COR2100 Economics and Society

Homework 1B – chapter 1
Due: 05/02/2020, in class, individual submission

Market analysis, elasticity

1. Show in a diagram the effect on the demand curve, the supply curve, the equilibrium price, and the
equilibrium quantity of each of the following events. Be sure to provide brief explanations for your
answers.
a. The market for newspapers in your town
Case 1: The salaries of journalists go up.
Case 2: There is a big news event in your town, which is reported in the newspapers.

b. The market for St. Louis Rams cotton T-shirts

Case 1: The Rams win the Super Bowl.
Case 2: The price of cotton increases.

c. The market for kaya toasts

Case 1: People realize how fattening kaya toasts are.
Case 2: People have less time to make themselves a cooked breakfast.

d. The market for the Principle of Economics textbook

Case 1: Your professor makes it required reading for all of his or her students.
Case 2: Printing costs for textbooks are lowered by the use of synthetic paper.

2. Find the flaws in reasoning in the following statements, paying particular attention to the distinction
between shifts of and movements along the supply and demand curves. Draw a diagram to illustrate
what actually happens in each situation.
a. “A technological innovation that lowers the cost of producing a good might seem at first to result in
a reduction in the price of the good to consumers. But a fall in price will increase demand for the good,
and higher demand will send the price up again. It is not certain, therefore, that an innovation will really
reduce price in the end.”
b. “A study shows that eating a clove of garlic a day can help prevent heart disease, causing many
consumers to demand more garlic. This increase in demand results in a rise in the price of garlic.
Consumers, seeing that the price of garlic has gone up, reduce their demand for garlic. This causes the
demand for garlic to decrease and the price of garlic to fall. Therefore, the ultimate effect of the study
on the price of garlic is uncertain.”

3. Use an elasticity concept to explain each of the following observations.

a. During economic booms, the number of new personal care businesses, such as gyms and tanning
salons, is proportionately greater than the number of other new businesses, such as grocery stores.
b. Cement is the primary building material in Mexico. After new technology makes cement cheaper to
produce, the supply curve for the Mexican cement industry becomes relatively flatter.
c. Some goods that were once considered luxuries, like a telephone, are now considered virtual
necessities. As a result, the demand curve for telephone services has become steeper over time.

4. According to data from the U.S. Department of Energy, sales of the fuel-efficient Toyota Prius hybrid
fell from 158,574 vehicles sold in 2008 to 139,682 in 2009. Over the same period, according to data
from the U.S. Energy Information Administration, the average price of regular gasoline fell from $3.27
to $2.35 per gallon. Using the midpoint method, calculate the cross-price elasticity of demand between
Toyota Prii (the official plural of “Prius” is “Prii”) and regular gasoline. According to your estimate of
the cross-price elasticity, are the two goods complements or substitutes? Does your answer make sense?
Formula for the mid-point method:
As price changes from P1 to P2, causing quantity to change from Q1 to Q2:
We take the average of price and quantity
 𝑃& + 𝑃(
𝑃"#$ =
2
𝑄& + 𝑄(
𝑄"#$ =
2
And so,
(𝑄& − 𝑄( )/𝑄"#$
𝜖=
(𝑃& − 𝑃( )/𝑃"#$

5. Market research has revealed the following information about the market for chocolate bars:
The demand schedule can be represented by the equation QD = 1600 – 300P, where QD is the quantity
demanded and P is the price.
The supply schedule can be represented by the equation QS = 1400 + 700P, where QS is the quantity
supplied.
a. Calculate the equilibrium price and quantity in the market for chocolate bars.
b. A shortage of milk raises the price of milk, causing the supply of chocolate to decrease to QS = 1200
+ 700P. First, use a diagram to illustrate roughly what should happen to the equilibrium price and
quantity of chocolate, then solve for the new equilibrium price and quantity to confirm.

Welfare analysis, government intervention

6. The accompanying diagram shows the market for cigarettes. The current equilibrium price per pack
is $4, and every day 40 million packs of cigarettes are sold. In order to recover some of the health care
costs associated with smoking, the government imposes a tax of $2 per pack. This will raise the
equilibrium price to $5 per pack and reduce the equilibrium quantity to 30 million packs.

The economist working for the tobacco lobby claims that this tax will reduce consumer surplus for
smokers by $40 million per day, since 40 million packs now cost $1 more per pack. The economist
working for the lobby for sufferers of second-hand smoke argues that this is an enormous overestimate
and that the reduction in consumer surplus will be only $30 million per day, since after the imposition
of the tax only 30 million packs of cigarettes will be bought and each of these packs will now cost $1
more. Who is right/wrong? And why?

7. 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-and-
demand 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?
b. Farmers complain that the price floor has reduced their total revenue. Is this possible? Explain.
c. In response to farmers’ 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?
Further practice (not for submission)

1. For each of the following situations, sketch the demand curve as accurately as possible.
a. Appendectomy is a life-saving operation that some people need. Regardless of the price, the quantity
demand is 300,000 every year.
b. For any price above $5 absolutely nobody will buy your lemonade, but at $5 you find that you are
able to sell as much lemonade as you like.
c. There is only one buyer. For any price above $100 this buyer wants nothing. For any price at or below
$100 this buyer wants exactly 20 units.

2. Suppose one of your friends offered the following argument: a rightward shift in demand will cause
an increase in price. The increase in price will cause a rightward shift of the supply curve, which will
lead to an offsetting decrease in price. Therefore, it is impossible to tell what effect an increase in
demand will have on price. Do you agree with your friend? If not, what is the flaw in your friend’s
reasoning?

3. Suppose the energy supply in your country is provided by nuclear reactors. Your country is both
sunny and windy at the same time and, therefore, many people have decided to set up sun collectors
and wind farms as a cheaper alternative to obtaining electricity. Explain how this might impact the price
of electricity in the country with the help of a graph. Would it still be feasible to create new nuclear
reactors?

4. The demand for ice cream is QD = 70 − 4P, and the supply of ice cream is QS = 10 + 2P, where P is
the price of ice cream.
a. Find the equilibrium price and quantity of ice cream.
b. Suppose consumers’ income increases and ice cream is considered as a normal good. As a result, the
demand curve for ice cream becomes QD = 100 − 4P. Find the new equilibrium price and quantity of
ice cream. Do your answers make sense? Confirm with a diagram (roughly, you don’t have to plot the
equations exactly).

5. The equilibrium price of coffee in an economy, measured in dollars, is about $2,000 per ton. To help
the coffee farmers earn a higher income, the government set the price to $2,500 per ton.
a. How will this affect the demand and supply of coffee in the coffee market?
b. Construct a diagram for coffee to show the effect of the government action. Will the coffee farmers
be better off?

6. In order to ingratiate himself with voters, the mayor of Gotham City decides to lower the price of
taxi rides. Assume, for simplicity, that all taxi rides are the same distance and therefore cost the same.
The accompanying table shows the demand and supply schedules for taxi rides.
a. Assume that there are no restrictions on the number of taxi rides that can be supplied (there is no
medallion system). Find the equilibrium price and quantity.
b. Suppose that the mayor sets a price ceiling at $5.50. How large is the shortage of rides? Illustrate
with a diagram. Who loses and who benefits from this policy?
c. Suppose that the stock market crashes and, as a result, people in Gotham City are poorer. This reduces
the quantity of taxi rides demanded by 6 million rides per year at any given price. What effect will the
mayor’s new policy have now? Illustrate with a diagram.

7. At Fenway Park, home of the Boston Red Sox, seating is limited to 39,000. Hence, the number of
tickets issued is fixed at that figure. Seeing a golden opportunity to raise revenue, the City of Boston
levies a per ticket tax of $5 to be paid by the ticket buyer. Boston sports fans, a famously civic-minded
lot, dutifully send in the $5 per ticket. Draw a well-labeled graph showing the impact of the tax. On
whom does the tax burden fall—the team’s owners, the fans, or both? Why?