Mankiw-PrinciplesofMicroeconomics:Questions&Answers PDF

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Microeconomics- Principles and Applications Chapter 4 – The Market Forces of Supply and Demand Q1. 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.” - See Figure A - W...

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Microeconomics- Principles and Applications

Chapter 4 – The Market Forces of Supply and Demand Q1. 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.” - See Figure A - When a cold snap hits Florida, it will damage the orange crop, leading to a decline in the supply of oranges, shown by a shift to the left of the supply curve of orange juice. This will result in a higher equilibrium price, and a lower equilibrium quantity. b. “When the weather turns warm in New England every summer, the price of hotel rooms in Caribbean resorts plummets.” - See Figure A - When the weather is warm in New England every summer, the demand for hotel rooms in the Caribbean will decline as fewer people want to escape New England for good weather. This fall in demand is shown by a shift to the left of the demand curve for hotel rooms, and results in a lower equilibrium price, and a lower equilibrium quantity. c. “When a war breaks out in the Middle East, the price of gasoline rises, and the price of a used Cadillac falls.” - See Figure A - When a war breaks out in the Middle East, several markets are affects. As a large proportion of oil production takes place there, the supply of gasoline falls, shown by a shift to the left of the supply curve. This leads to an increase in equilibrium price and decline of equilibrium quantity of gasoline. - As a result of a higher price for gasoline, the cost of running a used Cadillac will increase. This will lead to a decline in the demand for used Cadillacs as they will be less attractive, and more people will try to sell them. This will lead to a shift to the left of the demand curve and a shift to the right of the supply curve, and will result in a lower equilibrium price. Q2. “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. - See Figure A - This statement is in general false. As shown in Figure A, due to an increase in the demand for notebooks, the supplier will also raise the quantity of notebooks supplied. The could only be true if the supply curve was a vertical line, with a constant supply. Q4. 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 - Complements - DVDs and movie tickets - Substitutes - TV screens and movie tickets – Substitutes 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. - See Figure A - Due to technological developments, the cost of manufacturing TV screens falls. This leads to an increase in the supply of TV screens, shown by a shift to the right in the supply curve. This then leads to a decline in equilibrium price, and an increase in equilibrium quantity of TV screens.

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Microeconomics- Principles and Applications

c. Draw two more diagrams to show how the change in the market for TV screens affects the markets for DVDs and movie tickets. - See Figure A - As TV screens and movie tickets are substitutes, a decline in the price of TV screens leads to a fall in the demand for movie tickets, shown by a shift to the left of the demand curve. This leads to a decline in equilibrium price and equilibrium quantity of movie tickets. Q5. 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? - See Figure B - As computer chips have reduced in price, the input costs to produce computers will fall. This will lead computers to fall in price, and an increased demand for computers, shown by a shift to the right of the demand curve. This increased demand will lead to an increase in equilibrium price and equilibrium quantity of computers. - As computer software and computers are complementary goods, a decline in price of computers will lead to an increased demand for computer software, shown by a shift to the right of the demand curve. This increased demand will lead to an increase in equilibrium price and equilibrium quantity of computer software. - As computers and typewriters are substitute goods, a decline in price of computers will lead to a decrease in demand for computers, shown by a shift to the left of the demand curve. This decreased demand will lead to a decline in equilibrium price and equilibrium quantity of typewriters. Q6. 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. - See Figure B - When a hurricane in South Carolina damages the cotton crop, it will raise the input prices for making sweatshirts. Therefore, the supply of sweatshirts shifts to the left. The new equilibrium price is higher, and the new equilibrium quantity is lower. b. The price of leather jackets falls. - See Figure B - As leather jackets and sweatshirts can be substitute goods, when the price of leather jackets fall it leads more people to buy leather jackets. Therefore, fewer people will buy sweatshirts, and there will be a fall in demand with the demand curve shifting to the left. The new equilibrium price and equilibrium quantity will be lower. c. All colleges require morning exercise in appropriate attire. - See Figure B - Colleges requiring morning exercise in appropriate attire will increase the demand for sweatshirts, shifting it to the right. The new equilibrium price and equilibrium quantity will be higher. d. New knitting machines are invented. - See Figure B - The invention of new knitting machines will increase the supply of sweatshirts due to the technological development. This will lead to a decrease in the new equilibrium price and an increase in the equilibrium quantity.

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Microeconomics- Principles and Applications

Q13. Suppose that the price of basketball tickets at your college is determined by market forces. Currently, the demand and supply schedules are as follows: Price Quantity Demanded Quantity Supplied $4 10,000 tickets 8,000 tickets 8 8,000 8,000 12 6,000 8,000 16 4,000 8,000 20 2,000 8,000 a. Draw the demand and supply curves. What is unusual about this supply curve? Why might this be true? - See Figure B - The supply curve is unusual because it is vertical and it doesn’t increase with increased demand. The constant supply supplied does make sense, because in the basketball arena there will be a fixed number of seats. b. What are the equilibrium price and quantity of tickets? - The equilibrium price is $8. The equilibrium quantity is 8,000. c. Your college plans to increase total enrollment next year by 5,000 students. The additional students will have the following demand schedule: Price Quantity Demanded $4 4,000 tickets 8 3,000 12 2,000 16 1,000 20 0 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? - See Figure B - The new equilibrium price is $12. The new equilibrium quantity is 8,000.

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Microeconomics- Principles and Applications

Chapter 5 – Elasticity Q1. For each of the following pairs of goods, which good would you expect to have more elastic demand and why? a. required textbooks or mystery novels - Mystery novels. - I would expect mystery novels to have a more elastic demand than required textbooks because mystery novels would generally be perceived as luxuries, whereas required textbooks would be perceived as necessities as therefore more inelastic. Whether the good is a necessity or luxury depends on the preferences of the buyer. b. Beethoven recordings or classical music recordings in general - Beethoven recordings. - I would expect Beethoven recordings to have a more elastic demand than classical music recordings in general because Beethoven recordings is a more narrowly defined market than classical music recordings. It is easier to find close substitutes for narrowly defined categories such as Beethoven recordings, whereas it’s less easy to find a substitute for classical music recordings in general. c. Subway rides during the next six months or subway rides during the next five years - Subway rides during the next five years. - I would expect subway rides during the next five years to be more elastic because goods tend to have more elastic demand over longer time horizons. d. Root beer or water - Root beer. - I would expect root beer to be more elastic than water because goods with a close substitute such as root beer tend to have more elastic demand because it is easier for consumers to switch from that good to others. This however is not the case with water. In addition, water is a necessity, whereas root beer is more of a luxury, which again has more elastic demand. Q5. The equilibrium price of coffee mugs rose sharply last month, but the equilibrium quantity was the same as ever. Three people tried to explain the situation. Which explanations could be right? Explain your logic. Billy: Demand increased, but supply was totally inelastic. Marian: Supply increased, but so did demand. Valerie: Supply decreased, but demand was totally inelastic. - Billy: Demand increased, but supply was totally inelastic. - This explanation could be right because when the supply is perfectly inelastic, an increase in demand will increase the price keeping the quantity constant. The equilibrium point will then shift up. This leads to an increased price. Q7. You have the following information about good X and good Y:  Income elasticity of demand for good X: –3  Cross-price elasticity of demand for good X with respect to the price of good Y: 2 Would an increase in income and a decrease in the price of good Y unambiguously decrease the demand for good X? Why or why not? - Yes, an increase in income and a decrease in the price of good Y will decrease the demand for good X. - This is because a decrease in the price of good Y will lead to a decrease in the quantity demanded of good X. This is due to the cross-price elasticity of demand being positive meaning that the goods are substitutes, and typically used in place of

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one another. As the price of one good decreases, the quantity demanded of the other good also decreases. Also as there is an increase in income, and the income elasticity of demand for good X is negative. This means that an increase in income leads to a lower quantity of good X demanded.

Q13. Pharmaceutical drugs have an inelastic demand, and computers have an elastic demand. Suppose that technological advance doubles the supply of both products (that is, the quantity supplied at each price is twice what it was). a. What happens to the equilibrium price and quantity in each market? - See Figure C - In both markets, the increase in supply of both products will reduce the equilibrium price and increase the equilibrium quantity. The equilibrium price reduction will be greater in the pharmaceutical drugs market (inelastic demand) and the equilibrium quantity increase will be greater in the computers market (elastic demand). b. Which product experiences a larger change in price? - In the pharmaceutical drugs market with inelastic demand, the increase in supply of products leads to a larger decline in equilibrium price, and a smaller increase in equilibrium quantity. c. Which product experiences a larger change in quantity? - In the computers market with elastic demand, the increase in supply of products leads to a larger increase in equilibrium quantity and a smaller decline in equilibrium price. d. What happens to total consumer spending on each product? - In the pharmaceutical drugs market, the demand is inelastic, therefore the percentage increase in quantity will be lower than the percentage decrease in price; therefore, total consumer spending will decline. - In the computers market, the demand is elastic, therefore the percentage increase in quantity will be greater than the percentage decrease in price; therefore, total consumer spending will increase. Q14. Several years ago, flooding along the Missouri and the Mississippi rivers destroyed thousands of acres of 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? - See Figure C - A decrease in the supply of wheat will lead to an increase in the equilibrium price. Therefore, the farmers whose crops were not destroyed will benefit from a higher equilibrium price of the good as a result of the decreased supply. - In addition, wheat is a good that tends to have an inelastic demand. This is because it is a necessity good, has a broadly defined market and there are few substitutes for it. - As wheat has an inelastic demand, a decrease in supply will lead to a small decline in the equilibrium quantity of the good demanded, but a large increase in the equilibrium price. Please refer to Figure X. 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? - You would need to know the size of the price elasticity of demand. Then you could calculate whether the total revenue received by all the farmers as a group rose or declined comparable to prior to the floods.

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Microeconomics- Principles and Applications

Chapter 7 – Consumers, Producers and the Efficiency of Markets Q1. Melissa buys an iPod for $120 and gets consumer surplus of $80. a. What is her willingness to pay? - Her willingness to pay is $200. - This is because the consumer surplus is the amount the buyer is willing to pay for a good minus the amount the buyer actually pays for it. o $80= (willing to pay) - $120 o Therefore, the amount Melissa is willing to pay is $200. b. If she had bought the iPod on sale for $90, what would her consumer surplus have been? - Her consumer surplus would have been $110. - Consumer surplus = $200 - $90 c. If the price of an iPod were $250, what would her consumer surplus have been? - The consumer surplus is $0. - As Melissa’s willingness to pay is only $200, she wouldn’t purchase the iPod at $250, therefore there would be no consumer surplus as there is no transaction. Q4. It is a hot day, and Bert is thirsty. Here is the value he places on a bottle of water: - Value of first bottle $7 - Value of second bottle $5 - Value of third bottle $3 - Value of fourth bottle $1 a. From this information, derive Bert’s demand schedule. Graph his demand curve for bottled water. Bert’s demand schedule Price Quantity demanded More than $7 0 $5-$7 1 $3-$5 2 $1-$3 3 $1or less 4 - See Figure D for a graph with the demand curve for bottled water. b. If the price of a bottle of water is $4, how many bottles does Bert buy? How much consumer surplus does Bert get from his purchases? Show Bert’s consumer surplus in your graph. - When the price of a bottle of water is $4, Bert buys 2 bottles. - The consumer surplus from Bert’s purchases is $4. This is because for two bottles of water, his willingness to pay is $7 and he pays $4, therefore the consumer surplus is $3. Then for the third bottle of water his willingness to pay is $5 and he pays $4. - When these are added together ($1+$3) the consumer surplus equals $4. - The consumer surplus is displayed as area A on Figure D. c. If the price falls to $2, how does quantity demanded change? How does Bert’s consumer surplus change? Show these changes in your graph. - When the price falls to $2, the quantity demanded changes to 3 bottles of water, an increase of 1. - The consumer surplus increases to $9.

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This is because the total consumer surplus is now A+B, as shown on Figure D. A = $4. B = $5. o Bert’s willingness to pay for the first two bottles is $4 extra (on top of A), and for the third bottle an extra $1. This leaves a total of $5.

Q9. One of the largest changes in the economy over the past several decades is that technological advance reduces the cost of making computers. a. Draw a supply-and-demand diagram to show what happens to price, quantity, consumer surplus, and producer surplus in the market for computers. - See Figure D. - The declining cost of making computers results in a shift to the right in the supply curve, as shown in Figure D. - This leads to a decline in the equilibrium price, and an increase in the equilibrium quantity of computers. - The consumer surplus prior to the shift in supply is equal to A. - The producer surplus prior to the shift in supply is equal to B+D. - The consumer surplus after the shift in supply is equal to A+B+C+D - The producer surplus after the shift is supply is equal to D+E+F. b. Forty years ago, students used typewriters to prepare papers for their classes; today they use computer’s. Does that make computers and typewriters complements or substitutes? Use a supply-and-demand diagram to show what happens to price, quantity, consumer surplus, and producer surplus in the market for typewriters. Should typewriter producers be happy or sad about the technological advance in computers? - See Figure E. - Computers and typewriters are substitutes, as typewriters can be replaced by computers. - As they are substitutes, the declining cost of making computers will lead to the substitution of type writers for computers. This will lead to a decline in demand for type writers and a shift to the left of the demand curve, as shown in Figure E. - This leads to a decline in the equilibrium quantity of type writers and a decline in the equilibrium price. - The consumer surplus prior to the shift in demand is equal to A+B. - The producer surplus prior to the shift in demand is equal to C+D+E. - The consumer surplus after the shift in supply is equal to B+C. - The producer surplus after the shift is supply is equal to E. - Typewriter producers may be sad about the technological advances in computers, because the demand for their product will decline and the market will decrease in size. c. Computers and software are complements. Draw a supply-and-demand diagram to show what happens to price, quantity, consumer surplus, and producer surplus in the market for software. Should software producers be happy or sad about the technological advance in computers? - See Figure E. - As computers and software are complements, the declining cost of making computers will lead to the increased demand for computer software, and the demand curve will shift to the right. - This will lead to an increase in the equilibrium quantity and equilibrium price of computer software.

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The consumer surplus prior to the shift in demand is equal to A+B. The producer surplus prior to the shift in demand is equal to C+D+E. The consumer surplus after the shift in supply is equal to B+C. The producer surplus after the shift is supply is equal to E. Software producers will be happy about the technological advances in computers, because it will increase the demand and the market for their products.

d. Does this analysis help explain why software producer Bill Gates is one of the world’s richest men? - Yes - As one of the biggest changes of the past few decades has been the reduction in cost of producing computers, the demand for the complementary market of computer software has increased significantly. He founded Microsoft, one of the largest producers of computer software. Q11. Consider how health insurance affects the quantity of healthcare services performed. Suppose that the typical medical procedure has a cost of $100, yet a person with health insurance pays only $20 out of pocket. Her insurance company pays the remaining $80. (The insurance company recoups the $80 through premiums, but the premium a person pays does not depend on how many procedures that person chooses to undertake.) a. ...