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ECON 201 – INTRODUCTION TO MICROECONOMICS Assignment #1

Written by: Jad El-Rifai, 3981401

Wednesday February 11th 2004.

**1. The market forces of Supply and Demand.
**

a. Plotting the Demand and supply Curve. The following Table Illustrates the values used in the plotted graphs.

Price Per Unit ($) 8 6 4 2 1 0.5 Quantity Demanded 1 2 3 4 5 6 Quantity Supplied 10 8 6 4 2 0

**The resulting graph is illustrated below.
**

Demand and Supply Curves for Comic Books

9

8

7

Price of each comic book

6

5 Demand Supply 4

3

2

1

0 0 1 2 3 4 5 6 7 8 9 10 Quantity of comic books

b. Finding the Equilibrium point Plotted on the graph, as well as seen clearly in the table, the equilibrium is established for the price of $2.00. In fact, at this price, the supply equals the demand at 4 units.

c. The Law of Demand and the Law of Supply (Price Increase) According to the Law of Demand, if all other things remain constant, an increase of price (from the equilibrium price of $2) to $6 would decrease the quantity of comic books demanded to 2. Similarly, also provided all other things remain constant, the Law of Supply dictates that the number of comic books supplied would rise to 8. This creates a situation of excess supply, or surplus, and would lead to an increased inventory size for the suppliers. d. The Law of Demand and the Law of Supply (Price Decrease) The Law of Demand and the Law of Supply apply also in this case of price decrease under the price of equilibrium of $2. Ceteris Paribus, the decrease in price to $1 would raise the quantity demanded to 5 and drop the quantity supplied to 2. This creates a situation of excess demand (shortage) and reduces the size of suppliers’ inventory. e. The effect of income on the demand curve. Income is a determinant of demand. The Increase of income would increase the demand for comic books, which are considered to be normal goods. To obtain the new demand values, 3 units must be added for every price. The results are displayed in the table below.

Price Per Unit ($) 8 6 4 2 1 0.5 Quantity Demanded 1 2 3 4 5 6 Quantity Supplied 10 8 6 4 2 0 New Quantity Demanded 4 5 6 7 8 9

This increase of demand shifts the demand curve to the right, as illustrated in the updated graph below. This graph is the same as in (a) but the shifted demand curve has been added as a dotted line.

**Demand and Supply Curves for Comic Books
**

9

8

7

Price of each comic book

6

5

4

Demand Supply Shifted Demand

3

2

1

0 0 1 2 3 4 5 6 7 8 9 10 Quantity of comic books

f. Updated Equilibrium after Curve-Shift As seen from the updated table and the updated graph, the demand meets the supply at the quantity of 6. The equilibrium price is therefore $4.

**2. Elasticity and its applications
**

a. Calculating Price Elasticity of Demand Examples of for calculating each value in the table. i. To calculate (a) it’s simply the difference between two rows in the price column the total divided by the amount in the first row, i.e. (a) = (12-10)/12 = 0.167 ii. To calculate (b) it’s simply the difference between two rows in the quantity column the total divided by the amount in the first row, i.e. (b) = (2-3)/2 = -0.5 iii. The price elasticity of demand is the ratio between the % difference in quantity and the % difference in price. In other terms, (b) divided by (a). i.e. (c) = -0.5/0.167 = -3 iv. The slope of demand is the rise over the run of the demand curve, which means, the difference in price, divided by the difference in quantity between any two given points. Since the demand curve is linear, it has a constant slope. (d) = (12-10)/(2-3) = - 2 v. The total revenue is the price of one item multiplied by the total number of items (quantity). (e) = 12x2 = $24.00 The results of all the calculations are displayed in the table below.

Price Per Unit ($) Quantity Demande d % change in price (a) % change in quantity (b) -0.500 -0.333 -0.250 -0.200 -0.167 Elasticit y of demand (c) Slope of Deman d (d) Total revenu e (e)

12 10 8 6 4 2

2 3 4 5 6 7

0.167 0.200 0.250 0.333 0.500 -

-3.000 -1.667 -1.000 -0.600 -0.333 -

-2 -2 -2 -2 -2 -2

$24.00 $30.00 $32.00 $30.00 $24.00 $14.00

The negative values have been left as so to illustrate the direction of the respective curves. However, for the rest of the answers, the absolute value of these numbers will be considered. b. What is Price Elasticity of Demand?

Price elasticity of demand is a measure of the responsiveness of the quantity demanded to the change in its price. The price elasticity of demand is different for each point of the demand curve. Therefore, each price range has a different elasticity. The behavior for the $10 to $12 range is elastic, because Ed is superior to 1. At the $8 price, Ed is one and therefore the behavior is unit elastic. For a price of $6 and below, the behavior is inelastic since Ed is between 0 and 1. As for product classification, we could say that this product is inelastic with regard to price due to the high slope of demand. We could therefore assume that this product is deemed somewhat of a necessity. c. Relationship between the Slope of Demand and the Elasticity of Demand The main difference between the two curves is that the Elasticity of demand is a ratio of the percentage difference, where the slope is just the ratio of the differences. Although the slope is constant and the Elasticity is variable, the two curves are related to each other by an equation that factors in the price and the demand. Following is an explanation of how the relationship between the Slope of demand (Sd) and Elasticity of demand (Ed) is obtained. Q − Q0 Q Ed = (b) / (a) = P − P0 P If we multiply Ed by

and Sd =

P − P0 Q − Q0

Q − Q0 Q we obtain which is the inverse P − P0 P of Sd. Therefore, we could say the following: P Sd = = |-2| = constant Q × Ed To verify whether this relationship is accurate, it is tested below for a random point of the demand curve. For Q = 6 and P =4, Sd = relationship is verified. d. 4 4 = = 2. The test is successful and the 6 × 0.333 2

Maximizing total revenue. The total revenue is maximized at the unit-elastic level. Where the elasticity of demand is equal to 1, the price reaches the top value of $32.00.

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