Microeconomics Quiz Notes and Explanation

lOMoARcPSD|23780900 18. How prices allocate resources Suppose that there are three plots of mountain resort land available for sale in Interlaken and six potential buyers, each interested in purchasing one plot. Assume that all of the plots are basically indistinguishable and that the minimum selling price of each is $340,000. The following table lists each potential buyer's willingness and ability to purchase a plot of land. Person Willingness and Ability to Purchase (Dollars) Brian 500,000 Crysta l 400,000 Edison 360,000 Hilary 320,000 Kevin 300,000 Maria 280,000 Which of these people will purchase one of the three mountain resort plots? Check all that apply. Brian Crystal Edison Hilary Kevin Maria Points: 1/1 Close Explanation Explanation: Brian, Crystal, and Edison will purchase the plots because they are the only ones willing and able to meet the minimum selling price of $340,000. One or more of the other three people might have the ability, but not the willingness to pay the required price. Moreover, perhaps Hilary, Kevin, and Maria have a strong desire to own mountain resort land in Interlaken, but do not have the ability to pay the selling price. lOMoARcPSD|23780900 Now, assume that the three mountain plots have been sold to the people that you indicated in the previous section. Suppose that a few weeks after the last of those mountain plots is sold, another basically identical mountain plot goes on the market for sale at a minimum price of $330,000. This be sold, because no one will purchase it from the seller for at fourth plot will not least the minimum price. Points: 1/1 Close Explanation Explanation: To determine what will happen with the fourth plot, compare the minimum selling price with the willingness and ability to pay of the remaining buyers. The remaining buyer with the highest willingness and ability to pay is Hilary at $320,000. However, since $320,000 is less than the minimum selling price of $330,000 for this plot, no one will purchase the parcel. The seller will have to lower their minimum selling price if they 19. Elastic, inelastic, and unit-elastic demand The following graph shows the demand for a good. PRICE (Dollars per unit)QUANTITY (Units)Demand0Z35010Y17525X12535W5070 For each of the regions listed in the following table, use the midpoint method to identify if the demand for this good is elastic, (approximately) unit elastic, or inelastic. Region Between Y and Z Between W and X Elastic Inelastic Unit Elastic lOMoARcPSD|23780900 Region Elastic Inelastic Unit Elastic Between X and Y Points: 0.33 / 1 Close Explanation Explanation: The price elasticity of demand measures the responsiveness of consumers to changes in price. For example, if consumers change their purchasing behavior very little in response to a drastic change in price, demand is said to be inelastic; but if consumers change their purchasing behavior a lot in response to a small change in price, demand is said to be elastic. The price elasticity of demand is the percentage change in quantity divided by the percentage change in price. Demand is elastic when the price elasticity of demand is greater than 1, ignoring the negative sign. This occurs when the percentage change in quantity demanded is larger than the percentage change in price. Using the midpoint method, you can compute the percentage change in quantity and price between points Y and Z in the following way: Percentage Change in QuantityPercentage Cha = = 100×Q2−Q1Q2+Q12100×�2−�1�2+�12 nge in Quantity = = 100×10−2510+252100×10−2510+252 = = 100×−1517.5100×−1517.5 = = −86%−86% Percentage Change in PricePercentage Cha = 100×P2−P1P2+P12100×�2−�1�2+ nge in Price = �12 = 100×350−175350+1752100×350−175 = 350+1752 = 100×175262.5100×175262.5 = = = 67%67% lOMoARcPSD|23780900 The price elasticity of demand, therefore, equals the following (ignoring the negative sign): Price Elasticity of DemandPri = Percentage Change in QuantityPercentage Change in PricePercentage Chan ce Elasticity of Demand = ge in QuantityPercentage Change in Price = 86%67%86%67% = = 1.281.28 = Since the percentage change in quantity is greater than the percentage change in price, the price elasticity of demand is greater than 1, and demand is elastic between points Y and Z. Demand is unit elastic if the price elasticity of demand is equal to 1. This occurs when the percentage change in quantity demanded is equal to the percentage change in price. Using the midpoint method, the percentage change in price between points X and Y is 33%, and the percentage change in quantity between points X and Y is -33%. Since the percentage change in price is equal to the percentage change in quantity, the price elasticity of demand is 1, and demand is (approximately) unit elastic between points X and Y. Demand is inelastic if the price elasticity of demand is less than 1. This occurs when the percentage change in quantity demanded is smaller than the percentage change in price. Using the midpoint method, the percentage change in price between points W and X is 86%, and the percentage change in quantity between points W and X is -67%. This means the price elasticity of demand equals 67%86%=0.7867%86%=0.78. Since the percentage change in quantity demanded is smaller than the percentage change in price, the price elasticity of demand is less than 1, and demand is inelastic between points W and X. In general, demand tends to be elastic at relatively high prices, inelastic at relatively low prices, and unit elastic at prices toward the middle of the demand curve. True or False: The slope of the demand curve is not equal to the value of the price elasticity of demand. True False Points: 1/1 lOMoARcPSD|23780900 Close Explanation Explanation: You can summarize the results of this exercise as follows: Slope Elasticity Elastic or Inelastic? Between Y and Z 350−17510−25=−11.67350−17510−25= 86%67%=1.2886%67%=1 Elastic −11.67 .28 Between X and Y 175−12525−35=−5175−12525−35=−5 33%33%=1.0033%33%=1 Between W and X 125−5035−70=−2.14125−5035−70=−2.1 67%86%=0.7867%86%=0 4 .78 Region Unit Elastic .00 Inelastic In this case, the steeper part of the demand curve is the elastic portion, and the flatter part of the demand curve is the inelastic portion. However, despite this coincidence with nonlinear demand curves, you can see from the previous table that it’s important to remember that slope is still not the same as elasticity. In general, demand tends to be elastic at relatively high prices, inelastic at relatively low prices, and unit elastic at prices toward the middle of the demand curve, regardless of the linear or nonlinear construction of the demand curve. 20. Application: Elasticity and hotel rooms The following graph input tool shows the daily demand for hotel rooms at the Oceans Hotel and Casino in Atlantic City, New Jersey. To help the hotel management better understand the market, an economist identified three primary factors that affect the demand for rooms each night. These demand factors, along with the values corresponding to the initial demand curve, are shown in the following table and alongside the graph input tool. Demand Factor Average American household income Roundtrip airfare from Des Moines (DSM) to Atlantic City (ACY) Initial Value $50,000 per year $100 per roundtrip lOMoARcPSD|23780900 Demand Factor Initial Value Room rate at the Meadows Hotel and Casino, which is near the Oceans $200 per night Use the graph input tool to help you answer the following questions. You will not be graded on any changes you make to this graph. Note: Once you enter a value in a white field, the graph and any corresponding amounts in each grey field will change accordingly. 050100150200250300350400450500500450400350300250200150100500PRICE (Dollars per room)QUANTITY (Hotel rooms)Demand Graph Input Tool Market for Oceans's Hotel Rooms 350 Price (Dollars per room) Quantity Demanded (Hotel rooms per night) Demand Factors 50 Average Income (Thousands of dollars) 100 lOMoARcPSD|23780900 Demand Factors Airfare from DSM to ACY (Dollars per roundtrip) 200 Room Rate at Meadows (Dollars per night) For each of the following scenarios, begin by assuming that all demand factors are set to their original values and Oceans is charging $350 per room per night. If average household income increases by 10%, from $50,000 to $55,000 per year, the quantity of rooms demanded at the Oceans rises from 150 rooms per night to 165 rooms per night. Therefore, the income elasticity of demand is rooms at the Oceans are a normal good positive , meaning that hotel . Points: 0.8 / 1 Close Explanation Explanation: lOMoARcPSD|23780900 When the Oceans charges $350 and average household income is $50,000, it can fill 150 rooms per night at that price. However, if average household income increases to $55,000, the quantity of rooms demanded rises to 250 rooms per night. The income elasticity of demand measures how much the quantity demanded of a good changes when there is a change in consumers' income. You can calculate the income elasticity of demand for Oceans's hotel rooms by dividing the percentage change in quantity demanded by the percentage change in income: Income Elasticity of Dema Percentage Change in Quantity DemandedPercentage Change in IncomePercent = ndIncome Elasticity of Demand age Change in Quantity DemandedPercentage Change in Income = = 66.7%10%66.7%10% = = 6.76.7 = Using the income elasticity of demand, you can then categorize goods as either normal or inferior. When an increase in income leads to an increase in quantity demanded (or a decrease in income leads to a decrease in quantity demanded), the good is called a normal good. Therefore, goods with a positive income elasticity of demand are normal goods. However, when an increase in income leads to a decrease in the quantity demanded (or a decrease in income leads to an increase in quantity demanded), the good is called an inferior good. Therefore, goods with a negative income elasticity of demand are inferior goods. Because the income elasticity of demand is positive for Oceans's hotel rooms, it is a normal good. (Note: The percentage change calculations in this problem do not use the midpoint method.) If the price of a room at the Meadows were to decrease by 20%, from $200 to $160, while all other demand factors remain at their initial values, the quantity of rooms demanded at the Oceans falls from 165 lOMoARcPSD|23780900 rooms per night to 132 rooms per night. Because the cross-price elasticity of demand is Oceans and hotel rooms at the Meadows are substitutes positive , hotel rooms at the . Points: 0.6 / 1 Close Explanation Explanation: The cross-price elasticity of demand measures the sensitivity of the quantity demanded of one good to changes in the price of another good. To determine the cross-price elasticity of demand between hotel rooms at the Meadows and hotel rooms at the Oceans, divide the percentage change in the quantity demanded of hotel rooms at the Oceans by the percentage change in the price of hotel rooms at the Meadows. (Note: Remember to keep track of the direction of change. The sign of the cross-price elasticity of demand can be positive or negative, and the sign confers important information.) Cross-Price Elasticity of Percentage Change in Quantity of Rooms Demanded at OceansPercentage Change in Price of Hotel Roo DemandCros=ms at the MeadowsPercentage Change in Quantity of Rooms Demanded at OceansPercentage Ch s-Price Elasticity = ange in Price of Hotel Rooms at the Meadows of Demand =−66.7%−20%−66.7%−20% = =3.33.3 = Two goods are said to be complements when an increase in the price of one good decreases the quantity demanded of the other or when a decrease in the price of one good increases the quantity demanded of the other. On the other hand, two goods are said to be substitutes when an increase in lOMoARcPSD|23780900 the price of one good increases the quantity demanded for the other or when a decrease in the price of one good decreases the quantity demanded for the other. Because cross-price elasticity measures how the change in the price of one good affects the quantity demanded of another good, a negative value for cross-price elasticity indicates that the two goods are likely complements, while a positive value for cross-price elasticity signals that the two goods are likely substitutes. A value of zero for cross-price elasticity would indicate that the two goods are unrelated—a change in the price of one good would not affect the quantity sold of the other good. In this case, because visitors to Atlantic City can choose between staying at the Oceans and the Meadows, if one hotel lowers its price, demand for the other hotel will decrease (holding all else constant), so hotel rooms at the Oceans and hotel rooms at the Meadows are substitutes. (Note: The percentage change calculations in this problem do not use the midpoint method.) Oceans is debating decreasing the price of its rooms to $325 per night. Under the initial demand . Decreasing the conditions, you can see that this would cause its total revenue to increase price will always have this effect on revenue when Oceans is operating on the elastic portion of its demand curve. Points: 1/1 Close Explanation Explanation: When the Oceans charges $350, it can fill 150 rooms at that price. Total revenue is equal to price times quantity. Therefore, you can compute Oceans's revenue at this price in the following way: Total RevenueTotal Reven = Price×QuantityPrice×Quantity ue = = $350 per room per night×150 rooms$350 per room per night×15 = = = 0 rooms $52,500 per night$52,500 per night lOMoARcPSD|23780900 By lowering its price to $325, Oceans can fill 175 rooms. In this case, total revenue is $325 per room per night×175 rooms=$56,875 per night$325 per room per night×17 5 rooms=$56,875 per night, an increase of $4,375. When demand is inelastic, you know that the percentage change in price is larger than the percentage change in quantity. This means that total revenue will move in the same direction as the price change. Thus, when price increases, so does total revenue; when price decreases, total revenue decreases as well. When demand is elastic, you know that the percentage change in price is smaller than the percentage change in quantity, because consumers are highly sensitive to changes in price. This means that price and total revenue move in opposite directions. Thus, when price decreases, total revenue increases; when price increases, total revenue decreases. Because total revenue decreases when Oceans decreases its price, it must be operating on the inelastic portion of its demand curve. Another way to confirm this is by directly examining the price elasticity of demand for Oceans's rooms. The price elasticity of demand measures the responsiveness of consumers to changes in price. For example, if consumers change their purchasing behavior very little in response to a drastic change in price, demand is said to be inelastic; if consumers change their purchasing behavior a lot in response to a small change in price, demand is said to be elastic. The price elasticity of demand is the percentage change in quantity divided by the percentage change in price. If the Oceans drops its price from $350 to $325 per night—a decrease of 7.1%—the quantity of rooms demanded increases from 150 to 175, an increase of about 16.7%: Price Elasticity of DemandPri = Percentage Change in QuantityPercentage Change in PricePercentage Chan ce Elasticity of Demand = ge in QuantityPercentage Change in Price = 16.7%7.1%16.7%7.1% = = 2.42.4 = Since the percentage change in quantity demanded is greater than the percentage change in price, the price elasticity of demand is greater than 1, and demand is elastic in this region. (Note: The percentage change calculations in this problem do not use the midpoint method. ) lOMoARcPSD|23780900 21. Supply: Basic concepts Complete the following table by selecting the term that matches each definition. Definition The claim that, other things being equal, the quantity supplied of a good increases when the price of that good rises A graphical object showing the relationship between the price of a good and the amount that sellers are willing and able to supply at various prices The amount of a good that sellers are willing and able to supply at a given price A table showing the relationship between the price of a good and the amount of it that sellers are willing and able to supply at various prices Points: 1/1 Quantity Supplied Supply Curve Supply Schedule Law of Supply lOMoARcPSD|23780900 Close Explanation Explanation: The quantity supplied of a good is the amount of the good that sellers are willing and able to supply at a given price. This is different from a supply curve, which shows the entire relationship between the price of a good and the quantity of the good supplied. A supply schedule is a table that shows this relationship. The law of supply states that, other things being equal, the quantity supplied of a good increases when the price of that good rises. You can see the law of supply graphically in the upward-sloping supply curve. Apply your understanding of the previous key terms by completing the following scenario with the appropriate terminology. Your professor claims that one of the curves found on the following graph correctly illustrates the supply curve for records: 01234567891020181614121086420PRICE (Dollars per Record)QUANTITY (Millions of Records)S2S1 Because you understand the law of supply, you can deduce that the correct graphical representation . Moreover, you know that at a price of $10 per of the supply for records must be S1S1 record, the quantity supplied is five million records. Points: 1/1 Close Explanation Explanation: The law of supply claims that, all else equal, the quantity supplied of a good rises when the price of that good rises. This implies a positive relationship between quantity and price and, thus, an upwardsloping supply curve. Therefore, S1S1 is the more likely supply curve for records. This curve shows the relationship between the price of records and the amount that sellers are willing and able to supply, known as the quantity of records supplied. For example, at a price of $10 per record, the quantity supplied is five million records according to the supply curve. The curve shows you the entire relationship between prices and quantities.