Answer to Chapter

Chapter 5 Mankiw SOLUTIONS TO TEXT PROBLEMS Quick Quizzes 1. The outlay catch of remove is a measure of how much the touchstone take aimed of a unafraid responds to a diverge in the worth of that good, computed as the part transpose in measuring occupyed divided up by the percentage switch oer in harm. When want is dead (a line up centering slight than 1), a value augment raises occur tax gross, and a footing decrease reduces measure revenue. When ask is elastic (a scathe ginger nut greater than 1), a harm outgrowth reduces ingrained revenue, and a terms decrease cast ups total revenue.When necessity is unit elastic (a harm elasticity sufficient to 1), a transport in set does non affect total revenue. 2. The toll elasticity of turn in is a measure of how much the amount of money supplied of a good responds to a compound in the charge of that good, computed as the percentage trade in measuring rod supplied divided by the percentage va riety in worth. The charge elasticity of write out might be different in the coherent run than in the hornswoggle run because over short periods of sentence, firms cannot easily diverseness the sizes of their factories to make much or less(prenominal) of a good.Thus, in the short run, the measurement supplied is not genuinely responsive to the price. However, over dourer periods, firms can build new factories, expand existing factories, weedy old factories, or they can enter or exit a market. So, in the long run, the step supplied can respond substantially to a change in price. 3. A drought that destroys half of all produce crops could be good for farmers (at least those unaffected by the drought) if the lease for the crops is inelastic.The elusion to the left of the supply mold get hold ofs to a price increase that pass on raise total revenue if the price elasticity of demand is less than 1. No one farmer would sire an incentive to destroy his crops in the absence of a drought because he takes the market price as given. Only if all farmers destroyed a portion of their crops together, for example done a government program, would this plan work to make farmers better off. Questions for reassessment 1. The price elasticity of demand measures how much meter demanded responds to a change in price.The income elasticity of demand measures how much bar demanded responds to changes in consumer income. 2. The determinants of the price elasticity of demand include how available culmination renewals ar, whether the good is a necessity or a luxury, how broadly defined the market is, and the time horizon. Luxury goods piddle greater price elasticities than necessities, goods with close eases endure greater elasticities, goods in more(prenominal) narrowly defined markets have greater elasticities, and the elasticity of demand is greater the longer the time horizon. . The main advantage of victimization the mid-point formula is that it uses a constant base whether the change in price or measuring rod demanded is an increase or a decrease. 87 88 Chapter 5/Elasticity and Its Application 4. An elasticity greater than one agency that demand is elastic. When the elasticity is greater than one, the percentage change in quantity demanded exceeds the percentage change in price. When the elasticity equals postal code, demand is perfectly inelastic. at that place is no change in quantity demanded when in that location is a change in price. 5. see to it 1 presents a supply-and-demand diagram, showing the equaliser price, the balance quantity, and the total revenue received by producers. Total revenue equals the equipoise price times the counterbalance quantity, which is the area of the rectangle shown in the figure. Figure 1 6. If demand is elastic, an increase in price reduces total revenue. With elastic demand, the quantity demanded move by a greater percentage than the price rises. As a result, total revenue reduces. 7. A good with income elasticity less than zero is called an inferior good because as income rises, the quantity demanded declines. . The price elasticity of supply is calculated as the percentage change in quantity supplied divided by the percentage change in price. It measures how much quantity supplied responds to changes in price. 9. The price elasticity of supply of Picasso paintings is zero, because no matter how high price rises, no more can ever be produced. 10. The price elasticity of supply is usually larger in the long run than it is in the short run. Over short periods of time, firms cannot easily change the sizes of their factories to make more or less of a good, so the quantity supplied is not very responsive to price.Over longer periods, firms can build new factories or close old ones, so the quantity supplied is more responsive to price. 11. Because the demand for drugs is credibly to be inelastic, an increase in price go out lead to a rise in total expenditure. T herefore, drug users whitethorn resort to stealth or burglary to support their dresss. Chapter 5/Elasticity and Its Application Problems and Applications 89 1. a. riddle novels have more elastic demand than need textbooks, because mystery novels have close substitutes and are a luxury good, slice required textbooks are a necessity with no close substitutes.If the price of mystery novels were to rise, readers could substitute opposite types of novels, or buy fewer novels altogether. except if the price of required textbooks were to rise, students would have little choice but to pay the higher price. Thus, the quantity demanded of required textbooks is less responsive to price than the quantity demanded of mystery novels. b. van Beethoven recordings have more elastic demand than serious music music recordings in general. Beethoven recordings are a narrower market than classical music recordings, so it is easy to find close substitutes for them.If the price of Beethoven recordi ngs were to rise, great deal could substitute other classical recordings, like Mozart. But if the price of all classical recordings were to rise, substitution would be more difficult. (A transition from classical music to chip is un likely ) Thus, the quantity demanded of classical recordings is less responsive to price than the quantity demanded of Beethoven recordings. c. Subway rides during the next five years have more elastic demand than subway rides during the next six months. Goods have a more elastic demand over longer time horizons.If the get on for a subway ride was to rise temporarily, consumers could not switch to other forms of transportation without great expense or great inconvenience. But if the fare for a subway ride was to remain high for a long time, people would gradually switch to alternative forms of transportation. As a result, the quantity demanded of subway rides during the next six months volition be less responsive to changes in the price than the qua ntity demanded of subway rides during the next five years. d. stock beer has more elastic demand than pee.Root beer is a luxury with close substitutes, while water is a necessity with no close substitutes. If the price of water were to rise, consumers have little choice but to pay the higher price. But if the price of root beer were to rise, consumers could easily switch to other sodas. So the quantity demanded of root beer is more responsive to changes in price than the quantity demanded of water. 2. a. For backing travelers, the price elasticity of demand when the price of tickets rises from $200 to $250 is (2,000 1,900)/1,950/(250 200)/225 = 0. 05/0. 22 = 0. 23.For vacationers, the price elasticity of demand when the price of tickets rises from $200 to $250 is (800 600)/700 / (250 200)/225 = 0. 29/0. 22 = 1. 32. b. The price elasticity of demand for vacationers is higher than the elasticity for business travelers because vacationers can deal more easily a different mode o f transportation (like ride or taking the train). Business travelers are less likely to do so because time is more important to them and their schedules are less adaptable. 3. a. The percentage change in price is equal to (2. 20 1. 00)/2. 00 = 0. = 20%. If the price elasticity of demand is 0. 2, quantity demanded depart fall by 4% in the short run 0. 20 ? 0. 20. If the price elasticity of demand is 0. 7, quantity demanded will fall by 14% in the long run 0. 7 ? 0. 2. b. Over time, consumers can make adjustments to their homes by purchase alternative heat sources such as natural gas or electric furnaces. Thus, they can respond more easily to the change in the price of heating oil in the long run than in the short run. 90 Chapter 5/Elasticity and Its Application 4. If quantity demanded fell, price must have risen.If total revenue rose, then the percentage increase in the price must be greater than the percentage decline in quantity demanded. Therefore, demand is inelastic. 5. Both Billy and Valerie may be correct. If demand increases, but supply is totally inelastic, equilibrium price will rise but the equilibrium quantity will remain the same. This would as well occur if supply decreases and demand is totally inelastic. maren is incorrect. If supply and demand both rise, equilibrium quantity will increase, but the impact on equilibrium price is indeterminate. 6. a. If our income is $10,000, your price elasticity of demand as the price of compact discs rises from $8 to $10 is (40 32)/36/(10 8)/9 =0. 22/0. 22 = 1. If your income is $12,000, the elasticity is (50 45)/47. 5/(10 8)/9 = 0. 11/0. 22 = 0. 5. b. If the price is $12, your income elasticity of demand as your income increases from $10,000 to $12,000 is (30 24)/27/(12,000 10,000)/11,000 = 0. 22/0. 18 = 1. 22. If the price is $16, your income elasticity of demand as your income increases from $10,000 to $12,000 is (12 8)/10/(12,000 10,000)/11,000 = 0. 40/0. 18 = 2. 2. 7.Yes, an increase in inco me would decrease the demand for good X because the income elasticity is less than zero, indicating that good X is an inferior good. A decrease in the price of good Y will decrease the demand for good X because the two goods are substitutes (as indicated by a cross-price elasticity that is greater than zero). 8. a. If Maria always spends one-third of her income on vestments, then her income elasticity of demand is one, because maintaining her clothing expenditures as a constant fraction of her income factor the percentage change in her quantity of clothing must equal her percentage change in income. . Marias price elasticity of clothing demand is also one, because each percentage point increase in the price of clothing would lead her to reduce her quantity purchased by the same percentage. c. Because Maria spends a smaller proportion of her income on clothing, then for any given price, her quantity demanded will be lower. Thus, her demand curve has shifted to the left. Because s he will again spend a constant fraction of her income on clothing, her income and price elasticities of demand remain one. 9. a. If quantity demanded falls by 4. 3% when price rises by 20%, the price elasticity of demand is 4. /20 = 0. 215, which is fairly inelastic. b. Because the demand is inelastic, the Transit Authoritys revenue rises when the fare rises. c. The elasticity estimate might be unreliable because it is yet the first month after the fare increase. As time goes by, people may switch to other means of transportation in reaction to the price increase. So the elasticity may be larger in the long run than it is in the short run. 10. Toms price elasticity of demand is zero, because he wants the same quantity regardless of the price. Jerrys price elasticity of demand is one, ecause he spends the same amount on gas, no matter what the price, which means his percentage change in quantity is equal to the percentage change in price. Chapter 5/Elasticity and Its Application 91 11. a. With a price elasticity of demand of 0. 4, reducing the quantity demanded of cigarettes by 20% requires a 50% increase in price, because 20/50 = 0. 4. With the price of cigarettes currently $2, this would require an increase in the price to $3. 33 a aim using the midpoint method (note that ($3. 33 $2)/$2. 67 = . 50). b. The policy will have a larger effect five years from at a time than it does one year from now.The elasticity is larger in the long run, because it may take some time for people to reduce their cigarette usage. The habit of smoking is hard to break in the short run. c. Because teenagers do not have as much income as adults, they are likely to have a higher price elasticity of demand. Also, adults are more likely to be addicted to cigarettes, making it more difficult to reduce their quantity demanded in response to a higher price. 12. In order to determine whether you should raise or lower the price of admissions, you need to know if the demand is elastic or inelastic.If demand is elastic, a decline in the price of admissions will increase total revenue. If demand is inelastic, an increase in the price of admissions will cause total revenue to rise. 13. a. As Figure 2 shows, the increase in supply reduces the equilibrium price and increases the equilibrium quantity in both markets. b. In the market for pharmaceutical drugs (with inelastic demand), the increase in supply leads to a relatively large decline in the equilibrium price and a small increase in the equilibrium quantity. Figure 2 c.In the market for computers (with elastic demand), the increase in supply leads to a relatively large increase in the equilibrium quantity and a small decline in the equilibrium price. d. Because demand is inelastic in the market for pharmaceutical drugs, the percentage increase in quantity will be lower than the percentage decrease in price thus, total 92 Chapter 5/Elasticity and Its Application consumer using up will decline. Because demand is ela stic in the market for computers, the percentage increase in quantity will be greater than the percentage decrease in price, so total consumer spending will increase. 4. a. As Figure 3 shows, the increase in demand increases both the equilibrium price and the equilibrium quantity in both markets. b. In the market for beachfront resorts (with inelastic supply), the increase in demand leads to a relatively large increase in the equilibrium price and a small increase in the equilibrium quantity. c. In the market for automobiles (with elastic supply), the increase in demand leads to a relatively large increase in the equilibrium quantity and a small increase in equilibrium price. d.In both markets, total consumer spending rises, because both equilibrium price and equilibrium quantity rise. Figure 3 15. a. Farmers whose crops were not destroyed benefited because the destruction of some of the crops reduced the supply, causing the equilibrium price to rise. b. To tell whether farmers as a conclave were hurt or helped by the floods, you would need to know the price elasticity of demand. It could be that the total revenue received by all farmers as a group actually rose. 16. A worldwide drought could increase the total revenue of farmers if the price elasticity of demand for grain is inelastic.The drought reduces the supply of grain, but if demand is inelastic, the reduction of supply causes a large increase in price. Total farm revenue would rise as a result. If there is only a drought in Kansas, Kansas production is not a large enough proportion of the total farm product to have much impact on the price. As a result, price does not change (or changes by only a slight amount), while the getup by Kansas farmers declines, thus reducing their income. 17. The quantity demanded at various prices is shown in the table belowChapter 5/Elasticity and Its Application Price 1 2 3 4 5 6 Quantity Demanded 60 30 20 15 12 10 93 Figure 4 The demand curve is shown in Figure 4. When price rises from $1 to $2 (a 66. 67 % increase), quantity demanded falls from 60 to 30 (a 66. 67% decrease). Therefore, the price elasticity of demand is equal to one. When price rises from $5 to $6 (an 18. 18% increase), quantity demanded falls from 12 to 10 (an 18. 18% decline). once again the price elasticity is equal to one. A linear demand curve has a price elasticity that declines in absolute value as price falls. This demand curve has a constant elasticity equal to one.