INSTITUTE OF BUSINESS MANAGEMENT

COLLEGE OF BUSINESS MANAGEMENT

ECO 401-Z Micro and Macro Economics
Assignment # 2

Date of Submission: on the day of 1st hourly exam

1. Explain each of the following statements using supply-and-demand diagrams.

a. When a cold snap hits Florida, the price of orange juice rises in supermarkets throughout
the country.
Ans. Cold weather damages the orange crop, reducing the supply of oranges. This can be seen in Figure
below as a shift to the left in the supply curve for oranges. The new equilibrium price is higher than the old
equilibrium price.

b. When the weather turns warm in New England every summer, the price of hotel rooms in
Caribbean resorts plummets.
Ans. People often travel to the Caribbean from New England to escape cold weather, so the demand for
Caribbean hotel rooms is high in the winter. In the summer, fewer people travel to the Caribbean, because
northern climes are more pleasant. The result, as shown in Figure below, is a shift to the left in the demand
curve. The equilibrium price of Caribbean hotel rooms is thus lower in the summer than in the winter, as
the figure shows.

c. When a war breaks out in the Middle East, the price of gasoline rises and the price of a
used Cadillac falls.

Ans. When a war breaks out in the Middle East, many markets are affected. Because a large proportion of
oil production takes place there, the war disrupts oil supplies, shifting the supply curve for gasoline to the
left, as shown in Figure 1. The result is a rise in the equilibrium price of gasoline. With a higher price for
gasoline, the cost of operating a gas-guzzling automobile like a Cadillac will increase. As a result, the
demand for used Cadillacs will decline, as people in the market for cars will not find Cadillacs as attractive.
In addition, some people who already own Cadillacs will try to sell them. The result is that the demand
curve for used Cadillacs shifts to the left, while the supply curve shifts to the right, as shown in Figure 2.
The result is a decline in the equilibrium price of used Cadillacs.

Figure 1

Figure 2

2. An increase in the demand for notebooks raises the quantity of notebooks demanded but
not the quantity supplied. Is this statement true or false? Explain.
Ans. The statement that "an increase in the demand for notebooks raises the quantity of notebooks
demanded, but not the quantity supplied," in general, is false. As Figure 1 shows, the increase in demand
for notebooks results in an increased quantity supplied. The only way the statement would be true is if the
supply curve was a vertical line, as shown in Figure 2.

Figure 1

Figure 2

3. Consider the market for minivans. For each of the events listed here, identify which of the
determinants of demand or supply are affected. Also indicate whether demand or supply
increases or decreases. Then draw a diagram to show the effect on the price and quantity of
minivans.
a. People decide to have more children.
Ans. If people decide to have more children, they will want larger vehicles for hauling their kids around, so
the demand for minivans will increase. Supply will not be affected. The result is a rise in both the price and
the quantity sold, as Figure below shows.

b. A strike by steelworkers raises steel prices.

Ans. If a strike by steelworkers raises steel prices, the cost of producing a minivan rises and the supply of
minivans decreases. Demand will not be affected. The result is a rise in the price of minivans and a decline
in the quantity sold.

c. Engineers develop new automated machinery for the production of minivans.

Ans. The development of new automated machinery for the production of minivans is an improvement in
technology. This reduction in firms' costs will result in an increase in supply. Demand is not affected. The
result is a decline in the price of minivans and an
increase in the quantity sold.

d. The price of sports utility vehicles rises.

Ans. The rise in the price of sport utility vehicles affects minivan demand because sport utility vehicles are
substitutes for minivans. The result is an increase in demand for minivans. Supply is not affected. The
equilibrium price and quantity of minivans both rise.

e. A stock market crash lowers peoples wealth.

Ans. The reduction in peoples' wealth caused by a stock-market crash reduces their income, leading to a
reduction in the demand for minivans, because minivans are likely a normal good. Supply is not affected.
As a result, both the equilibrium price and the quilibrium
quantity decline.

4. Consider the markets for DVDs, TV screens, and tickets at movie theaters.
a. For each pair, identify whether they are complements or substitutes:

 DVDs and TV screens

DVDs and movie tickets
TV screens and movie tickets
Ans. DVDs and TV screens are likely to be complements because you cannot watch a DVD without a
television. DVDs and movie tickets are likely to be substitutes because a movie can be watched at a
theater or at home. TV screens and movie tickets are likely to be substitutes for the same reason.
b. Suppose a technological advance reduces the cost of manufacturing TV screens. Draw a
diagram to show what happens in the market for TV screens.
Ans. The technological improvement would reduce the cost of producing a TV screen, shifting the supply
curve to the right. The demand curve would not be affected. The result is that the equilibrium price will fall,
while the equilibrium quantity will rise

c. Draw two more diagrams to show how the change in the market for TV screens affects the
markets for DVDs and movie tickets.
Ans. The reduction in the price of TV screens would lead to an increase in the demand for
DVDs because TV screens and DVDs are complements. The effect of this increase in the demand for DVDs
is an increase in both the equilibrium price and quantity

The reduction in the price of TV screens would cause a decline in the demand for movie tickets because TV
screens and movie tickets are substitute goods. The decline in the demand for movie tickets would lead to
a decline in the equilibrium price and quantity
sold.

5. Over the past 30 years, technological advances have reduced the cost of computer chips.
How do you think this has affected the market for computers? For computer software? For
typewriters?
Ans. Technological advances that reduce the cost of producing computer chips represent a decline in an
input price for producing a computer. The result is a shift to the right in the supply of computers. The
equilibrium price falls and the equilibrium quantity rises.

Because computer software is a complement to computers, the lower equilibrium price of computers
increases the demand for software. As Figure below shows, the result is a rise in both the equilibrium price
and quantity of software.

Because typewriters are substitutes for computers, the lower equilibrium price of computers reduces the
demand for typewriters. As Figure below shows, the result is a decline in both the equilibrium price and
quantity of typewriters.

6. Using supply-and-demand diagrams, show the effect of the following events on the market
for sweatshirts.
a. A hurricane in South Carolina damages the cotton crop.
Ans. When a hurricane in South Carolina damages the cotton crop, it raises input prices for producing
sweatshirts. As a result, the supply of sweatshirts shifts to the left. The new equilibrium price is higher and
the new equilibrium quantity of sweatshirts is lower.

b. The price of leather jackets falls.

Ans. A decline in the price of leather jackets leads more people to buy leather jackets, reducing the
demand for sweatshirts. The result is a decline in both the equilibrium price and quantity of sweatshirts.

c. All colleges require morning exercise in appropriate attire.

Ans. The effects of colleges requiring students to engage in morning exercise in appropriate attire raises
the demand for sweatshirts. The result is an increase in both the equilibrium price and quantity of
sweatshirts.

d. New knitting machines are invented.

Ans. The invention of new knitting machines increases the supply of sweatshirts. As Figure shows, the
result is a reduction in the equilibrium price and an increase in the equilibrium quantity of sweatshirts.

7. Ketchup is a complement (as well as a condiment) for hot dogs. If the price of hot dogs
rises, what happens to the market for ketchup? For tomatoes? For tomato juice? For orange
juice?
Ans, Ketchup is a complement for hot dogs. Therefore, when the price of hot dogs rises, the quantity
demanded of hot dogs falls and this lowers the demand for ketchup. The end result is that both the
equilibrium price and quantity of ketchup fall. Because the quantity of ketchup falls, the demand for
tomatoes by ketchup producers falls, so the equilibrium price and quantity of tomatoes fall. When the price
of tomatoes falls, producers of tomato juice face lower input prices, so the supply curve for tomato juice
shifts out, causing the price of tomato juice to fall and the quantity of tomato juice to rise. The fall in the
price of tomato juice causes people to substitute tomato juice for orange juice, so the demand for orange
juice declines, causing the price and quantity of orange juice to fall. Now you can see clearly why a rise in
the price of hot dogs leads to a fall in the price of orange juice
8. The market for pizza has the following demand and supply schedules:

a. Graph the demand and supply curves. What is the equilibrium price and quantity in this
market?
Ans. Supply and Demand curves are plotted as below. Quantity supplied equals quantity demanded at a
price of $6 and quantity of 81 pizzas. Thus equilibrium price is $6 and equilibrium quantity is 81 pizzas.
b. If the actual price in
equilibrium price, what
the equilibrium?
Ans. If the price were greater
exceed quantity demanded,
gain sales. The price would
the only price at which there

this market were above the

would drive the market toward
than $6, quantity supplied would
so suppliers would reduce the price to
continue to adjust until it reached $6,
is no surplus.

c. If the actual price in

this market were below the
equilibrium price, what
would drive the market toward
the equilibrium?
Ans. If the price were less
than $6, quantity demanded would
exceed quantity supplied, so suppliers could raise the price without losing sales. The price would continue
to adjust until it reached $6, the only price at which there no shortage.
9. Consider the following events: Scientists reveal that eating oranges decreases the risk of
diabetes, and at the same time, farmers use a new fertilizer that makes orange trees produce
more oranges. Illustrate and explain what effect these changes have on the equilibrium price
and quantity of oranges.
Ans. The news of the increased health benefits from consuming oranges will increase the demand for
oranges, increasing both the equilibrium price and quantity. If farmers use a new fertilizer that makes
orange trees more productive, the supply of oranges will increase, leading to a fall in the equilibrium price
but a rise in the equilibrium quantity. If both occur at the same time, the equilibrium quantity will
definitely rise, but the effect on equilibrium price will be ambiguous.
10. Because bagels and cream cheese are often eaten together, they are complements.
a. We observe that both the equilibrium price of cream cheese and the equilibrium quantity of
bagels have risen. What could be responsible for this patterna fall in the price of flour or a
fall in the price of milk? Illustrate and explain your answer.
Ans. Because flour is an ingredient in bagels, a decline in the price of flour would shift the supply curve for
bagels to the right. The result, would be a fall in the price of bagels and a rise in the equilibrium quantity of
bagels.

Because cream cheese is a complement to bagels, the fall in the equilibrium price of bagels increases the
demand for cream cheese. The result is a rise in both the equilibrium price and quantity of cream cheese.
So, a fall in the price of flour indeed raises both the equilibrium price of cream cheese and the equilibrium
quantity of bagels.

What happens if the price of milk falls? Because milk is an ingredient in cream cheese, the fall in the price
of milk leads to an increase in the supply of cream cheese. This leads to a decrease in the price of cream
cheese, rather than a rise in the price of cream cheese. So a fall in the price of milk could not have been
responsible for the pattern observed.

b. Suppose instead that the equilibrium price of cream cheese has risen but the equilibrium
quantity of bagels has fallen. What could be responsible for this patterna rise in the price of
flour or a rise in the price of milk? Illustrate and explain your answer.
Ans. In part (a), we found that a fall in the price of flour led to a rise in the price of cream cheese and a rise
in the equilibrium quantity of bagels. If the price of flour rose, the opposite would be true; it would lead to
a fall in the price of cream cheese and a fall in
the equilibrium quantity of bagels. Because the question says the equilibrium price of cream cheese has
risen, it could not have been caused by a rise in the price of flour.
What happens if the price of milk rises? From part (a), we found that a fall in the price of milk caused a
decline in the price of cream cheese, so a rise in the price of milk would cause a rise in the price of cream
cheese. Because bagels and cream cheese are
complements, the rise in the price of cream cheese would reduce the demand for bagels, as Figure shows.
The result is a decline in the equilibrium quantity of bagels. So a rise in the price of milk does cause both a
rise in the price of cream cheese and a decline in
the equilibrium quantity of bagels.

11. Suppose that the price of basketball tickets at your college is determined by market
forces. Currently, the demand and supply schedules are as follows:

a. Draw the demand and supply curves. What is unusual about this supply curve? Why might
this be true?
Ans. The supply and demand curve is plotted below. The supply curve is vertical. The constant quantity
supplied makes sense because the basketball arena has a fixed number of seats at any price.

b. What are the equilibrium price and quantity of tickets?

Ans. Quantity supplied equals quantity demanded at a price of $8. The equilibrium quantity is 8,000
tickets.
c. Your college plans to increase total enrollment next year by 5,000 students. The additional
students will have the following demand schedule:

Now add the old demand schedule and the demand schedule for the new students to calculate
the new demand schedule for the entire college. What will be the new equilibrium price and
quantity?
Ans. The new equilibrium price will be $12, which equates quantity demanded to quantity supplied. The equilibrium
quantity remains 8,000 tickets.

Price
$4
$8
$12
$16
$20

Quantity Demanded
14,000
11,000
8,000
5,000
2,000

Quantity Supplied
8,000
8,000
8,000
8,000
8,000

12. Suppose that business travelers and vacationers have the following demand for airline tickets from New York to
Boston:

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 method in your calculations.)
Ans. For business travelers, the price elasticity of demand when the price of tickets rises from $200 to $250 is
Elasticitybt = [(2,000 1,900)/1,950]/[(250 200)/225] = 0.05/0.22 = 0.23.
For vacationers, the price elasticity of demand when the price of tickets rises from $200 to $250 is
Elasticityvac = [(800 600)/700] / [(250 200)/225] = 0.29/0.22 = 1.32.
b. Why might vacationers have a different elasticity from business travelers?
Ans. The price elasticity of demand for vacationers is higher than the elasticity for business travelers because
vacationers can choose more easily a different mode of transportation (like driving or taking the train). Business
travelers are less likely to do so because time is more important to them and their schedules are less adaptable.
13. Suppose the price elasticity of demand for heating oil is 0.2 in the short run and 0.7 in the long run.
a. If the price of heating oil rises from $1.80 to $2.20 per gallon, what happens to the quantity of heating
oil demanded in the short run? In the long run? (Use the midpoint method in your calculations.)
Ans. The percentage change in price is equal to
price = (2.20 1.80)/2.00 = 0.2 = 20%.
If the price elasticity of demand is 0.2, quantity demanded will fall by 4% in the short run [0.20 x 0.20]. If the price
elasticity of demand is 0.7, quantity demanded will fall by 14% in the long run [0.7 x 0.2].
b. Why might this elasticity depend on the time horizon?
Ans. Over time, consumers can make adjustments to their homes by purchasing alternative heat sources such as
natural gas or electric furnaces. Thus, they can respond more easily to the change in the price of heating oil in the long
run than in the short run.
14. Cups of coffee and donuts are complements. Both have inelastic demand. A hurricane destroys half
the coffee bean crop. Use appropriately labeled diagrams to answer the following questions.
a. What happens to the price of coffee beans?
Ans. The effect on the market for coffee beans is shown in Figure. When a hurricane destroys half of the crop, the
supply of coffee beans decreases, the price of coffee beans increases, and the quantity decreases.
Price

S2
S1

Demand
Quantity
Figure 2
b. What happens to the price of a cup of coffee? What happens to total expenditure on cups of coffee?
Ans. The effect on the market for cups of coffee is shown in Figure 2. When the price of coffee beans, an important
input into the production of a cup of coffee, increases, the supply of cups of coffee decreases, the price of a cup of
coffee increases, and the quantity decreases. Because cups of coffee have an inelastic demand, when the price of a
cup of coffee increases, the total expenditure on coffee increases.
b. What happens to the price of donuts? What happens to total expenditure on donuts?
Ans. The effect on the market for donuts is shown in Figure 3. When the price of coffee increases and the quantity
demanded of coffee decreases, consumers demand fewer donuts because coffee and donuts are complements. When

demand decreases, the price of donuts decreases. Because donuts have an inelastic demand, when the price of donuts
decreases, the total expenditure on donuts decreases.

Quantity
15. Suppose that your demand schedule for DVDs is as follows:

a. Use the midpoint method to calculate your price elasticity of demand as the price of DVDs increases
from $8 to $10 if (i) your income is $10,000 and (ii) your income is $12,000.
Ans. If your income is $10,000, your price elasticity of demand as the price of DVDs rises from $8 to $10 is
Elasticityprice = [(40 32)/36]/[(10 8)/9] =0.22/0.22 = 1
If your income is $12,000, the elasticity is
Elasticityprice = [(50 45)/47.5]/[(10 8)/9] = 0.11/0.22 = 0.5.
b. Calculate your income elasticity of demand as your income increases from $10,000 to $12,000 if (i) the price is $12
and (ii) the price is $16.
Ans. If the price is $12, your income elasticity of demand as your income increases from $10,000 to $12,000 is
Elasticityincome = [(30 24)/27]/[(12,000 10,000)/11,000] = 0.22/0.18 = 1.22.
If the price is $16, your income elasticity of demand as your income increases from $10,000 to $12,000 is
Elasticityincome = [(12 8)/10]/[(12,000 10,000)/11,000] = 0.40/0.18 = 2.2.
16. Maria has decided always to spend one-third of her income on clothing.
a. What is her income elasticity of clothing demand?

Ans. If Maria always spends one-third of her income on clothing, then her income elasticity of demand is one, because maintaining
her clothing expenditures as a constant fraction of her income means the percentage change in her quantity of clothing must equal her
percentage change in income.
b. What is her price elasticity of clothing demand?
Ans. Maria's price elasticity of clothing demand is also one, because every percentage point increase in the price of
clothing would lead her to reduce her quantity purchased by the same percentage.
c. If Marias tastes change and she decides to spend only one-fourth of her income on clothing, how does
her demand curve change? What is her income elasticity and price elasticity now?
Ans. Because Maria spends a smaller proportion of her income on clothing, then for any given price, her quantity
demanded will be lower. Thus, her demand curve has shifted to the left. Because she will again spend a constant
fraction of her income on clothing, her income and price elasticities of demand remain one.
17. The New York Times reported (Feb.17, 1996) that subway ridership declined after a fare increase:
There were nearly 4 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.
Ans. If quantity demanded falls by 4.3% when price rises by 20%, the price elasticity of demand is 4.3/20 = 0.215,
which is fairly inelastic.

b. According to your estimate, what happens to the Transit Authoritys revenue when the fare rises?
Ans. Because the demand is inelastic, the Transit Authority's revenue rises when the fare rises.
c. Why might your estimate of the elasticity be unreliable?
Ans. The elasticity estimate might be unreliable because it is only the first month after the fare increase. As time goes
by, people may switch to other means of transportation in response to the price increase. So the elasticity may be
larger in the long run than it is in the short run.
18. Consider public policy aimed at smoking.
a. Studies indicate that the price elasticity of demand for cigarettes is about 0.4. If a pack of cigarettes
currently costs $2 and the government wants to reduce smoking by 20 percent, by how much should it
increase the price?
Ans. With a price elasticity of demand of 0.4, reducing the quantity demanded of cigarettes by 20% requires a 50%
increase in price, because 20/50 = 0.4. With the price of cigarettes currently $2, this would require an increase in the
price to $3.33 a pack using the midpoint method (note that ($3.33 $2)/$2.67 = .50).
b. If the government permanently increases the price of cigarettes, will the policy have a larger effect on
smoking one year from now or five years from now?
Ans. The policy will have a larger effect five years from now than it does one year from now. The elasticity is larger in
the long run, because it may take some time for people to reduce their cigarette usage. The habit of smoking is hard to
break in the short run.
c. Studies also find that teenagers have a higher price elasticity of demand than do adults. Why might
this be true?
Ans. Because teenagers do not have as much income as adults, they are likely to have a higher price elasticity of
demand. Also, adults are more likely to be addicted to cigarettes, making it more difficult to reduce their quantity
demanded in response to a higher price.
19. Lovers of classical music persuade Congress to impose a price ceiling of $40 per concert ticket. As a
result of this policy, do more or fewer people attend classical music concerts? Explain.
Ans. If the price ceiling of $40 per ticket is below the equilibrium price, then quantity demanded exceeds
quantity supplied, so there will be a shortage of tickets. The policy decreases the number of people who attend
classical music concerts, because the quantity supplied is lower because of the lower price.
20. The government has decided that the free-market price of cheese is too low.
a. Suppose the government imposes a binding price floor in the cheese market. Draw a supply-anddemand diagram to show the effect of this policy on the price of cheese and the quantity of cheese sold.
Is there a shortage or surplus of cheese?
Ans. The imposition of a binding price floor in the cheese market is shown in Figure. In the absence of the price floor,
the price would be P1 and the quantity would be Q1. With the floor set at Pf, which is greater than P1, the quantity
demanded is Q2, while quantity supplied is Q3, so there is a surplus of cheese in the amount Q3 Q2.
b. Producers of cheese complain that the price floor has reduced their total revenue. Is this possible?
Explain.
Ans. The farmers complaint that their total revenue has declined is correct if demand is elastic. With elastic demand,
the percentage decline in quantity would exceed the percentage rise in price, so total revenue would decline.

c. In response to cheese producers complaints, the government agrees to purchase all the surplus
cheese at the price floor. Compared to the basic price floor, who benefits from this new policy? Who
loses?
Ans. If the government purchases all the surplus cheese at the price floor, producers benefit and taxpayers lose.
Producers would produce quantity Q3 of cheese, and their total revenue would increase substantially. However,
consumers would buy only quantity Q2 of cheese, so they are in the same position as before. Taxpayers lose because
they would be financing the purchase of the surplus cheese through higher taxes.

21. A recent study found that the demand and supply schedules for Frisbees are as follows:

a. What are the equilibrium price and quantity of Frisbees?

Ans. The equilibrium price of Frisbees is $8 and the equilibrium quantity is six million Frisbees.
b. Frisbee manufacturers persuade the government that Frisbee production improves scientists
understanding of aerodynamics and thus is important for national security. A concerned Congress votes
to impose a price floor $2 above the equilibrium price. What is the new market price? How many Frisbees
are sold?
Ans. With a price floor of $10, the new market price is $10 because the price floor is binding. At that price, only two
million Frisbees are sold, because that is the quantity demanded.
c.Irate college students march on Washington and demand a reduction in the price of Frisbees. An even
more concerned Congress votes to repeal the price floor and impose a price ceiling $1 below the former
price floor. What is the new market price? How many Frisbees are sold?
Ans. If theres a price ceiling of $9, it has no effect, because the market equilibrium price is $8, which is below the
ceiling. So the market price is $8 and the quantity sold is six million Frisbees.