Use supply and demand curves to illustrate how each of the following events would affect
the price of butter and the quantity of butter bought and sold:
a.
An increase in the price of ghee.
Most people consider butter and ghee to be substitute goods. An increase in the price
of ghee will cause people to increase their consumption of butter, thereby shifting the
demand curve for butter out from D1 to D2 in Figure 2.2.a. This shift in demand will
cause the equilibrium price to rise from P1 to P2 and the equilibrium quantity to
increase from Q1 to Q2.
Price
S
P2
P1
D2
D1
Q1
Q2
Quantity of Butter
Figure 2.2.a
b.
An increase in the price of milk.
Milk is the main ingredient in butter. An increase in the price of milk will increase the
cost of producing butter. The supply curve for butter will shift from S1 to S2 in Figure
2.2.b, resulting in a higher equilibrium price, P2, covering the higher production costs,
and a lower equilibrium quantity, Q2.
Price
S2
S1
P2
P1
D
Q2
Q1
Quantity of Butter
Figure 2.2.b
Note: Given that butter is in fact made from the fat that is skimmed off of the milk,
butter and milk are joint products. If you are aware of this relationship, then your
answer will change. In this case, as the price of milk increases, so does the quantity
supplied. As the quantity supplied of milk increases, there is a larger supply of fat
available to make butter. This will shift the supply of butter curve to the right and
the price of butter will fall.
c.
A decrease in average income levels.
Assume that butter is a normal good. A decrease in the average income level will cause
the demand curve for butter to shift from D1 to D2. This will result in a decline in the
equilibrium price from P1 to P2, and a decline in the equilibrium quantity from Q1 to
Q2. See Figure 2.2.c.
Price
S
P1
P2
D2
Q2
Q1
D1
Quantity of Butter
Figure 2.2.c
The city council of a small college town decides to regulate rents in order to reduce
student living expenses. Suppose the average annual market-clearing rent for a twobedroom apartment had been $500 per month, and rents are expected to increase to $800
within a year. The city council limits rents to their current $500 per month level.
a.
Draw a supply and demand graph to illustrate what will happen to the rental price
of an apartment after the imposition of rent controls.
The rental price will stay at the old equilibrium level of $500 per month. The
expected increase to $800 per month may have been caused by an increase in
demand. Given this is true, the price of $500 will be below the new equilibrium and
there will be a shortage of apartments.
b.
Do you think this policy will benefit all students? Why or why not.
It will benefit those students who get an apartment, though these students may also
find that the costs of searching for an apartment are higher given the shortage of
apartments. Those students who do not get an apartment may face higher costs as a
result of having to live outside of the college town. Their rent may be higher and the
transportation costs will be higher.
Consider a competitive market for which the quantities demanded and supplied (per year)
at various prices are given as follows:
a.
Price
Demand
Supply
($)
(millions)
(millions)
60
22
14
80
20
16
100
18
18
120
16
20
Calculate the price elasticity of demand when the price is $80 and when the price is
$100.
We know that the price elasticity of demand may be calculated using equation 2.1 from
the text:
Q D
QD
P Q D
ED 

.
P
Q D P
P
With each price increase of $20, the quantity demanded decreases by 2. Therefore,
QD  2

 0.1.
 P  20
At P = 80, quantity demanded equals 20 and
ED 
80 
0.1  0.40.
20 
Similarly, at P = 100, quantity demanded equals 18 and
ED 
b.
100 
0.1  0.56.
 18 
Calculate the price elasticity of supply when the price is $80 and when the price is
$100.
The elasticity of supply is given by:
QS
QS
P QS
ES 

.
P
QS P
P
With each price increase of $20, quantity supplied increases by 2. Therefore,
QS  2

 0.1.
 P  20
At P = 80, quantity supplied equals 16 and
ES 
80 
0.1  0.5.
16 
Similarly, at P = 100, quantity supplied equals 18 and
ES 
100 
0.1  0.56.
 18 
Question 4
X = Rs 10
Y = Rs 20
X=?
Y=4
10 * ? + 4 * 20 = 200
? = 12
X = Rs 20
20 * ? + 80 = 200
?=6
PEDX = -0.5/0.5 = -1  Relatively always more elastic than Good Y
Much of the demand for U.S. agricultural output has come from other countries. In 1998,
the total demand for wheat was Q = 3244 - 283P. Of this, domestic demand was QD = 1700 107P. Domestic supply was QS = 1944 + 207P. Suppose the export demand for wheat falls by
40 percent.
a.
U.S. farmers are concerned about this drop in export demand. What happens to the
free market price of wheat in the United States? Do the farmers have much reason
to worry?
Given total demand, Q = 3244 - 283P, and domestic demand, Qd = 1700 - 107P, we may
subtract and determine export demand, Qe = 1544 - 176P.
The initial market equilibrium price is found by setting total demand equal to supply:
3244 - 283P = 1944 + 207P, or
P = $2.65.
The best way to handle the 40 percent drop in export demand is to assume that the
export demand curve pivots down and to the left around the vertical intercept so that
at all prices demand decreases by 40 percent, and the reservation price (the maximum
price that the foreign country is willing to pay) does not change. If you instead shifted
the demand curve down to the left in a parallel fashion the effect on price and quantity
will be qualitatively the same, but will differ quantitatively.
The new export demand is 0.6Qe=0.6(1544-176P)=926.4-105.6P. Graphically, export
demand has pivoted inwards as illustrated in figure 2.5a below.
Total demand becomes
QD = Qd + 0.6Qe = 1700 - 107P + 926.4-105.6P = 2626.4 - 212.6P.
P
8.77
1544
926.4
Qe
Figure 2.5a
Equating total supply and total demand,
1944 + 207P = 2626.4 - 212.6P, or
P = $1.63,
which is a significant drop from the market-clearing price of $2.65 per bushel. At this
price, the market-clearing quantity is 2280.65 million bushels. Total revenue has
decreased from $6614.6 million to $3709.0 million. Most farmers would worry.
b.
Now suppose the U.S. government wants to buy enough wheat each year to raise the
price to $3.50 per bushel. With this drop in export demand, how much wheat would
the government have to buy? How much would this cost the government?
With a price of $3.50, the market is not in equilibrium.
supplied are
Quantity demanded and
QD = 2626.4-212.6(3.5)=1882.3, and
QS = 1944 + 207(3.5) = 2668.5.
Excess supply is therefore 2668.5-1882.3=786.2 million bushels. The government must
purchase this amount to support a price of $3.5, and will spend
$3.5(786.2 million) = $2751.7 million per year.
The table below shows the retail price and sales for instant coffee and roasted coffee for
1997 and 1998.
Retail Price of
Sales of
Retail Price of
Sales of
Instant Coffee
Instant Coffee
Roasted Coffee
Roasted Coffee
Year
($/lb)
(million lbs)
($/lb)
(million lbs)
1997
810
50
600
110
1998
880
45
540
125
a.
Using this data alone, estimate the short-run price elasticity of demand for instant
coffee. Derive a linear demand curve for instant coffee.
To find elasticity, you must first estimate the slope of the demand curve:
Given the slope, we can now estimate elasticity using the price and quantity data from
the above table. Since the demand curve is assumed to be linear, the elasticity will
differ in 1997 and 1998 because price and quantity are different. You can calculate the
elasticity at both points and at the average point between the two years:
To derive the demand curve for instant coffee Q=a-bP, note that the slope of the
demand curve is -0.07=-b. To find the coefficient a, use either of the data points from
the table above so that a=50+0.07*810=106.7 or a=45+0.07*880=106.7. The equation
for the demand curve is therefore
Q=106.7-0.07P.
b.
Now estimate the short-run price elasticity of demand for roasted coffee. Derive a
linear demand curve for roasted coffee.
To find elasticity, you must first estimate the slope of the demand curve:
Given the slope, we can now estimate elasticity using the price and quantity data from
the above table. Since the demand curve Q=a-bP is assumed to be linear, the elasticity
will differ in 1997 and 1998 because price and quantity are different. You can calculate
the elasticity at both points and at the average point between the two years:
To derive the demand curve for instant coffee, note that the slope of the demand curve
is -0.25=-b. To find the coefficient a, use either of the data points from the table above
so that a=110+0.25*600=260 or a=125+0.25*540=260. The equation for the demand
curve is therefore
Q=260-0.25P.
c.
Which coffee has the higher short-run price elasticity of demand?
think this is the case?
Why do you