Assignment 5

Assignment 5 – Principles of Economics

Ans 1


If the price ceiling is above the equilibrium price, the price ceiling is not binding. Market forces will naturally move the economy to the equilibrium and there will be no effect on price or quantity sold as a result of the price ceiling

If the price ceiling is below the equilibrium price, the price ceiling is binding. The quantity demanded in this case will be more than the quantity supplied. This will result in a shortage of tickets. The policy results in less number of people to attend classical music concerts.

















Ans 2

Since the price floor(Pf) is binding, it will be higher than the equilibrium price. At this floor price, the Quantity demanded(Qd) will be less than the quantity supplied(Qs). So there will be a surplus of chees(Qs-Qd) in the market.
This is possible if the price elasticity of the demand for cheese is greater than one (elastic). In this case, the percentage rise in price will be less than percentage decline in the quantity demanded. This will result in decline of total revenue.
The producers benefit from this policy because they will produce the Qs quantity and can sell that to government at the floor price to increase their total revenue. The consumers will still buy Qd amount and will neither gain nor lose. The losers will be the taxpayers because the government will buy the excess supply and will distribute that cost to the taxpayers.














Ans 3.

From the figure above, it is clear that the equilibrium price is $400 and equilibrium quantity is 300
Since the price ceiling is now 300, it is less than the equilibrium price and is binding. The new market price is $300 and at this price number of bedrooms rented will be 200





The new market price will be 450 and the number of rooms rented will be 275



Ans 4

Before tax was implemented, Pe is the price received by the suppliers; this same price was also paid by consumers. The quantity sold at this price was Qe. The difference between price paid by consumers and price received by suppliers is 0.
After tax, the price received by sellers is Ps and price paid by consumers is Pb, the quantity sold is Qt.

The difference between the price received by suppliers and price paid by consumers is Pb – Ps = 0.50.

The quantity of gasoline sold decreased to Qt



Ans 5

When the senator raised the payroll tax, the cost of hiring the workers will be more. This will result in shifting the demand curve to the left. As a result the firms will hire less workers. This will lead to unemployment which will make workers worser.


Ans 6

The price paid by consumers will rise by less than $500 if the government imposes a $500 tax on luxury cars. The burden of any tax will be shared by both producers and consumers. In this case since the demand for luxury cars is more elastic the major portion of the tax will be borne by the seller.

Ans 7

a.

It will not make a difference if the tax is imposed on producers or consumers. If the tax is imposed on producers the supply curve will shift upwards by an amount of 50 cents to S2. The equilibrium quantity becomes Q2, the price paid by consumers is P2 and price received by suppliers is P2-0.50.

If tax is imposed on consumers, the demand curve shifts by an amount of 50 cents to D2. The equilibrium quantity is again Q2 and the price paid by consumer is P2, the price received by suppliers is P2-50.


b. The tax will be more effective when the demand curve is more elastic. Greater elasticity of gasoline means that percentage decrease in quantity demanded will fall more in response to the %increase in price of gasoline. The above figure gives a clear picture of this fact. D1 is the elastic demand. In this case quantity shift is Q3-Q1 when price rises to P2. The D2 curve is less elastic and the shift in quantity is Q2-Q1 when price rises to P2.
c. The consumers of gasoline will be hurt because now they now get less gasoline at a higher price.
d. Since the quantity demanded will decrease, it will also decrease the supply of gasoline. The decrease in output may throw some workers out of job. If the price elasticity of gasoline demand is more the TR will fall which might reduce the wages of the workers.


Ans 8

The market wage is W2, Q3 people are employed, Q3-Q1 people are unemployed. The total wage payments = W2*Q3

b. An increase in the minimum wage will decrease employment.

The change in employment depends only on the elasticity of demand and not on elasticity of supply because there is a surplus in the market.

c. The increase in minimum wage will increase unemployment

The change in unemployment depends on both elasticity of demand and elasticity of supply. The elasticity of demand determines the quantity of labor demanded and the elasticity of supply determines the quantity of labor supplied. The difference between quantity supplied and quantity demanded of labor determines the total unemployment.

d. If the demand of unskilled labor were inelastic, the increase in minimum wage would raise the total wage paid to the unskilled workers. This is because since the demand is inelastic the percentage decline in employment will be less than the % rise in wage, so total wage payment will increase.

If the demand were elastic, total wage payment would decline because in that case the % decrease in employment would be more than the % increase in wage.

11.a.



The effect of the subsidy is a shift in the demand curve from D1 to D2 by 0.50 at each quantity . The effect can be seen in the figure above. The seller will now receive a price of P3 and buyer will pay a price of P2 which is equal to P3-0.50. The quantity sold before subsidy is Q1, after subsidy it will be Q2

b. Consumers are better off because they now get more icecream at the same price.
The buyers will also be better off because they will sell more at a higher price. Government is the loser who pays the amount that is subsidized.

Economics - Quiz1 Prep

Economics is the study of how society manages its scarce resources

Principles of Economic
1. Every decision involves tradeoffs



Efficiency - getting the most out of scarce resources
Equity - distributing the benefits of those resources fairly among society's members

2. The cost of something is what you give up to get something

The opportunity cost of an item is what you give up to get that item

3. Rational people think at the margin

Q. Why is water cheap while diamonds are expensive


A. Rational people think at margin. The marginal utility of diamond is more than the marginal utility of water. It does not matter much if you drink 1 unit of water or 2, but definitely an additional unit of diamond matters a lot .

4. People respond to incentives

5. Trade can make everyone better off.

6. Markets are a good way to organize economic activity

7. Governments can sometimes improve market outocmes

A market failure is a situation in which a market left on its own fails to allocate
resources efficiently

Externality : Impact of one person's action on the well being of a bystander

Public goods : Characteristics of non-excludability and non-rivalry in consumption

Market power : The ability of a single person (or small group) to unduly influence market prices

8. A country's standard of living depends on it ability to produce goods and services.

9. Prices rise when government prints too much money.

10.Society faces a short-run trade-off between inflation and unemployment

The market forces of demand and supply

Remember in the exam if nothing is mentioned, assume it is a normal good

Normal goods are those for which demand increases(decreases) when income increases(decreases)

Giffen goods do not follow law of demand , when price falls demand also falls e.g exclusive brand of liquor

Inferior goods are those where demand increases(decreases) when income decreases(increases)

Shift in the demand curve happens when non-price determinant things change


Fall in price in one good reduces the demand for another good, the two goods are substitutes.
Fall in price of one good raises the demand for another good, the two goods are compliments.

Increase in demand shifts the demand curve outwards(away from the Y-AXIS)
Decrease in demand shifts the demand curve inwards(towards the Y-AXIS)

Increase in supply shifts the supply curve outwards(towards the X-Axis)
Decrease in supply shifts the supply curve inwards(away from the X-Axis)

Q3 Page 85

a. The price of grain is kind of raw material for producing eggs. If the price of grain falls, the producers will have to bear less price to produce the eggs. So, at a given price the eggs supplied will be more, the supply curve will shift outwards reducing the equilibrium price to P2 and increasing the equilibrium quantity to Q2




b. Bacon and egg are complements. So, in this case if price of Bacon falls, demand for bacon will rise which will in turn increase the demand for eggs increasing the equilibrium price to P2 and equilibrium quantity to Q2




c. In this case the demand for egg will fall, which will shift the demand curve inwards reducing both the equilibrium price and quantity

d. In this case the supply of eggs will be reduced which will shift the supply curve inwards increasing the equivalent price and reducing the equivalent quantity.

e. The demand for egg will increase which will shift the demand curve outwards.


Elasticity and its application

Price elasticity of demand = %change in Qd/%change in P
Remember to use midpoint formula to claculate price elasticity of demand
According to this formula
e = (Q2-Q1)/[(Q2+Q1)/2]
------------------------
(P2-P1)/[(P2+P1)/2]


Determinants of Price Elasticity(very important concept)

1. Price elasticity is higher when substitutes are available
2. Price elasticity is higher for narrowly defined goods
3. Price elasticity is higher for luxuries
4. Price elasticity is higher in the long run

Rule of thumb
Flatter the curve, bigger the elasticity(memory tip: big f(l)at guy)
Steeper the curve,smaller the elasticity(memory tip, if curve is (S)teeper, elasticity is (S)maller)

e>1 - Elastic demand
e = 0 - Perfectly inelastic
e = infinity - Perfectly elastic
e= 1 - unit elastic

e= lower protion of the demand curve/upper portion of the demand curve

e= (dQ/dP)P/Q

Total revenue = P*Q
Average revenue = TR/Q = P*Q/Q = P, so AR curve is the demand curve itself
Marginal revenue = change in revenue/change in output = ΔTR/ΔQ

Remember this

1. MR is steeper than AR
2. MR is the slope of the total revenue curve
3. At maximum TR, MR is zero
4. AR and MR curve have the same vertical intercept
5. TR will increase if demand is inelastic
6. TR will decrease if demand is elastic
7. TR will remain same if demand is unitary elastic

Income elasticity = %change in Qd/%change in Income

Cross price elasticity = % change in Qd for good 1 / % change in price of good 2

Session 6

Price ceiling

• A legal maximum on the price at which a good can be sold
• Example : Rent Control

Price floor

• A legal minimum on the price at which a good can be sold
• Example : Minimum wage

Tax incidence

• the manner in which the burden of tax is shared among participants in a market

If supply is more price-elastic than demand, greater burden is borne by buyers

If demand is more price-elastic than supply, greater burden is borne by sellers

Assignment 4

1. For each of the following pairs of goods,which good you expect to have more elastic demand and why?
a) Required textbooks or mystery novels.
b) Beethoven recordings or classical music recordings in general.
c) subway rides during the next 6 months or subway rides during the next 5 years
d) root beer or water
Ans :
a) Required textbooks or mystery novels - Mystery novels will have more elastic demand because they are not necessities compared to textbooks. We cannot do away with textbooks as they are necessary to complete a particular subject. As a result textbooks will have a inelastic demand relative to the mystery novels.
b) Beethoven recordings or classical music recordings in general - Beethoven recordings are more narowly defined form of music. Narrowly defined things have more substitutes and so are more elastic in demand
c) Price elasticity is higher in the long run than in short run. It might be possible to find more substitutes for rides during the next 5 years. So subway rides during the next 5 years will be more elastic.
d) Water is a necessity and does not have a close substitute. So water will have less elastic demand compared to root beer which is not a necessity and also have more close substitutes.
2. Suppose that business travelers and vacationers have the following demand for airline tickets from New York to Boston:

style='margin-left:18.5pt;border-collapse:collapse;mso-padding-alt:0in .5pt 0in .5pt'>

Price	Quantity Demanded (Business Travelers)	Quantity Demanded (Vacationers)
150	style='mso-spacerun:yes'>           2100 tickets	style='mso-spacerun:yes'>           1000 tickets
200	2000	800
250	1900	600
300	1800	400

a) As the price of tickets rises from $200 to $250, what is the price elasticity of demand for (i) business travelers and (ii) vacationers? (Use the midpoint formula in your calculations.)
b) Why might vacationers have a different elasticity from business travelers?
Ans:
a)
i) Price elasticity for business travellers
= (Q2-Q1)/[(Q2+Q1)/2]/(P2-P1)/[(P2+P1)/2]
= [(1900-2000)/1950]/[(250-200)/225]
= -0.23
Therefore, elasticity = |-0.23| = 0.23

ii) Price elasticity for vacationers = (Q2-Q1)/[(Q2+Q1)/2]/(P2-P1)/[(P2+P1)/2]
= [(600-800)/700]/[(250-200)/225]
= -1.29
Therefore, elasticity = |-1.29| = 1.29
b) For vacationers, travel is of less necessity compared to business travellers. Vacationers have longer time horizon for travel while the business travellers have a very short time to travel. Vacationers also have several other subsitutes like travelling by car. That substitute is not appropiate for business travellers as they need to reach faster to their place of destination.
This is why vacationers will have a higher elasticity of demand for air tickets compared to the business travellers
3. Suppose the price elasticity of gasoline is 0.3 in the short run and 0.9 in the long run.
a) If the price of a gallon of gasoline falls from $2.50 to $2.25, what happens to the quantity of gasoline demanded in the short run ?In the long run ?(Use the midpoint formula in your calculations.)
b) Why might the elasticity of demand for gasoline depend on time horizon?

Ans : a) The percentage change in price = (2.25 - 2.50)/2.375 = 0.11 = 11%. The price elasticity in the short term is 0.3, so quantity demanded will rise by 0.3*.11 =33%. Since the long run elasticity is 0.9, it will rise by 0.9*0.11 = 99% in the long run.
b) Overtime people might prefer to drive their cars to work instead of car pooling, because they might see more value in that. As the gas price has decreased, driving their own car will not cost much and also they will be more independent regarding when to start or or leave from office.
4. Suppose that your demand scheduled for T shirt is as follows
style='margin-left:18.5pt;border-collapse:collapse;mso-padding-alt:0in .5pt 0in .5pt'>

Price	Quantity Demanded (Income-$12000)	Quantity Demanded (Income-$15000)
$5	style='mso-spacerun:yes'>           20 Tshirts	style='mso-spacerun:yes'>           25 Tshirts
8	16	22
11	12	19
14	8	16
17	style='mso-spacerun:yes'>                               4	13

a. Use the midpoint method to calculate your price elasticity of demand as the price of T shirts increases from $5 to $8 if (i)your income is $12000 and ii)your income is $15000.
b.Calculate your income elasticity of demand as your income rises from $12000 to $15000 if (i) the price is $14 and (ii) the price is $17
Ans : a) If your income is $12000, the price elasticity of demand when price increases from $5 to $8 is [(16-20)/18]/[(8-5)/6.5] = 0.48

If your income is $15000, the price elasticity of demand when price increases from $5 to $8 is [(22-25)/23.5]/[(8-5)/6.5] = 0.28
b)Income elasticity at price $14 = [(16-8)/12]/[(15000-12000)/13500] = 3
Income elasticity at price $17 = [(13-4)/8.5]/[(15000-12000)/13500] = 4.76

5. Maria has decided always to spend one-third of her income on clothing
a) What is her income elasticity of clothing demand ?
b) What is her price elasticity of clothing demand ?
c) If Maria's tastes change and she decides to spend only 1/4 of her income on clothing,how does her demand curve change? What is her income elasticity and price elasticity now?

Ans:
a) Her income elasticity of clothing demand will be 1. This is because since she is spending a constant fraction of her income, her percentage change in clothing demand must equal to her percentage change in income. Suppose her income is $6000 and price of clothing is $2, then she buys 1000 clothes. If her income rises by 5% it becomes 6300 and she buys 1050 clothes, a 5%increase in demand.

b)The price elasticity of her clothing demand will also be 1. An increase in the price of clothes would lead to reduce her purchase by the same percentage. Suppose the price of clothing is $2 and her income is $6000, she will buy 1000 clothes. If the price increases by 1%, she will buy 990 clothes which is a 1% reduction.

c) Since she will now spend less on clothes, for any given price she will buy less clothes. He demand curve will shift to the left . But becasue she will still spend a fixed portion of her inclome on clothing, her income and price elasticity of demand will still be 1.

6. The New York Times reported(Feb 17 1996 P 25) that subway ridership declined after a fare increase: "There were nearly four million fewer riders in December 1995, the first full month after the price of a token increased 25 cents to $1.50, than in the previous December, a 4.3 percent decline."
a. Use these data to estimate the price elasticity of demand for subway rides.
b. According to your estimate , what happens to the Transit Authority's revenue when the fare rises?
c.Why might your estimate of the elasticity be unreliable?

Ans:
a. The percentage price increase = 0.25/1.25 = 20%, The price elasticity of demand of subway rides = 4.3/20 = 0.215 which is inelastic
b. Since the demand is inelastic, the total revenue of Transit Authority will rise.
c. The elasticity is unreliable because the elasticity is calculated over a short period(only the first month after the fare increase). In the long run people might switch other means of transportation which might increase the price elasticity of demand and reduce the total revenue.

7.Two drivers - Tom and Jerry-each drive up to a gas station .Before looking at the price ,each places an order.Tom says ."I'd like 10 gallons of gas."Jerry says ,"I'd like $10 worth of gas." what is each driver's price elasticity of demand?

Ans: The price elasticity of Tom's demand is zero because his quantity of demand always remains the same irrespective of the price.

The price elasticity of Jerry's demand is 1 because he spends the same amount of money on gas irrespective of the price.which means his percentage change in quantity is equal to the percentage change on price.

8.Consider public policy aimed at smoking.
a.Studies indicate that the price elasticity of demand for cigarretes is about 0.4. If a pack of cigarretes currently costs $2 and the government wants to reduce smoking by 20 percent, by how much should it increase the price.

b.If the governement permanently increases the price of cigarrettes, will the policy have a larger effect on smoking 1 year from now or 5 years from now?

c. Studies also find that teenagers have a higher price elasticity than do adults. Why might this be true?

Ans: a) Pice elasticity = %change in quantity demanded/%change in price. Since the price elasticity = 0.4, to reduce the quantity demanded to 20% will require a 50% increase in price(0.4 = 20/%change in price, %change in price = 20/0.4 = 50). Using the midpoint method, the new price should be as below

X2-2/(X2+2)/2 = 0.50.

So, X2(new price) should be $3.33.

9. You are the curator of a museum. The museum is running short of funds,so you decide to increase revenue.Should you increase or decrease the price of admission? Explain.

Ans : This depends on the price elasticity of demand
If the demand for visiting meuseums is inelastic, the price should be increased
If the demand for visiting meuseums is elastic, the price should be decreased

10.Corn has a elastic demand and gasoline has an inelastic demand. Suppose that the government places a tax on each product that lowers the supply of each product by half (that is ,the quantity supplied at each price is 50 percent of what it was)
a. What happens to the equilibrium price and quantity in each market?
b. Which product experiences a larger change in price?
c. Which product experiences a larger change in quantity?
d. What happens to total consumer spending on each product?

Ans:
a. The decrease in supply will raise the equivalent price but reduce the equivalent quantity in both the markets. But the increase in equivalent price will be more in the market of gasoline which has an inelastic demand. The decrease in equivalent quantity will be more in the market of corn which is elastic in nature.
b. The market of gasoline will experience a larger change in price.
c. The market of corn will experience a greater change in quantity
d.In the market of gasoline the %increase in price will be more than the % decrease in quantity demanded. So, the total consumer spending will increase in this market.

In the market of corn the %increase in price will be less than the %decrease in quantity demanded. So, the total consumer spending will decrease in this market.

11. Beachfront resorts have an inelastic supply,and automobiles have an elastic supply. Suppose that a rise in population doubles the demand for both products (that is, the quantity demanded at each price is twice what it was).
a. What happens to the equilibrium price and quantity in each market ?
b. Which product experiences a larger change in price ?
c. Which product experiences a larger change in quantity ?
d. What happens to total consumer spending on each product ?

Ans:
a. The increase in demand will increase both equilibrium price and quantity
b. In the beachfront resorts market which is a inelastic supply, the increase in demand leads to a relativley large increase in price and less increase in quantity.
c. In the automobile market which is a elastic supply, the increase in demand leads to a relativley large increase in quantity and less increase in price.
d. Since both equilibrium price and quantity increase the consumer spending will increase.in both markets.

12. Several years ago,flooding along the Missouri and Mississippi rivers destroyed thousands of acres wheat.
a. Farmers whose crops were destroyed by the floods were much worse off, but farmers whose crops were not destroyed benefited from the floods. Why?
b. What information would you need about the market for wheat to assess whether farmers as a group were hurt or helped by the floods?

Ans :
a. Destruction of some of the crops reduced the supply which increased the eqilibrium price. This is the reason why farmers whose crops were not destroyed benefitted.
b. We need to know the price elasticity of demand for wheat .

13. Explain why the following might be true : A drought around the world raises the total revenue that farmers receive from the sale of grain, but a drofht only in Kansas reduces the total revenue that Kansas farmers receive.

Ans : World wide market is a broader market and people will not have much substitute for grain if we consider the world market as a result the demand will be inelastic. Due to the drought supply will reduce and it will increase the price. Since the demand is inelastic in this case total revenue will increase if the price is raised.

Kansas market is a subset of the world market and is narrowly defined. People will have options other than the Kansas market to buy the grains. So, in the case the price elasticity of demand will be elastic. Due to the drought supply will reduce, price will increase but since the price elasticity of demand is inelastic total revenue will fall in this case.

Session 5

Examples of:

Elastic :

Δ Q > Δ P

Inelastic:
Δ Q < Δ P

Unit elastic:
Δ Q = Δ P

Perfectly inelastic -
Δ Q = 0
e.g; competitive market eg a potato market where everyone knows the proce of each other's potato.

Perfectly elastic

Note:

1.When slope is constant, elasticity varies from 0 to α
2.As you raise price,elasticity also increases
3.e = Lower part of the curve/upper part of the curve
4.Revenue is a seller concept

Total revenue(TR) = Price x Quantity - It is the price paid by buyers and received by sellers of a good

Average revenue (AR) = TR/Q = PxQ/Q = P - It is the total revenue divided by the number of units sold. AR curve is the demand curve itself.

Marginal revenue(MR) = ΔTR/ΔQ - It is the extra revenue that the seller gets by offering an extra unit for sale.

Note:

1. MR is steeper than AR
2. MR is the slope of the total revenue curve
3. At maximum TR, MR is zero
4. AR and MR curve have the same vertical intercept
5. TR will increase if demand is inelastic
6. TR will decrease if demand is elastic
7. TR will remain same if demand is unitary elastic