solution1 - Problem Set 1 CHAPTER2...

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Problem Set 1 CHAPTER 2 THE BASICS OF SUPPLY AND DEMAND QUESTIONS FOR REVIEW 2.  Use supply and demand curves to illustrate how each of the following events  would affect the price of butter and the quantity of butter bought and sold: a. An increase in the price of margarine. Butter and margarine are substitute goods for most people.  Therefore, an  increase in the price of margarine will cause people to increase their  consumption of butter, thereby shifting the demand curve for butter out  from  D 1  to  D 2  in Figure 2.2.a.  This shift in demand causes the equilibrium  price of butter to rise from  P 1  to  P 2  and the equilibrium quantity to increase  from  Q 1  to  Q 2 . D 1 D 2 P 1 P 2 S Price Quantity of Butter Q 1 Q 2 Figure 2.2.a b. An increase in the price of milk. Milk is the main ingredient in butter.   An increase in the price of milk  increases the cost of producing butter, which reduces the supply of butter.  The supply curve for butter shifts from  S 1  to  S 2  in Figure 2.2.b, resulting in  1
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a higher equilibrium price,   P 2   and a lower equilibrium quantity,   Q 2 , for  butter. D P 1 P 2 S 2 Price Quantity of Butter Q 1 Q 2 S 1 Figure 2.2.b Note :  Butter is in fact made from the fat that is skimmed from milk; thus  butter and milk are joint products, and this complicates things.  If you  take   account   of   this   relationship,   your   answer   might   change,   but   it  depends on why the price of milk increased.  If the increase were caused  by an increase in the demand for milk, the equilibrium quantity of milk  supplied would increase.  With more milk being produced, there would be  more milk fat available to make butter, and the price of milk fat would  fall.   This would shift the supply curve for butter to the right, resulting in a  drop in the price of butter and an increase in the quantity of butter  supplied. c. A decrease in average income levels. Assuming that butter is a normal good, a decrease in average income will  cause the demand curve for butter to decrease (i.e., shift from  D 1  to  D 2 ).   This will result in a decline in the equilibrium price from  P 1 P 2 , and a  decline in the equilibrium quantity from  Q 1  to  Q 2 .  See Figure 2.2.c. 2
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D 1 P 1 P 2 S Price Quantity of Butter Q 1 Q 2 D 2 Figure 2.2.c 5.  Explain why for many goods, the long-run price elasticity of supply is larger  than the short-run elasticity.
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This note was uploaded on 10/24/2009 for the course ECON 201 taught by Professor Wana during the Spring '08 term at University of Iowa.

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solution1 - Problem Set 1 CHAPTER2...

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