1.

U se the following table to answer the question:

Jif Peanut Butter Skippy Peanut Butter Smucker’s Grape Jelly

Price Quantity Price Quantity Price Quantity
$1.50 75 $1.75 75 $3.25 75
$1.75 65 $1.75 100 $3.15 65
$2.00 50 $1.75 105 $3.10 55
$2.50 20 $1.75 110 $3.07 45

a. Calculate the price elasticity of demand for Jif Peanut Butter: using the first
two rows of the table, using the middle two rows of the table, using the last
two rows of the table.

The formula for this problem is exactly the same as in part a, so for the first two
⎛ (65 − 75) ⎞ ⎛ − 10 ⎞ ⎛ − 10 ⎞
⎜⎜ ⎟⎟ ⎜⎜ ⎟⎟
(65 + 75) / 2 ⎠ (140 / 2 ) ⎠ ⎜⎝ 70 ⎟⎠ − 0.143
rows: ⎝ = ⎝ = = = −0.929 . In this
⎛ (1.75 − 1.50) ⎞ ⎛ 0.25 ⎞ ⎛ 0.25 ⎞ 0.154
⎜⎜ ⎟⎟ ⎜⎜ ⎟⎟ ⎜ ⎟
⎝ (1.75 + 1.50) / 2 ⎠ ⎝ (3.25 / 2 ) ⎠ ⎝ 1.625 ⎠
case the demand for Jif Peanut Butter is inelastic because the price-elasticity of
demand is less than 1. Using the same formula for the other sets of rows, and
dropping the minus sign because all price elasticity’s of demand are negative,
gives the following answers:

Rows 2 and 3: 1.962

Rows 3 and 4: 3.857
Note that the price-elasticity of demand is elastic in these two calculations.
b. Calculate the price elasticity of demand for Jif Peanut Butter using the first
and third row of the table. Why is your answer not equal to the average of the
first two elasticity’s from part a?

The price elasticity of demand for the first and third rows uses the same equation
we have been using all along. Therefore the calculation looks like this:
⎛ (50 − 75) ⎞ ⎛ − 25 ⎞ ⎛ − 25 ⎞
⎜⎜ ⎟⎟ ⎜⎜ ⎟⎟ ⎜ ⎟
⎝ (50 + 75) / 2 ⎠ = ⎝ (125 / 2 ) ⎠ = ⎝ 62.5 ⎠ = − 0.40 = −1.399 . The average of
⎛ (2.00 − 1.50) ⎞ ⎛ 0.50 ⎞ ⎛ 0.50 ⎞ 0.286
⎜⎜ ⎟⎟ ⎜⎜ ⎟⎟ ⎜ ⎟
⎝ (2.00 + 1.50) / 2 ⎠ ⎝ (3.50 / 2 ) ⎠ ⎝ 1.75 ⎠
the first two elasticity’s is equal to (0.929 + 1.962)/2 = 2.891/2 = 1.446. This
number is not the same as the one above, because the demand curve for Jif Peanut
Butter is not a straight line.

c. Calculate the price elasticity of demand for Skippy Peanut Butter using the
first two rows of the table. (Trick question alert!)
You cannot answer this question. Note that these are points on different demand
curves. When the price of a good changes it shifts the demand curve for a
substitute. So these are points on different curves. If you try, you will get a
divide by zero problem. Note this does not imply that the demand for Skippy
Peanut Butter is perfectly elastic. The demand curve has actually shifted.

d. Calculate the price elasticity of demand for Smucker’s Grape Jelly using the
first and last row of the table.

The price elasticity is 8.772. This makes the demand for jelly very elastic.
Note: the sign of this elasticity is positive. This is because I needed to get the
numbers to work for parts h and i. This doesn’t make any sense as a price
elasticity of demand. I made the numbers this way for simplicity.

e. Using the first two rows of the table, calculate the cross-price elasticity of
demand of Skippy for Jif.

For the cross-price elasticity, we are comparing what happens to the quantity
demanded of one good, when the price of another good changes. So we need the
% change in quantity of the first good, Skippy, and the % change in price of the
second good, Jif. Therefore the calculation looks like this:
⎛ (100 − 75) ⎞ ⎛ 25 ⎞ ⎛ 25 ⎞
⎜⎜ ⎟⎟ ⎜⎜ ⎟⎟ ⎜ ⎟
⎝ (100 + 75) / 2 ⎠ = ⎝ (175 / 2) ⎠ = ⎝ 87.5 ⎠ = 0.286 = 1.857 . Because this is a
⎛ (1.75 − 1.50) ⎞ ⎛ 0.25 ⎞ ⎛ 0.25 ⎞ 0.154
⎜⎜ ⎟⎟ ⎜⎜ ⎟⎟ ⎜ ⎟
⎝ (1.75 + 1.50 ) / 2 ⎠ ⎝ (3.25 / 2 ) ⎠ ⎝ 1.625 ⎠
cross-price elasticity, the sign is important. The fact that the cross-price elasticity
is positive means that these two goods are substitutes.

f. Using the middle two rows, calculate the cross-price elasticity of demand of
Skippy for Jif.

Using the same formula as always, the cross-price elasticity is 0.366. Again the
cross-price elasticity is positive indicating the goods are substitutes.

g. A cross-price elasticity of demand near zero means that the items are not very
closely related. A cross-price elasticity that is high in absolute value means
the goods are closely related. Does the change in cross-price elasticity
between parts e and f make sense? Why or why not?

Jif and Skippy go from being fairly strong substitutes in part e, to being weak
substitutes in part f. This makes sense to me, because when the price falls the first
time all of the people who are indifferent between the two brands (the ones who
view them as strong substitutes) switch to Skippy. However, the people that don’t
switch are the ones who think that Jif is superior peanut butter. These people
don’t think that Jif and Skippy are really substitutes. Thus I would expect the two
goods would look like close substitutes initially, and them look less and less like
substitutes as the price falls.

h. Calculate the cross-price elasticity of demand of Skippy for Smucker’s using

the first two rows in the table. What does this tell us about the relationship
between Skippy and Smucker’s?

This is the same calculation as in part e, using the quantity of Skippy, and the
price of Smucker’s.
⎛ (100 − 75) ⎞ ⎛ 25 ⎞ ⎛ 25 ⎞
⎜⎜ ⎟⎟ ⎜⎜ ⎟⎟ ⎜ ⎟
⎝ (100 + 75) / 2 ⎠ = ⎝ (175 / 2 ) ⎠ = ⎝ 87.5 ⎠ = 0.286 = −9.137 . The
⎛ (3.15 − 3.25) ⎞ ⎛ − 0.10 ⎞ ⎛ − 0.10 ⎞ − 0.0313
⎜⎜ ⎟⎟ ⎜⎜ ⎟⎟ ⎜ ⎟
⎝ (3.15 + 3.25) / 2 ⎠ ⎝ (6.40 / 2) ⎠ ⎝ 3.20 ⎠
negative sign on the cross-price elasticity means that these two goods are
compliments. In addition, because the number is fairly far from zero, we can
say that these two goods are very close compliments.

i. Calculate the cross-price elasticity of demand of Skippy for Smucker’s using

the last two rows in the table. What does this tell us about the relationship
between Skippy and Smucker’s?

Repeating the calculation in part h using the last two rows gives us a cross-price
elasticity of -4.784. This again tells us that Smucker’s Grape Jelly and Skippy
Peanut Butter are fairly close compliments, but not as close of compliments as
they were in part h.
2. In response to higher oil prices, the United States rapidly increased production of
ethanol, a fuel made using corn.

a. Using a supply and demand diagram show what would happen to the price of
corn. Explain why you moved the curves that you did.
Corn
Price

S
P2

P1
D2

D1

Q1 Q2 Quantity
The increase in ethanol production would increase the demand for corn (change in
preferences, or # of buyers). In order to produce more ethanol the manufacturers
need more raw materials; in this case corn. This would shift the demand curve for
corn to the right as shown above by the shift from D1 to D2. This would increase
the equilibrium quantity and also increase the equilibrium price of corn.

b. Given what happened in part a, show the effect on the market for corn tortillas.
Explain.
Corn Tortillas
Price
S2
S1

P2

P1

D
Q2 Q1 Quantity
Since corn is an input into corn tortillas, when the price of corn increases, the
supply of corn tortillas will decrease (price of an input rises). This is shown in the
graph above by a leftward shift in the supply curve from S1 to S2. This will increase
 the market price of corn tortillas from P1 to P2, and decrease the equilibrium
quantity from Q1 to Q2.

c. On February 1, 2007 75,000 Mexicans protested their government to institute

price controls (fix the price at a certain level) on corn tortillas. If the Mexican
government followed the will of this group, what would happen in the corn tortilla
market in Mexico? (Hint: The market should include the shift in your graph from
part b, but keep the original price.)

Corn Tortillas
Price
S2
S1

P1

D
QS QD Quantity
If the price of corn tortillas was fixed at P1, then when supply decreased from S1 to
S2, the market would not be able to adjust to equilibrium. Instead the quantity
demanded would stay the same at QD, because nothing has changed on the demand
side of the market. However supply would fall dramatically to QS. This would lead
to a shortage of corn tortillas. People want to buy QD, but there are only QS
available. The protesters were complaining that the price of corn tortillas was so
high that they could not afford to eat. But if the government does institute price
controls, then the people will be able to afford corn tortillas, but there won’t be any
available to buy!

d. Not all Mexicans are unhappy about the changes in the corn market. Which
groups of people benefit from the change? Why?

Mexican farmers are probably happy with this change. As the price of corn rises
they can sell the corn they grow for higher prices. Also potentially companies
that sell flour tortillas would be happy with this development. There are lots of
possible answers to this question, the key is that in almost every case what hurts
one person, benefits another.

3. The internet has given college students from all over the world the ability to
communicate with each other more easily. Among other things this has allowed
students more options for disposing of textbooks they no longer desire and more
options for acquiring used textbooks.

a. Using a supply and demand diagram show the effect this would have on the
market for used textbooks. Shift only the Supply curve. Explain the reasons
why you made any changes.
Used Textbooks
Price

S1

S2
P1

P2

D1

Q1 Q2 Quantity
Since there are now more options for students to buy used textbooks, this will
increase the supply of used textbooks (increase in number of suppliers). This will
cause the market price of used textbooks to fall, and the equilibrium quantity will rise.

b. Using a supply and demand diagram show the effect this would have on the
market for used textbooks. Shift only the Demand curve. Explain the reasons
why you made any changes.
Used Textbooks
Price

S
P2

P1
D2

D1

Q1 Q2 Quantity
Since there are more options for students wishing to purchase used textbooks, more
students will choose to purchase used rather than new textbooks. This increases the
demand for used textbooks, shifting the curve to the right. The reason for the shift is
basically a population increase. The used textbook market is now global, rather than
isolated to individual campuses. The graph below shows the demand increase which
causes the equilibrium price to increase and the equilibrium quantity to increase.

c. Which effect do you think would have more of an impact, the effect in part a, or
the effect in part b? Carefully explain why you gave the answer you did?

I would tend to think that the increase in supply would be larger. It seems to me that
it is a hassle, and risky to buy used textbooks online. As a result I think their will be
lots of new sellers, but not as many new buyers. You could have answered this
question either way, as long as you gave an explanation for your answer.

d. Combine your graphs from parts a and b in order to tell a story that is consistent
with the following data: The price of new textbooks has been rising. (Hint: new
and used textbooks are substitutes.) Your answer to part d should contain graphs
of both the new and used textbook markets.

The effect in part a was an increase in supply, the effect in part b was in increase in
demand. The graph below shows both of these shifts in the same picture. Demand
shifts to the right from, D1 to D2, and the supply curve also shifts to the right, from S1
to S2.
Used Textbooks
Price

S1

S2
? P1
D2

D1
Q1 Q2 Quantity
We can see from the above graph that the equilibrium quantity unambiguously
increases. The effects from both parts a and b cause the quantity to increase.
However in the case of price we have a problem. In part a, the market price
decreased and in part b the market price increased. This means overall we don’t
know whether the equilibrium price went up, down, or stayed the same. So how do
we figure out which of these three outcomes is consistent with the other
information?

The other piece of information is this: the price of a substitute increased. The only
way we can get a price increase for anything is either demand has to increase, or
supply has to decrease. ‘Prices of related goods’ shows up on the list of things that
cause the demand curve to shift, so the demand for new textbooks must have
increased. There is no reason, given the information in the problem, that would
cause the supply curve to shift. This is shown in the graph below.
New Textbooks
Price

S
P2

P1
D2

D1

Q1 Q2 Quantity
Now we have to work backwards. We know that demand for a good increases
when the price of a substitute rises. This means that in order to observe the price of
new textbooks rising, it must have been a result of the price of used textbooks
rising. In order for the price of used textbooks to rise, we need to redraw the first
figure to look like this:
Used Textbooks
Price

S1
S2
P2

P1
D2

D1

Q1 Q2 Quantity

In this graph we can see that the increase in demand (D1 to D2) is substantially
larger than the increase in supply (S1 to S2). Thus the increase in price caused by
the demand shift has a greater effect than the decrease in price caused by the supply
shift. So overall the price of used textbooks goes up.
 Now to check our answer we can ask the following question. If we saw the price of
used textbooks rising, what would we expect to happen in the new textbook
market? Since these two are substitutes, when the price of used textbooks goes up
we would expect more people to buy new textbooks instead of the now relatively
more expensive used ones. More people wanting new textbooks would cause the
demand for new textbooks to increase. The demand curve for new textbooks would
shift to the right, and the price of new textbooks would rise. This matches the
information in the problem, so the graph at the top of this page is the correct way to
combine the supply and demand shifts in the used textbook market.

This answer goes against my intuition from part c, so either there is important
information I am leaving out, or the effect on demand is larger than the effect on
supply.

4. A frost in California has resulted in damage to Tropicana orange groves.

a. Draw a single supply and demand diagram showing the market for Tropicana
oranges before and after the frost. Underneath your diagram explain why you
made the changes that you did.

Tropicana Oranges
Price
S2
S1

P2

P1

D
Q2 Q1 Quantity
The initial equilibrium for Tropicana oranges is at the point P1, Q1 which in the
intersection of the demand curve (D) and the supply curve (S1). After the frost,
Tropicana orange groves have been hurt by cold weather, so the supply of
Tropicana oranges will decrease. This shifts the supply curve from S1 to S2.
When this happens, the price of Tropicana oranges rises, and the equilibrium
quantity falls. The new equilibrium point is P2, Q2.

Note: The rise in price changes the quantity demanded, but not the demand curve.
 b. After the frost, Senator Snort (R- S.C.) notices that the prices of both Sunkist (a
Florida orange grower) and Tropicana oranges have risen. In televised Senate
hearings, Snort admonishes tearful witness Anita Bryant (the spokesperson for
Sunkist): “These price increases are direct evidence of corporate piracy on the
part of Sunkist, lining its pockets at the expense of the widows and orphans who
depend upon oranges for their health and well-being. This is immoral and un-
American behavior that will not stand” Use a diagram for Sunkist oranges along
with a written explanation to explain why Senator Snort is incorrect.

Sunkist Oranges
Price

S
P2

P1
D2

D1

Q1 Q2 Q3 Quantity

Again the initial equilibrium for Sunkist oranges is at the point P1, Q1 which in the
intersection of the demand curve (D1) and the supply curve (S). Tropicana
oranges and Sunkist oranges are substitutes. So as the price of Tropicana oranges
increases, as shown in part a, people start buying Sunkist oranges instead. This
causes the demand curve for Sunkist oranges to increase, shift to the right. This is
shown above by the shift from D1 to D2. This causes the price of Sunkist oranges
to rise, and the equilibrium quantity to rise.

If Sunkist had not raised their price, then there would have been a shortage of
oranges. This is shown above by Q3. The demand curve has changed to D2, so if
the price does not change, the quantity demanded will be Q3. However, the
quantity supplied will still be Q1. This would make there be a shortage of
oranges. Thus oranges would have to be rationed by something other than price.
Perhaps first-come-first-serve which would still cause problems for widows and
orphans that couldn’t get to the store quickly.

2. A new technological breakthrough in the manufacturing of fiberglass allows twice as

much fiberglass to be made in a day than was previously possible.
a. Use a supply and demand diagram to show what would happen to the market for
fiberglass.
 Fiberglass
Price

S1

S2
P1

P2

D1

Q1 Q2 Quantity
A technological breakthrough that increased manufacturer’s ability to produce
fiberglass would increase supply at every price, shifting the supply curve to the right.
This is shown above by the shift from S1 to S2. This would decrease the equilibrium
price, and increase the equilibrium quantity.

b. Use a supply and demand diagram to show what would happen to the market for
skateboards (fiberglass is an input to skateboard production).
Skateboards
Price

S1

S2
P1

P2

D1

Q1 Q2 Quantity

A reduction in the price of an input makes skateboards cheaper to produce resulting in

an increase in supply of skateboards. This shifts the supply curve to the right,
decreasing the equilibrium price from P1 to P2, and increasing the equilibrium
quantity from Q1 to Q2.

c. At the X-games, two different skateboarders fall and paralyze themselves. This
makes people think that skateboarding is much more dangerous. Show the effect
this would have of the market for skateboards.
 Skateboards
Price

P1

P2

D2 D1
Q2 Q1 Quantity
If people think that skateboarding is more dangerous than it was previously, they will
change their preferences for skateboards. This will cause the demand for skateboards
to be lower at every price, thus shifting the demand curve to the left. This is shown in
the graph above by the shift from D1 to D2. As a result, the equilibrium price falls,
and the equilibrium quantity also decreases.

d. What is the overall effect on the market for skateboards? Draw one graph that
combines the shifts from parts b and c.

Skateboards
Price

S1

S2
P1

P2 D1
D2
Q1 Quantity
?

This graph simply combines the increase in supply (shift to the right from S1 to S2) and
the decrease in demand (shift to the left from D1 to D2). The increase in supply causes
the equilibrium price to fall and the equilibrium quantity to increase. The decrease in
demand causes both the equilibrium price and quantity to fall. When we combine these
two effects, we know that the equilibrium price will end up lower since it decreases with
both of the shifts. However, we don’t know which direction the quantity moves because
one effect causes it to increase and the other causes it to decrease. In order for us to
know where quantity ended up we would need to know the size of the shifts.