Extra Problems Sheet 1- Solution

Ch 2 - Demand, Supply, and equilibrium Prices

Ch 3 Demand Elasticities

Problem 1 Shifts in Demand and supply

For each statement indicate whether the demand curve or the supply curve of chicken will shift
to the right or to the left and specify the variable that caused the shift

Note that Chicken is considered as a normal good

1- As the Income of Mr. brown increased he purchases more chicken nuggets (D shifts
right)
2- When the price of meat decreased by 20%, consumers decreased their chicken
consumption. (D shifts left) Substitutes
3- The government provided chicken vaccines to farmers raising chicken (S shifts right)
4- Chicken producers are facing high production taxes. (S shifts left)

What effect will each of the following have on the supply of automobile tires?

1- A technological advance in the methods of producing tires. S shifts right

2- A decline in the number of firms in the tire industry. S shifts left
3- An increase in the price of rubber used in the production of tires. S shifts left
4- The expectation that the equilibrium price of auto tires will be lower in the future than it
is currently. S shifts right
5- The charging of a per-unit tax in each auto tire sold. S shifts left
6- The granting of a 50-cent-per-unit subsidy for each auto tire produced. S shifts right

Problem 2 Equilibrium D and S and autoregulation

Below is the market demand and supply for motorcycles:

(D): Q = 100 000 – 6P (S): Q = 14P – 150 000
1) Find the equilibrium price and quantity.
P= 12 500 Q= 25 000

2) If the price is equal to $15 000, will there be a shortage or a surplus? Explain.
P>Pequ => Qs > Qd => Surplus

3) Calculate the excess in the market.

Surplus = Qs – Qd = 60 000 – 10 000 = 50 000 units

4) Calculate the quantity traded of motorcycles at that price.

Qd = 10 000
5) How does this situation affect the price?
Ps decrease => Qs decrease => Qd increase until equilibrium is reached.

Problem 3 Equilibrium D and S and autoregulation

Suppose the following two equations:

P = 50 – 2Qd and P = 10 + 2 Qs

1) Draw the demand and supply. L1 3pts

2) What is the equilibrium price and quantity?

50-2q=10+2q

Q=10 => P= 30

3) Suppose the price on the market is 25$ is there a shortage or a surplus? What is its
amount? And how will the economy autoregulate itself?

Shortage => P increases

4) Suppose the price on the market is 35$ is there a shortage or a surplus? What is its
amount? And how will the economy autoregulate itself?

Surplus=> P decreases

Problem 4 Equilibrium D and S and autoregulation

Assume that the demand and supply of hamburgers can be represented in the following
diagrammatic model.
 4

3.5

2.5
price ($)

2
Supply
1.5
Demamd
1

0.5

0
0 100 200 300 400 500 600 700
quantity / period

1) What is the equilibrium quantity Q1, and the equilibrium price P1.

Equilibrium price = $2; Equilibrium quantity = 300 hamburgers.

2) Derive the demand equation.

P=b+aQd

a=

3=b-0.005*100 => b=3.5 => P=3.5-0.005Qd

3) Suppose the price on the market is 3 what is the prevailing situation.

Qs= 500 Qd= 100 Surplus

4) How will the economy auto regulate itself?

Price will decrease

Problem 5 PED and TR

Given the demand curve Qd = 200 - 4P

1- How much is the quantity demanded at a price of 9 dollars? 11 dollars?

 P Q
9 164
11 156

2- Use the above information to find the elasticity of demand if the price increases from $9
to $11.

Ed = = - 0.25

3- According to your answer in part 2, state whether the demand is elastic or inelastic. And
how would the increase in price affect total revenue.

Since |Ed|< 1→ Inelastic demand

Demand is inelastic; the 25% increase in price lead to a decrease in the sales of 5%, the revenue
generated by the increase in price overcompensate the decrease in sales generated by this
increase in price. At the end Total Revenue increases.

Problem 6 PED and TR

Given the following demand and supply equation for the furniture market.

D: P = 400 – 0.6Q S: P= 50 + 0.1Q

1- Calculate the equilibrium price and quantity.

At equilibrium P = P
400 -0.6Q = 50 + 0.1Q
Q = 500 and P = 100

2- Calculate price elasticity of demand as the price increases from 100$ to 150$. Interpret your
result.
Change in Q demanded

P Q demanded
100$ 500
150$ 416

Elasticity of Demand

Ed = = 0.45

As the price increases by 40% the quantity demanded decreases by 18%

 As the price increases by %1 the quantity demanded decreases by %0.45
 0.45 is less than 1 thus demand is inelastic.

3 – Use your result in the previous question to state weather this increase in price will lead to an
increase or decrease in the total revenue.

Demand is inelastic; the 40% increase in price lead to a decrease in the sales of 18%, the revenue
generated by the increase in price overcompensate the decrease in sales generated by this
increase in price. At the end Total Revenue increases.

4 – Calculate total revenue at the price of 100$ and 150$ and prove your analysis in question 3.

At P = 100, Qd is 500  TR = $50,000

At P = 150, Qd is 416.66  TR = $62499
Thus as price increases TR increases too, Demand is inelastic

Problem 7 Calculating elasticities from a demand equation

Suppose the demand for good X is given by = 500 – 10Px + 2Py + 0.7 I where Px is the price
of good X. Py is the price of some other good Y, and I is income. Assume that Px is currently
$10, Py is currently $5, and I is currently $100

1- What is the elasticity of demand for good X with respect to its price at the current
situation? Interpret your result

Q at current prices and income is = 500 – 100 + 10 + 70 = 480

Price elasticity of demand at current price $10 is

= – 10 * = |- 0.208 | < 1 Inelastic

 As the price increases by %1 the quantity demanded decreases by %0.208

2- What is the cross-price elasticity of the demand for good X with respect to the price of
good Y at the current situation? What can you tell about X and Y

Cross-price elasticity of demand

=2* = 0.021 > 0 X and Y are substitute goods

3- What is the income elasticity of demand for good X at the current situation? Comment on
the type of good X

Income elasticity of demand

= 0.7 * = 0.146 > 0 X is a normal good
Problem 8 Equilibrium and PED
Assume that the demand and supply for a commodity is represented by the equations:
P = 10 - 0.2Qd
P = 2 + 0.2Qs
Where Qd and Qs are quantity demanded and quantity supplied, respectively, and P is price.
1- Using the equilibrium condition, solve the equations to determine equilibrium price and
equilibrium quantity.

Pe =$6, and Qe = 20

2- Calculate the price elasticity of demand and the price elasticity of supply at the
equilibrium price. Use the point elasticity formula to compute these two values of these
elasticities

Elasticity of Demand = -1.5

Elasticity of Supply = 1.5
Problem 9 Equilibrium and Elasticities

Firm A produces batteries and has the following supply equation: P=5+0.1Q and it faces a
market demand defined by P=20-0.2Q

1- Calculate the equilibrium price and quantity

Equilibrium
Q=Q
5+ 0.1Q = 20 – 0.2Q
0.3Q = 15
Q = 50 and P = 10
2- Calculate price elasticity of demand and the price elasticity of supply as the price increases
from 10$ to 15$. Interpret your result.

Change in Q demanded and Q supplied

P Q demanded Q supplied
10$ 50 50
15$ 25 100

Elasticity of Demand

Ed = = 1.65

As the price increases by 40% the quantity demanded decreases by 66%

 As the price increases by %1 the quantity demanded decreases by %1.65
 1.65 is greater than 1 thus demand is elastic.

Elasticity of Supply

Es= = 1.65

As the price increases by 40% the quantity supplied increases by 66%

 As the price increases by %1 the quantity supplied increases by %1.65
 1.65 is greater than 1 thus supply is elastic.

3 – Use your result in the previous question to state weather this increase in price will lead to an
increase or decrease in the total revenue

Demand is elastic; the 40% increase in price lead to a decrease in the sales of 66%, the
revenue generated by the increase in price did not overcompensate the decrease in sales
generated by this increase in price. At the end Total Revenue decreases.

4 – Calculate total revenue at the price of 10$ and 15$ and prove your analysis in question 3

TR = P*Q
At P = $10, TR = 10*50 = $500
At P = $15, TR = 15*25 = $375
As price increases, TR decreases elastic
5- Firm B has the same supply curve as Firm A but it faces a demand defined by Q=50

5.1 What is the equilibrium price and quantity of Firm B

Q = 50 P = 5 + 0.1(50) = $10

5.2 Calculate the price elasticity of demand as the price increases from 10 to 15$. Interpret result

Change in Q demanded

P Q demanded
10$ 50
15$ 50

Ed = =0

As the price increases by 40% the quantity demanded does not decrease
 As the price increases by %1 the quantity demanded decreases by %0
 the demand is perfectly inelastic (Q demanded is completely not

 responsive to changes in P).
6- Calculate the cross price elasticity of demand between batteries and energizers given that the
price of energizers decreases from 10$ to 7$ while the quantity demanded of batteries decreases
from 50 to 30 units. Analyze your results.

Ed = = 1.4 >0

 batteries and energisers are substitutes

7- Calculate income elasticity of demand, as income increases from 500$ to 600$ and the
quantity demanded of batteries decreases from 2 to 1. Analyze your results.

Ey = = -3.66<0 z

 batteries are inferior

Problem 10 Calculating elasticities from a demand equation

Suppose the demand for good X is given by = 200 – 10Px + 5Py + 0.6 I , where Px is the price
of good X. Py is the price of some other good Y, and I is income. Assume that Px is currently $5,
Py is currently $10, and I is currently $400

1- What is the elasticity of demand for good X with respect to its price at the current
situation? Use the point elasticity formula. Interpret your result

Q at current prices and income is = 200 – 10*5 + 5*10 + 0.6*400 = 440

Price elasticity of demand at current price $10 is

= – 10 * = |- 0.113| < 1 Inelastic
 As the price increases by %1 the quantity demanded decreases by %0.113

2- What is the cross-price elasticity of the demand for good X with respect to the price of
good Y at the current situation? Use the point elasticity formula. What can you tell about
X and Y

Cross-price elasticity of demand

=5* = 0.113 > 0 X and Y are substitute goods

3- What is the income elasticity of demand for good X at the current situation? Use the point
elasticity formula. Comment on the type of good X.

Income elasticity of demand

= 0.6 * = 0.545 > 0 X is a normal good

Problem 11 Elasticities

Suppose that business travelers and vacationers have the following demand for airline tickets
from Dubai to Beirut:

Price $ Quantity Demanded Quantity Demanded

(business travelers) (Vacationers)
150 2100 Tickets 1000 Tickets
200 2000 Tickets 800 Tickets
250 1900 Tickets 600 Tickets
300 1800 Tickets 400 Tickets

1 - As the price of tickets rises from $200 to $250, what is the price elasticity of demand for
(i) business travelers and (ii) vacationers? (Use the midpoint formula)
Ed = %∆Qd/%∆P

Ed = [(1900-2000)/(1900+2000)/2] x 100 / [( 250-200)/(250+200)/2] x 100 = 0.23 in absolute

value
For vacationers, the price elasticity of demand when the price of tickets rises from $200 to

$250 is [(600 – 800)/(600+800)/2] x100/ [(250 – 200)/(250+200)/2] x100 = 1.28 in absolute

value

2 - Why might vacationers have a different elasticity of demand for tickets from business
travelers? Explain
The price elasticity of demand for vacationers is higher than the elasticity for business travelers
because vacationers can choose more easily a different mode of transport (like driving or taking
the train) and have more flexible travel dates. Business travelers are less likely to do so because
time is more important to them and their schedules are less adaptable.

Part B

Fadi says “I buy 10 liters of gas every week regardless of their price”. What is the value of Fadi’s
price elasticity of demand for gas? Explain

Fadi's price elasticity of demand is zero, because he wants the same quantity regardless of the
price.

Part C

You have the following information about Good X and Good Y:

 Income elasticity of demand for Good X = -3

 Cross-Price elasticity of demand for Good X with the respect to the price of Good Y=2
Would an increase in income and a decrease in the price of good Y unambiguously decrease the
demand for good X? Why or why not?

Yes, an increase in income would decrease the demand for good X because the income elasticity
is less than zero, indicating that good X is an inferior good. A decrease in the price of good Y
will decrease the demand for good X because the two goods are substitutes (as indicated by a
cross-price elasticity that is greater than zero). Therefore, the quantity demanded will decrease.

Problem 12 Elasticities

1 - Anna owns the Sweet Alps Chocolate store. She charges $10 per pound for her hand
made chocolate. You, the economist, have calculated the elasticity of demand for
chocolate in her town to be 2.5. If she wants to increase her total revenue, what advice
will you give her and why? Be able to explain your answer.

Anna should lower her price. Her price elasticity of demand for chocolate is elastic (greater
than one) and therefore, when she lowers her price she will sell a lot more chocolate. The greater
quantity sold will make up for her lower price, increasing her total revenue. In other words, she
is selling at a lower price but making up for it in volume of sales.

2 - If the price of good increases by 8% and the quantity demanded decreases by 12%, what
is the price elasticity of demand? Is it elastic, inelastic or unitary elastic?
-12%/8% = -.12/.08 = -1.5. Again, drop the negative sign, so the elasticity is 1.5. This means it
is elastic (greater than one)

3 - Discount stores sell relatively elastic goods. Ceteris paribus, explain why selling at a
relatively low price is profitable for them?
It is profitable because with elastic goods, dropping the price lower can bring them a lot more
business. Therefore, at the low prices they can sell a large volume of goods, making up for the
lower prices and bringing in more revenue (P x Q).

4 - In summer 2007, Sony decided to cut the price of its PlayStation 3 video game console
from 600$ to 500$. One industry analyst forecast that the price cut would increase sales
from 80,000 units per month to 120,000 units per month. Assuming the analyst’s forecast
is correct, use the midpoint formula to calculate the price elasticity of demand for
PlayStation 3.

Answer: The price elasticity of demand = 40.0%/–18.2% = –2.2 (Demand is elastic)

5 - If the cross elasticity of demand between peanut butter and milk is -1.11, then are peanut
butter and milk substitutes or complements? Be able to explain your answer.

Complements, negative relationship between price and quantity

6 - 10 percent increase in income brings about a 15 percent decrease in the demand for a
good. What is the income elasticity of demand and is the good a normal good or an
inferior good? Be able to explain your answer.
Inferior good, negative relationship between income and demand

Problem 13 PED and TR

The below table provides the Price Elasticity of Demand for Movie Tickets as Measured by the
Elasticity Coefficient. The demand equation for Movie Tickets is P = 9 – Q
 1- What is the value of the maximum total revenue?
Max TR is achieved when Demand is unit elastic, and price is averaged between $5 and
$4  price is 4.5 (9/2) and Q is 4.5 from the equation
Thus TR is 4.5*4.5 = $20.25
2- What do you expect to happen for Total revenue as the price of a movie ticket decreases
from $8 to $7?
Between those two prices, demand is elastic  as price decreases, total revenue will
increase

3- Use total revenue test to prove that demand is inelastic as price decreases from $3 to $1
At $3, Qd is 6  TR = 18
At $1, Qd is 8  TR = 8
As price decreases from $3 to $1, TR decreases from $18 to $8  P and TR move in the
same direction when demand is inelastic and this is the case

Problem 14 Elasticities

Part A and B are Independent

Part A:

1- Given the following information, calculate the Income Income Quantity

Elasticity of demand. And comment. $ 500 5
$ 1,000 6
%Δ Q 18% = 0.27 Normal Good
%Δ I 67%

2- Given the following information, calculate the Cross

price elasticity of demand. And comment. Price of X Quantity of Y
$ 100 5000
%Δ Q -50% 0.75 Substitutes $ 50 3000
%Δ P -67%

Part B:

Suppose that the price elasticity of demand for gasoline is 0.2 in the short run and 0.7 in the long
run. If the price of gasoline rises by 28%, what effect on quantity demanded will this have…?

1- In the short run?

Quantity will decrease by 5.6%
2- In the long run?
Quantity will decrease by 19.6 %
3- Comment on the results from a and b.
On the long run the demand is more elastic because of the habitude.

Problem 15 PED and TR

Suppose that the below total revenue curve is derived from a particular linear demand curve

1- What is the price of good X when total revenue is $20

At Q=4 => P=5

At Q=5 => P=4

2- Calculate price elasticity of demand when price increases from $4 to $5

%Δ P 22% = - 1
%Δ Q -22%

3- Comment on total revenue based on the result calculated above

Since PED= 1 => TR is MAX

4- Prove that demand is inelastic when TR decreases from $14 to $8

as the TR decreases from 14 to 8$ => the quantity would be increasing, and the cause of that is a
decrease in prices. so, price and TR are moving in the same direction so the demand is inelastic.