ECON 200.

Introduction to Microeconomics Homework 3 Part I

Name:________________________________________

[Multiple Choice]

1. A life-saving medicine without any close substitutes will tend to have (a)
a. a small elasticity of demand.
b. a large elasticity of demand.
c. a small elasticity of supply.
d. a large elasticity of supply.

2. The price of a good rises from $8 to $12, and the quantity demanded falls from 110 to 90 units.
Calculated with the midpoint method, the elasticity is (b)
a. 1/5.
b. 1/2.
c. 2.
d. 5.

3. A linear, downward-sloping demand curve is (d)

a. inelastic.
b. unit elastic.
c. elastic.
d. inelastic at some points, and elastic at others.

4. The ability of firms to enter and exit a market over time means that, in the long run, (c)
a. the demand curve is more elastic.
b. the demand curve is less elastic.
c. the supply curve is more elastic.
d. the supply curve is less elastic.

5. An increase in the supply of a good will decrease the total revenue producers receive if (a)
a. the demand curve is inelastic.
b. the demand curve is elastic.
c. the supply curve is inelastic.
d. the supply curve is elastic.

6. The price of coffee rose sharply last month, while the quantity sold remained the same. Each of five
people suggests an explanation: (c)
Tom: Demand increased, but supply was perfectly inelastic.
Dick: Demand increased, but it was perfectly inelastic.
Harry: Demand increased, but supply decreased at the same time.
Larry: Supply decreased, but demand was unit elastic.
Mary: Supply decreased, but demand was perfectly inelastic.
Who could possibly be right?
a. Tom, Dick, and Harry
b. Tom, Dick, and Mary
c. Tom, Harry, and Mary
d. Dick, Harry, and Larry
e. Dick, Harry, and Mary
7. An efficient allocation of resources maximizes (c)
a. consumer surplus.
b. producer surplus.
c. consumer surplus plus producer surplus.
d. consumer surplus minus producer surplus.

8. When a market is in equilibrium, the buyers are those with the __________ willingness to pay and the
sellers are those with the __________ costs. (b)
a. highest, highest
b. highest, lowest
c. lowest, highest
d. lowest, lowest

9. Producing a quantity larger than the equilibrium of supply and demand is inefficient because the
marginal buyer’s willingness to pay is (c)
a. negative.
b. zero.
c. positive but less than the marginal seller’s cost.
d. positive and greater than the marginal seller’s cost
[Short Answer]

1. If the elasticity is greater than 1, is demand elastic or inelastic? If the elasticity equals zero, is demand
perfectly elastic or perfectly inelastic?
An elasticity greater than one means that demand is elastic. When the elasticity is greater than
one, the percentage change in quantity demanded exceeds the percentage change in price. When the
elasticity equals zero, demand is perfectly inelastic. There is no change in quantity demanded when
there is a change in price.

2. On a supply-and-demand diagram, show equilibrium price, equilibrium quantity, and the total
revenue received by producers.
The figure presents a supply-and-demand diagram, showing the equilibrium price, P, the
equilibrium quantity, Q, and the total revenue received by producers. Total revenue equals the
equilibrium price times the equilibrium quantity, which is the area of the rectangle shown in the figure.

3. If a fixed quantity of a good is available, and no more can be made, what is the price elasticity of
supply?
If a fixed quantity of a good is available and no more can be made, the price elasticity of supply
is zero. Regardless of the percentage change in price, there will be no change in the quantity supplied.

4. A storm destroys half the fava bean crop. Is this event more likely to hurt fava bean farmers if the
demand for fava beans is very elastic or very inelastic? Explain
Destruction of half of the fava bean crop is more likely to hurt fava bean farmers if the demand
for fava beans is very elastic. Destruction of half of the crop causes the supply curve to shift to the left
resulting in a higher price of fava beans. When demand is very elastic, an increase in price leads to a
decrease in total revenue because the decrease in quantity demanded outweighs the increase in price.
5. For each of the following pairs of goods, which good would you expect to have more elastic demand
and why?

a. required textbooks or mystery novels

Mystery novels have more elastic demand than required textbooks because mystery novels
have close substitutes and are a luxury good, while required textbooks are a necessity with no close
substitutes. If the price of mystery novels were to rise, readers could substitute other types of novels, or
buy fewer novels altogether. But if the price of required textbooks were to rise, students would have
little choice but to pay the higher price. Thus, the quantity demanded of required textbooks is less
responsive to price than the quantity demanded of mystery novels.

b. Beethoven recordings or classical music recordings in general

Beethoven recordings have more elastic demand than classical music recordings in general.
Beethoven recordings are a narrower market than classical music recordings, so it is easier to find close
substitutes for them. If the price of Beethoven recordings were to rise, people could substitute other
classical recordings, like Mozart. But if the price of all classical recordings were to rise, substitution
would be more difficult. (A transition from classical music to rap is unlikely!) Thus, the quantity
demanded of classical recordings is less responsive to price than the quantity demanded of Beethoven
recordings.

c. subway rides during the next six months or subway rides during the next five years
Subway rides during the next five years have more elastic demand than subway rides during the
next six months. Goods have a more elastic demand over longer time horizons. If the fare for a subway
ride was to rise temporarily, consumers could not switch to other forms of transportation without great
expense or great inconvenience. But if the fare for a subway ride was to remain high for a long time,
people would gradually switch to alternative forms of transportation. As a result, the quantity
demanded of subway rides during the next six months will be less responsive to changes in the price
than the quantity demanded of subway rides during the next five years.

d. root beer or water

Root beer has more elastic demand than water. Root beer is a luxury with close substitutes,
while water is a necessity with no close substitutes. If the price of water were to rise, consumers have
little choice but to pay the higher price. But if the price of root beer were to rise, consumers could easily
switch to other sodas or beverages. So the quantity demanded of root beer is more responsive to
changes in price than the quantity demanded of water.

6. Suppose the price elasticity of demand for heating oil is 0.2 in the short run and 0.7 in the long run.

a. If the price of heating oil rises from $1.80 to $2.20 per gallon, what happens to the quantity of heating
oil demanded in the short run? In the long run? (Use the midpoint method in your calculations.)
The percentage change in price is equal to (2.20 – 1.80)/2.00 x 100 = 20%. If the price elasticity
of demand is 0.2, quantity demanded will fall by 4% in the short run[20% x 0.2]. If the price elasticity of
demand is 0.7, quantity demanded will fall by 14% in the long run [20% x 0.7].
b. Why might this elasticity depend on the time horizon?
Over time, consumers can make adjustments to their homes by purchasing alternative heat
sources such as natural gas or electric furnaces. Thus, they can respond more easily to the change in the
price of heating oil in the long run than in the short run.

7. A price change causes the quantity demanded of a good to decrease by 30 percent, while the total
revenue of that good increases by 15 percent. Is the demand curve elastic or inelastic? Explain.
If quantity demanded fell, price must have increased according to the law of demand. For a
price increase to increase total revenue, the percentage increase in the price must be greater than the
percentage decline in quantity demanded. Therefore, demand is inelastic

8. Cups of coffee and donuts are complements. Both have inelastic demand. A hurricane destroys half
the coffee bean crop. Use appropriately labeled diagrams to answer the following questions.

a. What happens to the price of coffee beans?

The effect on the market for coffee beans is shown in the figure. When a hurricane destroys
half of the crop, the supply of coffee beans decreases, the price of coffee beans increases, and the
quantity decreases.
Price S2
S1

Demand

Quantity

b. What happens to the price of a cup of coffee? What happens to total expenditure on cups of coffee?
The effect on the market for cups of coffee is shown in the figure above. When the price of
coffee beans, an important input into the production of a cup of coffee, increases, the supply of cups of
coffee decreases, the price of a cup of coffee increases, and the quantity decreases.
Because cups of coffee have an inelastic demand, when the price of a cup of coffee increases,
the total expenditure on coffee increases.

c. What happens to the price of donuts? What happens to total expenditure on donuts?
The effect on the market for donuts is shown in the figure. When the price of coffee increases
and the quantity demanded of coffee decreases, consumers demand fewer donuts because coffee and
donuts are complements. When demand decreases, the price of donuts decreases.
Because donuts have an inelastic demand, when the price of donuts decreases, the total
expenditure on donuts decreases.
 Price
Supply

D2 D1

9. The New York Times reported (Feb.17, 1996) that subway ridership declined after a fare increase:
“There were nearly 4 million fewer riders in December 1995, the first full month after the price of a
token increased 25 cents to $1.50, than in the previous December, a 4.3 percent decline.”

a. Use these data to estimate the price elasticity of demand for subway rides.
The percentage change in price (using the midpoint formula) is (1.50 – 1.25)/(1.375) × 100% =
18.18%. Therefore, the price elasticity of demand is 4.3/18.18 = 0.24, which is very inelastic.

b. According to your estimate, what happens to the Transit Authority’s revenue when the fare rises?
Because the demand is inelastic, the Transit Authority's revenue rises when the fare rises.

c. Why might your estimate of the elasticity be unreliable?

The elasticity estimate might be unreliable because it is only the first month after the fare
increase. As time goes by, people may switch to other means of transportation in response to the price
increase. So the elasticity may be larger in the long run than it is in the short run.

10. You are the curator of a museum. The museum is running short of funds, so you decide to increase
revenue. Should you increase or decrease the price of admission? Explain.
To determine whether you should increase or decrease the price of admissions, you need to
know if the demand is elastic or inelastic. If demand is elastic, a decline in the price of admissions will
increase total revenue. If demand is inelastic, an increase in the price of admissions will cause total
revenue to rise.
11. Melissa buys an iPhone for $120 and gets consumer surplus of $80.

a. What is her willingness to pay?

Consumer surplus is equal to willingness to pay minus the price paid. Therefore, Melissa’s
willingness to pay must be $200 ($120 + $80).

b. If she had bought the iPhone on sale for $90, what would her consumer surplus have been?
Her consumer surplus at a price of $90 would be $200 − $90 = $110.

c. If the price of an iPhone were $250, what would her consumer surplus have been?
If the price of an iPhone was $250, Melissa would not have purchased one because the price is
greater than her willingness to pay. Therefore, she would receive no consumer surplus.

12. An early freeze in California sours the lemon crop. Explain what happens to consumer surplus in the
market for lemons. Explain what happens to consumer surplus in the market for lemonade. Illustrate
your answers with diagrams.
If an early freeze in California sours the lemon crop, the supply curve for lemons shifts to the left,
as shown in the fiigure. The result is a rise in the price of lemons and a decline in consumer surplus from
A + B + C to just A. So consumer surplus declines by the amount B + C.
In the market for lemonade, the higher cost of lemons reduces the supply of lemonade, as
shown in the figure. The result is an increase in the price of lemonade and a decline in consumer surplus
from D + E + F to just D, a loss of E + F. Note that an event that affects consumer surplus in one market
often has effects on consumer surplus in other markets.
13. Suppose the demand for French bread rises. Explain what happens to producer surplus in the market
for French bread. Explain what happens to producer surplus in the market for flour. Illustrate your
answers with diagrams.
A rise in the demand for French bread leads to an increase in producer surplus in the market for
French bread, as shown in the figure. The shift of the demand curve leads to an increased price, which
increases producer surplus from area A to area A + B + C.

The increased quantity of French bread being sold increases the demand for flour, as shown in
the figure. As a result, the price of flour rises, increasing producer surplus from area D to D + E + F. Note
that an event that affects producer surplus in one market leads to effects on producer surplus in related
markets.
14. It is a hot day, and Bert is thirsty. Here is the value he places on each bottle of water:
Value of first bottle $7
Value of second bottle $5
Value of third bottle $3
Value of fourth bottle $1

a. From this information, derive Bert’s demand schedule. Graph his demand curve for bottled water.
Bert’s demand schedule is:

Price Quantity demanded

More than $7 0
$5 to $7 1
$3 to $5 2
$1 to $3 3
$1 or less 4

Bert’s demand curve is:

b. If the price of a bottle of water is $4, how many bottles does Bert buy? How much consumer surplus
does Bert get from his purchases? Show Bert’s consumer surplus in your graph.
When the price of each bottle of water is $4, Bert buys two bottles of water. His consumer
surplus is shown as area A in the figure. He values his first bottle of water at $7, but pays only $4 for it,
so has consumer surplus of $3. He values his second bottle of water at $5, but pays only $4 for it, so has
consumer surplus of $1. Thus Bert’s total consumer surplus is $3 + $1 = $4, which is the area of A in the
figure.

c. If the price falls to $2, how does quantity demanded change? How does Bert’s consumer surplus
change? Show these changes in your graph.
When the price of each bottle of water falls from $4 to $2, Bert buys three bottles of water, an
increase of one. His consumer surplus consists of both areas A and B in the figure, an increase in the
amount of area B. He gets consumer surplus of $5 from the first bottle ($7 value minus $2 price), $3
from the second bottle ($5 value minus $2 price), and $1 from the third bottle ($3 value minus $2 price),
for a total consumer surplus of $9. Thus consumer surplus rises by $5 (which is the size of area B) when
the price of each bottle of water falls from $4 to $2.
15. Ernie owns a water pump. Because pumping large amounts of water is harder than pumping small
amounts, the cost of producing a bottle of water rises as he pumps more. Here is the cost he incurs to
produce each bottle of water:
Cost of first bottle $1
Cost of second bottle $3
Cost of third bottle $5
Cost of fourth bottle $7

a. From this information, derive Ernie’s supply schedule. Graph his supply curve for bottled water.
Ernie’s supply schedule for water is:
Price Quantity supplied
More than $7 4
$5 to $7 3
$3 to $5 2
$1 to $3 1
$1 or less 0

Ernie’s supply curve is:

b. If the price of a bottle of water is $4, how many bottles does Ernie produce and sell? How much
producer surplus does Ernie get from these sales? Show Ernie’s producer surplus in your graph.
When the price of each bottle of water is $4, Ernie sells two bottles of water. His producer
surplus is shown as area A in the figure. He receives $4 for his first bottle of water, but it costs only $1 to
produce, so Ernie has producer surplus of $3. He also receives $4 for his second bottle of water, which
costs $3 to produce, so he has producer surplus of $1. Thus Ernie’s total producer surplus is $3 + $1 = $4,
which is the area of A in the figure.

c. If the price rises to $6, how does quantity supplied change? How does Ernie’s producer surplus change?
Show these changes in your graph.
When the price of each bottle of water rises from $4 to $6, Ernie sells three bottles of water, an
increase of one. His producer surplus consists of both areas A and B in the figure, an increase by the
amount of area B. He gets producer surplus of $5 from the first bottle ($6 price minus $1 cost), $3 from
the second bottle ($6 price minus $3 cost), and $1 from the third bottle ($6 price minus $5 price), for a
total producer surplus of $9. Thus producer surplus rises by $5 (which is the size of area B) when the
price of each bottle of water rises from $4 to $6.
16. The cost of producing flat-screen TVs has fallen over the past decade. Let’s consider some
implications of this fact.

a. Draw a supply-and-demand diagram to show the effect of falling production costs on the price and
quantity of flat-screen TVs sold.
The effect of falling production costs in the market for flat-screen TVs results in a shift to the
right in the supply curve, as shown in the figure. As a result, the equilibrium price of flat-screen TVs
declines and the equilibrium quantity increases.

Price of flat-screen TVs

S1 S2

A
P1 D
B C
P2
E F
G

Demand
Q1 Q2 Quantity of flat-screen TVs

b. In your diagram, show what happens to consumer surplus and producer surplus.
The decline in the price of flat-screen TVs increases consumer surplus from area A to A + B + C +
D, an increase in the amount B + C + D. Prior to the shift in supply, producer surplus was areas B + E (the
area above the supply curve and below the price). After the shift in supply, producer surplus is areas E +
F + G. So producer surplus changes by the amount F + G – B, which may be positive or negative. The
increase in quantity increases producer surplus, while the decline in the price reduces producer surplus.
Because consumer surplus rises by B + C + D and producer surplus rises by F + G – B, total surplus rises
by C + D + F + G.

c. Suppose the supply of flat-screen TVs is very elastic. Who benefits most from falling production costs?
- consumers or producers of these TVs?
If the supply of flat-screen TVs is very elastic, then the shift of the supply curve benefits
consumers most. To take the most dramatic case, suppose the supply curve were horizontal, as shown
in the figure. Then there is no producer surplus at all. Consumers capture all the benefits of falling
production costs, with consumer surplus rising from area A to area A + B.
Price of flat-screen TVs

A
S1
B
S2

Demand

Quantity of flat-screen TVs