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# Professor Allen ECG 507-001 Fall 2005 PROBLEM SET 1 1. Use supply and demand analysis (including diagrams) to indicate the effect of each of the...

8. Sony cut the price of its 42” HDTV plasma TV from \$3000 in the first quarter of 2005 to \$2500 in the second quarter. Sales increased from 25,000 to 30,000.

a) Based on this information, what is your best estimate of the price elasticity of demand?
b) How valid is this procedure for estimating price elasticity of demand? When will it give reasonable estimates and when will it give misleading ones?
c) Panasonic decided to hold the price of its 42” plasma TV at \$3000. Their sales fell from 15,000 to 12,500. What is your best estimate of the cross-price elasticity of demand for Panasonic plasma sets?

Professor Allen ECG 507-001 Fall 2005 PROBLEM SET 1 1. Use supply and demand analysis (including diagrams) to indicate the effect of each of the following events on the price and quantity sold (at retail) of gasoline: a) OPEC lowers oil prices b) New federal regulations require refiners to further reduce emissions c) Congress imposes a price ceiling of \$2 per gallon to stop price gauging d) Toyota launches a new superhybrid vehicle that gets 100 miles per gallon e) The price of parking increases dramatically in a number of major urban areas f) Resorts announce price cuts in reaction to light bookings so far this fall 2. After further renovations Carter-Finley stadium now can seat 55,000 excited Wolfpack fanatics. Coach Amato and Athletic Director Fowler are deciding on the best pricing strategy to make sure the stadium is full after last year’s losing season. They expect demand for tickets at a typical game to be Q D = 70 – P, where quantity demanded is measured in thousands and price is measured in dollars. In other words, if P=0, then Q D = 70 thousand. a) Coach Amato wants to maximize attendance, because he believes that a full house of howling Pack fans enhances his odds of winning the ACC and going to a BCS bowl game. What price does the coach want to charge? b) Fowler is interested in the bottom line. Since the costs of putting on a football game are basically fixed, he wants the most revenue possible. What price generates the most revenue? c) This same problem arises throughout the entertainment industry, e.g., how much to charge for a NASCAR race or a Bruce Springsteen concert. Give an example of a situation (e.g., a specific entertainer or event) when the best pricing strategy is to fill the concert hall or arena. Give another example of a situation when the best pricing strategy is to maximize revenue. 3. Find a recent newspaper or magazine article that discusses recent price changes for a particular good, or one that claims that there is a surplus or shortage of a particular good. Evaluate the economic logic used in the article. If it is correct, explain why using the supply and demand tools we have developed, indicating which curve shifted which way and why. If it is incorrect, point out the logical flaws or inconsistencies and try to explain what really happened using the information in the article. 4. Alarmed at the recent loss of jobs in the textile industry and worried that he almost failed to get CAFTA passed, President Bush decides to raise tariffs on all textile imports. To simplify matters, suppose that there were no barriers to free trade in textiles before these tariffs were imposed and that the price of a yard of a standard textile product steel was \$20. Six months after Bush imposed a tariff of \$4 per yard, the Commerce Department reports that US production has increased from 100
(million) yards per year to 115 (million) and many textile mills have reopened and expanded production. The Commerce Department also tracks textile consumption and finds that it has declined from 190 (million) yards before the tariff to 170 (million) yards. a) Who in the US economy is better off because of this tariff? Who is worse off? On the whole is the economy better or worse off? Explain your answer using supply and demand analysis (including a diagram), but without doing any calculations. b) Calculate the change in consumer surplus and the change in producer surplus resulting from the tariff. How much better or worse off is the economy? 5. The next president decides to increase the federal gasoline tax by 50 cents to help balance the budget, reduce pollution (and greenhouse gases), and improve the trade balance. Before the tax increase, the price of gas was \$2.50 per gallon. a) Assuming no further sifts in supply and demand, will the price of gas end up being \$3, less than \$3, or more than \$3? Explain. b) Suppose the gas price paid by consumers ends up being \$2.90. Consumption goes from 200 billion gallons to 180 billion. Explain whether gasoline producers are better or worse off. What about gasoline consumers? What about the economy overall? [Hint: answer this question without making any calculations; save the calculations for the next part below.] c) Calculate the change in producer and consumer surplus resulting from the gas tax increase. Also calculate the deadweight loss. 6. The next president after that gets a grim report from her new Secretary of Defense. The military is unable to recruit all of the troops needed to maintain U.S. forces at the desired level of preparedness. The defense secretary recommends the reinstitution of the draft. Suppose you are the chairperson of the president’s Council of Economic Advisors and the president has asked you to these three questions: a) Why are we unable to attract enough troops? b) What would be the economic effects of instituting a draft? Who would gain? Who would lose? Would the economy be better or worse off? c) What advise would you give the President on how to deal with this situation? 7. Desperate for revenue, the North Carolina legislature has finally decided to raise the cigarette tax. Currently the tax is five cents per pack, third lowest in the nation. A tax analyst indicates that the elasticity of supply for cigarettes is 5.0 and the elasticity of demand is –0.2.
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