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True or False Questions
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1. There is a decrease in the demand for a commodity when the price of a substitute commodity increases. 2. When the supply curve is positively sloped, an increase in demand will result in a larger quantity supplied. 3. A surplus exists when the market price is above the equilibrium price. 4. Government subsidization of rms producing Good A results in an increase in the demand for Good A. 5. Demand is inelastic if the percentage increase in quantity exceeds the percentage decrease in price. 6. A decline in price leaves total revenue unchanged when ED = 1. Answers: 1. False; 2. True; 3. True; 4. False; 5. False; 6. True
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Solved Problem 2.1 Explain what happens to the demand curve for air transportation between New York City and Washington, D.C., as a result of the following events: a. The income of households in metropolitan New York and Washington, D.C., increases 20%.
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22 PRINCIPLES OF ECONOMICS
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b. The cost of a train ticket between New York City and Washington, D.C., is reduced 50%. c. The price of an airline ticket decreases 20%. Solution: a. Individuals will travel more since they have more disposable income. The demand for air transportation between NYC and Washington increases; the demand curve shifts up and to the right. b. The cost of an alternative mode of transportation between NYC and Washington has decreased; thus, more individuals will travel by train between NYC and Washington. The demand for air transportation decreases; the demand curve shifts down and to the left. c. There is no shift, but there is a movement down the existing demand curve; the lower price for an airline ticket results in an increase in the number of people traveling (quantity demanded) by air between NYC and Washington. Solved Problem 2.2 Suppose the market supply and demand curves for Good A are initially S and D, respectively, in Figure 2-3; equilibrium price is $3 and equilibrium quantity is 280 units.
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CHAPTER 2: Demand, Supply, and Equilibrium
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a. Suppose improved technology in the production of Good A shifts the market supply curve from S to S , ceteris paribus. After the initial supply shift, what is the relationship between quantity demanded and quantity supplied at the initial $3 equilibrium price b. What is the new equilibrium price and quantity after the technological advance has increased the supply of Good A Solution: a. Quantity demanded for market schedule D is 280 units when the price is $3, while market supply is 330 units. There is a surplus of Good A at the initial $3 equilibrium price which puts downward pressure on the price of Good A. b. Equilibrium price falls from $3 to $2 as a result of the increase in market supply; equilibrium quantity increases from 280 to 320 units. Solved Problem 2.3 Why has the federal government placed price oors on some agricultural goods Solution: A price oor is a government-mandated price that exists above the market s equilibrium price; price oors result in a surplus of production. While market demand for most agricultural commodities is relatively stable over time, market supply is very much in uenced by the weather. A drought, for example, decreases supply and pushes up prices while a bumper crop can severely depress agricultural prices. The profitability of farming becomes uncertain, as does the price of food products and the income needed to feed a household. Thus, the reasons for agricultural price supports (price oors) are: (1) to stabilize farmer incomes and encourage farmers to continue farming whether there are bumper crops or droughts; (2) to provide a steadier ow of agricultural products at relatively stable prices; and (3) to stabilize the amount of income that households need to spend on food. Solved Problem 2.4 a. Is the demand for table salt elastic or inelastic Why b. Is the demand for stereos elastic or inelastic Why Solution: a. The demand for salt is inelastic because there are no good substitutes for salt and households spend a very small portion of their total in-
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