Econ 211 Problem Set 2
Answer Key
1. Computer market
a) P rises; Q falls
b) P rises; Q rises
c) P rises; Q falls
d) P falls; Q falls
e) P falls; Q ???
f) P falls; Q ???
2. Gasoline Market
a) P falls; Q rises
b) P rises; Q rises
c) P falls; Q falls
d) P rises; Q falls
e) P ???; Q rises
f) P rises; Q ???
3. Hotdog Market
a) P rises; Q rises
b) P falls; Q falls
c) P rises; Q falls
d) P falls; Q rises
e) P ???; Q rises
f) P falls; Q ???
4. Supply must have increased.
5. Supply must have decreased.
6. Supply and Demand
a) Two things are possible: either the supply curve has also shifted to
the right or the supply curve is perfectly elastic.
b) Two things are possible: either the demand curve has increased or the
demand curve is perfectly elastic.
c) The demand for rental housing will probably decrease due to the exit of
the major employers. This will then cause the equilibrium price of rental
housing to fall and the quantity to fall.
d) The demand for cotton probably fell, thus pulling down the price and
quantity of cotton.
7. Do you think the employers will simply absorb all of the economic burden
of the tax? In what ways will employees absorb some of the tax? This
question is equivalent to the cigarette tax example we did in class.
8. If, at the current "price", the quantity demanded of babies is greater
than the quantity supplied then, yes, it is a shortage. The "price" of
babies, however, is not your typical price. Babies are typically rationed
according to non-price criteria...what are they?
9. Terminology
a) Incorrect usage. This statement confuses a shift of the demand curve
with movement along one.
b) Correct usage. During a recession, incomes generally fall, thus
reducing demand.
10. Elasticity.
a) Elastic, since they expected a revenue increase stemming from the lower
fares.
b) E = [(1/3)(.75)]/400 = 0.06; caffiene can be addicting
c) Yes, the claim is consistent since elasticity is E = .4 (inelastic).
d) E = 1.4 for teens. Elasticity is likely to be smaller for older smokers
due to addiction (few available substitutes for delivering nicotine) and
the fact that older smokers are likely to have more income than teens.
e) Elastic.
f) Quantity demanded will fall by 10% (using the midpoint formula).
11. Mr Bennett is assuming that the demand for drugs is price elastic (so
that there will be a relatively large increase in consumption after the
price falls due to legalization). He also assumes that increase in
consumption will lead to similar increase in addiction.
12. Step function supply and demand curves.
a) See graph below.
b) P = $25; Q = 9;
c) CS = $60; PS = $120; Social Welfare = CS + PS = $180
d) With a price ceiling, Qd = 10 and Qs = 5; a shortage of 5 units results.
CS = $110; PS = $50; Social Welfare = $160
e) With a price floor, Qd = 4 and Qs = 9; a surplus of 5 units results.
CS = $40; PS = $100; Social Welfare = $140
13. Supply must have increased.
14. The answer to this can be found in Chapter 4.
15. The first sentence is ok: if the Drug Enforcement Agency (DEA) captures
100 tons of cocaine the supply curve will shift to the left. The first
clause of the second sentence is ok: if supply falls, then price will rise.
The second clause of the second sentence, however, is incorrect: a rise in
the price of cocaine will not shift the supply curve.
16. The price of water has gone up for two reasons: there has been an
increase in demand (due to an influx of people and bigger swimming pools)
and a decrease in supply (due to the drought). To determine which set of
analysts had described the dominant cause, you must know what happened to
the equilibrium quantity of water traded. If the increase in demand was
the dominant cause, we would expect to see more water traded on the
market. If the drought was the cause, we would expect to see less water
traded on the market. Thus, the answer depends on which curve shifted
the most.
17. The key to this question is to recognize that the amount of crime
committed by users depends on the total funds necessary to support one's
habit. The total funds necessary is equivalent to the total expenditures
made by users in the heroin market; in other words, total funds = PQ (price
times quantity). Consequently, if the government increases penalties on
heroin suppliers, the supply curve will shift to the left, the price of
heroin will increase and the equilibrium quantity of heroin will fall.
Since demand for heroin is assumed to be inelastic, the total expenditures
made on the part of heroin users will rise as price goes up. Since total
expenditures rise, the amount of crime will also rise.
18. The answer is in your notes and in Chapter 5.
19. Parkin #1 Chapter 4:
The price elasticity of demand is 1.00 at a price of $3 because this
is the midpoint of the linear demand curve. Alternatively, calculate the
midpoint elasticity between $2 and $4, which will approximate the
elasticity at $3:
[(50-100)/75]/[(4-2)/3] = 1.00
Parkin #2 Chapter 4:
The price elasticity of demand is infinity at a price of $6 and 0 at a
price of $0.
20. These definitions are in your notes and Chapter 6.
21. DWL is the reduction in social welfare (as measured by the sum of
producer and consumer surplus). DWL occurs whenever there is
underproduction or overproduction.
20.
a) Revenue will not change.
b) Revenue will decrease.
c) Revenue is maximized at either $300 or $400 [though a clever student
may note that the demand curve is linear and interpolate that, at a price
of $350 per chip, 35 million chips are sold, which yields a total revenue
of $12.25 billion.]
d) In part (c), if you answered $300, the quantity would be 40 million
chips per year; if you answered $400, the quantity would be 30 million.
e) At a price of $350, the demand is unit elastic.
f) At a price of $250, demand is inelastic.
g) The revenue is maximized when elasticity equals 1.00.
22. Floppy disk market
a) P = $1.00; Q = 3
b) CS = $2.25
c) PS = $0.75
d) Total Surplus = $3.00
23. Labor market
a) W = $4
b) Employment = 2000 hours
c) There is no unemployment.
d) The level of employment remains at 2000 because the $3 minimum wage has
no impact since it is set below the free market wage.
e) If the wage is set at $5, Qd = 1500 and Qs = 2500. Hence there is a
surplus of 1000 hours: that is, there is unemployment of 1000 hours.
f) With a minimum wage at $5, an increase in demand of 500 hours (at each
wage rate) will reduce the amount of unemployment to 500 hours.
24. Tax on brownies.
a) P = $0.60; Q = 4 million
b) A 20 cent tax will shift the supply curve up (vertically). The tax
raises the equilibrium price to $0.70 and decreases the quantity to 3
million.
c) The government collects tax revenue of $0.20 per brownie times 3
million brownies, or $600,000. Consumers pay 10 cents of the tax per
brownie, as the price paid rises from 60 cents to 70 cents. Hence, in
total, consumers pay $300,000 of the tax. Producers (also) pay 10 cents of
the tax per brownie because their net price received falls from 60 cents to
50 cents. Hence, producers pay $300,000 of the tax.
