Unit 4 Microeconomics: Fall 2020

(4B): If the slope of the demand curve is zero, the price elasticity of that demand curve will be

(4B): perfectly elastic

(4A): Rank the following in order from the least demand elastic to the most elastic:

(4A): 1- Allergy medicine that is prescribed by a physician, 2- Any over-the-counter allergy medicine, 3- Sudafed Cold and Allergy Medicine --> Necessity is important for understanding elasticity. Prescription medication is an example of a good that we purchase out of necessity. If a consumer is told to take a medication by a physician, chances are that she will do so and be relatively insensitive to price. Prescription allergy medicine is the least elastic. Generic goods will have lots of options. The more substitutes there are for a good, the greater the elasticity will be. That means that with other options, it is easy for a consumer to switch between brands if prices fluctuate. Sudafed Cold and Allergy Medicine is a brand name for a type of medicine and is a specific kind within a large selection of medicines. Any general over-the-counter medicine will be just as good to some consumers, so if the price of a specific brand goes up, they will replace it with another option. Over-the -counter allergy medicine is less elastic then than the specific product Sudafed Cold and Allergy Medicine, because there are fewer substitutes. But there are likely to be some substitutes.

(4A): The suppliers of _________ are more likely to have a tax imposed on their production. Why?

(4A): Gasoline, because demand is relatively inelastic --> The elasticity of demand for jewelry is more elastic than gasoline. The government would get more revenue from taxing a good that has an inelastic demand since the tax would lead to very small changes in consumption.

(4A): The price elasticity of demand is __________ if demand is elastic.

(4A): Greater than one --> If demand is elastic, a change in price will cause a greater change in quantity. Specifically, a given percentage change in price will cause a larger percentage change in quantity demanded. Since price elasticity of demand is the percentage change in quantity demanded divided by the percentage change in price, the price elasticity of demand will be greater than one.

(4A): If the income elasticity of a good is 0.8, what do we know about the good?

(4A): It is a normal good --> With respect to income elasticity of demand, if the measure is positive, it is a normal good - i.e., income is increasing and quantity demanded is also increasing.

(4A): A man spends approximately 45% of his income on air travel and his sister only spends about 2% of her income on air travel (and that is the only difference). We would expect the man's demand for air travel to be ______ elastic than his sister's?

(4A): More --> Another determinant of elasticity is the percentage of one's income is spent on a good. If someone spends a significant amount of their salary on a good, then they will probably be more sensitive to changing prices than someone who spends a small percentage of their income on a good. In the question given, the man spends a lot more on air travel than his sister does and is probably more sensitive to changes in cost. Therefore, his demand for air travel will be more elastic than that of his sister.

(4A): Why are the admission prices to Disneyland often discounted, but the price of concessions and souvenirs inside Disneyland rarely ever discounted?

(4A): Once someone enters Disneyland, there are no substitutes available for concessions or souvenirs - if you want to eat or buy a memento, you must buy from Disney. That is, once you are in the park, the elasticity of demand for other purchases is very small.

(4A): A firm has a choice of raising or lowering its price. If the firm wishes to increase its total revenues, what should it do?

(4A): Raise price when demand is inelastic, because the revenues gained from the price increase will be larger than the revenues lost from the smaller quantity sold. --> If a firm raises its price, then it will gain revenues from the higher price but lose revenues from the decrease in quantity demanded. If demand is inelastic, the percentage change in quantity will be less than the percentage change in price. The loss in revenues from the decrease in quantity will be less than the gain in revenues from the increase in price.

(4A): Why are college textbooks so expensive when other books that cost the same to produce have a lower price?

(4A): The elasticity of demand for college textbooks is very inelastic because they are required.

(4A): Last October, the highest-paying passenger on United Flight 815 from Chicago to Los Angeles paid $1,248.51. The lowest-paying passenger on the same flight paid $87.21. Can we say anything about the likely elasticities of demand of the two customers? Use the concepts of marginal analysis and opportunity cost to explain why it might make sense for United Airlines to charge some lucky soul so little.

(4A): United Airlines can raise its Total Revenues by raising fares for those with inelastic demand and lowering fares for those with elastic demand. The first person's demand is relatively inelastic, while the latter's is probably much more elastic. The marginal cost to United of offering an empty seat to a person on a flight that is scheduled to depart is negligible. Therefore, as long as the fare covers the small additional cost of carrying one more passenger, profits will increase.

(4A): Which of the following goods would be the most likely to be subject to a government-imposed tax?

(4A): bottle of alcohol, such as whisky and gin --> The government is most likely to impose a tax on a good with a very inelastic demand. That includes goods that people can become addicted to, like cigarettes and alcohol.

(4A): If the country enters a period of prosperity, resulting in consumer incomes increasing by 4% and the income elasticity of a good is - 0.8, what will happen to the quantity demanded for that good?

(4A): it will fall by 3.2% --> Solve for change in quantity in the income elasticity equation; multiply 4% by minus 0.8% to get 3.2% decrease in quantity.

(4A): Which of the following is likely to have the largest elasticity of supply?

(4A): the producer of vanilla ice cream --> It is far easier for a producer of vanilla ice cream to react and change production if the price of vanilla ice cream changes than it is for a dentist or someone who builds yachts.

(4A): When price decreases, quantity increases. Price elasticity of demand measures how much ___________.

(4A): the quantity increases when price decrease --> When price decreases, quantity increases. Price elasticity of demand measures how much ___________.

(4B): The figure below depicts a market for cigarettes. The initial demand curve is D and the initial supply curve is S. The government imposes an excise tax of $6 on every carton of cigarette sold. So S is the post-tax supply curve for cigarettes. B is the pre-tax equilibrium and A is the post-tax equilibrium. At the post-tax equilibrium what amount do sellers charge the consumer and how much of that amount do they get to keep? (PICTURE 1)

(4B): $13; $7

(4B): If the slope of the demand curve is -1.4, price is $5 and quantity demanded is 13 units, the price elasticity of demand is

(4B): .27

(4B): If the price elasticity of demand for pineapple is 0.75, a 4% increase in the price of pineapple will lead to a

(4B): 3% decrease in the quantity demanded of the pineapple

(4B): The figure below depicts a market for cigarettes. The initial demand curve is D and the initial supply curve is S. The government imposes an excise tax of $6 on every carton of cigarette sold. So S is the post-tax supply curve for cigarettes. B is the pre-tax equilibrium and A is the post-tax equilibrium. What is the total amount of tax collected by the government? (PICTURE 1)

(4B): 30,000 x $6

(4B): The quantity of red wine demanded increases from 25 to a 100 bottles in response to a price reduction from $20 to $15. What is the price elasticity of demand for wine? Use the mid-point average formula.

(4B): 4.2

(4B): An increase in the price of golf clubs from $75 to $125 led to an increase in quantity supplied from 200 units to 300 units. The price elasticity of supply for golf club is ______ so the supply curve is _______. Hint: use the midpoint average formula.

(4B): 4/5; inelastic

(4B): Refer to the figure under. The price elasticity of demand at point A is (PICTURE 2)

(4B): 5/2

(4B): When the price of insulin was $10 consumers demanded 100 units; when the price was $15 consumers demanded 100 units; and when the price was $20 consumers demanded 100 units. Based on this information, insulin must have a(n) _________demand curve.

(4B): perfectly inelastic

(4B): Why does a consumer's price elasticity of demand for a good depend on the fraction of the consumer's income spent on the good?

(4B): A consumer's price elasticity of demand for a good depends on the fraction of the consumer's income spent on that good because a price change alters the real value of the consumer's purchasing power. This effect grows larger as the share of the consumer's budget spent on a good increases.

(4B): Suppose that in an attempt to induce citizens to conserve energy, the government enacts regulations requiring all air conditioners to be more efficient in their use of electricity. After the regulation is implemented, government officials are surprised to discover that people are using even more electricity than before. How is this possible?

(4B): By requiring people to buy more efficient air conditioners, the government effectively reduced the price of buying cooler air. If the demand for cool air is sufficiently elastic with respect to price, people may buy so much more of it that they end up using more electricity.

(4B): Suppose that while rummaging through your uncle's closet you find the original painting of "Dogs Playing Poker", a valuable piece of art. You decide to organize an exhibition of the painting in your uncle's garage. The demand for tickets to the exhibition is given below. If you wish to maximize your revenue from ticket sales, what price will you charge for each ticket? Why? (PICTURE 6)

(4B): Demand is unit elastic at the mid point of a straight line downward sloping demand curve. Demand is elastic for prices above $6 and inelastic for prices below $6. So if you charge more than $6, total revenue will fall. If you charge less than $6, total revenues will fall as well. So to maximize total revenue, you should charge $6.

(4B): Why do economists pay little attention to the algebraic sign of the elasticity of demand for a good with respect to its own price, yet pay careful attention to the algebraic sign of the elasticity of demand of a good with respect to another good's price?

(4B): The algebraic sign of the elasticity of demand for a good with respect to its own price conveys no useful information because it is always negative. By contrast, the elasticity of demand for a good with respect to the price of another good can be either positive or negative depending on whether the goods are substitutes or complements, so it is important to keep track of the sign in this case.

(4B): Why is supply elasticity higher in the long run than in the short run?

(4B): When the price of a good rises, firms usually need to increase the amount of inputs they buy in order to increase the quantity of output supplied. This is a time-consuming process for certain kinds of inputs while it is done relatively quickly for other inputs. Thus, the longer the period of time considered, the more likely it is that the firm can increase the needed inputs and increase output in response to a change in price.

(4B): The figure below depicts a market for cigarettes. The initial demand curve is D and the initial supply curve is S. The government imposes an excise tax of $6 on every carton of cigarette sold. So S is the post-tax supply curve for cigarettes. B is the pre-tax equilibrium and A is the post-tax equilibrium. Because the demand curve is downward sloping (i.e., consumers cut back on smoking when cigarette prices go up) the seller is not able to transfer the entire burden of the tax on to the consumers. Indeed sellers and buyers (same thing as consumers) share the burden. Let x% be the consumer's share of the burden and y% be the seller's share. Then, (PICTURE 1)

(4B): X = 50%; y = 50%

(4B): Elvis loves to eat peanut butter with bananas. Martha thinks the combination of peanut butter and bananas is repulsive. Economists would classify peanut butter and bananas as

(4B): complements only if their cross-price elasticity is negative

(4B): If the percentage change in the price of a good is less than the percentage change in quantity demanded of that good, then the demand for that good, with respect to price, is

(4B): elastic

(4B): Suppose the price P gives us a price elasticity of demand equal to 1. Any price higher than P will move us to the ________ part of the demand curve.

(4B): elastic

(4B): Big-ticket items such as refrigerators have a __________ price elasticity of demand compared to low budget items such as paper towels.

(4B): higher

(4B): Pepsi One is a close substitute for Diet Coke. After Pepsi introduced Pepsi One, the price elasticity of demand for Diet Coke ________ and Coke's ability to raise revenues through price increases ________.

(4B): increased; was reduced

(4B): If a demand curve is defined by the equation P = 5. What is its price elasticity of demand?

(4B): infinity

(4B): If the slope of the demand curve is zero, the price elasticity of that demand curve will be

(4B): infinity

(4B): Suppose that each serving of Mac & Cheese costs exactly $0.50 to make no matter how many servings are produced. This means that the price elasticity of supply for Mac & Cheese is ______ and the supply is _______.

(4B): infinity; perfectly elastic

(4B): Refer to the figure below. If the price changes from $10 to $4, what happens to the price elasticity of supply? (PICTURE 4)

(4B): it will increase

(4B): For OutBack Steakhouse, seating capacity is limited in the short run. In the long run they can add as many seats as they want. Therefore, the price elasticity of supply for the meals in OutBack would be _______ in the short run than in the long run.

(4B): lower

(4B): Jeans in general have fewer close substitutes than any specific brand of jeans. Therefore the demand for jeans would be ____________ than the demand for a specific brand of jeans.

(4B): more inelastic

(4B): If the demand for salad dressing increased when the price of lettuce decreased, cross price elasticity would be ________, and we would say these two goods are _________.

(4B): negative; complements

(4B): During recessions, when workers lose their jobs and have lower incomes, sales of durable goods (goods with a life expectancy of 3 years or more) decline. This tells us that durable goods are

(4B): normal goods

(4B): If the demand curve for a good can be represented by the equation Q = 1. A decrease in the price of the good will

(4B): not change the quantity demanded

(4B): Chris had been charging a dollar a pound for potatoes. When Chris lowered the price to 90 cents, total revenue fell. When Chris raised the price to $1.10, total revenue fell again. Why?

(4B): price elasticity of demand is unitary at $1.00

(4B): The price elasticity of demand for tickets to a football game is 2. If the ticket price increases by 1%, then:

(4B): quantity demanded falls by 2%

(4B): If the local electricity utility wants to raise revenues, it should _____ its price because demand for electricity is likely to be _____

(4B): raise; inelastic

(4B): In surveying their alumni, State U's economics department discovered that ramen noodle consumption declined as soon as students graduated and found jobs. One conclusion the survey team might draw from this result is that

(4B): ramen noodles is an inferior good

(4B): The figure below depicts a market for cigarettes. The initial demand curve is D and the initial supply curve is S. The government imposes an excise tax of $6 on every carton of cigarette sold. So S is the post-tax supply curve for cigarettes. B is the pre-tax equilibrium and A is the post-tax equilibrium. If the demand curve were to become less elastic at B, we can predict that:

(4B): the buyer's share of the tax burden will rise

(4B): A 10% decline in the price of oranges leads to a 15% decline in the quantity of pears demanded. Therefore we may conclude that:

(4B): the cross price elasticity of demand for pears is 1.5

(4B): Suppose the company that owns the vending machines on your campus has doubled the price of a can of soda and yet they sell almost the same number of sodas per day as before. This suggests:

(4B): there are few other places to purchase soda on campus

(4B): Refer to the figure below. If the price of a latte increases from $2.00 to $2.50, (PICTURE 3)

(4B): total revenue would decrease

(4B): Total expenditures for coffee reached a maximum at a price of $5 per lb. At this price the demand for coffee is

(4B): unit elastc

(4B): In 1985 a desert community stopped pumping from a 1000 foot well because it had run dry. In 2005 the price of water doubled. The community then drilled the well deeper and started pumping again. In this community,

(4B): water production faces increasing opportunity costs

(4B): Refer to the figure below. Demand curves D0 and D1 are parallel to each other. Let εX denote the price elasticity of demand at any point X. Which of the following describes the relationship between εA, εB and εC? (PICTURE 5)

(4B): εA > εC > εB