Economics: Supply and Demand and Price Elasticity

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MBAAF 601
Managerial Economics

Problem Set # 2

Demand, Supply and Elasticity

1. Draw a circular-flow diagram. Identify the parts of the model that correspond to the flow of goods and services and the flow of dollars for each of the following activities. a. Sam pays a storekeeper $1 for a quart of milk.

b. Sally earns $4.50 per hour working at a fast food restaurant. c. Serena spends $7 to see a movie.
d. Stuart earns $10,000 from his 10 percent ownership of Acme Industrial.

2. What is a competitive market? Briefly describe a type of market that is not perfectly competitive.

3. What are the demand schedule and the demand curve and how are they related? Why does the demand curve slope downward?

4. Popeye’s income declines, and as a result, he buys more spinach. Is spinach an inferior or a normal good? What happens to Popeye’s demand curve for spinach?

5. What are the supply schedule and the supply curve and how are they related? Why does the supply curve slope upward?

6. Does a change in producers’ technology lead to a movement along the supply curve or a shift in the supply curve? Does a change in price lead to a movement along the supply curve or a shift in the supply curve?

7. Describe the role of prices in market economies.

8. List and explain the four determinants of the elasticity of demand.

9. How did elasticity help explain why drug interdiction could reduce the supply of drugs, yet possibly increase drug related crimes?

10. 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
b. Beethoven recordings or classical music recordings in general c. Heating oil during the next six months or heating oil during the next five years d. Root beer or water

11. Suppose that business travelers and vacationers have the following demand for airline tickets from New York to Boston:

PRICE QUANTITY DEMANDEDQUANTITY DEMANDED
(BUSINESS TRAVELERS)(VACATIONERS)

$15021001000
2002000800
2501900600
3001800400

a. As the price of tickets rises from $200 to $250, what is the price elasticity of demand for: i) Business travelers?
ii) Vacationers?
Use the midpoint method in your calculations.
b. Why might vacationers have a different elasticity than business travelers?

12. The New York Times reported (Feb. 17, 1996,p. 25) that subway ridership declined after a fare increase: "There were nearly four 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. b. According to your estimate, what happens to the Transit Authority's revenue when the fare rises? c. Why might your estimate of the elasticity be unreliable?

13. Two drivers--Tom and Jerry--each drive up to a gas station. Before looking at the price, each places an order. Tom says, "I'd like 10 gallons of gas." Jerry says, "I'd like $10 worth of gas." What is each driver's price elasticity of demand?

14. Economists have observed that spending on restaurant meals declines more during economic downturns than does spending on food to be eaten at home. How might the concept of elasticity help to explain this phenomenon?

15. Consider public policy aimed at smoking.
a. Studies indicate that the price elasticity of demand for cigarettes is about 0.4. If a pack of cigarettes currently costs $2 and the government wants to reduce smoking by 20 percent, by how much should it increase the price? b. If the government permanently increases the price of cigarettes, will the policy have a larger effect on smoking one year from now or five years from now? c. Studies also find that teenagers have a higher price elasticity than do adults. Why might this be true?

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