Question

01/ (Total marks: 30 marks) Consider the market for Pear juice in a city. What will happen to the equilibrium price and quantity of Pear juice in each of the following events? Assume buyers will purchase orange juice as a replacement of pear juice. You should state whether demand or supply (or both) have been moving along the same curve or shifted and in which direction. (In each case assume ceteris paribus). You have to use a demand-supply diagram in illustrating the above events with explanation.. (a) The price of orange juice increases. (b) The price of pear juice decreases. (c) Consumers expect the price of pear juice to fall in next week. (d) Recent typhoon destroys most of the pear trees in the city. (e) Event (a) and event(d) occur at the same time. Show all possible outcomes. Q2/ (Total marks: 25 marks) In Pioneer Village, the price elasticity of demand for bus rides is -0.8, the income elasticity of demand for bus rides is - 0.25, and the cross elasticity of demand for bus rides with respect to gasoline for private car is 0.4. (a) Is the demand for bus rides elastic or inelastic with respect to the price of a bus ride? Explain your answer. (b) Would an increase in bus fares increase the bus company's total revenue? Explain your answer. (c) Describe the relationship (substitutes or complements) between bus rides and gasoline. Explain your answer. (d) If the price of gasoline increases by 15% with no change in the price of a bus ride, how will the number of bus rides change? (e) In Pioneer Village, is a bus ride a normal or inferior good? Explain your answer. (f) If incomes in Pioneer Village increase by 5% with no change in the price of a bus ride, how will the number of bus rides change?

Answer 1

(Q1)

In each of the graphs, D0 and S0 represent initial demand and supply curves of pear juice, intersecting at point A. Initial price is P0 and quantity is Q0.

(a)

Increase in price of orange juice, a substitute, will increase demand for pear juice. Increase in demand shifts demand curve rightward, increasing both price and quantity. In following graph, D0 shifts right to D1, intersecting S0 at point B with higher price P1 and higher quantity Q1.

(b)

Lower price of pear juice will increase its quantity demanded, causing a downward movement along demand curve from point A to point B where price falls from P0 to P1 and quantity rises from Q0 to Q1.

(c)

Expected fall in future price will decrease current consumption, decreasing demand. Decrease in demand shifts demand curve leftward, decreasing both price and quantity. In following graph, D0 shifts left to D1, intersecting S0 at point B with lower price P1 and lower quantity Q1.

(d)

The typhoon will decrease market supply of pears, lowering supply of pear juice. Decrease in supply shifts supply curve leftward, increasing price and decreasing quantity. In following graph, S0 shifts left to S1, intersecting D0 at point B with higher price P1 and lower quantity Q1.

(e)

From part (a), higher demand increases price and increases quantity. From part (d), lower supply increases price and decreases quantity. Net effect is a definite increase in price but effect on quantity is uncertain, giving rise to following three possibilities.

(1) Rightward shift in demand is more than the leftward shift in supply: Quantity increases

In following graph, D0 shifts right to D1 and S0 shifts left to S1, intersecting at point B with higher price P1 and higher quantity Q1.

(2) Rightward shift in demand is less than the leftward shift in supply: Quantity decreases

In following graph, D0 shifts right to D1 and S0 shifts left to S1, intersecting at point B with higher price P1 and lower quantity Q1.

(3) Rightward shift in demand is equal to the leftward shift in supply: Quantity remains the same

In following graph, D0 shifts right to D1 and S0 shifts left to S1, intersecting at point B with higher price P1 and same quantity Q0.

NOTE: As HOMEWORKLIB Answering Policy, 1st question has been answered.