Problem Set 2

Due by Thursday, September 26, 2019 (Section 1 - TuTh)

Due by Monday, September 30, 2019 (Section 2 - MW)

Please write your answers to the following questions on a piece of paper, or download and print a PDF copy (link above) to write on. You may also type your answers and print out a hard copy.

You may work together (and I highly encourage that) but you must turn in your own answers. Your TA, under my supervision, will grade homeworks 70% for completion, and for the remaining 30%, pick one question to grade for accuracy - so it is best that you try every problem, even if you are unsure how to complete it accurately.

Concepts and Critical Thinking

Please answer the following questions briefly (1-3 sentences). Use examples as necessary. Be sure to label graphs fully, if appropriate.

Question 1

Describe, in your own words, the (i) price effect, (ii) real income effect, and (iii) substitution effect from a price change.

Question 2

Under what conditions can the law of demand be violated (however theoretical)?

Question 3

For each of the following pairs, which of the two goods is more likely to have a low price elasticity of demand (less elastic) and why?

Part A

Demand for tangerines vs. demand for fruit

Part B

Demand for beef next month vs. demand for beef over the next decade

Part C

Demand for Exxon gasoline at the corner of 7th and Grand vs. demand for gasoline in the entire city

Part D

Demand for insulin vs. demand for vitamins

Question 4

Suppose that, holding prices constant, Alice has preferences over the number of books she purchases, illustrated in the table below.

Income Books
$5 5
$10 6
$15 20
$20 25
$25 26
$30 10
$35 9
$40 8
$45 7
$50 6

Draw a smooth approximation of Alice’s Engel curve for books, and indicate the range(s) of income over which books are normal and/or inferior goods.

Quantitative Applications

Show all work for calculations. You may lose points, even if correct, for missing work. Be sure to label graphs fully, if appropriate.

Question 5

Steve spends his disposable income on meals at restaurants (r) and paperback novels (n). His usual restaurant meal costs $25, and paperback books cost $8. When Steve’s monthly income is $240, he goes out to eat 8 times and purchases 5 books. When his income rises to $282, he goes out to eat 10 times and purchases 4 books.

Part A

Calculate the income elasticity for meals at restaurants (r). Is this an inferior, necessity, or luxury good?

Part B

Calculate the income elasticity for paperback novels (n). Is this an inferior, necessity, or luxury good?

Question 6

Kendra buys eggs (e), bagels (b), and coffee (c) for breakfast for the week.

Part A

When eggs are $2/carton, she buys 5 bagels. When the price of eggs falls to $1/carton, she buys 4 bagels. Calculate the cross-price elasticity between eggs and bagels. Are they complements or substitutes for Kendra?

Part B

When eggs are $2/carton, she buys 3 cups of coffee. When the price of eggs falls to $1/carton, she buys 6 cups of coffee. Calculate the cross-price elasticity between eggs and coffee. Are they complements or substitutes for Kendra?

Question 7

Sketch a graph showing a decrease in the price of a good (on the horizontal axis, e.g. x if you want). Indicate the (real) income effect, substitution effect, and price effect on the graph. Labelling points and describing each effect as a movement between specific points is sufficient.

Question 8

The demand for gym memberships is given by qD=500−5p

Part A

Write the inverse demand function.

Part B

Calculate the price elasticity of demand at a price of $80. Is this relatively elastic or relatively inelastic?

Part C

What is the total revenue at a price of $80?

Part D

Calculate the price elasticity of demand at a price of $10. Is this relatively elastic or relatively inelastic?

Part E

What is the total revenue at $10?

Part F

At what price is demand unit elastic, i.e. ϵD=−1?

Part G

What is the total revenue at the price you find in part (f)?