Homework 2
Economics 503
Foundations of Economic Analysis
Assigned: Week 2
Due: Week 3
1. We observe the income of the consumers of diamond rings increase by 10%. We
observe that the equilibrium consumption of diamond rings goes up by 5%.
Assume that nothing else happens to cause a change in the equilibrium in the
diamond ring market. Explain why, we can infer that diamond rings are normal
goods, but why we can’t say if they are income elastic luxury goods or income
inelastic. Use at most 1 paragraph and 1 graph.
2. For reasons of safety, the Chinese government orders the closure of 75% of the
coal mines currently operating in the PRC. Draw a graph of the effect of this on
closure on the world coal market. Draw a graph of the effect of this on the world
oil market. Explain your graphs in 1 paragraph or less.
3. The cross price elasticity of demand for oil with respect to Sport Utility Vehicles
is -.1. The governments of the world agree to a tax on SUV’s which raises the
price of SUV’s world-wide by 10%. Calculate the size of the shift in the demand
curve for oil that results. The short-term price elasticity of demand for oil is -.061.
The short-term price elasticity of supply for oil is .04. Calculate the short-run
effect (in % terms) of the tax increase on the equilibrium price and quantity of oil
sold in the world market. The long-term price elasticity of demand for oil is -.3;
the long-term price elasticity of supply is .35. Calculate the long run % change in
the equilibrium price and quantity of oil caused by this tax.
4. Posit a simple demand curve for breakfast cereal of the form Q = 100 - 5P where
Q is the quantity of breakfast cereal and P is the price per box. Calculate Q and
Revenue (R) at each of the following price points. What is the price elasticity of
demand as we move from price point to price point? What is the price point
where revenue is largest? Explain why raising prices above that point does not
increase revenues.
Price
Q
R evenue
Elasticity
5
6
7
8
9
10
11
12
13
14
15
;
5. Below are short-term and long-term demand schedules for petroleum as well as a
supply schedule. Assume that the supply schedule is the same in the long-term
and the short-term. Calculate the equilibrium level of price and quantity for oil in
the short and the long term within the range of $5 per barrel (Hint: the answer is
the same for the short-term and the long-term). . Assume that a conflict in the
Middle East permanently reduces the amount of oil that can be supplied at any
price level. After the shock, only 94% of the previous level is supplied at any
price level. Calculate the new supply schedules. Assuming the short-run and longrun demand curves are unchanged, calculate the new price of oil in the short-term
and in the long-term (within a range of $5).
Price
10
15
20
25
30
35
40
45
50
55
60
65
70
Demand
Short-term Long-term
31,060.3 48,317.8
30,301.5 40,259.2
29,774.4 35,370.7
29,371.9 31,991.4
29,047.0 29,471.5
28,775.2 27,496.4
28,541.7 25,892.8
28,337.4 24,556.2
28,155.8 23,419.1
27,992.6 22,435.9
27,844.4 21,574.4
27,708.8 20,811.1
27,583.8 20,128.6
Supply
27,693.7
28,146.5
28,472.3
28,727.5
28,937.8
29,116.8
29,272.7
29,411.0
29,535.2
29,648.0
29,751.3
29,846.8
29,935.4