Chapter 6: Elasticity

Question 4: The accompanying table lists the cross-price elasticities of demand for
several goods, where the percent quantity change is measured for the first good of the
pair, and the percent price change is measured for the second good.

a) Explain the sign of each of the cross-price elasticities. What does it imply about the
relationship between the two goods in question?
- A negative cross-price elasticity of demand indicates that the two goods are
complements, in this case are air-conditioning units and kilowatts of electricity; SUVs
and gasoline.
- A positive cross-price elasticity of demand indicates that the two goods are substitutes,
in this case are coke and pepsi; McDonald’s burgers and Burger King’s burgers; butter
and margarine.
b) Compare the absolute values of the cross-price elasticities and explain their magnitudes. For
example, why is the cross-price elasticity of McDonald’s burgers and Burger King burgers less
than the cross-price elasticity of butter and margarine?
- The greater the value of cross-price elasticity of demand is, the closer the two goods are
substitutes (positive) or complements (negative).
- McDonald’s burgers and Burger King’s burgers are less closely substitutes than butter
and margarine are.
c) Use the information in the table to calculate how a 5% increase in the price of Pepsi affects
the quantity of Coke demanded.
- 5% increase in the price of Pepsi affects the quantity of Coke demanded: 0.63 * 5% =
3.15% (increased by 3.15%)
d) Use the information in the table to calculate how a 10% decrease in the price of gasoline
affects the quantity of SUVs demanded.
- 10% decrease in the price of gasoline affects the quantity of SUVs demanded: 0.28 *
10% = 2.8% (increase by 2.8%)
Question 8: A recent study determined the following elasticities for Honda Civics:
Price elasticity of demand = 2
Income elasticity of demand = 1.5
The supply of Civics is elastic. Based on this information, are the following statements
true or false? Explain your reasoning.
a) A 10% increase in the price of a Civic will reduce the quantity demanded by 20%.
- True
- 2*10% = 20%, 10% increase in price will reduce 20% in quantity demanded
b) An increase in consumer income will increase the price and quantity of Civics sold.
- True
- The income elasticity of demand is positive, meaning increased income will increase
price and quantity of Civics sold

Chapter 10: The Rational Consumer

Question 2: Bruno, the consumer in Problem 1, is best friends with Ruby who shares
Bruno’s love for energy bars and smoothies. The accompanying table shows Ruby’s
utilities from smoothies and energy bars.

The price of an energy bar is $2, the price of a smoothie is $4, and Ruby has $20 of
income to spend.
a) Which consumption bundles of energy bars and smoothies can Ruby consume if she spends
all her income? Illustrate Ruby’s budget line with a diagram, putting smoothies on the horizontal
axis and energy bars on the vertical axis.
 - The bundles that Ruby can consume if she spends all her income:
+ 0 energy bars, 5 smoothies
+ 2 energy bars, 4 smoothies
+ 4 energy bars, 3 smoothies
+ 6 energy bars, 2 smoothies
+ 8 energy bars, 1 smoothies
+ 10 energy bars, 0 smoothies
b) Calculate the marginal utility of each energy bar and the marginal utility of each smoothie.
Then calculate the marginal utility per dollar spent on energy bars and the marginal utility per
dollar spent on smoothies.

Quantity of Marginal Marginal Quantity of Marginal Marginal

energy bars utility of each utility per smoothies utility of each utility per
energy bar dollar spent smoothie dollar spent
(utils) on energy (utils) on smoothie
bars (utils) (utils)

2 14 7 1 32 8

4 12 6 2 28 7

6 10 5 3 24 6

8 8 4 4 20 5

10 6 3 5 16 4
c) Draw a diagram in which both the marginal utility per dollar spent on energy bars and the
marginal utility per dollar spent on smoothies are illustrated. Draw the quantity of energy bars
increasing from left to right, and the quantity of smoothies increasing from right to left. Using this
diagram and the utility-maximizing principle of marginal analysis, predict which bundle — from
all the bundles on her budget line — Ruby will choose.

- The bundle Roby will choose is utility-maximizing and on her budget line is 4 energy
bars and 3 smoothies.
Question 10: Scott finds that the higher the price of orange juice, the more money he
spends on orange juice. Does that mean that Scott has discovered a Giffen good?
- A Giffen good is a good which demand increases as price increases and vice versa.
- It does not mean Scott has discovered a Giffen good because it does not mention Scott
demands more orange juice as the price increases. He just happens to spend more
money on orange juice as the price increases.

Chapter 11: Behind the supply curve: Inputs and costs

Question 2: Marty’s Frozen Yogurt is a small shop that sells cups of frozen yogurt in a
university town. Marty owns three frozen-yogurt machines. His other inputs are
refrigerators, frozen-yogurt mix, cups, sprinkle toppings, and, of course, workers. He
estimates that his daily production function when he varies the number of workers
employed (and at the same time, of course, yogurt mix, cups, and so on) is as shown in
the accompanying table.
a) What are the fixed inputs and variable inputs in the production of cups of frozen yogurt?
- The fixed inputs are frozen-yogurt machines, refrigerators and the shop.
- The variable inputs are frozen-yogurt mix, cups, sprinkle toppings, employed workers.
b) Draw the total product curve. Put the quantity of labour on the horizontal axis and the quantity
of frozen yogurt on the vertical axis.

c) What is the marginal product of the first worker? The second worker? The third worker? Why
does marginal product decline as the number of workers increases?
- The MPL of the first worker is 110 cups
- The MPL of the second worker is 90 cups
- The MPL of the third worker is 70 cups
 - The marginal product declines as the number of workers increases due to the principle
of diminishing return of labours. The workers (varied inputs) have fewer frozen-yogurt
machines to work with as well as the number of refrigerators is fixed, which decrease the
productivity of the labours
Question 12: Daniella owns a small concrete-mixing company. Her fixed cost is the cost
of the concrete-batching machinery and her mixer trucks. Her variable cost is the cost of
the sand, gravel, and other inputs for producing concrete; the gas and maintenance for
the machinery and trucks; and her workers. She is trying to decide how many mixer
trucks to purchase. She has estimated the costs shown in the accompanying table based
on estimates of the number of orders her company will receive per week.

a) For each level of fixed cost, calculate Daniella’s total cost for producing 20, 40, and 60 orders
per week.

TC
Quantity of trucks
20 orders 40 orders 60 orders

2 $8,000 $11,000 $18,000

3 $8,800 $10,800 $17,800

4 $9,200 $11,600 $16,400

b) If Daniella is producing 20 orders per week, how many trucks should she purchase and what
will her average total cost be? Answer the same questions for 40 and 60 orders per week.
- Daniella should purchase 2 trucks if she is producing 20 orders per week. Her ATC is
$400 per order
- Daniella should purchase 3 trucks if she is producing 40 orders per week. Her ATC is
$270 per order
- Daniella should purchase 4 trucks if she is producing 60 orders per week. Her ATC is
$273.3 per order

Chapter 12: Perfect competition and the supply curve

Question 4: Consider Bob’s company described in Problem 3. Assume that flower pot
production is a perfectly competitive industry. For each of the following questions,
explain your answers.

a) What is Bob’s break-even price? What is his shut-down price?

- Assume that Bob produced 7,000 flower pots
+ Bob’s break-even price is $14.14 for each flower pot
+ Bob’s shut-down price is $7 for each flower pot
b) Suppose the price of a flower pot is $2. What should Bob do in the short run?
- Bob should shut down in the short run as P < minimum AVC
c) Suppose the price of a flower pot is $7. What is the profit-maximizing quantity of flower pots
that Bob should produce? What will his total profit be? Will he produce or shut down in the short
run? Will he stay in the industry or exit in the long run?
- The profit-maximizing quantity of flower pots that Bob should produce is 5,000 flower
pots.
 - His total profit will be -$35,000.
- He should produce in the short run as P > minimum AVC.
- He should exit in long run as P < minimum ATC.
d) Suppose instead that the price of a flower pot is $20. Now what is the profit-maximizing
quantity of flower pots that Bob should produce? What will his total profit be now? Will he
produce or shut down in the short run? Will he stay in the industry or exit in the long run?
- The profit-maximizing quantity of flower pots that Bob should produce is 7,000 flower
pots.
- His total profit will be $41,000
- He should produce in the short run as P > minimum AVC
- He should stay in the long run as P > minimum ATC
Question 6:
a) A profit-maximizing business incurs an economic loss of $10,000 per year. Its fixed cost is
$15,000 per year. Should it produce or shut down in the short run? Should it stay in the industry
or exit in the long run?
- The business should produce in the short run to minimize the loss.
- The business should exit the industry in the long run as it is incurring a loss.
b) Suppose instead that this business has a fixed cost of $6,000 per year. Should it produce or
shut down in the short run? Should it stay in the industry or exit in the long run?
- The business should shut down in the short run to minimize the loss.
- The business should exit the industry in the long run as it is incurring a loss.