumer surplus and producer surplus and identify these areas in the graph below.(Be sure to label the axes and functions, and number your intercepts.)

P

40 S

CS

PE = $20

PS 10 D

0 QE = 5 10 Q

Equilibrium Price: $20 Equilibrium Quantity: 5

(Show your complete algebraic solution for the equilibrium price and quantity in the space below.)

In Equilibrium: S = D

40 – 4Q = 10 + 2Q

30 = 6Q

5 = QE

PE = 40 – 4 (5) = $20 for demand and PE = 10 + 2 (5) = $20 for supply

Consumer Surplus at Equilibrium: $50 (Show all work.)

CS = ½ (20 x 5) = $50

Producer Surplus at Equilibrium: $25 (Show all work.)

PS = ½ (10 X 5) = $25

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