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Chapter 02 – Supply and Demand

Answers to Discussion Questions

1. After terrorists destroyed the World Trade Center and surrounding office
buildings on September 11, 2001, some businesspeople worried about the risks
of remaining in Manhattan. What effect would you expect their concern to have
on the price of office space in Manhattan? Over time, those fears eased and the
area around the World Trade Center site was made into a park, so the destroyed
office buildings were never rebuilt. Who would be likely to gain economically
from the creation of this park? Who would be likely to lose?

Answer:
The destruction of the World Trade Center caused a change in both the supply of and
the demand for office space in Manhattan. The change in supply was a physical
reduction in the available space; the change in demand came from worry from
businesspeople about issues of safety. When both supply and demand decrease in this
way, the effect on quantity is obvious: there will be less office space rented in
Manhattan. What is not clear is the effect on price. If the decrease in supply were greater
than the decrease in demand, price would rise; if the other way around, price would fall.

In the long run, after office space is rebuilt, the supply curve would shift back out to (or
closer to) its original position. If demand never rebounded, then this would cause an
overall reduction in the price of office space.

However, now that the area around the World Trade Center has been turned into a park,
the decrease in supply is permanent. Further, if demand were to rebound (say because
the park causes a lower density of office space, making it a less likely target for another
attack, thereby alleviating concerns), this would mean a higher price in the long run.
Those who owned the office space not destroyed by the attacks would be the “winners,”
as they would see their prices rise. The “losers” would be those who pay higher rents for
their office space.

2. If the U.S. government were to ban imports of Canadian beef for reasons
unrelated to health concerns, what would be the effect on the price of beef in the
 United States? How would the typical American’s diet change? What about the
typical Canadians? What if the ban suggested to consumers that there might be
health risks associated with beef?

Answer:
A ban on Canadian beef would lower the supply of beef available to U.S. consumers,
which would cause an increase in the price of beef. Initially, before the price changes,
there will not be enough beef to satisfy demand. This will cause upward pressure on
prices, driving some consumers out of the market, and leading some suppliers into the
market. Depending on how much of the beef being sold in the U.S. was Canadian beef,
the increase could be great. Americans will reduce their beef consumption (though
more Americans are producing beef than before).

2-1
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Chapter 02 – Supply and Demand

In Canada, beef producers would be supplying too much beef to the market, with no one
to buy it. This will cause downward pressure on prices. Because of the decrease in
price, some Canadian consumers will enter the market and some producers will leave
the market. Canadians will consume more beef (and produce less).

Unless U.S. consumers believed that the health risk associated with Canadian beef also
implied health risks associated with U.S.-produced beef, the analysis for the U.S.
would not be any different. If U.S. consumers did believe that all beef was unsafe, this
would cause a decrease in the demand for beef, which would reverse the price-
increasing trend of the ban (making the final effect on price ambiguous) while further
reducing beef consumption.

If Canadian consumers believed that their beef was unsafe, there would also be a
decrease in demand. This would counter the trend toward consuming more beef (so that
the final effect on beef consumption would be ambiguous, but it would further reduce the
price.

3. Published reports indicate that Economics professors have higher salaries

than English professors. Discuss the factors that might be responsible for this.

Answer:
Salaries are determined by demand and supply. Relative to English, fewer Economics
Ph.D.’s are granted every year. Additionally, economists have relatively more
nonacademic job options, further reducing the supply of Economics professors, relative
to English. There may be more demand for English professors, but the difference in
demand is not large enough to make up for the difference in supply.

4. In the last 30 years, the wage difference between high school and college graduates
has grown dramatically. At the same time, the fraction of adults over age 25 that
have college degrees has risen from around 16 percent to over 27 percent. How
might the widespread adoption of computers explain these trends?

Answer:
Widespread adoption of computers has increased the demand for computer literate
workers while decreasing the demand for computer illiterate workers. College graduates
are more likely to have the necessary computer literacy. Also, the increase in demand
for computer literate workers has been faster than the increase in supply of college
graduates.

2-2
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Chapter 02 – Supply and Demand

Answers to Problems

2.1 Consider again the demand function for corn in formula (1). Graph the
corresponding demand curve when potatoes and butter cost $0.75 and $4 per
pound, respectively, and average income is $40,000 per year. At what price does
the amount demanded equal 15 billion bushels per year? Show your answer using
algebra.

Answer:
Formula 1 - Consider the demand function for corn:

where Qdcorn is the amount of corn demanded per year in billions of bushels; Pcorn is the
price of corn per bushel; Ppotatoes and Pbutter are the price of potatoes and butter per
pound, respectively; and M is consumers’ average annual income.

The corresponding demand curve when potatoes and butter cost $0.75 and $4 per
pound, respectively, and average income is $40,000 per year---see the graph below:

At the price of $2.00 the amount demanded is equal to 15 billion bushels per year.

2-3
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Chapter 02 – Supply and Demand

Explanation:
Graphing a linear demand curve is most easily done by finding the x- and y-intercepts.

Y-intercept = 9.5: Substitute the values of Ppotatoes, Pbutter , and M into the demand function
and find the price of corn, Pcorn, at which Qd equals zero.
Qd = 5 – 2Pcorn + 4Ppotatoes – 0.25Pbutter + 0.0003M
0 = 5 – 2Pcorn + 4(0.75) – 0.25(4.00) + 0.0003(40,000)
0 = 5 – 2Pcorn + 3 – 1 + 12
– 19 = – 2Pcorn
Pcorn = 9.5 = y

X-intercept = 19: Substitute the values of Ppotatoes, Pbutter , and M into the
demand function. Set the price of corn, Pcorn, equal to zero and solve for Qd.
Qd = 5 – 2Pcorn + 4Ppotatoes – 0.25Pbutter + 0.0003M
Qd = 5 – 2Pcorn + 4(0.75) – 0.25(4.00) + 0.0003(40,000)
Qd = 5 – 2(0) + 3 – 1 + 12
Qd = 19 = x-intercept.
To find the price, set the demand function equal to 15. Substitute the values of Ppotatoes,
Pbutter, and M into the demand function and find the price of corn, Pcorn, at which Qd
equals 15.
Qd = 5 – 2Pcorn + 4Ppotatoes – 0.25Pbutter + 0.0003M
15 = 5 – 2Pcorn + 4(0.75) – 0.25(4.00) + 0.0003(40,000)
15 = 5 – 2Pcorn + 3 – 1 + 12
15 = 19 – 2Pcorn
– 4 = – 2Pcorn
Pcorn = $2.00.

2.2 Consider again the supply function for corn in formula (2). Graph the
corresponding supply curve when diesel fuel costs $2.75 per gallon and the
price of soybeans is $10 per bushel. At what price does the amount supplied
equal 21 billion bushels per year? Show your answer using algebra.

Answer:
Consider the supply function for corn:

where Qscorn is the amount of corn supplied per year in billions of bushels; Pcorn is the
price of corn per bushel; Pfuel is the price of diesel fuel per gallon; and Psoybeans is the
price of soybeans per bushel.

The corresponding supply curve is presented below:

2-4
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Chapter 02 – Supply and Demand

At a price of $6.00 the amount supplied is equal to 21 billion bushels per year.

Explanation:
Graphing a linear supply curve is not quite as simple as graphing a linear demand curve
(because it is upward-sloping, it only has one positive intercept).

Determine the y-intercept: Substitute the price of fuel and the price of soybeans into the
supply function. Set Qs at zero and solve for the price at which no bushels of corn will
be supplied to the market. The y-intercept = $1.80.

Determine the supply curve: Substitute the price of fuel and the price of soybeans into the
supply function. Set the quantity of corn supplied equal to the upper end of the relevant
output range (40). Solve for QS= 40 = −9 + 5P, so that P = $9.80.

First, set the supply function equal to 21 billion bushels and substitute the price of
fuel and the price of soybeans. Next, solve for the price of corn, Pcorn.

Q2corn = 9 + 5Pcorn – 2Pfuel -1.25Psoybeans

21 = 9 + 5Pcorn – 2($2.75) – 1.25($10)
21 = 9 +5Pcorn – 5.50 -12.50
21 = -9 + 5Pcorn
30 = 5Pcorn
Pcorn = 6
When the quantity supplied is 21 billion bushels, the price of corn is $6.00.

2-5
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Chapter 02 – Supply and Demand

2.3 What is the equilibrium price for the demand and supply conditions described in
Problems 1 and 2? How much corn is bought and sold? What if the price of diesel
fuel increases to $4.50 per gallon? Show the equilibrium price before and after
the change in a graph.

Answer:
The demand for corn (measured in billions of bushels) is given by:

The supply of corn is given by:

The equilibrium price for the demand and supply conditions described in Problems 1 and
2 is $4.00.

11 billion bushels of corn is bought and sold.

If the price of diesel fuel increases to $4.50 per gallon, the price of corn will increase
to $4.50.

Explanation:
At equilibrium Qs = Qd.
9 + 5Pcorn – 2Pfuel – 1.25Psoybeans = 5 – 2Pcorn + 4Ppotatoes – 0.25Pbutter + 0.0003M
9 + 5Pcorn – 5.5 – 12.50 = 5 – 2Pcorn + 3 – 1 + 12
–28 = –7Pcorn
Pcorn = $4.00

By inserting the new price into either the quantity demanded or quantity supplied
equation, we can see how much corn is bought and sold. When the price is set by the
market, the quantity of corn bought and sold is 11 billion bushels.

QScorn = 9 + 5($4.00) – 2($2.75) – 1.25($10)

QScorn = 11

If fuel prices increase to $4.50 per gallon, the price of corn will rise to $4.50 and less
will be produced.

9 + 5Pcorn – 9.00 – 12.50 = 5 – 2Pcorn + 3 – 1 + 12

–31.50 = –7Pcorn
Pcorn =$4.50
QScorn = 9 + 5($4.50) – 2($4.50) – 1.25($10)
QScorn = 10

2-6
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Chapter 02 – Supply and Demand

2.4 Suppose that the demand function for a product is Qd = 200/P and the supply
function is Qs = 2P. What is the equilibrium price and the amount bought
and sold?

Answer:
The equilibrium price is $10. The equilibrium quantity that will be bought and sold is
20 units.

Explanation:
Solve Qd = QS.
200/P = 2P
P2 = 100
P = 10.

Therefore:
Qd = 200/10 = 20.

QS = 2(10) = 20.

2.5 The daily worldwide demand function for crude oil (in millions of gallons) is Qd
= 17 - √P and the daily supply function is Qs √P - 1, where P is the price per
gallon. What is the equilibrium price of crude oil? What is the quantity
bought and sold each day?

Answer:
The equilibrium price of crude oil is $81. The equilibrium quantity bought and sold each
day is 8 million gallons.

Explanation:
Equate Qd and QS.

When P = 81,

2-7
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Chapter 02 – Supply and Demand

2.6 Consider again the demand and supply functions in Worked-Out Problem 2.2
(page 31). Suppose the government needs to buy 3.5 billion bushels of corn for a
third-world famine relief program. What effect will the purchase have on the
equilibrium price of corn? How will it change the amount of corn that is bought
and sold?

Answer:
Consider the following demand and supply functions for corn:

Demand is given by:

Qdcorn = 15 – 2Pcorn
Supply is given by:
QScorn = 5Pcorn – 6
where P is the price in dollars and Q is the quantity in billions of bushels. Suppose the
government needs to buy 3.5 billion bushels of corn for a third-world famine relief
program.

The equilibrium price of corn before the government purchase is $3. The equilibrium
price of corn after the government purchase is $3.50.

Explanation:
To find the equilibrium price before the government purchase we set supply equal
to demand:

QScorn = Qdcorn

5Pcorn – 6 = 15 – 2Pcorn
7Pcorn = 21
Pcorn = 3

The effect of the government purchase will be to reduce the available quantity supplied
by 3.5 billion bushels.

Therefore, the new supply function is given by:

QScorn = 5Pcorn – 6 – 3.5

Demand is given by:

Qdcorn = 15 – 2Pcorn

2-8
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Chapter 02 – Supply and Demand

At equilibrium

5Pcorn – 6 – 3.5 = 15 – 2Pcorn

Equilibrium price equals $3.50, and equilibrium quantity equals 8.0 billion bushels
plus 3.5 billion bushels purchased by the government.

Alternatively, the government purchase of 3.5 billion bushels of corn can be seen as an
outward shift in demand by 3.5. This will result in a new demand function: Qd = 18.5
– 2P. Note that the new equilibrium price and quantity will still be $3.50 per bushel
and 11.5 billion bushels of corn including the 3.5 billion bushels purchased by the
government.

2.7 Suppose that the U.S. demand for maple syrup, in thousands of gallons per year,
is Qd = 6000 - 30P, where P is the price per gallon. What is the elasticity of
demand at a price of $75 per gallon?

Answer:
The elasticity of demand is -0.60.

Explanation:
At price P, denoted Ed equals the percentage change in the amount demanded for each
1 percent increase in the price. Demand for maple syrup is given by:

Qd = 6,000 – 30P

The elasticity of demand for a linear demand curve starting at price P and quantity Q is:

For a linear demand curve of the form QD = A – BP, the first term in parentheses
equals –B. Therefore:

Specifically:

Ed = –30 x 75/ (6,000 – (30 x 75))

Ed = –0.6

2.8 Consider again Problem 7. At what price is the expenditure on maple syrup by
U.S. consumers highest?

Answer:
The expenditure on maple syrup by U.S. consumers is highest at $100.

2-9
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Chapter 02 – Supply and Demand

Explanation:
The largest total expenditure and maximum revenue occur when price elasticity of
demand equals –1. A small increase in price causes total expenditure to increase if
demand is inelastic and decrease if demand is elastic. Total expenditure is largest at a
price for which the elasticity equals –1.

Specifically,

–1 = –30 x (P/ (6,000 – (30P))

6,000 – 30P = 30P
6,000 = 60P
P = 100

2.9 Suppose the demand function for jelly beans in Cincinnati is linear. Two years
ago, the price of jelly beans was $1 per pound, and consumers purchased 100,000
pounds of jelly beans. Last year the price was $2, and consumers purchased
50,000 pounds of jelly beans. No other factors that might affect the demand for
jelly beans changed. What was the elasticity of demand at last year’s price of $2?
At what price would the total expenditure on jelly beans have been largest?

Answer:
The elasticity of demand at last year’s price is –$2. The total expenditure on jelly beans
would have been largest at a price of $1.50.

Explanation:
First find the elasticity of demand.

Ed = –50,000 x 2/ 50,000
Ed = –2
Use Ed to derive the linear demand curve of the form:

Use known values for Qd, B, and P to solve for A.

50,000 = A – 50,000 x 2
A = 150,000

2-10
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Chapter 02 – Supply and Demand

Qd = 150,000 – 50,000P

Use this result to answer the next question. The largest total expenditure and maximum
revenue occur when price elasticity of demand equals –1.

–1 = –50,000P/ (150,000 – (50,000P))

P = $1.50

2.10 Consider again the demand and supply functions in In-Text Exercise 2.2 (page
31). At the equilibrium price, what are the elasticities of demand and supply?

Answer:
Consider the following demand and supply functions for corn:

Demand is given by:

Qdcorn = 15 – 2P
Supply is given by:

Qscorn = 5P – 6
At the equilibrium price, the elasticities of demand ( ) is equal to –0.67 and supply
(ES) is equal to 1.67.

Explanation:
Find equilibrium price by setting .

15- 2P = 5P - 6
21 = 7P
P = $3.00

Price elasticity of demand:

Ed = (ΔQ/ΔP) x (P/Q)
Ed = -B(P/Q)
Ed = -2 x 3.00/ (15 – (2 x 3.00))
Ed = -2 x (3.00/ 9.0)
Ed = -0.67

Price elasticity of supply:

Es = (ΔQ/ΔP) x (P/Q)
ES = -d(P/Q)
Es = 5 x 3.00/(5 x 3.00) - 6)

2-11
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Chapter 02 – Supply and Demand

Es = 5 x (3.00/9.00)
Es = 1.67

2.11 Last September, the price of gasoline in Chattanooga was $2 a gallon, and
consumers bought 1 million gallons. Suppose the elasticity of demand in
September at a price of $2 was -0.5, and that the demand function for gasoline
that month was linear. What was that demand function? At what price does
consumers’ total expenditure on gasoline reach its largest level?

Answer:
The demand function is Qd = 1,500,000 - 250,000P. Consumer’s total expenditure
on gasoline reaches its largest level at a price of $3.

Explanation:
Derive the linear demand curve of the form .

Step1: Find the slope using price elasticity of demand.

Ed = (ΔQ/ΔP) x (P/Q)
Ed = (B) x (P/Q)
-0.50 = (B) x (2.00/1,000,000)
B = –250,000

Step 2: Determine the constant (intercept).

Qd =A – BP
1,000,000 = A – (250,000 x 2.00)
A = 1,500,000

The equation is Qd = 1,500,000 – 250,000P

The largest total expenditure occurs when

Ed = (∆Q/∆P) x (P/Q)
–1 = –250.000 x P/(1,500,000 – (250,000P))
–1,500,000 + 250,000P = –250,000P
500,000P = 1,500,000
P = $3

2.12 Suppose the annual demand function for the Honda Accord is Qd = 430 – 10 PA
+ 10 PC – 10 PG, where PA and PC are the prices of the Accord and the Toyota
Camry respectively (in thousands), and PG is the price of gasoline (per gallon).
What is the elasticity of demand for the Accord with respect to the price of a
Camry when both cars sell for $20,000 and fuel costs $3 per gallon? What is
the elasticity with respect to the price of gasoline?

2-12
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Chapter 02 – Supply and Demand

Answer:
The elasticity of demand for the Accord with respect to the price of a Camry when both
cars sell for $20,000 and fuel costs $3 per gallon is 500. The elasticity with respect to
the price of gasoline is –0.075.
Explanation:

Qd = 430 – 10 PA + 10 PC – 10 PG
Qd = 430 - (10 x 20,000) + (10 x 20,000) - (10 x 3.00) = 400

Cross-price elasticity of demand for Honda Accords with respect to the price of a
Toyota Camry:

Epc = (ΔQ/ΔP) x (P/Q)

Epc = 10 x (20,000/ 400)
Epc = 500.0

Cross-price elasticity of demand for Honda Accords with respect to the price of gasoline:

Epg = (ΔQ/ΔP) x (P/Q)

Epg = –10 x (3/400)
Epg = –0.075

2.13 The demand for a product is Qd = A - BP, where P is its price and A and B are
positive numbers. Suppose that when the price is $1 the amount demanded is 60
and the elasticity of demand is –1. What are the values of A and B?

Answers:
A = 120.
B = 60.

Explanation:
Derive the linear demand curve

Step 1: Solve for (–B) using elasticity of demand along with the given values for P and Q.

Ed = (ΔQ/ΔP) x (P/Q)
–1 = (ΔQ/ΔP) x (1.00 / 60)
–B = (ΔQ/ΔP)
B = 60

Step 2: Solve for A using the known values for Qd, B, and P.

Qd = A – BP
60 = A – (60 x 1.00)

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Chapter 02 – Supply and Demand

A = 120
Qd = 120 – 60P

Answers to Calculus Problems

2.1 The demand function for a product is Qd= 100 - BdP. Suppose that there is a tax
of t dollars per unit that producers must pay and that the supply function for the
product when the tax is t and the price is P is Qs = Bs ( P - t) - 5. What is the
equilibrium price as a function of the tax t? Define the “pass-through rate” of a
small increase in the tax as the derivative of the market price consumers pay
with respect to the tax: dP/dt. What is the pass-through rate of a small tax
increase in this market? How does it depend on Bd and Bs?

Answer:
The equilibrium price as a function of the tax t is

105
+

+ +

Define the "pass-through rate" of a small increase in the tax as the derivative of the
market price consumers pay with respect to the tax: dP/dt. The pass-through rate of
a small tax increase in this market is
+

The pass-through rate increases as Bs increases and decreases as Bd increases.

Explanation:
Equate and .

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