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UW-Madison ECON 101 - Economics 101 Answers to Homework 2

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Economics 101Spring 2011Answers to Homework #2Due 2/15/11Directions: The homework will be collected in a box before the lecture. Pleaseplace your name, TA name and section number on top of the homework (legibly).Make sure you write your name as it appears on your ID so that you can receive thecorrect grade. Please remember the section number for the section you areregistered, because you will need that number when you submit exams andhomework. Late homework will not be accepted so make plans ahead of time.Please show your work. Good luck!1. Consider the following markets. For each example identify how the demand curve and/or supply curve will shift? (Answer each question by “left” or “right” and make specific reference to which curve is shifting.) For each example identify what will happen to the equilibrium price and quantity. (Answer each question by “increase”, “decrease”, or “ambiguous” and make sure you identify price or quantity in your answer.) a. Consider the pink bow tie market: colorful prom night attire comes back into fashion, raising the demand for pink bow ties. Key: Demand curve shifts right, no shift in supply ,equilibrium price increases, and equilibrium quantity increases.b. The legal prescription drug market: the expiration of drug patents increases the number of generic drugs available to consumers.Key: Supply curve shifts right, no shift in demand, equilibrium price decreases, and equilibrium quantity increases.c. The stock market: forecasters predict a good time for the economy, prompting millions of potential stock sellers to hang on to their stocks.Key: Supply curve shifts left, no shift in demand, equilibrium price increases, and equilibrium quantity decreases.d. The new car market: New technology allows Ford to produce cars with fewer resources, so their cars are sold cheaper. At the same time, soaring gasoline prices cause consumers to want fewer cars.Key: Demand curve shifts left, supply curve shifts right, equilibrium price decreases,and the change in equilibrium quantity is ambiguous.1e. The new pickup truck market: a technological advancement enables pickup truckmanufacturers to produce the vehicles at a lower cost than before. At the same time, Chuck Norris, a famous actor, says, "Driving a pickup truck is so cool!" Many people who admire Chuck Norris suddenly go out and buy pickup trucks.Key: Demand curve shifts right, supply curve shifts right, equilibrium quantity increases, and the change in equilibrium price is ambiguous.f. The kitty litter market: a blizzard is forecast to hit Madison in the next week. Fearing the prospect of getting their cars stuck in the snow, Madison residents rush to buy kitty litter to use for traction. Key: Demand curve shifts right, no shift in supply, equilibrium price and quantity increase.g. The DVD market: the technology to produce DVDs becomes much more efficient, slashing production time and cost of DVDs. Meanwhile, Blu-ray (a competing technology) drops its prices by half in hopes of encouraging consumers to not switchto DVD technology.Key: Supply in the DVD market shifts right due to the decreased cost of DVDs, and demand in the DVD market shifts left due to the decrease in the price of a substitute good. Equilibrium price decreases and quantity change is unknown.h. Corn market: More acres being devoted to corn than ever before to respond to the growing demand for corn to use in ethanol fuels.Key: Demand curve shifts right, supply curve shifts right, equilibrium quantity increases, change in price is unknown.2. Consider a café that serves both pizza and cookies. Suppose the demandcurve and supply curve for pizza in a café is given by Demand: Q=300 – 20P – 20Pc Supply: Q=10P – 10 where Pc is price of a cookie. a. Suppose the price of a cookie is Pc = 5. Find the equilibrium price and quantity of pizza. Key: Plug the price of a cookie into the demand curve, then we get Demand: Q=200-20P; Supply: Q=10P-10. Hence, the equilibrium price is P*=7, and equilibrium quantity is Q*=60. b. Due to a change in the price of cookies, the new equilibrium price of pizza changes to P*’ = 5. What must be the price of a cookie now? 2Key: Plug the new equilibrium price into supply curve, we know that the equilibriumquantity should be Q*'=40. Using the equation of the demand curve, we can get the new price of a cookie is Pc'=(300-20×5-40)/20=8 c. Are pizza and cookies substitutes or complements in this example? Key: When the price of a cookie increases from 5 to 8, the quantity of pizza decreases from 60 to 40. Hence, the two goods are substitutes in this example.3. Suppose that in the market for pineapples there are three consumers: person Awhose demand curve is QA = - P + 5, person B whose demand curve is QB = -2 P + 6,and person C whose demand curve is QC = -(3/4) P + 3. a. Solve each person’s demand function for P. (Rewrite the equations for the demandcurves, and put P on the left hand side.)Key: Person A: P = -QA + 5; Person B: P = -(1/2)QB + 3; Person C: P = -(4/3)QC + 4. b. Determine who demands pineapples at what price ranges.Key: From the above function forms, we find that no one demands for pineapples if P> 5; only person A demands some if 4 < P ≤ 5; persons A and C demand some if 3 < P≤ 4; and all three persons demand some if 0 ≤ P ≤ 3.c. Take the horizontal summation of each person’s demand at each price range, and graph the market demand curve for pineapples. In addition to the graph, provide theequation(s) for the market demand curve and the relevant price ranges. Key: If 4 < P ≤ 5, the market demand is QM = QA = - P + 5. If 3 < P ≤ 4, the market demand is QM = QA + QC = [- P + 5] + [-(3/4) P + 3] = -(7/4)P +8. If 0 ≤ P ≤ 3, the market demand is QM = QA +QB + QC = [- P + 5] + [-2 P + 6] + [-(3/4) P + 3] = -(15/4)P +14. 34. Consider the health club market in Madison. The demand for health club services is given by Q = 20 – 3P, and supply is given by Q= P-4, where Q represents health clubmemberships and P represents the price of a membership. a. Find the equilibrium price and quantity in this market.Key: Equilibrium price P*= 6, Equilibrium quantity Q*= 2b. Now, the citizens in Madison pay more attention to their health. Everyone's reservation price for a unit of health club


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UW-Madison ECON 101 - Economics 101 Answers to Homework 2

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