- Spending the first $50 on advertising would increase your profit; spending the second $50 would decrease your profit.
- Spending the first $50 on advertising would increase your profit; spending the second $50 would also increase your profit.
- Overall, your business's total profit will be positive if you spend the first $50 on on advertising; your business's total profit will be negative if you spend the second $50.
- Both statements (a) and (c) are definitely correct.
- Both statements (b) and (c) are definitely correct.
| Chris | Taylor | ||||
|---|---|---|---|---|---|
| No trade | clothing | food | clothing | food | |
| 20 | 20 | 33 | 9 | I | |
| With trade | clothing | food | clothing | food | |
| produce | 0 | 40 | 60 | 0 | II |
| trade | +24 | -12 | -24 | +12 | |
| consume | 24 | 26 | 36 | 12 | III |
- Scenario I: If John doesn't use the value on his card at one of the participating restaurants, that value is completely lost. This is the view expressed in the following quote from an Atlanta Journal-Constitution story ("New UGA meal card is ticket to Athens; Students who pay in have choice of downtown eateries", Sept. 6, 2002): "[a] UGA student was quoted as saying that `my parents like the idea the most; this way they can make sure I'm eating with my money and not spending it other places.'"
- Scenario II: John can sell his card to another person, who is willing to pay him an amount of cash that depends on the unused value remaining on the card.
- is higher in scenario I
- is higher in scenario II
- is the same positive number in both scenario I and scenario II
- is equal to zero in both scenario I and scenario II
- a rise in income and a rise in the price of Peanuts
- a fall in income and a fall in the price of Peanuts
- a rise in income and a rise in the price of Hot Dogs
- a fall in income and a fall in the price of Hot Dogs
- a fall in the price of peanuts and a rise in the price of hot dogs
- We know that Jane likes Bundle B better than she likes Bundle A.
- We know that Jane likes Bundle C better than she likes Bundle A.
- We know that Jane likes Bundle C better than she likes Bundle B.
- Answers (b) and (c) are both correct.
- Answers (a), (b), and (c) are all correct.
- To be able to afford one more meal, Richard has to give up two shirts.
- To obtain one more meal, Richard is willing to give up two shirts.
- To obtain one more shirt, Richard is willing to give up two meals.
- Both (a) and (b) are correct.
- Both (a) and (c) are correct.
- more ; fewer
- fewer ; more
- more ; more
- fewer ; fewer
- Not enough information is given to determine how much X Tom or Jerri should buy.
The accompanying figure is Rob's demand curve for cake.
According to the picture, when
the price of a cake is $5, Rob will buy ____ cakes.
[answer and explanation]
- the price of good X fell
- the demand curve for good X shifted to the right
- Either (a) or (b) could have occurred.
- Both (a) and (b) must have occurred.
- The statement could never be true.
I. An increase in income
II. An increase in the price of a Y
III. An increase in the price of a Z
Which of the changes described above would cause the demand curve for X to shift to the left? [answer and explanation]
- shift to the right of ; shift to the left of ; shift to the right of
- shift to the right of ; shift to the right of ; shift to the left of
- movement down along ; shift to the left of ; shift to the right of
- shift to the right of ; movement up along ; movement down along
- movement down along ; movement up along ; movement down along
(i) Scientific studies indicate that eating products made out of soy has beneficial health effects. People buy more (soy) tofu.
(ii) Automobile company X reduces the price it charges for its cars by $1000. People buy more of company X's cars.
(iii) Due to a disease that harms cows, the price of milk rises substantially. Because they eat less cold cereal, people buy more oatmeal.
(iv) Because there are more people who need them (i.e., there are more old folks), people buy more wheelchairs.
In how many of the above cases are the increased purchases (of tofu, X cars, oatmeal, and wheelchairs) best explained by saying there was "an increase in demand" for the relevant product? [answer and explanation]
- number of units of the good they buy
- total amount they spend on the good
- Both (a) and (b) are correct.
- Neither (a) nor (b) is correct.
- negative ; complements
- negative ; substitutes
- positive ; complements
- positive ; substitutes
- zero ; unrelated
- The elasticity of demand for product X is a smaller number than it had previously believed.
- The incomes of the customers of Product X rise (assuming Product X has a positive income elasticity).
- Product Y, which has a negative cross-price elasticity with Product X, becomes more expensive.
- All of (a)-(c) would be bad news for the seller of Product X.
- None of (a)-(c) would be bad news for the seller of Product X.
- the quantity demanded of both goods, and the total expenditure on both goods
- the quantity demanded of (only) good X, and the total expenditure on (only) good X
- the quantity demanded of (only) good Y, and the total expenditure on (only) good Y
- the total expenditure on (only) good X
- the total expenditure on (only) good Y
- Case A: the price elasticity for a general product category. Case B: the price elasticity for a specific brand within a general product category.
- Case A: the price elasticity for gasoline when the change in quantity demanded is computed over a few months. Case B: the price elasticity for gasoline when the change in quantity demanded is computed over a few years.
- The Case A elasticity is larger than is the Case B elasticity for both (a) and (b).
- The Case A elasticity is larger than is the Case B elasticity for neither (a) nor (b).
Question 1 answer is: a. Spending the first $50 on advertising would increase your profit; spending the second $50 would decrease your profit.
Explanation: This questions relates to the principle of looking at marginal changes to determine the best amount of some activity to undertake. Specifically, if you are considering doing a "little more" of something, you should compare the resulting marginal benefit you will receive with the resulting marginal cost you will incur.
In this particular situation, the marginal cost of an advertisement is always $50.
The marginal benefit of advertising depends on the the profit you earn from each sale, and on the amount by which your sales increase. Here, each sale earns you a profit of $10 (you sell at a price of $20 something that costs you $10). The first ad produces 7 new sales, and thus its marginal benefit (the increase in your profit) is $70. For the first ad, therefore, MB ($70) is greater than MC ($50), which tells us that buying the first advertisement increases your profit.
For the second ad, the story is different. The marginal cost is still $50, but now the marginal benefit is only $20 (an increase of 2 sales at a $10 profit per sale). Since MB is less than MC, buying the second ad decreases your profit.
Note one important point. Looking at marginal effects can tell us only how changes in behavior will change your overall outcome. Marginal analysis can not tell us whether your overall outcome is good or bad; it tells us only whether that outcome is getting better or getting worse.
This is why statement (c) is not a correct answer.
We know for sure that buying the first ad will raise your firm's profit, while buying the second will reduce it. It is therefore possible that your total profit will be positive if you buy one ad and negative if you buy two. But, it's not true that this is the only possible outcome. Rather, it's also possible that your firm's overall profit might be positive in both situations (but bigger in the first than in the second). It's also possible that your profit might be negative in both situations (but less negative in the first than in the second). Statement (c) can be true, but is not definitely true.
The bottom line is to remember that looking at marginal benefit and marginal cost is a very important way to determine how changes in behavior will cause an outcome to change. Comparing MB and MC tells us whether an taking a certain action will make the outcome better or worse. However, even if an outcome is getting worse, it can still be an (overall) positive outcome -- it just won't be as positive as it could have been. [Correspondingly, even if an outcome is getting better, it can still be an (overall) negative outcome -- just not as bad as it could have been.]
Question 2 answer is: b. only I and II
Explanation: In the no-trade world (in which a person can consume only what he or she produces), Chris and Taylor are restricted to both produce and consume on (or inside) their respective production possibilities frontiers. The quantities given in row I are thus correct answers.
Opening up trade between Chris and Taylor doesn't alter either person's production capabilities. When each of them specializes by producing only a single good, Chris and Taylor are still producing on their PPFs. [Graphically, each person is producing at one of the points where a PPF hits an axis (for either clothing or food.] The quantities given in row II are thus correct answers.
When trade is possible, Chris and Taylor can --- through specialization and exchange --- consume quantities of goods that are outside their PPFs. The quantities given in row III are thus not on their PPFs, and are not correct answers.
Question 3 answer is: b. 1/10 ; 1/8
Explanation: The first part of the question is answered simply by finding the amount of fruit that Wilma can produce in one hour. We know that if Wilma works a full 10-hour day, she can produce 1 basket of fruit. Therefore, in 1 hour, it must be true that Wilma can produce 1/10 of a basket of fruit.
For the second part of the question, we start out by finding the amount of cloth that Wilma can produce in one hour. Since we know that, in a 10-hour day, Wilma can produce 5 feet of cloth, it must be true that Wilma can produce 1/2 of a foot of cloth per hour. The question tells us that for every 1 foot of cloth that Wilma gives to Betty, Wilma gets back 1/4 of a basket of fruit. If Wilma gives Betty one-half of a foot of cloth, therefore, she'll get back one-half of the 1/4 basket of fruit. In other words, by producing cloth for one hour, Wilma can get (through trade) 1/8 of a basket of fruit.
It's probably easier to compute the answer by using the following formula (in which Wilma's "production rate" is multiplied by the "trade rate"):
|
While the question doesn't ask this, note that (since 1/8 is more than 1/10) Wilma gets more fruit by devoting one hour of work to producing cloth and trading for fruit than she could get by producing fruit on her own.
Question 4 answer is: b. is higher in scenario II
Explanation: To measure the opportunity cost of an action, one looks at the (best) alternative action that a person could have taken instead. In scenario II, John could either use his meal card to pay for his own food, or he could sell the card to some other person and receive cash. John could then spend that cash on some "other" item. Thus, in scenario II, when John uses his card to pay for a meal he is giving up something -- whatever else he would have purchased with the money he got by selling the card. In this situation, there is an opportunity cost to John of using the card to pay for a meal.
In scenario I, in contrast, there is literally nothing else that John can do with his meal card other than use it to pay for food (which is what his parents wanted him to do). John either uses the value on the card at a restaurant, or the card sits unused in a drawer. If John uses the card to pay for food, he is not giving up any alternative that he could have acquired instead. In this situation, therefore, there is no opportunity cost to using the meal card to pay for food.
Question 5 answer is: d. higher ; smaller
Explanation: Having more "space" in a vehicle means that it uses more gasoline. There is thus an opportunity cost (in this case, it's an explicit cash cost) to having more "space". The more expensive is gasoline, the greater is this cost. Since gas costs more in Country A, the cost of space in that country is higher than it is in Country B.
Since the cost of space in higher in Country A, people will tend to consume less space there; i.e., residents of Country A will drive smaller cars.
[In the real world, obviously, you could think of Country A as being in Europe, and Country B as being the United States.]
Question 6 answer is: c. a rise in Income and a rise in the Price of Hot Dogs
Explanation: When the location of a budget constraint moves because of changes in two monetary values, one can just piece together the movements that result from each change, and see which two changes could possibly add up to that shown in the figure.
Take the possible answers in order. A rise in Income and a rise in the Price of Peanuts would mean that the budget constraint shifts out, and then the horizontal intercept moves in. One net effect must be that the maximum quantity of Hot Dogs that Bobby can afford increases. This is inconsistent with the picture, so answer a is not correct.
A fall in Income and a fall in the Price of Peanuts would mean that the BC shifts in, and then the horizontal intercept moves out. One net effect must be that the maximum quantity of Hot Dogs that Bobby can afford decreases. This is inconsistent with the picture, so answer b is not correct.
A rise in Income and a rise in the Price of Hot Dogs would mean that the BC shifts out, and then the vertical intercept moves down. One net effect must be that the maximum quantity of Peanuts that Bobby can afford increases. This is consistent with the picture. If the two changes just balanced each other, it's possible that the maximum quantity of Hot Dogs that Bobby can afford would -- as shown in the picture -- not change. Answer c is certainly a possible correct answer; let's check the other possibilities.
A fall in Income and a fall in the Price of Hot Dogs would mean that the BC shifts in, and then vertical intercept moves up. One net effect must be that the maximum quantity of Peanuts that Bobby can afford decreases. This is inconsistent with the picture, so answer d is not correct.
A fall in the Price of Peanuts and a rise in the Price of Hot Dogs would mean that the horizontal intercept would move out, while the vertical intercept would move down. One net effect muct be that the maximum quantity of Hot Dogs that Bobby can afford decrease. This is inconsistent with the picture, so answer e is not correct.
While the changes described in answer c aren't guaranteed to produce the movement shown in the picture (the maximum quantity of Hot Dogs that Bobby can afford could increase, decrease, or remain unchanged depending on the relative size of the changes their Price and in Bobby's Income), it is the only one of the five choices that could possibly produce that picture. Answer c must therefore be the correct choice.
Question 7 answer is: d. Answers (b) and (c) are both correct -- which means that we know only that Jane likes Bundle C better than she likes either Bundle A or Bundle B.
Explanation: Since Jane likes both shakes and hamburgers, we know that she must like a bundle that has more of both goods better than she likes a bundle that has less of both goods. She thus definitely prefers Bundle C to the other two bundles.
The remaining question is whether we can say anything about whether Jane likes Bundle A better than Bundle B, or vice versa. In fact, we can't make any such statement. Bundle A has more hamburgers, while Bundle B has more shakes. If Jane really likes hamburgers (and only somewhat likes shakes), she would like Bundle A better than B. On the other hand, if Jane really likes shakes (and only somewhat likes hamburgers), she would like Bundle B better than A. Since we don't know enough about Jane's preferences to distinguish between these two possibilities, we can't say which of these two bundles she likes better.
If we did know what Jane's indifference curves looked like, we could easily determine whether she liked Bundle A or Bundle B better by simply seeing whether A or B was on a higher indifference curve. Since we don't have information about the shapes of her indifference curves, however, we again conclude that we can't tell whether Jane likes Bundle A or Bundle B better.
Note in particular that we can't simply add together the number of shakes and the number of hamburgers and decide that Jane likes Bundle B better than Bundle A because B has 8 items while A has only 7. Adding together in this way is correct only if Jane gets exactly the same amount of satisfaction from a shake as she gets from a hamburger. If Jane is completely indifferent between a shake and a burger, then 8 "things" is preferable to 7 "things." Since we don't know how Jane values one shake compared to one burger, however, we can't know how she ranks these two bundles.
Finally, note that the costs of the three bundles (or whether or not Jane can afford to buy any or all of them) are irrelevant to this question. The question asks only about which bundle(s) Jane likes better than she does others. This question is entirely distinct from the issue of how much the bundles cost.
Question 8 answer is: a. steep ; flatter
Explanation: A person who is "very close to becoming a full-fledged vegetarian" would presumably place a lower value on a unit of beef than would an "average" person. Correspondingly, such a person would presumably value tofu more heavily than would an "average" person. When thinking about the near-vegetarian's consumption prefernces, therefore, we would expect him to be willing to give up a lot of beef (which he doesn't much value) in exchange for a fairly small amount of tofu (which he does value). [At a minimum, the above statements should be true when comparing the attitudes of the near-vegetarian with those of an average person.]
From the question, remember that the vertical axis measures units of beef, and the horizontal axis measures units of tofu. Start with some arbitrary combination of beef and tofu, which gives the near-vegetarian some particular level of satisfaction. To find another combination of beef and tofu that gives him the same degree of satisfaction (i.e., to find another point on the same indifference curve that goes through the original point), we imagine a point with a lot less beef (because each unit of beef matters only a very little to him), and only modestly more tofu (because a fairly small increase in the amount of tofu -- on which he places a relatively greater value -- will offset the drop in satisfaction from losing the beef).
Uisng an indifference curve to connect the two points that provide the same level of satisfaction therefore produces an IC that is rather steep (at least when compared to an IC of an average person).
For the second part of the question, remember that graphs of budget constraints have the quantities of the relevant goods on the axes (not their prices). When the price of beef rises (with nothing else changing), the maximum amount of beef that any person can afford to buy falls. The point at which the budget constraint hits the vertical intercept thus falls. Clearly, such a change makes a person's BC flatter.
Question 9 answer is: b. To obtain one more meal, Richard is willing to give up two shirts.
Explanation: The three possible answers are all similar in one way: they all involve a ratio of 2 units of one good versus 1 unit of the other good.
One difference between the answers is that answer a states that the 2:1 ratio is relevant to what Richard is "able to afford". Answers b and c both state that the ratio is relevant to the amount of one good that Richard is "willing to give up" to get the other good.
Any statement about what an individual can afford must relate to a person's budget constraint. In the diagram, we see that the (absolute value of the) slope of Richard's BC equals one. [We know this because the vertical and horizontal intercepts of the BC equal each other.] The prices of one shirt and of one meal thus must equal each other. To afford one more meal, therefore, Richard has to give up only one shirt. Answer a is incorrect.
Two points are labeled on Richard's indifference curve. The (absolute value of the) slope of the IC between these points equals (1/2) -- moving between the points involves going vertically one unit (9 vs. 8) and going horizontally two units (30 vs. 32). It is between these two points that Richard is willing to trade off (which is what an indiffernec curve tells us) the goods at a 2:1 rate.
Specifically, starting from point X, a trade in which Richard gave up two shirts and got one meal would neither make him better off nor worse off (i.e., such a trade would leave him on the same indifference curve). Richard would rather give up fewer than two shirts to obtain one meal, but at point X he is willing to make a give-up-2-shirts-to-get-1-meal trade. Answer b is correct.
To explain why answer c is incorrect: it would be an appropriate statement if the indifference curve at the relevant point had an (absolute value of the) slope equal to 2 -- i.e., if Richard was willing to give up 2 units of the good on the vertical axis (2 meals) to get 1 unit of the good on the horizontal axis (1 shirt). The indifference curve doesn't have this slope at point X (although it must have this slope at some other point).
In fact, starting from point X, making a 2-meal-for-1-shirt trade would leave Richard with 6 meals and and 33 shirts; that cobination of goods would leave Richard below the lliustrated indifference curve. Richard is not willing to make this trade because so doing would leave him worse off than he is at point X.
Question 10 answer is: a. more ; fewer
Explanation: Through the point (10,10), the (absolute value of the) slope of Tom's indifference curve equals 2. This tells us that (starting from that point) giving up 2 units of Y and getting 1 unit of X leaves Tom just as well off as he was at (10,10). In other words, Tom is willing to give up as many as 2 Y to obtain 1 X.
On the other hand, Jerri's indifference curve tells us that (starting from (10,10)) giving up 1 unit of Y and getting 2 units of X leaves her just as well off as she was originally. In other words, Jerri is willing to give up no more than 1 Y in exchange for 2 X, and is willing to give up no more than 2 X in exchange for 1 Y.
Each of the good costs $1. Thus, we know that Tom and Jerri both have budget constraints with (absolute value of the) slopes equal to 1.
Tom is willing to give up 2 Y to get 1 X. In fact, he only has to give up 1 Y to get 1 X. He should do exactly that -- he should buy more than 10 X.
Jerri is willing to give up 2 X in exchange for 1 Y. In fact, she only has to give up 1 X to get 1 Y. She should do that -- she should buy less than 10 X.
Another way to answer this question is to draw a picture that illustrates the described situation. Looking at that picture might make the answer clearer than the does the above written explanation.
Question 11 answer is: b. 6
Explanation: First, remember the demand curve described above does not tell us that when the price of cake is $8, Rob chooses to buy 16 cakes. Rather, it tells us that when the price of cake equals $8, Rob buys 0 cakes, and then his consumption of cake increases as the price falls, until he's buying 16 cakes when the price is $0.
To figure out consumption when the price is $5, start at $5 on the vertical axis, and draw a straight horizontal line until you hit the demand curve. Then go straight down from there until you hit the horizontal axis. The number where you hit the horizontal axis is the number of cakes that Rob buys.
This number can be found in two ways. Both use the fact that the (absolute value of the) slope of the demand curve is 1/2.
[By the way, we know that the (absolute value of the) slope of the demand curve equals 1/2 because the intercepts described above are 8 and 16. Moving down the demand curve from the vertical intercept to the horizontal intercept involves moving down 8 units and over 16 units. Since slope equals (vertical movement) divided by (horizontal movement) (or "rise" divided by "run"), the (absolute value of the) slope equals 8 divided by 16.]
We start our calculations at the vertical intercept of the demand curve (where price = $8 and quantity = 0). Since we are interested in a price of $5, we lower the price from $8 to $5, which entails moving down $3. Since you went down three units, you must go over 6 units. Why 6 units? Because we know that the (absolute value of the) slope of the demand curve = 1/2 (we computed this above), and this fact tells us that when we slide along the demand curve, a 1 unit movement in the vertical direction always matches up with a 2 unit movement in the horizontal direction. Remembering that a price of $8 matched up with a quantity of zero units, moving down along the demand curve by $3 (from a price of $8 to a price of $5) entails moving over 6 units (from a quantity of 0 to a quantity of 6).
Alternatively, you can use the formula y=b+mx, or in this case P=(intercept)+(slope)Q. The intercept here is 8; the slope is – 1/2 (here you have to use the minus sign). Thus, P=8-(1/2)Q. Plugging P=5 into the equation and solving produces (1/2)Q=3, or Q=6.
[If you'd like one more question on which to practice, here's one. Straight-line demand curve, vertical intercept at 15, horizontal intercept at 5. What Quantity will this person buy when the Price equals 6? The answer is very near the bottom of this page.]
Question 12 answer is: a. the price of good X fell
Explanation: The quoted passage states that there was no change in the demand for good X. This immediately rules out any answer (all of b, c, and d) in which the demand curve for X shifts. Saying there is no change in demand is equivalent to saying that there has been no movement of the entire demand curve.
The only remaining issue is whether it is possible for quantity demanded to increase without a shift of demand. Such an outcome is, of course, perfectly logical -- it would simply entail a downward movement between two points on a stationary demand curve. Such a movement would be the result of a fall in the price of good X.
Question 13 answer is: c. both I (an increase in income) and II (an increase in the price of Y -- a complement)
Explanation: Remember first that an inferior good (like good X) is one for which people buy less of the good as their income rises (possibly because they can now afford something they like better), and correspondingly buy more of the good as their income falls.
Also, remember that a leftward shift in a demand curve represents a reduction in the amount that people want to buy. Putting these together, an increase in income causes people to buy less of an inferior good, which is shown by shifting the demand curve for X to the left. Possibility I is thus correct.
Now, remember that when two goods are complements, people tend to use them together. If the price of Y rises, people will consume less Y. If X and Y are complements, people will then consume less X. Again this is represented by shifting the demand curve for X to the left (to lower levels of quantity). Possibility II is thus correct.
Finally, remember that when two goods are substitutes, people tend to consume one or the other. If the price of Z rises, people will consume less Z. If X and Z are substitutes, people will then consume more X (to replace some of the Z they've given up). We would represent this by shifting the demand curve for X to the right (to higher levels of quantity). Possibility III is thus incorrect.
Question 14 answer is: c. movement down along ; shift to the left of ; shift to the right of
Explanation: The changes in behavior described in this question are all caused by a single event -- a fall in the price of bread. This change causes people to buy more bread (because it got cheaper), to buy less rice (bread and rice are substitutes, and people who buy more bread will choose to buy less rice), and to buy more butter (bread and butter are complements, and people who buy more bread will choose to buy more butter).
The reason that people in this situation have increased their purchases of bread is not because there's been a change in the degree to which they like bread. In fact, there's no reason to think that their fundamental attitude toward bread has changed at all. In other words, their demand curve for bread has not moved -- it has remained stationary.
What has changed, however, is that bread buyers are at a different "point" on the market demand curves than they were before. Since the price of bread fell, consumers "moved down" along a stationary demand curve to a point that represented a (lower Price, higher Quantity) combination than they were at before.
In contrast, consumers really do have different attitudes concerning the amounts of rice and butter they wish to buy. Even if the prices of these goods were to remain unchanged, people would want (for the reasons noted above) to buy less rice and more butter than they had been previously buying. Thus, by fundamentally altering the amount of rice and butter that consumers want to buy, a fall in the price of bread shifts the demand curves for rice and butter.
Specifically, since people wish to buy less rice than they were buying earlier, the demand curve for rice has shifted to the left (towards lower quantities); since people want to buy more butter than before, the demand curve for butter has shifted to the right (towards higher quantities).
Question 15 answer is: d. 3
Explanation: There are basically two reasons why people might increase their purchases of a product -- either the product gets cheaper (which can lead people to buy more of the good even if they don't necessarily "like" it any better), or people have (for some reason) become fundamentally more interested in buying the product (so that they'll buy more of it even if its price remains unchanged).
The first reason -- buying more of an item only because it gets cheaper -- is illustrated by moving between two points on a stationary demand curve. The fact that the demand curve doesn't move tells us that people's basic attitudes toward the product haven't changed; rather, the change in their behavior is entirely response to the lower price. Such a change in behavior is not called an increase in demand -- demand itself didn't change, which is illustrated by the fact that the demand curve didn't move. [The change is behavior is instead called a change in quantity demanded.]
The second reason -- buying more of an item because the consumers' interest in having it has changed -- is called an increase in demand. Demand increases in this case because the entire demand curve shifts. In this case, people are altering their behavior not because the good's price has changed, but because either their preferences or information have changed, their incomes have changed, the price of some related product (a complement or a substitute) has changed, or the number of people of the type who wish to possess the product has changed.
This question requires us to determine how many of the four cases are examples of an increase in demand (a shift of the demand curve) as opposed to only an increase in quantity demanded (a movement along a stationary demand curve).
One case is clearly not an increase in demand -- in situation (ii), the reason that people are buying more X cars is not that they fundamentally like the cars any better (if the price hadn't fallen, we are given no reason to believe that people would have increased their purchases). Rather, people are buying more simply because the manufacturer has reduced their price. The demand curve for X cars didn't shift -- rather the consumption point just moved down along a stationary demand curve.
The other three cases are examples of increases in demand (shifts of the demand curve). The information about health benefits leads people to "like" tofu better and therefore to buy more of it (even if its price remains unchanged). The rise in the price of milk causes a substitute for oatmeal (cold breakfast cereal with milk) to become more expensive; people thus choose to buy more oatmeal (even at an unchanged price). The rise in the number of old people means that there are more people interested in owning wheelchairs (even at an unchanged price). People are not buying more tofu, oatmeal, or wheelchairs because those products got less expensive. Rather, the market demand curves for these products shifted to the right -- demand increased -- because people are fundamentally more interested in buying them. At an unchanged price, people will decide to buy more units. That is an increase in demand.
Question 16 answer is: c. 1.33
Explanation: In this question, we are given the information needed to compute price elasticity in the simplest way. Remember that the definition of price elasticity indicates that (where we're using very awkward looking signs for "absolute value"):
| elasticity | = | | | percentage change in quantity demanded percentage change in price |
| |
This prob>em gives the changes in quantity and price in percentage terms, so all one has to do is plug the numbers into the elasticity formula -- always remember that the percentage change in quantity goes on the top of the fraction and the percentage change in price goes on the bottom -- to get 8%/6% = 1.33.
Question 17 answer is: b. 1/4.
Explanation: The following shows the basic formula for price elasticity, as well as one method that can be used to compute it:
| elasticity | = | | | percentage change in quantity demanded percentage change in price |
| | = | | | (actual change in Q) / (average Q) (actual change in P) / (average P) |
| |
In other words, the percentage change in something is equal to the (actual change between the starting and finishing values) / (average of the starting and finishing values).
| Price | Quantity Demanded |
|---|---|
| 2.1 | 7.9 |
| 1.9 | 8.1 |
The elasticity at $2 is found by using a slightly higher price (like $2.10) and a slightly lower price ($1.90), and computing the elasticity using the two points on the demand curve that match up with those prices. In class, we used a table like this to display price and quantity information like that given in this question.
Using these numbers, quantity demanded was originally 8.1, and changed to 7.9. The actual change in quantity is thus .2 (actually -.2, but since our answer will be in absolute-value, terms, we'll drop the minus sign), and the average value of quantity is 8.
Price was originally $1.90, and changed to $2.10. The actual change in price is thus .2, and the average value of price is 2.
Plugging these values into the elasticity formula produces
| elasticity | = | (actual change in Q) / (average Q) (actual change in P) / (average P) |
= | .2 / 8 .2 / 2 |
= | .2 8 |
× | 2 .2 |
= | 1 4 |
[One could also get the same answer by saying that the percentage change in quantity demanded is (.2/8)=.025=2.5%, and the percentage change in price is (.2/2)=.1=10%; combining these shows that the elasticity = .025 / .1 = 2.5% / 10% = 1/4.]
Question 18 answer is: e. 8% ; fall
Explanation: The first blank is solved as follows.
According to the definition
| Elasticity | = | | | % Change in Qd
% Change in P |
| |
Whenever we know two of these three terms, the formula can be used to figure out the third. Here, elasticity = 2, and percentage change in price = 4%. Plugging these two values into the formula produces
| 2 | = | | | % Change in Qd
4% |
| |
Solving this equation shows that the top value in the fraction must equal 8%. You may be able to simply see that 8% is the correct answer, or you may prefer to get the answer by cross multiplying to produce 2 × 4% = (percentage change in quantity demanded) = 8%.
For the second blank, the key point is that an elasticity equal to 2 tells us that demand is elastic at the current market price. When demand is elastic, a price increase creates a decrease in quantity demanded that is larger in percentage terms. Price rises, but quantity bought goes down by more (in percentage terms); as a result, the total amount spent on the good falls.
Question 19 answer is: d. elastic ; greater
Explanation: This question is similar to the one preceding it -- both rely on the link between (i) the demand elasticity for a product, and (ii) the relationship between a change in the product's price and the amount that people spend on it. In the previous question, however, you were told the elasticity and asked to determine how spending was affected by a price change. In this question, you're told what happened to spending, and asked to determine what must therefore be true about elasticity.
This question tells us a decrease in the price of a good caused the amount of money that people spend on the good to rise. In general terms, this tells us that people's behavior must be very responsive when the price of the good changes -- the only way a fall in price could lead to a rise in total expenditure is if people react to the fall in price by buying quite a bit more of the good.
More specifically, the pattern described in the question --- fall in P leading to rise TE -- can exist only if the demand for the good falls in the elastic range (i.e., only if the price elasticity of demand equals a value greater than 1).
Consistent with the above statement about consumer behavior being very responsive, elastic demand (elasticity greater than 1) holds when the value on top of the elasticity formula (the percentage change in Quantity demanded) is larger (in absolute value) than is the value on the bottom of the formula (the ' percentage change in Price).
Had the price decrease led to a reduction in spending, the answers would all reverse. In such a case, consumer behavior is relatively unresponsive, the elasticity is smaller than 1, and the percentage change in Quantity demanded in smaller (in absolute value) than is the percentage change in Price.
Question 20 answer is: a. number of units of the good they buy
Explanation: Demand curves are drawn with Price on the vertical axis and Quantity on the horizontal. The fact that a demand curve is downward sloping tells us only that as the Price rises, the Quantity demanded falls. [Or, of course, that as the Price falls, the Quantity demanded rises.]
Knowing only that a higher Price will result in fewer people buying a good doesn't tell us anything about the total amount that will be spent on the good. If the higher price leads to a large reduction in purchases, then the total amount spent will fall. If, on the other hand, the higher price leads to only a small reduction in purchases, then the total spent will rise. To know which of these cases actually occurs, we have to know the extent of the change in Quantity. In other words, we have to know something about the elasticity of demand. [Or, in demand curve terms, we need to know whether the demand curve is "steep" or "flat".]
Since we don't know the elastcity (or the "steepness" of the demand curve), we don't have enough information to determine anything about how the total amount spent on the good changes.
Question 21 answer is: b. 3%
Explanation: To answer this question, we use the the basic elasticity formula, plug in the two values we know, and solve for the third (the unknown) value.
| Elasticity | = | | | % Change in Qd
% Change in P |
| |
Plugging in what we know -- elasticity equals 2, and the desired change in quantity (the quantity sold by the firm and demanded by customers) equals 6% -- produces:
| 2 | = | | | 6%
% Change in P |
| |
Solving this equation to find the change in price necessary to produce this outcome results in: % Change in P × 2 = 6% or % Change in P = 6% / 2 = 3%.
Question 22 answer is: b. rise by 4%
Explanation: Note that this question differs from the previous one -- to answer it we need to use not just the elasticity formula, but also a second formula that gives us an (approximate) value for the change in the total expenditure on the good.
However, we start answering the question in the same way -- we plug the two values we know into the elasticity formula and solve for the third value. In this case, we know the Elasticity value and the Price change, and need to determine the Quantity change.
| Elasticity | = | | | % Change in Qd
% Change in P |
| |
Plugging in what we know -- elasticity equals 1/3, and the price rose by 6% -- produces:
| 1
3 |
= | | | % Change in Q
6% |
| |
Solving this equation to find the change in percentage change in Quantity demanded that results from the Price change results in: % Change in Q = 6% × 1/3 = 2%. Since the Price rose by 6%, the Quantity demanded fell by 2%.
Once we have this answer, we can use the following formula, which was explained in class.
|
[This is really an "approximation" formula rather than a strict "equality" formula.]
In using this formula, one has to be careful to use a minus sign where it is appropriate. If the price of the good rises, the quantity demanded falls. In this case, % Change in P is a positive number and % Change in Q is a negative number. [Similarly, if price is falling (% Change in P < 0), then quantity is rising (% Change in Q > 0).]
In this problem, % Change in Quantity = – 2% and % Change in Price = + 6%. Thus, % Change in TE = + 6% – 2% = + 4%.
Question 23 answer is: a. negative ; complements
Explanation: The question tells us that when Bull gets more expensive, the market demand curve for Dawg shifts left. By telling us this, the question informs us that when the price of Bull rises, people wish to buy less Dawg.
There are a number of different approaches to answering this question, One is to plug the two changes just described into the cross-price-elasticity formula, which has the "percentage change in the quantity demanded of one good" on top of the fraction, and the "percentage change in the price of another good" on the bottom. While we don't know the exact percentages in this question, we do know that the change in the price of Bull was positive, and that the change in the quantity demanded of Dawg was negative.
Plugging these two facts into the cross-price-elasticity formula leaves us with a negative number divided by a positive number. The value for the cross-price elasticity must therefore be negative. Once you know this you may simply remember that (by definition) two goods with a negative cross-price elasticity are complements.
Alternatively, one could begin to answer this question by reasoning out the relationship between the two goods, Obviously, a rise in the price of Bull leads people to buy less Bull. The question tells us that people also buy less Dawg. It therefore appears that people tend to consume Bull and Dawg together -- if they buy less Bull, they don't need as much Dawg. Bull and Dawg must therefore be complements.
Once you know this, you can use the definitions to remind you that two complementary goods have a negative cross-price elasticity.
The question could also be answered without using the "complements have negative cross-price elasticity" definition at all. You could instead reason out the answers to both the first and second blanks as described above.
Question 24 answer is: c. Product Y, which has a negative cross-price elasticity with Product X, becomes more expensive.
Explanation: When considering answer (a), remember that the "demand elasticity" (or price elasticity) measures the extent to which the quantity demanded of a good changes when its price changes. The bigger the value of the elasticity, the more that people cut back on their purchases when the price rises (and the more that people increase their purchases when the price falls). Conversely, the smaller the elasticity, the less that people cut back on their purchases when the price rises (and the less that people increase their purchases when the price falls).
When the seller of Product X finds out that the demand elasticity for its product is smaller than it had previously believed, it means the firm can raise its price and lose fewer customers than it had previously thought. That is clearly good news for the firm.
Considering answer (b): when a good has a positive income elasticity, a rise in income will lead consumers to buy more units of the good. Again, that is good news for the seller.
Answer (c) describes two goods that have a negative
cross-price elasticity between them. Remember that the
cross-price elasticity for Product X and Product Y is
computed using this formula:
|
If Product Y has a negative cross-price elasticity with Product X, it means that the change in the price of Y and the quantity demanded of X move in opposite directions. I.e., a positive change in the price of Y leads to a negative change in the quantity demanded of X. [Or, a negative change in the price of Y leads to a positive change in the quantity demanded of X.] It's the existance of one negative change and one positive change that make the cross-price elasticity a negative number.
In the case of a negative cross-price elasticity, a rise in the price of Product Y means that (other things equal) fewer units of Product X will be bought. That is bad news for sellers of X.
Another way to answer this question is to remember the definitions of complements and substitutes. In particular, two goods that have a negative cross-price elasticity between them are classified as complements. [A higher price for Y means that less Y is purchased, and if less X is also bought (so that X and Y are complements) then the price of Y and the quantity demanded of X are moving in opposite directions.] It's bad news for a firm when a complement of its good becomes more expensive.
Question 25 answer is: d. the total expenditure on (only) good X
Explanation: The fact that a demand curve has the standard downwad-sloping shape tells us higher Prices are associated with lower values for Quantity demanded (in turn, lower Ps are associated with larger Qs). Thus a fall in the price of either good will increase the quantity of that good that consumers wish to buy.
Whether a decrease in price will increase or decrease the amount that people spend on a product depends on whether the demand for the product is elastic or inelastic.
When demand is elastic, a price change leads to a relatively large change in buying behavior. In particular, when price falls, so many more units of the good are purchased that the total amount of money spent on the item rises.
In contrast, when demand is inelastic, a price change leads to a relatively small change in buying behavior. When price falls, therefore, there's a fairly small increase in the quantity of the good purchased. The total amount spent on the good thus falls.
In this problem, therefore, a price decrease causes spending on good X (inelastic demand) to fall, but causes spending on good Y (elastic demand) to rise.
Question 26 answer is: d. The Case A elasticity is larger than is the Case B elasticity for neither (a) nor (b).
Explanation: The larger the value for a price elasticity, the larger the degree to which buyers alter their behavior in response to a price change.
In general, the more alternatives consumers have to a certain
product, the larger will be the demand elasticity for that
product. This is because one way in which consumers can
respond to a change in the price of a particular good is
to switch between that good and goods that are
alternatives for it. [Since we're talking
about the elasticity of a specific good, we know that while
the price of that good has changed, the prices of other goods
-- including the alternative goods -- haven't changed.]
The closer the alternatives, the more switching there will
be (i.e., the bigger the change in quantity demanded).
When an elasticity is defined for a specific brand within
a general category of good (rather than for the general
category), there will very likely be a number of close
alternatives (including all the other brands of that
same general good). A change in the price of one brand
(keeping the prices of all the other brands unchanged) will
therefore likely lead to a large change in the quantity
demanded of that brand. Of the situations presented in
answer (a), therefore, Case B (specific brand) will have
a larger elasticity value than will Case A (general
product).
For a change in the price of gasoline, the explanation is
a little different. In this case, computing the percentage
change in quantity demanded over a fairly short period of
time will likely produce a small value because people
generally have a limited number of ways to change their
gasoline consumption quickly. Most people will still be
driving the same car they bought before the price change,
and will also be living and working in places they choose
previously.
If there' a change in the price of gasoline that is sustained,
in contrast, the quantity of gas used can change in number of
different ways. Over time, a person (for instance) could
obtain a vehicle that gets different gas mileage, or could
choose a new place to work or to live in order to alter
commuting distances. For a good like gasoline, therefore,
we expect that the change in usage (caused by a given price
change) will be larger when the percentage change in
quantity demanded is measured over a few years (Case B)
rather than over a few months (Case A).
For both answers (a) and (b), therefore, the elasticity that
is most likely larger is the one described in Case B.
The answer to the additional practice question given in the
answer to Question 11 is: 3.