CHAPTER 2 - CHAPTER 2 THE BASICS OF SUPPLY AND DEMAND...

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CHAPTER 2 THE BASICS OF SUPPLY AND DEMAND REVIEW QUESTIONS 1. Suppose that unusually hot weather causes the demand curve for ice cream to shift to the right. Why will the price of ice cream rise to a new market-clearing level? Assume the supply curve is fixed. The unusually hot weather will cause a rightward shift in the demand curve, creating short-run excess demand at the current price. Consumers will begin to bid against each other for the ice cream, putting upward pressure on the price. The price of ice cream will rise until the quantity demanded and the quantity supplied are equal. Figure 2.1 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. Most people consider butter and margarine to be substitute goods. 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 will cause the equilibrium price to rise from P 1 to P 2 and the equilibrium quantity to increase from Q 1 to Q 2 .
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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 will increase the cost of producing butter. The supply curve for butter will shift from S 1 to S 2 in Figure 2.2.b, resulting in a higher equilibrium price, P 2 , covering the higher production costs, and a lower equilibrium quantity, Q 2 . Figure 2.2.b Note: Given that butter is in fact made from the fat that is slimmed off of the milk, butter and milk are joint products. If you are aware of this relationship, then your answer will change. In this case, as the price of milk increases. so does the quantity supplied. As the quantity supplied of milk increases, there is a larger supply of fat available to make butter. This will shift the supply of butter curve to the right and the price of butter will fall. c. A decrease in average income levels. Assume that butter is a normal good. A decrease in the average income level will cause the demand curve for butter to shift from D 1 to D 2. This will result in a decline in the equilibrium price from P 1 to P 2 , and a decline in the equilibrium quantity from Q 1 to Q 2 . See Figure 2.2.c.
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Figure 2.2.c 3. Suppose a 3 percent increase in the price of corn flakes causes a 6 percent decline in the quantity demanded. What is the elasticity of demand for corn flakes? The elasticity of demand is the percentage change in the quantity demanded divided by the percentage change in the price. The elasticity of demand for corn flakes is . This is in the elastic region of the demand curve, where the elasticity of demand exceeds -1.0. 4. Why do long-run elasticities of demand differ from short-run elasticities? Consider two goods: paper towels and
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CHAPTER 2 - CHAPTER 2 THE BASICS OF SUPPLY AND DEMAND...

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