ECN 100 – Homework #3 This homework covers the essentials of Chapter #3

| November 24, 2016

Hi can I have help with these questions.

ECN 100 – Homework #3

This homework covers the essentials of Chapter #3 in the textbook and the associated lecture material. A basic notion in micro-economics is that Demand Exists – that is, we all desire to consume products at some level and at some lifestyle. Some people strive to consume a lot. Others strive to, or must, live lives with less consumption. But even the most simple of lives depend on the acquisition and use of some goods (like, say, food and antibiotics), so as I say – Demand Exists. In this homework, we look the basic theory and issues behind the notions of consumer demand curves.

(1)

What does “homogeneity” of demand mean? If the prices of all goods rises by 10% and you get a 10% income raise, what happens to your “real” income and purchasing power. If you were to represent this situation on an indifference map as you consumed goods X and Y, how would you show it?

(2)

You consume two goods, X and Y. You really prefer X to Y. Also for you Y is an Inferior good. X is a Normal good. Starting from an initial position of equilibrium, you face a sudden rise in income. Go re-establish a new equilibrium. How would you represent all of this on your indifference map?

(3)

You are in equilibrium on your indifference map with respect to X and Y. Your income does not change, but the price of X falls. You move to a new point of equilibrium on the indifference map. Show:

Where you end up if both X and Y are normal goods.
Where you end up if X is normal and Y is inferior.
Where you end up if X is inferior and Y is normal.
Now: Show the impact of the income and substitution effects with respect to your consumption of the good X in each of the three cases. Are the substitution effects different in each of these three two cases?

(4)

What is a Giffen Paradox? If the good X is subject to a Giffen Paradox, show with indifference curve, how you would respond to a sudden rise in the price of X. Show the income and substitution effects with respect to your consumption of X after the price rise.

(5)

Using indifference curve analysis, show how a TAX on the consumption of the good X may be less satisfactory from a satisfaction standpoint (utility standpoint) than a tax that raises the equivalent amount of money on income.

(6)

Using indifference curve analysis, show how a unit TAX on the consumption of the good X that is completely reimbursed back to the consumer can lead to less satisfaction than before, even when the entire tax amount is handed back to the consumer.

(7)

You are in equilibrium on your indifference map in your consumption of X and Y. The price of X drops. Show where you might end up if X and Y were complement goods. Show where you might end up if X and Y demonstrated substitutability.

(8)

Here is a question that deals with the notion of exogenous variables and your ability to consume goods and services.

Let’s say that you live on a Pacific Island with a bunch of other people. Let’s say as well is that your “profession” is to make and sell “wind kites”. This is a very desirable form of entertainment for the islanders. The market has determined the price of what you make (wind-kites), and the prices of all of the other things that you want to buy. You consume coffee and candy as goods X and Y. Your income is from the sale of wind-kites.

You face two issues: First, you really what more coffee and candy than you can afford, and Second, some other people are out there also making wind-kites.

So, what do you propose to do to raise your “income” (push out your budget constraint) in order to consume more of these two items that you really crave? How would you represent your successful efforts on a two-dimension graph? What if the price of coffee skyrockets? What happens to your graph? What happens to your consumption of coffee and candy of both are normal goods? What additional steps might you take to maintain your purchasing power over the goods you “demand” to consume?

When it comes to your manufacture of wind-kites, can you think in what ways any accumulated knowledge and wisdom on the island (the past experience and efforts of other people) helps you in your profession?

Note: there are many possible answers to (8), but all follow a correct micro-economic logic. And this is an economic logic that we all face every day of our lives in the real world.

(9)

Simple, but important. What is the difference between a “shift in demand” (an increase or decrease in demand) and a “change in the quantity demanded”? What do these concepts have to do with endogenous and exogenous variables?

(10)

Now here is a challenge. If you can work through the answer to this problem and understand it, you will have an insight as to what can drive national economic and most especially foreign policy of a country like the United States.

The GDP of the USA is almost 70% consumption of goods and services by individuals. It is desire and possibility to consume all these goods that provide incentives for businesses to make the goods and therefore provide employment and income for hundreds of millions of people.

Just about all of the goods that we consume and use in the USA are made with petroleum (oil) as an input. Soap, plastics, machines, medicines, and (obviously) gasoline and diesel fuel are examples. Suppose we had an indifference curve that showed the relationship between the consumption of all oil and oil-based goods (X) and all other goods (Y) for all Americans.

Show what would typically happen in terms of income effects, substitution effects, and welfare loss if the US suddenly faced a large rise in the price of imported oil.

(11)

An issue facing just about all consumers (ALL OF US) is that of trying to move out the budget constraint (increasing purchasing power through a rise in income). I admit, I want that too. Using indifference curve analysis, we see how movements in income can “compensate” for price changes.

Let’s say you were faced with a rise in the general price level for all of the goods you desire to consume. How would this impact your position in the budget-constraint indifference curve diagram?

Now, remembering the diagram about earnings and wage-power that I put on the board in an early lecture, think of ways that you could try to remedy this situation, right now? Remember the three factors that will determine how much purchasing power you will have over the goods and services that others in the community produce (should you WANT to consume them).

What resources are there in the community that can help you solve this problem? (This is a very practical and real-life question that should make our ECN 100 theory more relevant to you.)

(12)

Which of the two phrases that follow would indicate a demand curve moving vertically or horizontally?

An article that coffee is healthy results in people drinking more coffee at any price.

An article that coffee is healthy results in people wanting to pay more for coffee no matter how much they drink.

(13) (use point elasticity of demand calculations for all elasticity problems)

If he price of coffee rises from $3 to $4 per pound and as a result you lower your consumption of coffee from 4 pounds per week to 3 pounds per week, what is your personal elasticity of demand for coffee? Is your demand elastic or inelastic at this point?

(14)

Why is it that we can assume that the price elasticity of demand for Noah’s Bagels is inelastic? If the price pf a plain bagel at Noah’s rises from 99 cents to $1.12, what can Noah expect to happen to the percentage of bagels purchased? What can Noah expect to happen to his total revenue earned after this price increase of the bagel?

Why would a typical business such as Noah’s Bagels desire a demand curve for its product that is as least elastic or as inelastic as possible?

(15)

If the price of X drops from $1 to 80 cents, and the quantity rises from 2,000 pounds purchased to 3,000 pounds purchased what can we say about the relationship between total revenue from the sale of X and the value of the price elasticity of demand? Suppose that the demand for X rises from 2,000 pounds to 2,100 pounds after the price drop. What can we say about the rise in total revenue from the sale of X and the price elasticity of demand in that case?

In general what is the relationship between the change in total revenue from the sale of a product and the value of the price elasticity of demand?

(16)

If a linear demand curve has a slope of One, what is the value of the price elasticity of demand on this demand curve at its midpoint? What is the value of the price elasticity on the curve above the midpoint? Below the midpoint?

(17)

If the price of beer rises from $1 to $1.50 per glass, and the consumption of wine rises from two to three glasses per evening, what can we say abut the cross elasticity of demand between beer and wine? Are these two commodities complements or substitutes on this measurement? What would you expect be the value of the cross elasticity of demand between beer and “beer-peanuts”? Why do we say that if the sign of the cross elasticity of demand is Negative, the goods in question are Complements?

(18)

If you were to develop a demand curve for coffee only from the substitution effect connected to the possible price changes for coffee, why is it that the demand curve would ALWAYS be downward sloping. Show how this demand curve would be determined using the indifference map and budget constraint diagram for a typical coffee consumer.

(19)

Let’s say the commodity “X” is a Giffen Good. Using the indifference map and budget constraint for the typical consumer of this good, show how the combination of the substation and income effects results is an UPWARD SLOPING demand curve for “X”.

(20)

This next question is related to (6) above and is repeated for emphasis.

Your government wants you to consume less Coffee. It believes that the caffeine in coffee is harmful to your health. Thus, your government decides to place a tax on your purchase of coffee. Coffee is a NORMAL good. This tax is a FIXED PERCENTAGE of the price (amount of money) you pay to this product. For every dollar you spend on coffee, you pay a “t” percent tax on that dollar. Therefore the more money you spend on coffee, the more tax you pay.

BUT, your government feels sorry for you and decides to rebate back to you the tax you pay on the coffee that you purchase (all of it). With the rebate, you can do what you wish.

Please use the tools we have developed thus far in the course to show:

(1) The original consumer equilibrium before the tax and the impact of the tax on the budget line and the new consumer equilibrium after the imposition of the tax.

(2) The impact of the tax rebate on the consumer and the new consumer equilibrium after the rebate.

(3) How the new consumer equilibrium with the rebate leaves the consumer “worse off” than had the tax not been levied in the first place.

(21)

If potatoes are an inferior good, how would we show that to be the case using a simple calculation of the income elasticity of demand for potatoes?

(22)

An individual or group demand curve can also be called the “Willingness to Pay” curve.

As we have seen, this curve can be derived from indifference map analysis.

If we have a demand curve for Mint-Chip ice cream that shows consumption at Zero with a price of $10, and a consumption of 10 scoops at a price of Zero, and the market price happens to be $5.00, what can we say about the Consumer Surplus in this case? What does this concept pf consumer Surplus have to do with the Willingness to Pay, and to total welfare of the consumer?

I think that is enough already! Have fun!

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