Chapter 4 1.

Show how the following demand curves are likely to shift in response to the indicated changes: In words: a. drought: will lessen consumers need for umbrellas (tastes change). This will lower demand, shifting the demand curve to the left. b. high popcorn prices: If we assume that popcorn and movie tickets are complements, then an increase in popcorn prices means lower popcorn AND movie ticket consumption. This is a decrease in the demand for movie tickets, and is shown by a leftward shift of the demand curve. c. increased price of tea: if Coffee and tea are substitutes, then an increase in the price of tea means less tea consumption and more coffee consumption. This increase in Demand will cause the demand curve to shift out or to the right. d. higher income/computers: If computers are a normal good, the increase in consumer income will increase the demand for computers, shifting the demand curve to the right. e. higher income/Ramen: If Ramen is an inferior good, then the increase in consumer income will decrease the demand for Ramen noodles, shifting the demand curve to the left. P&A # 1 a. cold snap will cause a shortage of oranges, so as supply of oranges falls, the price of oranges rises. As oranges are the leading input into orange juice, the supply of orange juice will decrease because of the higher price of oranges. This will shift supply left, increasing the price and decreasing the quantity. b. New England's warm weather will lower the demand for Caribbean hotels (fewer people will be trying to escape the cold, and will stay in New England). This shifts the demand curve to the left, which lowers the price of a caribbean hotel. c. War in the Middle East will decrease our supply of oil (as they export a majority of oil for the world). Supply shifts left, increasing the price. Furthermore, the increased price of gas influences the market for used Cadillacs in the following way. Gas is a complement good to Caddilacs. When the price of the compliment rises (gas prices rose) the demand for used Cadillacs will fall. This shifts the demand curve left, lowering price. IN ADDITION. . .more

people will want to switch from driving a Cadillac to a more fuel-efficient car. They sell their Cadillacs, increasing the supply of used Cadillacs as well. Supply shifts right, further lowering the price. Note: since we had a shift of both supply and demand curve for Cadillacs, we cannot be certain how the quantity of used Cadillacs will change. We CAN be certain of the decrease in price.

P&A3 Minivans a. More kids means tastes for minivans improve. Demand increases, shifting right. Price and quantity increase. b. increase steel prices--input prices rise, lowering supply. Supply shifts left, increasing price and decreasing quantity. c. New technology will increase supply. Supply shifts right, decreasing price and increasing quantity. d. Prices of stations wagons rise--this is a substitute to the minivan. Fewer people will buy station wagons, so more will buy minivans. This increases the demand for minivans, shifting demand right and increasing price and quantity e. lower wealth will decrease the demand for minivans. This shifts the demand

curve left, lowering both price and quantity.

P&A 6 In 2010, there will be a big need for baby sitters, so demand for babysitters rises. This shifts the demand curve right, increasing the price of baby sitting services.

By 2020, the number of teenagers old enough to baby sit skyrockets, so that the supply of baby sitters rises. This shift of supply to the right will lower the price of baby sitting services. P&A12 (This was a tricky one.) First, the "successful marketing campaign" aimed to change people's tastes for champagne. As it was successful, it increased demand, shifting the demand curve to the right. This caused the "stratospheric champagne prices" (higher prices) that the execs were "giddy" about. Their fears about the high prices causing demand to plummet are incorrect, because they did not look at WHY prices rose. They changed consumer tastes for the product (through the ad campaign) and thus increased customer demand for the product. . .meaning that consumers are now WILLING to pay more for their champagne. The execs should not worry, but celebrate with some of that overpriced champagne. P&A9: Equilibrium price is $6 and the quantity is 81. Even if you didn't draw this, you could have seen this on the supply schedule, since at a price of $6, both quantity demanded and quantity supplied are 81.

If the market price were too high, then there would be excess supply. The suppliers would lower prices to get rid of inventories, and lower their production accordingly. If the market price were too low, then there would be excess demand (shortage). The consumers would be willing to pay a higher price to get the pizza, and would bid up the price accordingly. 3. a. the price of cheeseburgers falls--substitute goods gets cheaper, so demand for pizza falls. This shifts demand left, lowering both price and quantity. b. the price of mozarella increases--input good price rises, so supply falls. Supply shifts left, raising price and lowering quantity. c. consumers' incomes rise--demand rises as incomes rise, WHEN pizza is a normal good. Demand shifts right, increasing price and quantity. d. new automated pizza-making technology is introduced--the new technology will increase supply. Supply shifts right, decreasing price and increasing

quantity.

Chapter 7 1. Twenty gallons of water will give you greater total utility, because the quantity is larger. Our total utility rises as we consume more of a good. 2. Twelve gallons of water will give you greater marginal utility, because our marginal utility decreases as we consumer more of the good. By the 12th gallon, we've already had quite a bit of water. By the 20th gallon we may actually be sick of water and will gain only very little from its consumption. P&A # 1 The bad weather will decrease the supply of lemons available, which will cause the price to rise and the quantity to fall. This LOWERS the amount of consumer surplus in the market for lemons. The higher price of lemons will also decrease the supply of lemonade (as lemons are the main input into lemonade). The lower supply of lemonade will increase the price and decrease the quantity of lemonade. This also will LOWER the consumer surplus in the market for lemonade. (In both the market for lemons or the market for lemonade, consumer surplus shrinks from the combined purple and blue sections, to ONLY the blue section, when the prices rise.)

P&A # 7. Demand is in blue: the horizontal stretches are at $8 (Sally Jessie), $7 (Jerry), $5 (Montel) and $2 (Oprah). The supply curve is in red: the horizontal stretches are at $2 (Firm D), $3 (Firm A), $4 (Firm C) and $6 (Firm B).

Efficiency: Supply equals demand at a quantity of three haircuts. Who cuts hair? The lowest cost (most efficient) suppliers--Firms D, A and C, in this example. Who gets a haircut? Those who want it the most--Sally Jessie, Jerry and Montel, in this example. Maximum Total Surplus is 11. This is the area between supply and demand, summed up for each of the three haircuts. NOTICE: The question did not ask for price. Why? Because we cannot be certain. We can say that price will be somewhere between $4 and $5, because that is the section where supply and demand are equal. Without a set price, the individual consumer and producer surplus cannot be determined.

If I were to tell you that price ends up at $5, CS = 5 and PS = 6. If Price were $4, then CS = 8 and PS = 3. In either case TS = 11. However, consumers do better with the lower price and producers do better with the higher price.

Chapter 5 1. a. The price elasticity of demand describes how responsive the quantity demanded is to a change in the price of that good. Large elasticities mean that there is a greater demand response (or it is more elastic). b. Goods which have elastic demand curves: there are many answers, but in general, they would be goods categorized as luxuries, goods over long time horizons, good with close substitutes and goods in narrowly defined markets. c. Goods which have inelastic demand curves: again, there are many answers, but in general, they would be goods categorized as necessities, goods over very short time horizons, goods without close substitutes, and goods in broadly defined markets. d. Elastic demand curves are flat and inelastic demand curves are steep: Elastic demand curves imply that the quantity demanded is very responsive (or very large) for a change in price. If the slope is "rise over run", and the "rise" here is price and the "run" is quantity demanded, then elastic demand curves have a very large "run" for a given "rise." If the denominator is larger, the slope will be smaller. . .or flatter as the question put it. Alternatively, an inelastic demand curve is NOT very responsive. So we'd see small changes in quantity demanded, or small "runs" for a given price change. The smaller denominator makes the slope larger. . .implying a steeper demand curve. 2. If the price elasticity of demand for a good is elastic, its price should be decreased in order to increase total revenue. The elastic good would see a larger increase in quantity demanded compared to the decrease in price. Although the firm would be making less money on each good that they sell, they would be

more than compensated by selling many, many more goods.

3. Mankiw P&A #1 a. Mystery novels, because they are a luxury, not a necessity. b. Beethoven, because it is a narrowly defined market and there are more close substitutes like Bach or Brahms. c. Heating oil over the next five years, because of the longer time frame. People will evenually switch out of oil heat to gas heat. d. Root beer, as it is a "luxury" item compared to water. 4. Mankiw P&A #3a i.the price elasticity of demand for consumers with incomes of $10,000 is unit elastic.

ii.the price elasticity of demand for consumers with incomes of 12,000 is inelastic.

Mankiw #3b i. When price is $12, the income elasticity is:

ii. When price is $16, the income elasticity is:

5. Mankiw P&A # 8 a. If we recall that the elasticity is equal to the percentage change in quantity demanded by the percentage change in price, we can solve for the percentage change in price. We were given information that the elasticity was 0.4 and that the desired change in quantity demanded was 20%.

This implies that they should increase price by 50%, or increase it from $2 to $3. b. Five years from now. The higher prices now will cause some people to eventually quit smoking (or not start) so that demand will fall much more in the long run than it will in the short run. c. Teens should have a larger price elasticity of demand for cigarettes because this is when most people begin smoking. If prices are higher, fewer teens will become addicted in the upcoming years, and quantity demanded will be more affected later than it can be now. 6. The elasticity of supply of lawnmowers would be larger over the span of one year. Supply is more flexible over longer time horizons since it takes time to increase production (hire more workers, order more equipment, etc.). Over the short run, you can only change the quantity supplied by what you have already built (and these days, inventories are kept relatively small). 7. Mankiw P&A # 11, page 116. a. As seen in the figure below, both the equilibrium price and the equilibrium

quantity will increase when demand increases. b. The Beachfront properties will experience a larger change in price (and a smaller change in quantity) because of the inelastic supply. c. The Auto market will experience a larger change in quantity (and a smaller change in price) because of the elastic supply. d. Consumer spending (Price x Quantity) increases in both cases, since both price and quantity increase. (However, we cannot say precisely which will increase more.)

Chapter 6 1. Mankiw P&A #2, page 136, with some changes. . . First, the competitive equilibrium is drawn on the left. There is no deadweight loss when we are at the competitive equilibrium because we are selling the efficient quantity at the efficient price.

a. The new equilibrium is on the right. The price will increase and the quantity will decrease, compared to the competative equilibrium. There is a surplus of cheese (excess supply). There is a deadweight loss as a result of the price floor, because the quantity is restricted. Therefore, we cannot get any surplus on the items that are never sold. b. It is definitely possible that the farmers can lose revenue (Price x Quantity) when the price floor is increased. Although the price does rise, if the quantity falls by a greater percentage than the increased price, the farmers Total Revenue will fall. The more elastic is the demand for Cheese, the higher is the probability that they will lose TR as a result of the price floor. (Recall that when demand is Elastic, price increases will DECREASE total revenue. 2. Mankiw P&A #4 a. without the tax: Price paid for beer by consumer is P*, Price recieved by sellers is also P*, Quantity of beer sold is Q*. There is NO difference between the price paid by consumers and the price received by sellers. b. with the $2 tax: Price paid by consumers is Pb, Price received by sellers is Ps, quantity sold is Qt. The difference between the consumer and seller prices is (Pb-Ps) which is equal to $2 in this case (the size of the tax). The quantity of beer sold has decreased with the tax in place. Ttotal welfare has decreased when the tax is imposed. Both producer and consumer surplus shrink, and the government revenue does not equal this loss in CS and PS. There is a deadweight loss.

3. Mankiw P&A #6, page 137. The $500 tax on luxury cars will be split between consumers and sellers, such that the price that consumers pay will rise, but not by the full $500.