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. Labeling points and describing each effect as a movement between specific points is sufficient.
Question 8
The demand for gym memberships is given by \[q_D=500-5p\]
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. \(\epsilon_D=-1\)?
Part G
What is the total revenue at the price you find in part (f)?