Unit 2 Demand & Supply Problem Set #2 PDF

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Demand & Supply Problem Set...

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Unit 2 Problem Set #2 1. (a) Demand is the different quantities of goods that consumers are willing and able to buy. In the Law of Demand, there is an inverse relationship between price and quantity demanded. As a price goes down, quantity demanded goes up. Demand shifters shift the entire demand curve, so, at the same prices, more or less people are willing and able to purchase that good. There are six demand shifters: 1. Consumer Taste: diet fads, scientific discoveries, celebrity spokesperson, popular trends, 2. Number of Consumers: more people in an area due to immigration for examples, 3. Consumer Expectations: if the price is about to go up or down, 4. Complements: goods that are used together, if the price of one increases, the demand of the other will fall, 5. Substitutes: goods used in place of one another, if the price of one increases, the demand for the other will increase, 6. Income: the income of consumers changes demand, but how depends on the type of good (Normal Good and Inferior Good). (b) Supply is the different quantities of goods that producers are willing and able to sell. In the Law of Supply, there is a direct (or positive) relationship between price and quantity supplied. As the price increases, the quantity producers make increases, and vice versa. This happens because at higher prices, profit-seeking firms have an incentive to produce more. There are six supply shifters: 1. Input Costs: resources, 2. Number of Producers: the number of producers that produce a certain good, 3. Technology: if there is a new technology producing a certain good, 4. Government Action: taxes or subsidies (payment), 5. Opportunity Cost of Alternative Production: raising the price of a certain good that is used to produce another good, 6. Producer Expectations: what the producers expect. (c) We buy goods because we get utility (satisfaction/ benefit) from them. An example would be as you consume more units of good, the additional satisfaction from each additional unit will start to decrease. (d) Consumer surplus is the difference between what the buyer is willing to pay and what he/she actually paid. CS= buyer’s maximum price. Producer surplus is the difference between the price to seller received and how much he/she was willing to sell it for. Price seller's minimum.

2. 3. (a) There are four government actions: price floor, price ceiling, tariffs, and subsidies. Price floor is the minimum legal price a seller can sell a product. The result is surplus. Price ceiling is the maximum legal price a seller can charge for a good. The result is shortages. Subsidies is the government payments to producers. The result is protecting producers from competition. The last government action is tariffs and quotas. Tariffs is tax on imported goods that raises prices. A quota is a limit on the number of imports. The

government sets the maximum amount that can come in the country. The result is higher prices for consumers.

(b) Since cigarettes are a necessity to smokers, they are unlikely to stop consuming them because of a small increase in price.

4. 5. (a) Elasticity is a measurement of consumers responsiveness to a change in price. In Elastic Demand, quantity is sensitive to price change, for example, pizza and coke. In Inelastic Demand, quantity is insensitive to price change, for example, gas and toilet paper. (b) i. Price Elasticity of Demand is used to determine the elasticity % ∆∈Quantity , and 0 = coefficient number. The formula is % ∆∈Price Perfectly Inelastic, 0.5 = Inelastic, 1 = Unit Elastic, 1.5 = Elastic,  = Perfectly Elastic. ii. Cross Price Elasticity is used to determine how sensitive a product is to a change in price of another good. The formula is % ∆∈Quantity of Good X , and negative = Complements, positive = % ∆∈Price of Good Y Substitutes. iii. Income Elasticity is used to determine how sensitive a product is to a % ∆∈Quantity , and change in consumer’s income. The formula is % ∆∈Income negative = Inferior, positive = Normal. (c) In the total revenue test, if the price increases and the total revenue decreases, the demand curve is elastic. If the price increases and the total revenue increases, the demand curve is inelastic. If there is no change in total revenue, the demand curve is unit elastic. For example, if the price of good X goes down from $10 to $5 and the demand increases from 10 to 25, the demand curve would be elastic since price went down and total revenue went up. If that same good’s demand had only gone up to 15, the demand curve would be inelastic since both price and total revenue went down.

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(a) (b) You determine the utility maximum combination by comparing the Marginal Utility per $ for both goods. The good with the higher Marginal Utility per $ is the one you chose until you run out of money. In this example, you would buy 2 CDs and 4 DVDs. (c) You would compare the Marginal Utility per $ and chose the good with the higher Marginal Utility per $. If my reward increased to $130, I would buy 3 CDs and 5 DVDs....