Q1F11AnswersExplained - Quiz 1 Fall 2011 True/False Bubble...

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Quiz 1, Fall 2011, October 19, 2011 True/False Bubble in A for True and B for False 1. If the demand curve for a good is price inelastic, an inward shift in the supply curve for the good (less supplied at every price) will increase the total revenue of suppliers. Answer: True As shown in the diagram above, an inward shift is the supply curve will increase the price of the good and decrease the equilibrium quantity of the good, as the competitive equilibrium moves up along the demand curve. As an approximation, the percentage change in revenue is given by the following formula: ± ² ³ ´ µ ·¸ ¸ , where R is revenue, ∆R is the change in revenue, P is price, ∆P is the change in price, q is quantity, and ∆q is the change in quantity. The first term on the right (∆P/P) is positive and the second term (∆Q/Q) is negative. Which effect is larger in absolute value? The price elasticity tells us. The price elasticity of demand is the ratio of the percentage change in quantity to the percentage change in price, moving along the demand curve. If a good is price inelastic, its price elasticity is between -1 and 0, which means that the percentage change in its price must be greater in absolute value than the percentage change in quantity. The positive price effect dominates the negative quantity effect and thus the change in revenue is positive. Price Original Supply Demand New Supply Quantity

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2. In “The Accidental Theorist,” Paul Krugman characterizes economic theory as mainly a collection of parables. Answer: True In “The Accidental Theorist, Krugman is criticizing a book by the journalist William Greider. Greider argues that because of recent technological changes the global supply of goods is outstripping the global demand for goods, which will cause unemployment. Greider accumulates many facts and figures to support his argument. Krugman argues that those facts and figures are largely irrelevant because Greider has failed to think through the logic of his position. To illustrate, Krugman starts his critique with a parable about an economy that produces only two things: hot dogs and buns. People consume these goods in tandem: one hot dog requires one bun. Using that fable, Krugman shows the logical fallacy of Greider’s position. In the second paragraph of the essay, he writes One of the points of this essay is to illustrate a paradox: You can’t do serious economics unless you are willing to be playful. Economic theory is not a collection of dictums laid down by pompous authority figures. Mainly, it is a menagerie of thought experiments—parables, if you like—that are intended to capture the logic of economic processes in a simplified way. Because I’ll be passing on a few parables in this course, I wanted you to know that it’s OK.
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Q1F11AnswersExplained - Quiz 1 Fall 2011 True/False Bubble...

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