Question

Two drivers—Bob and Cho—each drive up to a gas station. Before looking at the price, each places an order. Bob says, “I'd like 10 gallons of gas.” Cho says, “I'd like $10 worth of gas.”

Which of the following statements is correct? Check all that apply.

Cho's demand is inelastic.

Bob's demand is elastic.

Bob's demand is perfectly inelastic.

Cho's demand is perfectly elastic.

Answer 1

Answer-

Two drivers – Tom and Jerry – each drive up to a gas station. Before looking at the price, each places an order. Tom says, “I’d like 10 gallons of gas.” Jerry says, “I’d like $10 worth of gas.” What is each driver’s price elasticity of demand?

Tom's price elasticity of demand is zero, because he wants the same quantity regardless of the price. Jerry's price elasticity of demand is one, because 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.

b) Assume the following total value schedule for some consumer. Fill in the MV column in the table below.

    Q     Total Value (TV)     Marginal Value (MV)

    1            $10                               -$10---

    2            $19                                   9

    3            $27                                   8

4. $3                                       7
5. $40                                       6
6. $45                                       5
7. $49                                       4
8. $52                                       3
9. $54                                       2

Assume the price of this good is $6. To maximize consumer surplus, a consumer would purchase how many units? What is consumer surplus at this quantity? Show consumer surplus on your graph.

The consumer would set sets marginal value equal to the price and he would purchase 5 units.

Consumer surplus would be the total surplus the consumer would earn on the first five units.

Consumer surplus = (10-6)+(9-6)+(8-6)+(7-6) +(6-6) = $10

Consumer surplus is the area above the price and below the demand curve.

3. (20) Beachfront resorts have an inelastic demand, and computers have an elastic demand. Suppose that technological advance doubles the supply of both products (that is, the quantity supplied at each price is twice what it was).

a)         What happens to the equilibrium price and quantity in each market?

b)         Which product experiences a larger change in price?

c)         Which product experiences a larger change in quantity?

d)         What happens to total consumer spending on each product?

1. The increase in supply decreases the equilibrium price and increases the equilibrium quantity in both markets.
2. In the market for beachfront resorts (with inelastic demand), the increase in supply leads to a relatively large decrease in the equilibrium price and a small increase in the equilibrium quantity.
3. In the market for automobiles (with elastic demand), the increase in demand leads to a relatively large increase in the equilibrium quantity and a small decrease in equilibrium price.
4. In the market for beachfront resorts, total consumer spending declines (because of inelastic demand), but in the market for computers, total consumer spending increases (because of elastic demand).

4. (20) The table below represents the total utility schedule of two goods X and Y at different quantities:

Quantity	TUx	MUx	MUx/Px	MUx/P'x	TUy	MUy	MUy/Py
1	36	36	18	36	22	22	22
2	68	32	16	32	42	20	20
3	96	28	14	28	60	18	18
4	120	24	12	24	76	16	16
5	140	20	10	20	90	14	14
6	156	16	8	16	102	12	12
7	168	12	6	12	112	10	10
8	176	8	4	8	120	8	8
9	181	5	2.5	5	125	5	5
10	184	3	1.5	3	128	3	3

a. If Price of X=$2, Price of Y=$1, Consumer’s income=$20, what is the optimal combination of good X and good Y that will maximize consumer’s utility? What is the total utility of this optimal combination?

Optimal combination is Qx = 6, and Qy = 8.

Total Utility of this optimal combination = 156 + 120 = 276

b. If Price of X= $1, Price of Y=$1, Consumer’s income=$20,

1. What is the new optimal quantity of good X and good Y?

Qx = 10 and Qy = 10

2. What has happened to the quantity of good X and to the quantity of good Y? What can you conclude about the relationship between good X and good Y (substitutes or complements)? Explain.

Quantities of both goods X and Y increased. Therefore, these two goods are complements.

3. Calculate the cross-price elasticity of the two goods.

Price elasticity = % change in Qy / % change in Px = 0.3333

5. (20)

a) In the last decade or so there has been a dramatic expansion of small retail convenience stores (such as Kwik Shops, 7-Elevens, Gas ‘N Shops) although their prices are generally much higher than those in the large supermarkets. What explains the success of the convenience stores?

These stores are selling convenience as well as the goods that are purchased there. Because of their small size and convenient locations, they save busy consumers time. In an era when most consumers are working at least 40 hours per week, their time is valuable, and when only a few items are needed, the time saved must be worth the additional cost one pays for shopping at these convenience stores. (You seldom, if ever, see anyone buying a week’s worth of groceries at such shops.)

b) Firm A faces the following total cost schedule. Fill in the MC column.

      Q      Total Cost (TC)          Marginal Cost (MC)

       0                 0                               ----

1. $                                               $
2. $3                                              
3. $6                                              
4. $10                                            
5. $1                                            
6. $21                                            
7. $28                                            
8. $36                                            
9. $45                                            

If the price of the good was $4, how units would be produced? What would producer surplus be at this quantity? Show producer surplus on your graph.

The firm would set MR = MC and produce a quantity of 4.

Producer surplus would be the total surplus the firm would earn on the first four units.

Producer surplus = (4-1)+(4-2)+(4-3)+(4-4) = $6

Producer surplus is the area below the price and above the marginal cost curve.