Economics 1 / Bucher-Koenen

Name_______________________________ DUE Monday, January 24th

Problem Set 2
Demand and Supply Applications, Elasticity A. Multiple choice questions Please respond to the multiple choice questions below and explain your answer. No credit will be given if no explanation is provided: 1) Queuing is a __________ rationing system that may arise in the case of ____________. a) price; a supply shortage b) price; excess supply c) nonprice; a supply shortage d) nonprice; excess supply

2) If a price ceiling is set below the equilibrium price the result will be: a) excess supply b) a supply shortage c) market equilibrium d) price rationing

3) If the American government imposes a tariff (import tax) on low-quality tires from China, the result on the American low-quality tire market will be: a) supply decreases; price increases b) supply increases; price decreases c) demand increases; price increases d) demand decreases; price decreases

4) If the demand for hot dogs is elastic, and the price of hot dogs increases by 10%, then the quantity demanded of hot dogs will: a) decrease by less than 10% b) decrease by 10% or more c) increase by less than 10% d) increase by more 10% or more e) drop to zero

5) In a market with several farmers whose wheat is indistinguishable, demand for farmer Bob's wheat is ____________ and if he increases the price by 10%, the quantity demanded of his wheat will ______________. a) perfectly inelastic; drop to zero b) perfectly inelastic; decrease by 10% c) perfectly inelastic; exceed supply d) perfectly elastic; drop to zero e) perfectly elastic; decrease by 10% f) perfectly elastic; exceed supply

6) If a price floor is set below the equilibrium price, the result will be: a) excess supply b) a supply shortage c) market equilibrium d) nonprice rationing

7) Of the following figures:

a) (I) is perfectly elastic, (II) is unitarily elastic b) (I) is perfectly elastic, (II) is perfectly inelastic c) (I) is perfectly inelastic, (II) is unitarily elastic d) (I) is perfectly inelastic, (II) is perfectly elastic

8) A change in the price of frozen pizza from $5 to $4 leads to an increase in quantity demanded from 20 pizzas to 24. What is the elasticity of demand for frozen pizza? a) -1 or 100% b) -0.82 or 82% c) -0.05 or 5% d) -0.80 or 80%

9) A 5% increase in the price of hamburgers causes a 10% increase in the quantity demanded of hot dogs. The cross-price elasticity of hot dogs with respect to hamburgers is ________ and hot dogs and hamburgers are ___________. a) -2; substitutes b) -2; complements c) 2; substitutes d) 2; complements

10) Eggs have a demand elasticity of 0.5. To increase revenues by 5%, Egg producers should ___________ the price of Eggs by _______. a) raise; 10% b) lower; 10% c) raise; 3.3% d) lower; 3.3

B. Analytical Question The following question considers the effects of different government policies on shrinking the dependency on oil by reducing gasoline consumption. The first government policy involves a limit on production. The governments second policy option is to set the price of gasoline above the market price. The third option involves a tax on gasoline suppliers. The fourth involves the effects of a Cash for Clunkers program, in which the government offers rebates to consumers for trading in old, low-mileage vehicles (clunkers) for newer, fuel-efficient automobiles. The following equations describe the supply and demand of gasoline in the market (in millions of gallons per day) where P is the price per gallon.

Qd = -30.4P + 399 Qs = 272P -357

a) In this market, how many millions of gallons does the U.S. consume per day, and at what price? Q = ____________ P = ____________

b) What is the consumer surplus? CS = ___________

c) What if the government imposes a 300 mill. gal. per day limit on gasoline production? What is the new quantity produced? If the price remains at the free-market price above, what is the new consumer surplus? Q = ________ CS = ____________

d) If producers wanted to eliminate any shortages that occur with the new production limit, to what must they raise the price? What's the consumer surplus in this case? P = ________ CS = ____________

e) At market equilibrium, what is the elasticity of demand and the elasticity of supply? Compute using a 10% price increase. Is demand elastic or inelastic? Is supply elastic or inelastic? (The answers to this question resemble actual elasticity data estimated in a 2003 Congressional Budget Office report). PED, demand = __________. Demand is elastic/inelastic. PES, supply = ___________. Supply is elastic/inelastic.

f) Now, imagine that instead of the production limit introduced in (c), the government locks the price at 10% above the market price from (a). Approximate the decrease in consumption using demand elasticity. Compute the actual decrease in consumption. Approximate change in Q = ________ Actual change in Q = ___________

g) Alternatively, the government could institute a $0.25 tax on suppliers. What happens to supply in this case? What is the new supply function? What is the new market equilibrium? By how much does consumption decrease from part (a)? Supply Increases/Decreases/Stays The Same. Q = __________ P = __________ Qs = __________P + ________

h) Another policy the government may consider is to initiate a "Cash for Clunkers" program, in which they offer rebates when people trade-in old, low-mileage vehicles ("clunkers") for newer, more fuel-efficient automobiles. Assume this decreases demand (demand, not quantity demanded) by 2%, or, in other words, causes demand to be 98/100 of what it previously was. What is the new demand function? What is the new equilibrium using the original supply equation from (a)? By how much is consumption reduced using this policy? (On August 20th, 2009, some news sources reported almost 500,000 trade-ins through cash for clunkers. With about 250,000,000 cars registered in the U.S., this represents 0.2% of automobiles in use. With some simplifying assumptions, this could lead to a reduction in gasoline by 0.2%, 10 times less than what's used in this question.) P =_________ Q = ________ Change in Q = __________ Qd = __________P + ________