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Homework Assignment #3 due by 11:59 PM on February 7 (100 points) Part 1: Answer the following multiple choice (MC) questions (you may highlight, bold, or enter a letter in the blank – 2 points each): 1. __D____ If the price of a sub sandwich increases by 2% and the quantity demanded falls by 5%, then there will be a. an increase in the price elasticity of demand. b. an increase in the price elasticity of supply . c. a shift in the demand curve. d. a decrease in revenue. 2.___A___If an increase in the price of a good leads to no change in the quantity demanded, then the demand for the good is a. perfectly inelastic b. perfectly elastic c. elastic d. unit elastic.
3. ___D___ Figure 3.2 shows the market for milk. According to this diagram what happens to revenue when the price of milk falls from $3.00 to $1.00? a. Revenue falls from $3,000 to $1,000 b. Revenue rises from $1,000 to $3,000 c. Revenue remains unchanged at $1,000 d. Revenue remains unchanged at $3,000. 4. __C____Figure 3.2 shows the market for milk. According to this diagram, the demand for milk is a. perfectly elastic b. perfectly inelastic c. unit elastic d. income elastic.
5. __D___ Figure 3.3 shows demand for bread. Using the elasticity formula, the price elasticity of demand over the range from $1.00 to $1.50 is closest to which of the following? a. -0.50 b. -0.60 c. -1.45 d. -1.67
6. __D____ Again, referring to Figure 3.3, according to the diagram the demand for bread is a. unit elastic at all prices. perfectly in elastic at all prices c. perfectly elastic at all prices d. varies along the demand curve depending on the price. 7. __A____ Again, referring to Figure 3.3, the demand for bread is a. more elastic at higher prices of bread. b. less elastic at higher prices of bread. c. always unit elastic. d. always perfectly elastic. 8. ___A___Other things being equal, narrowly defined goods tend to be less elastic because they a. have fewer substitutes. b. have more complements. c. are more difficult to find. d. have higher prices. 9. ___B___An inferior good necessarily has
a. a positive price elasticity of demand b. a negative income elasticity of demand. c. a negative cross-elasticity of demand. d. a negative price elasticity of supply.
10. __C___Figure 3.5 shows the effect of a cigarette tax levied on the sellers of cigarettes. If E1 is the equilibrium before the tax, and E2 is the equilibrium after the tax, what do we conclude? (Hint: figure out what the tax is, then look at where the E price is after the tax is put in place. Tax revenue = Q x Tax) a. The tax rate is $0.75 per pack. b. The sellers bear a larger share of the burden of the tax than the buyers. c. The tax revenue collected by the government is a total of $5,000. d. All of the above.
11. ___C___Referring to figure 3.5, how much money per pack is the cigarette vendor able to recoup after the tax is added to the price? What is the vendor’s actual share of the cost? Who bears the burden of the tax, the vendor or the customer? a. $1.00, $0.00, the customer b. $0.00, $1.00, the vendor c. $0.75, $0.25, the customer d. $0.25, $0.75, the vendor 12. __B___When would the passage of a law prohibiting the purchase of a drug likely to be most effective at reducing the use of the drug? a. The drug has few substitutes b. The demand for the drug is elastic c. The demand for the drug is inelastic d. The cost of supplying the drug remains low, despite the passage of the law. 13. __A___When analyzing the demand elasticity of flowers,
a. roses tend to be more elastic than flowers . b. flowers tend to be more elastic than roses. c. flowers are more elastic the week before Mother’s day d. both b and c. 14. ___D___Generally speaking, a price increase in an item with inelastic demand a. will generate greater revenue. b. will result in a more elastic demand in the long term. c. will generate the same revenue over time. d. both a and b. 15. ___C____ Cross-elasticity of demand
a. will be positive for substitutes like cabbage and lettuce when the price of cabbage goes up. b. will be negative for complements like SUVs and gasoline when the price of gasoline goes up c. both a and b d. none of the above.
Part 2: Answer the following questions (insert your answers directly below each question): 1. How does tax revenue generated on a product with inelastic demand compared to the tax revenue generated on a product with elastic demand? Why the difference? (page 86) (10 points) A tax imposed on a good that has an inelastic demand will generate more tax revenue than a tax on a good with elastic demand, assuming similar supply conditions. If the good’s demand is more elastic, that means its demand is more sensitive to a price increase. There, the price increase due to the tax will cause quantity purchased and tax revenue to be less than the revenue on a product with inelastic demand.
2. What is the relationship between elasticity or inelasticity of demand and who bears the most burden (customer or business) of a tax on various products/services (see pages 84 and 85). (10 points) The more inelastic the demand relative to supply, the more tax burden the customer will bear. For gas, in the short term, customer will cut back somewhat, but they still need gas (inelastic demand), so they will bear most of the expense. If demand were elastic, they could walk away in greater numbers, lowering quantity, and shifting most of the burden to the vendor.
3. Turn to pages 78 and 79 of the textbook. Briefly explain the relationship between opportunity cost and elasticity/inelasticity of demand. Use an example if it will help. (10 points). The more an individual bears the opportunity cost, the more elastic demand. Example- business travel. Travel expenses- they are inelastic to the travel because he does not pay the cost. They are more elastic to the business traveler’s boss because he does bear the expense.
4. Define price elastic demand, price inelastic demand and Unit elastic demand. Be sure to reference revenue in your explanation. (page 73) (10 points). Price inelastic demand-as price increases, the decrease in revenue due to the decrease in quantity does not exceed the revenue increase due to
the price increase, therefore, total revenue increase or the percentage change in price is greater than the percentage change in quantity, therefore total revenue increase. Unit Elastic demand- as price changes, quantity changes but revenue does not.
5. Define Price elasticity of supply. Then list 2 determinants of elasticity of supply and how they affect it. (page 81/82) (10 points) the ratio of the percentage change in the quantity of a good supplied to a given percentage change in its price, other things being equal. 1 Mobility of factors of production, the more mobile, the more elastic the supply. 2 Time. As with demand, supply tends to be more elastic in the long term as inputs that are difficult to change in the short run are eventually altered in the long run.
6. Explain the relationship between Substitutes, Complements, and Elasticity (page 78)(10 points). The demand for a good tends to be more elastic the more narrowly the good is defined The demand for the product of a single firm tends to be more elastic than the demand for the output of all producers operating in the market If something is a minor complement to an important good, demand for tends to be inelastic.
7. Using examples, explain the relationship between Income Elasticity of Demand and normal and inferior goods (page 80)(10 points). Orange juice considered as a board category is a normal good; people tend to consume more of it as their income rises. However, when the definition is narrowed so that house brand and national brand frozen orange juice are treated as separate products, the house brand product turns out to be an inferior good. As their incomes rise, consumers substitute the higher- quality national brands, which have a positive income elasticity of demand.