Assume the demand function for skin care products is given by Q = 1,000 – 20 P + 5I. If P=$25 and I=$1,000 currently,
then:
A.
skin care products are a normal good. (CORRECT)
B.
the elasticity of demand is equal to 11.
C.
(a) and (b) .
Elasticity=(1/slope)*(P/Q)=(1/[1/20])*($45/5500)=0.16 which does not equal 11, so B is wrong.
31)
32)
Assume that several firms compete in the market for cellular phones, and that the price elasticity for this industry is
equal to 0.75. Based on this information, would you advise a firm in this industry to increase its price? If so, what is the
percentage loss in total sales this firm should expect to experience?
A.
Definitely yes. Total revenues would increase, since  < 1. Sales would decrease by only .75% for each 1%
increase in price.
B.
Not enough information is provided to make a sound decision. For the same reason it is not possible to
predict what the loss in sales for one firm would be.(CORRECT)
C.
Definitely no. Each 1% increase in price would result in 7.5% reduction in total sales, negatively affecting
total revenues.
Assume the demand curve for skirts in Europe is P = 100 – QE (or Qe=100 - P), while the U.S demand is P = 100 –
¼QUS. (or Qus = 400 - 4P). Over the range of prices which demand is more price elastic?
A.
U.S. demand is more elastic. CORRECT
B.
European demand is more elastic.
C.
It depends on the price level.
D.
U.S. and European demand have the same elasticity for any price level.
Assume that the price is $1 in each country. Since Elasticity of demand = (1/slope)*(P/Q), then in Europe
(1/1)*($1/10)=0.1. In the US, (1/[1/4])*($1/6)=0.66. 0.66 is larger than 0.1, so the U.S. is more elastic.
33.
34.
Assume D1 represents the current demand curve for skis. Which of the following would be likely to cause D1 to shift to
D2?
Increase in demand
a)
An increase in the price of snowboards. (CORRECT)
b)
An increase in the price of ski boots and clothing.
c)
A decrease in the price of skis
(WITH RESPECT TO “C”, REMEMBER THAT A LOWER PRICE INCREASES QUANTITY BECAUSE OF THE
LAW OF DEMAND. THIS IS WHY DEMAND CURVES SLOPE DOWNWARD.
ALSO, EVEN THOUGH A LOWER PRICE WILL NEVER CAUSE THE DEMAND OR SUPPLY CURVES TO SHIFT
POSITION, IT DOES CAUSE THE BUDGET CONSTRAINT TO ROTATE OUT SO THAT CONSUMERS CAN BE
ON A HIGHER INDIFFERENCE CURVE AND BE HAPPIER. IN OTHER WORDS, PEOPLE ARE HAPPIER ON
THE LOWER PORTIONS OF THE DEMAND CURVE.
Assume SeatComfy Inc. estimates the demand for its table chairs to be Q = 5,000 – 25P + 4I +10PA – 15 PT, where P =
the price of SeatComfy’s chairs; PA = average price of competitors’ chairs; P T = price of tables; and I = average income
of SeatComfy’s customers. Which of the following is true? “C” IS CORRECT
a)SeatComfy’s chairs are inferior goods; SeatComfy’s chairs and tables are complements, while SeatComfy’s and competitors’
chairs are substitutes. SeatComfy’s sales decrease by 250 units for each $10 increase in their own price.
b)SeatComfy’s chairs are normal goods; SeatComfy’s and competitors’ chairs are substitutes, while SeatComfy’s sales are not
affected by the pricing decisions of tables’ producers. SeatComfy’s sales increase by 50% if the price decreases by $2.
c)SeatComfy’s chairs are a normal good; SeatComfy’s chairs and tables are complements, while SeatComfy’s and competitors’
chairs are substitutes. SeatComfy’s sales decrease by 25 units for each dollar increase in price.
35.
Assume the demand function for SeatComfy’s table chairs is as given in the previous question (Q = 5,000 – 25P + 4I
+10PA – 15PT). Moreover, assume that currently P = 10, P A = 15, I = 500, PT = 100. Which of the following is true?
a)
If SeatComfy increases its price by 1%, sales will increase as well as total revenues.
b)
If SeatComfy decreases its price by 1%, sales will increase, while total revenues will decrease.
c)
If SeatComfy increases its price by 1%, sales will decrease, while total revenues will increase.
Q=5650-25P OR P=5650-(1/25)Q. THE SLOPE IS 1/25, PRICE IS $10, AND QUANTITY IS 5400, SO THE
ELASTICITY = (1/[1/25])*($10/5400)=0.046 WHICH IS INELASTIC. THIS MEANS THAT WHEN PRICE
36.
INCREASES TOTAL REVENUE WILL DECREASE. ALSO, THE LAW OF DEMAND IMPLIES THAT IF PRICE
INCREASES SALES WILL DECREASE. “B” AND “C” BOTH SEEM TO FIT THIS.
37.
a)
b)
c)
d)
FarAwayDrive Inc. has recently increased the price of its golf balls from $4.00 to $6.00. In response to this increase in
price, sales decreased from 2,200 to 1,800 units. If no other information concerning the demand is available, which of
the following is true about the sensitivity of demand (using the ARC or mid-points formula) for FarAwayDrive’s golf
balls?
The ARC-elasticity (midpoints formula) of demand is 2.0.
The ARC-elasticity (midpoints formula) of demand is ½ or .50.
The ARC-elasticity (midpoints formula) of demand is 2/3 or .667.
The ARC-elasticity (midpoints formula) of demand is 4/11 or .364.
THE MIDPOINT FORMULA IS ELASTICTY=[(Q2-Q1)/(THE AVERAGE QUANTITY)] /[(P2-P1)/(THE AVERAGE
PRICE)]. THE CHANGE IN QUANTITY IS 400, THE AVERAGE QUANTITY IS 2000, THE CHANGE IN PRICE IS
$2, AND THE AVERAGE PRICE IS $5. SO (400/2000)/($2/$5)=0.2/0.4=0.5. “B” IS CORRECT
38.
Assume Pyrotex Inc. estimates the demand for its fireworks to be linear. If the current price charged by
Pyrotex is such that the elasticity of demand is equal to 2.5, which of the following statements is true?
a)Pyrotex will increase its revenues by decreasing the price of fireworks.
b)Pyrotex will increase its revenues by increasing the price of fireworks.
c)Pyrotex cannot increase its revenues by changing the price of fireworks.
d)Not enough information is provided to determine whether or not Pyrotex is currently maximizing its profits.
THE ELASTICITY IS ELASTIC SINCE IT IS GREATER THAN 1. IF PRICE DECREASES, TR WILL
INCREASE. SO “A” IS CORRECT.
39.
40.
Computer equipment is believed to be a normal good. This means that:
A.
the quantity of computer equipment consumed decreases as income increases.
B.
the income elasticity of demand for computer equipment is negative.
C.
the quantity of computer equipment increases as income increases. (CORRECT)
D.
None of the above
If a firm is earning a large economic profit and the firm operates in a fairly competitive market, then, over
time:
a) old firms will exit and prices will rise.
b) old firms will exit and prices will fall.
c) new firms will enter and prices will rise.
d) new firms will enter and prices will fall.
ECONOMIC PROFITS MEAN THAT FIRMS WILL MAKE MORE IN THIS INDUSTRY THAN IN
THEIR NEXT BEST ALTERNATIVE. FIRMS ENTER, SUPPLY INCREASES (SHIFTS TO THE
RIGHT), AND PRICE FALLS. “D” IS CORRECT.
41. Each semester, Mark pays $1700 tuition and $400 for books and supplies. Mark gives up $5,000 that he
could have made if he worked. He lives in the same apartment that he lived in before college and pays
$400 for the apartment and $400 for food. Assuming that Mark will eat and live somewhere even if he
doesn’t go to school, what is Mark’s cost of going to school each semester?
a. $2900.
b. $2100.
c. $1700.
d. $7900.
e. $7100.
TUITION, BOOKS AND SUPPLIES, AND FOREGONE EARNINGS ARE ALL OPPORTUNITY
COSTS OF COLLEGE. THE APARTMENT AND FOOD ARE NOT OPPORTUNITY COSTS OF
COLLEGE SINCE HE WOULD HAVE LIVED SOMEWHERE AND EATEN IF HE HAD NOT GONE
TO COLLEGE. SO $1700+$400+$5000=$7100. “E” IS CORRECT.
42. Zambizi’s Bakery is a firm in a competitive industry. Zambizi produces 1,000 cakes a day and sells
them for $15 each. At this quantity, Zambizi’s variable costs are $8,000, the fixed costs are $6,000, and
total costs are $14,000. What should Zambizi do?
A) Keep producing and make an economic loss.
B) Keep producing and make an economic profit.
C) Shut down and take a loss equal to its total variable cost.
D) Shut down and take a loss equal to its total fixed cost.
E) Keep producing and make zero economic profits.
TR=$15,000 AND TC=$14,000. PROFIT IS $1,000, SO “B” IS CORRECT.
IN THE LONG RUN THE PROFIT WILL BE GONE BECAUSE OF EITHER (1) ENTRY OF NEW
FIRMS OR (2) BECAUSE OTHER PEOPLE WILL TRY TO BUY THIS FIRM WHICH INCREASES
ITS OPPORTUNITY COST UNTIL THERE IS NO ECONOMIC PROFIT. AN EXAMPLE IS TAXI
CAB MEDIALIONS IN NEW YORK CITY, FIRMS MIGHT SEEM TO MAKE A LARGE PROFIT
BECAUSE OTHER TAXI CABS ARE NOT ALLOWED TO ENTER THE MARKET, HOWEVER, THE
VALUE OF THE MEDIALION WHICH IS A LICENSE TO 0PERATE A TAXI HAS INCREASED TO
AROUND $200,000 EACH. (REMEMBER THAT THE FIRM IS GIVING UP $200,000 IF IT KEEPS
THE MEDALION. IT IS AN IMPLICIT COST) IF THE PROFITABLE ASSET IS PRICED TOO LOW
SO THAT THERE ARE ECONOMIC PROFITS, PEOPLE WILL BE WILLING TO BUY IT, THE
PRICE WILL INCREASE UNTIL PEOPLE ARE MAKING THE SAME AMOUNT AS THE NEXT
BEST OPPORTUNITY (ZERO ECONOMIC PROFITS). SO IN THE LONG RUN IF A FIRM OWNS
ASSETS THAT ARE VERY PROFITABLE, OTHERS WILL BE WILLING TO BUY THEM. THE
FIRM DOESN’T MAKE ECONOMIC PROFITS ANYMORE.
43. Which of the following is a likely consequence of rent controls?
A. People living in rent controlled housing want to have rent controls lifted.
B. Landlords don’t want to rent to people with low and unstable incomes.
C. The quality of rental housing improves.
D. It is easy for new residents in an area to find apartments.
E.
Landlords clearly prefer to have rent controls because they can be choosier on who to rent to.
RENT CONTROL MAKES IT SO THAT OWNERS HAVE A SURPLUS OF PEOPLE TO RENT
TO. IT I HARD TO FIND AN APARTMENT, SO OWNERS CAN BE CHOSIER SUCH AS NOT
RENTING TO PEOPLE WHO THEY THINK WILL HAVE A DIFFICULT TIME PAYING THE
RENT. “B” IS CORRECT. OWNERS ALSO WILL TEND TO LET APARTMENTS GET RUN
DOWN, IT WILL BE HARD TO FIND APARTMENTS FOR NEW RENTERS, AND PEOPLE WHO
CURRENTLY HAVE APARTMENTS DON’T WANT THEIR RENT TO INCREASE SO THEY
VOTE TO KEEP RENT CONTROL. OWNERS WOULD PREFER TO BE ABLE TO INCREASE
RENTS.
44. Amy is thinking about going to the movies tonight to see Princess Diaries. A ticket costs $7 and she
will have to give up 4 hours of work. She earns $8 an hour. What is the cost of seeing the movie?
A)
$7.
B)
$39.
C)
$32.
D)
$24.
E)
$31.
THE OPPORTUNITY COST IS THE PRICE OF THE MOVIE AND THE VALUE OF THE TIME.
$7+4*$8=$39. “B” IS THE RIGHT ANSWER.