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					                            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










                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 long-
   run 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        Short-term Long-term        Supply
                          10    31,060.3 48,317.8           27,693.7
                          15    30,301.5 40,259.2           28,146.5
                          20    29,774.4 35,370.7           28,472.3
                          25    29,371.9 31,991.4           28,727.5
                          30    29,047.0 29,471.5           28,937.8
                          35    28,775.2 27,496.4           29,116.8
                          40    28,541.7 25,892.8           29,272.7
                          45    28,337.4 24,556.2           29,411.0
                          50    28,155.8 23,419.1           29,535.2
                          55    27,992.6 22,435.9           29,648.0
                          60    27,844.4 21,574.4           29,751.3
                          65    27,708.8 20,811.1           29,846.8
                          70    27,583.8 20,128.6           29,935.4