PPA 723

Practice questions for Quiz one.

1) Provide the formula for calculating the following, and answer all follow up questions.

= a. = Define a supply elasticity.

The percentage change= in the quantity supplied divided by the percentage change in the price of the good supplied.

<= span style=3D'mso-list:Ignore'>&nbs= p; &= nbsp; &nbs= p; &= nbsp; &nbs= p; i. &nb= sp; Is it positive or negative? Why?

It is positive for the purposes of this class. If pr= ice goes up, suppliers supply more. In more complicated settings this may not hold, but as far as you are concerned yes it is positive since suppliers respond to a higher selling price by bid= ding resources away from alternative uses and supplying more.<= /p>

= b. Define an own-price demand elasticity.

The percentage change= in the quantity demanded divided by the percentage change in the price of the good= demanded.

<= span style=3D'mso-list:Ignore'>&nbs= p; &= nbsp; &nbs= p; &= nbsp; &nbs= p; i. &nb= sp; Is it positive or negative? Why?

It is negative since = that is the law of demand – price and quantity have an inverse relationship o= n a demand curve.

= c. = Define a cross price demand elasticity.

The percentage change= in the quantity demanded divided by the percentage change in the price of a logica= lly related good.

<= span style=3D'mso-list:Ignore'>&nbs= p; &= nbsp; &nbs= p; &= nbsp; &nbs= p; i. &nb= sp; Is this positive or negative if the two goods in question are substitutes? Why= ?

It is positive if the= two goods in question are substitutes, as the increase in the price of the good= that is a substitute leads more consumers to adopt the good in question, leading= to increased demand for our good in question.

= d. Define an income elasticity of demand.

The percentage change= in the quantity demanded of a good divided by the percentage change in income.

<= span style=3D'mso-list:Ignore'>&nbs= p; &= nbsp; &nbs= p; &= nbsp; &nbs= p; i. &nb= sp; Is this positive or negative for an normal good? Why?

For a normal good, it= is positive. As a consumer’= ;s income increases, they consume more of a normal good and less of an inferior good.
Last year, sports shops in the Central New York area sold 200,000 SU Orangemen football sweatshirts during the first four g= ames of the season. The price per sweatshirt was $24. This year= , the price per sweatshirt is $22, and over the same period, the sport shops have sold 250,000. Which of the following explanations is consistent with the facts?

= a. = Demand has shifted up this year compared to last year since the team is doing bett= er.

= b. Demand has shifted down this year compared to last year due to lower consumer inco= mes reflecting the slow growth of wages and large growth in unemployment over t= he past year in this area.

= c. = Supply has shifted up due to an increase in the price of orange dye since the FDA banned the less expensive orange dye used in the production of last year’s sweatshirts since it causes some consumers to have their eyebr= ows fall out.

= d. Supply has shifted down due to a decrease in the cost of supplying sweatshirts due= to the new US – Bangladesh trade agreement that allows cheaper production of sweatshirts in Bangladesh.

Draw each and explain which explanation you choose and= why.

I leave it to you to = draw them, but the idea is that:

Case (a) leads to inc= reased price and increased quantity in the new equilibrium.

Case (b) leads to dec= reased price and decreased quantity in the new equilibrium.

Case ( c) leads to increased price and decreased quantity in the new equilibrium.

Case (d) leads to dec= reased price and increased quantity in the new equilibrium.

The description of the problem tells us that price has decreased from $24 to $22.

The quantity sold has increased from 200000 to 250000.

Decreased price and i= ncreased quantity is what we have, and only case (d) matches that pattern, so it is = the one consistent with the facts.
3) The demand curve is given = to you as Q=3D100-50*P.

= a. = Fill out the following table (use the relatively higher price / relatively lower quantity pair in the elasticity calculation).

Price	Quantity	Elasticity
$0.50	75	-------------------= -------
$0.75	62.5	=3D-0.6
$1.00	50	=3D-1
$1.25	37.5	=3D-1.67=
$1.50	25	=3D-2.5<= /span>

= b. Draw this demand curve with price on the y axis and quantity on the x axis. Identify on this graph the range o= ver which the demand curve is inelastic, and over which it is elastic. Identify the unit elastic point.

The unit elastic point is where p=3D1.00 and q =3D 50 the way I asked you to ca= lculate it. To the left of this point (higher p / lower q) demand is elastic and to the right of this point (lowe= r p / higher q) demand is inelastic.

4) Assume the price of good= 1 is $20 per unit, the price of good 2 is $20 per unit, and the consumer’s income is $100.

a. Draw the budget constraint = if the consumer’s income is $100.

= ;

b. If the price of good 1 chan= ges to $10 per unit, illustrate on a graph how this changes the budget constraint.=

c. If the consumer’s inc= ome increases to $200 given the original prices, illustrate on a graph how this changes the budget constraint.

5= ) The demand curve for milk is defined by ₌ and the sup= ply curve by ₌.

= a. = What is the equilibrium price – quantity pair?

70-20*p=3D10+10*p

60=3D30p

p=3D2. If p =3D 2, Q= d =3D 30, Qs =3D 30, Q =3D 30.

= b. If the government sets a price floor at $3.00, will there be a surplus or a shortage of milk?

There will be a surpl= us, as the price floor is above the market clearing equilibrium in the absence of = the price floor, and that is what a price floor does – it leads quantity supplied to be greater than quantity demanded if set above market price.

= c. = How much surplus or shortage will there be?

At a price of 3, the = quantity supplied is 10+10*3, or 40 and the quantity demanded is 70-20*3 or 10. There will be a surplus of 30.

= d. Draw the original demand and supply graph, and show the situation with a price floor. Label everything that moves!!!

6= ) Say that you know for a particular consumer and particular consumption bundle t= he marginal utility of consuming coffee is 5 and the marginal utility of consu= ming Tylenol is 10.

= a. = The ratio of these marginal utilities defines the slope of what curve (no, the answer is not “the studying for PPA quiz” curve)?

The slope of the indi= fference curve is defined by the (negative) ratio of marginal utilities. (At the optimal bundle where MRS= =3DMRT this will also be the slope of the budget line, but this happens only at the optimal bundle not along the whole curve.)

= b. If the price of coffee is 10 and the price of Tylenol is 15, why is the consumption bundle identified above not an optimal bundle?

MRS =3D -(5/10) =3D -.5. MRT =3D (-10/15) =3D -.3.

MU Coffee =3D5 / pric= e of coffee =3D10 or ½.

MU Tylenol =3D 10 / p= rice of coffee =3D 15 or 2/3.

The MRS is not equal = to the MRT, the MU per dollar on coffee is not equal to the M= U per dollar on Tylenol, so we are not at the optimal bundle.

= c. = Should we increase coffee consumption alone, increase Tylenol consumption alone, increase both, or reduce both to arrive at the optimal bundle? Why? (Illustrate using a graph)

Certainly not decreas= e both by more is better than less. = If we assume the original bundle that gave us the marginal utilities listed above= is on the budget line then we know that we can’t increase both given the nature of the tradeoffs implied by a budget line.

By diminishing margin= al utility, I will be able to reduce the MU of the commodity that has a margin= al utility to price ratio that is too high by increasing consumption of it (and given the nature of the tradeoff, decreasing consumption of the other good which will increase the marginal utility of it). I should consume more Tylenol and = less coffee.
7) Suppose you are setting to= lls for the Tappan Zee Bridge. The current toll is $2 per trip and there are currently 100,000 trips per hour.

= a. = How many trips will there be if you raise the toll by 25% and the price elastic= ity of demand for bridge crossing is -0.5?

Elasticity of demand = =3D % change in Q / % change in p

-0.5=3D[( change in Q/ Q) divided by % = change in price]

-0.5=3D[(change in Q / 100,000) divided by 25%]

Change in Q =3D (-0.5)*(0.25)*(100,000) =3D -12,500

New quantity is 87,50= 0

= b. How will this change your revenue per hour?

Old revenue per hour = was $2 per trip, 100,000 trips, $200,000 per hour.=

New revenue per hour = is based on 25% increase in price, 2*1.25 is $2.50 per trip.

$= 2.50 per trip, 87,500 trips, or total hourly revenue of $218,750.

It will increase the = total hourly revenue, by $18,750.

= c. = What if the estimate of the price elasticity in (a) is wrong and price elasticit= y is in fact -1.5. What will be the change in revenue per hour for the same price change if this second elastic= ity is in fact true?

Change in Q =3D (-1.5)*(0.25)*(100,000) =3D -37,500

New Q is 62,500, and = the price is $2.50, so total hourly revenue now is $156,250. I have decreased revenue by 43,750= .
8) The commodity in question = is tickets on the train between Syracuse and = New York City. Draw four separate graphs showing:<= span style=3D'mso-spacerun:yes'> an upward demand shift, a downward demand shift, an upward supply shift, and a downward supply shift. Provide a story to explain w= hat caused each one (like I make up stories to illustrate the shifts in class).=

You can do the graphs.

Story lines possible:

Demand shifts up: The linkages to rail transport thr= ough the Syracuse regional transport center make train travel more attractive to consumers and more convenient than the old station in East Syracuse, so more people= take the train.

Demand shifts down: A lot of press coverage is devoted= to an AMTRAK train that got stuck for 7 hours near Utica by a flooded track, turning the scheduled 5 hour trip into a 13 hour ordeal. Consumers shift away from AMTRAK f= earing the same could happen to them.

Supply shifts up: The trainwork= ers union wins concessions from AMTRAK, pushing up the price of labor for the company.

Supply shifts down. The price of fuel used to run the = trains decreases.

9) A US government official appears on Meet the Press ( a weekly national political affairs TV show) and says that a program of cooperation between the US government and the Colombian government to eradi= cate coca supply is working in the war against drugs as evidenced by the fact th= at the street price of cocaine has increased by 50% in the past year.

= a. = If this interpretation is correct, = should the market equilibrium amount of cocaine have increased or decreased since = last year (show on a graph).

The effort to eradica= te the coca supply is a supply side story, so the implicit story is that the governments have launched a campaign that shifts supply up in the cocaine market, since coca is an input to production of cocaine. If this is tru= e, and we have an upward supply shift, then price should increase and quantity should decrease. Something like this =

b.Can the government official also claim that t= he street price of cocaine going up and the estimated total quantity sold decreasing supports the argument that programs aimed at convincing school children not to use drugs are effective?&n= bsp; Why or why not?

No, this is a downwar= d demand side story. If this is their argument, it should have the implication that a downward demand shift occur= red due to the campaign to shift preferences away from cocaine, so that we would predict both quantity and price decrease. While both supply shifting a= nd demand shifting policies happening at once could be true to match the facts with the story (with the supply impact on price outweighing the demand impa= ct), if the argument is that the school program alone led to this result and the= re is no supply side story such as in (a) the argument does not match the facts.

1= 0) Consu= mer theory basics.

= a. = What is the technical name for the slope of the budget line?

T= he marginal rate of transformation.=

= b. What is the technical name for the slope of the indifference curve?

T= he marginal rate of substitution.

= c. = Which of these reflects the consumer’s preferences?

T= he marginal rate of substitution.

= d. Distinguish between diminishing marginal utility and diminishing utility.

Diminishing marginal = utility says that for each extra unit consumed, the consumer gets a smaller increme= ntal increase in utility. Diminish= ing utility says that an extra unit consumed gives lower utility. The first (diminishing marginal ut= ility) is consistent with consumer theory, while under the assumptions we have made diminishing utility is not possible with increased consumption of a “good”.

= e. = Describe how having two goods which are both inferior in a two good graph violates t= he “more is better than less” principle.

A good which is inferior implies that increased income leads to decreased consumption of the good. Divi= de up a graph with x1 on the x axis and x2 on the y axis and draw a budget line, = an indifference curve, and describe their intersection (tangency) as an optimal bundle. We can see that to go= to the NW from this bundle means that x2 is normal and x1 is inferior, to the = NE means both are normal, and to the SE means x1 is normal, x2 is inferior. To increase the opportunity set and consume less of the two goods means that w= ith more money you consume less of both goods and reject the bundle that you co= uld afford before and can still afford to consume less of both. You can’t do this and be on = a higher indifference curve given the properties of indifference curves, and more is better than less tells you that the further you are on a ray from the origin the better you are.