Problem Set 3 1. In 2004 a company sold 35,000 MP3 players at $150 each. In 2005 the same company sold 40,000 MP3 players at $190 each. Explain how this is possible using supply and demand diagram. 2. Explain what kind of problems price ceilings and price floors intend to address. What are the possible consequences of price controls? 3. Assume that the price elasticity of demand for JT Chip Co. chips is 4.0. The company decreases the price of each bag of chips from $1.89 to $1.49. Does the number of bags sold increase or decrease? By how much does the number of bags sold change? 4. What happens if the price of plasma television sets falls, ceteris paribus? 5. What happens if a better technology is discovered for producing plasma television sets? 6. If Dell computer and HP computers are substitutes, then what is the effect of a decrease in the price of Dell computers on HP computers? 7. You need to use Figure 1 on the next page to answer this question. a. Suppose that the supply function for oranges is presented by S1 and the demand function for oranges is presented by D1. Use the Figure 1 to determine what is the equilibrium price and quantity? b. Suppose that there was a drought in Florida and California that damaged crops of oranges. What happens at the market for oranges? What are the new market supply and market demand functions? What are the equilibrium price and quantity? c. Now, we are in the equilibrium point of question (b), i.e. our market supply and market demand are the new market demand and the new market supply that you indicated in question b. Next, suppose that the producers of grapefruit, grape, and apple juice increased the price for their products. What happens to the equilibrium price and quantity for oranges? d. Now, we are in the equilibrium point of question (c). Suppose that due to very favorable weather conditions for oranges supply of oranges moves to S3. What is the new equilibrium price and quantity? e. Assume that we are now in equilibrium point (Q6, P3). Suppose that there was an increase in the price of fertilizers that farmers heavily use to grow oranges. Suppose further that there was a change in tastes for oranges. What happens to the equilibrium price and quantity? Can we figure it out? What kind of problem we may run into? f. Suppose that we are in equilibrium (Q4, P3). The government in the USA very actively supports the farmers by setting a price floor for many agricultural products. What happens if government sets a price floor equal to P2? Do we have a shortage or surplus? g. What if a price floor is set equal to P6 instead of P4? Do we have a shortage or surplus? h. Suppose again that we are in equilibrium (Q4, P3) and government sets a price ceiling equal to P2. Do we have a shortage or surplus? Figure 1 S2 S1 P6 P5 P4 P3 P2 P1 S3 D2 D3 D1 0 0 Q1 Q2 Q3 Q4 Q5 Q6 8. You need to use the graph below to answer the following questions: Demand 14 12 10 8 6 4 2 0 0 4 8 12 16 20 24 28 A B C D E F a) Compute the price elasticity using the points A and B b) Compute the price elasticity using the points C and D c) Compute the price elasticity using the points E and F d) Is the price elasticity constant along the demand curve? 9. Consider the market for cigarettes. When the price of cigarettes increases by 15 %, the quantity demanded of cigarettes decreases by approximately 5%. What is the price elasticity of cigarettes? Is the demand for cigarettes elastic or inelastic? 10. Consider the market for chairs. Assume that currently the market equilibrium price is $200 for one chair. At that price equilibrium quantity is 1500 of chairs sold. Suppose that the furniture companies have decided to decrease the supply of chairs. As we know, the decrease in supply results in higher equilibrium price. Assume that the equilibrium price increases from $200 to $350. The equilibrium quantity of chairs sold at this price is 700. a. Compute the total revenue of furniture companies before the decrease in supply. Label it TR1. b. Compute the total revenue after the decrease in supply. Label it TR2. c. What happens to the total revenue of furniture companies when they decrease supply? d. What can you say about the elasticity of demand for chairs? Does it look like elastic or inelastic demand? e. Draw a graph showing the relationship between elasticity of demand and total revenue. 11. Consider the market for any two goods: alophont and bilophont P. of Biloph = $5 P. of Biloph = $10 Price of Biloph. = $10 A B C D E Price of Alophont 2 4 6 8 10 Income = $1500 Income = $1500 QD of Alophont QD of Alophont 27 24 21 18 15 31 28 25 22 19 Income = $2000 QD of Alophont 33 30 27 24 21 a. Draw a graph showing a demand for alophont when price of bilophont is $5 and $10 and all other things do not change. b. Is a cross-elasticity between alophont and bilophont positive or negative? c. Are goods alpohont and bilophont substitutes or complements? Why? d. Draw a graph showing a demand for alophont when income = $1500 and $2000 and all other things do not change. e. Is the income elasticity for alophont positive or negative? f. Is a good alophont normal or inferior good? Why? 12. Consider the following Demand and Supply Schedule P Qd P 2 27 2 4 24 4 6 21 6 8 18 8 10 15 10 Qs 9 15 21 27 33 a. Draw a graph of demand and supply in the figure below. Label the demand function as D1 and the supply function as S1. What is the equilibrium price and quantity? Demand and Supply 11 10 9 8 7 6 5 4 3 2 1 0 6 9 12 15 18 21 24 27 30 33 36 b. Suppose that a government imposes a tax on buyers equal to $3. Use the graph below to show what happens to supply and demand. What is the new equilibrium quantity? What is the new equilibrium price that producers charge? What is the price that consumers pay after the tax? Demand and Supply 11 10 9 8 7 6 5 4 3 2 1 0 6 9 12 15 18 21 24 27 30 33 36 c. How much of the tax is actually paid by consumers? d. How much of the tax is actually paid by producers? e. Go back to our original demand D1 and supply S1. Assume that instead of taxing buyers a government imposes a tax on sellers (producers) equal to $3. Use the graph below to show what happens to supply and demand. What is the new equilibrium quantity? What is the price that consumers pay after the tax? What is the amount that actually goes to producers? Demand and Supply 11 10 9 8 7 6 5 4 3 2 1 0 6 9 12 15 18 21 24 27 30 33 36 f. How much of the tax is actually paid by consumers? g. How much of the tax is actually paid by producers?