ANSWERS:
1. A
Ø If something has an inelastic demand, then it will be relatively unresponsive to price changes. Quantity demanded will still be affected (unless it’s perfectly inelastic), but it won’t change by too much.
2. C
Ø Use the total revenue test to solve this problem. Since a small increase in the price caused total revenue to decrease, we know that quantity demanded must have decreased by a large amount. Therefore, demand was elastic since it was relatively responsive to the price change. TR = P x Q. ¯ TR = P x Q¯ (Elastic Demand).
3. D
Ø An increase in demand is a represented by a rightward shift of the demand curve. Thus, equilibrium price and quantity will rise.
4. B
Ø Minimum wage laws are an example of price floors. They set a minimum that employers must pay their employees. In order for a price floor to be effective, it must be set above the market equilibrium price. Since this in the case, quantity supplied (# of laborers) > quantity demanded (# of laborers employers are willing to hire at that wage).
5. E
Ø The short run is a time in which quantity supplied can be adjusted by manipulating the existing plant capacity. Building new factories or plants is the main thing that you can’t do in the short run.
6. C
Ø A negative income elasticity of demand represents an inferior good. An income elasticity between 0 and 1 represents a normal good. And, an income elasticity greater than 1 represents a superior good.
7. A
Ø Opportunity cost is a notion that represents a trade-off. Opportunity cost implies that resources are scarce and to do or have more of one thing, you must give up something else.
8. E
Ø An economy will achieve a faster rate of growth if they choose to produce more capital goods than consumer goods. The reason for this is simply that the production of capital goods will lead to improvements in technology allowing us to be more productive and expand our production possibilities frontier.
9. E
Ø Remember that our production possibilities curve is constructed under the assumptions that resources and technology are fixed. If there is a change in either of these things, the curve will shift inward or outward depending on the direction of the change. Since resources and technology are fixed, they don’t change when you move along the curve.
10. C
Ø Since gas and tires are complements, an increase in the price of gas will cause the demand for tires to decrease. Thus, the demand curve for tires will shift to the left.
11. C
Ø An outward shift in the production possibilities curve can only occur if there is a change in one of our assumptions. Remember, the curve is constructed assuming resources and technology are fixed. Thus, an increase in capital equipment (technology) would cause the curve to shift outward.
12. C
Ø Rent controls are an example of a price ceiling. An effective price ceiling is set below market equilibrium. Thus, when rent controls are lifted, the price and number of units supplied will increase and the number of units demanded will decrease.
13. A
Ø The law of diminishing marginal utility states that consumers eventually reach a point where each successive unit of a good or service brings less and less satisfaction. And, in the end, you’ll experience negative returns signaling that your desire for that particular good has been satisfied.
14. B
Ø For this problem, calculate the total revenue and apply the total revenue test. At $4 per ticket, 200 people would buy tickets, therefore the total revenue = $4 x 200 = $800. At $2 per ticket, 400 people would buy tickets, therefore the total revenue = $2 x 400 = $800. Since the change in total revenue = 0, the demand for tickets is unit elastic.
15. A
Ø Even though the lawyer can type faster than the typist, his time for practicing law is more valuable. It would cost the lawyer $1000 ($500 x 2) in lost wages to do her own typing, whereas it would only cost her $400 ($40 x 10) to hire the student to do her typing. Therefore, it makes sense to hire the typist.
16.
Ø Income elasticity of demand = % D QD / % D Income
Ø Price elasticity of demand = % D QD / % D Price
17.
Ø Full Employment – All available resources are being employed.
Ø Full Production – All employed resources are providing maximum satisfaction. This implies that we are achieving allocative and productive efficiency. Allocative efficiency consists of producing the goods and services “most wanted” by society and productive efficiency entails producing in the least costly manner.
18.
Ø Price Floor – Minimum price a producer can sell his or her goods or services. It’s only effective if set above the market equilibrium.
Ø Price Ceiling – Maximum price a producer can sell his or her goods or services. It’s only effective if set below the market equilibrium.
Ø Price floors and price ceilings are both price controls that distort market behavior!
19.
Ø D QD is simply a movement along the demand curve in response to a price change.
Ø D D is a shift of the entire demand curve in response to a change in one of the non-price determinants of demand.
20.
Ø Tastes and preferences.
Ø Number of buyers.
Ø Price of related goods in consumption (substitutes and complements).
Ø Income (normal and inferior goods).
Ø Consumer expectations.
21.
Ø Price of resources.
Ø Number of sellers.
Ø Price of related goods in production (substitutes and complements)
Ø Taxes and subsidies.
Ø Technology.
Ø Producer expectations.
22.
Ø Midpoint Formula = (D QD / Average QD) / (D P / Average P) = [(200-400) / 300] / [5 / 12.5] = 1.66
Ø Always remember to take the absolute value of the coefficient of elasticity of demand.
23.
Ø Over time, supply becomes more elastic because there is time to build a new plant or hire better qualified workers to adjust the level of production.
Sample Written Response Question:
A) Newly invented farm equipment will cause supply to increase (the entire curve will shift to the right).
1. Since supply is inelastic and increases, the market price of wheat will decrease by a relatively large %.
2. Since supply is inelastic and increases, the industry output of wheat will decrease by a relatively small %.
3. The revenue of wheat farmers will decrease (total revenue test). We assumed that the supply and demand curves are price inelastic, thus the % ¯ Price > % Quantity Demanded. Therefore, total revenue will ¯.
B) Announcement that wheat reduces the risk of heart attacks will cause demand to increase (curve shifts to the right).
1. The market price of wheat will increase.
2. The industry output of wheat will also increase.
C) An effective price floor for wheat will be set above the market equilibrium price.
1. The market price of wheat will increase to the price set by the price floor.
2. The consumer surplus will decrease. Consumer surplus is the difference between the demand curve and the market price over all units sold.
3. The industry output of wheat will increase thereby creating a surplus of wheat!
Sample Supply & Demand Question:
1. The stock market crash causes incomes to decrease. Thus, the demand for PCs will also decrease. The
entire demand curve will shift to the left.
2. As the price of glass used in making computer monitors decreases, the supply of computer will
increase since the price of input resources has decreased. Thus, the entire supply curve will shift to
the right.
CONCLUSION:
Ø The price of computers will fall, but the quantity sold is indeterminate since we don’t know the size of these shifts!