Written HW4

Basic Economic Theory, Econ 201, Drury University, Spring 2018
Homework 4
Due in class on Thursday, March 22
(98 points + 2 bonus points; Each question is worth 2 points)
Chapter 5:
1. The price elasticity of demand (PED) measures the magnitude of the response in quantity
demanded to a change in price. Which of the following statements about the PED is correct?
a. The price elasticity of demand tends to be higher in the long run than in the short run.
b. Price elasticity of demand reflects the many economic, psychological, and social forces
that shape consumer tastes.
c. Other things equal, if good x has close substitutes and good y does not have close
substitutes, then the demand for good x will be more elastic than the demand for good y.
d. All of the above are correct.
2. Suppose that Juan Carlos is filling out a survey that he received in the mail. The survey asks
him what he would do if the price of his favorite toothpaste increased. Juan Carlos reports that he
would switch to a different brand. The survey asks what he would do if the price of all toothpastes
increased. Juan Carlos reports that he must use toothpaste, so he would have to adjust his
spending elsewhere. These examples illustrate the importance of
a. changes in total revenue in determining the price elasticity of demand.
b. a necessity versus a luxury in determining the price elasticity of
demand.
c. the definition of a market in determining the price elasticity of demand.
d. the time horizon in determining the price elasticity of demand.
3. If the price of walnuts rises, many people would switch from consuming walnuts to consuming
pecans. But if the price of salt rises, people would have difficulty purchasing something to use in
its place. These examples illustrate the importance of
a. the availability of close substitutes in determining the price elasticity of
demand.
b. a necessity versus a luxury in determining the price elasticity of demand.
4. Suppose that gasoline prices increase dramatically this month. 1 Lola commutes 100 miles to
work each weekday. Over the next few months, Lola drives less on the weekends to try to save
money. Within the year, she sells her home and purchases one only 10 miles from her place of
employment. These examples illustrate the importance of
1
When consumers face rising gasoline prices, they typically reduce their
quantity demanded more in the long run than in the short run. According to
one estimate, a 10 percent increase in gasoline prices reduces gasoline
consumption by about 2.5 percent after one year and 6 percent after five
years. About half of the long-run reduction in quantity demanded arises
because people drive less and about half arises because they switch to more
fuel-efficient cars. Note that price elasticity of demand of gasoline is
extremely low in the short-run; even in the long-run (e.g. in five years), price
elasticity is still below 1.
1
a. the availability of substitutes in determining the price elasticity of
demand.
b. a necessity versus a luxury in determining the price elasticity of demand.
5. Suppose the price of a bag of frozen chicken nuggets decreases from $6.50 to $5.75 and, as a
result, the quantity of bags demanded increases from 600 to 800. Using the midpoint method, 2 the
price elasticity of demand for frozen chicken nuggets in the given price range is
a. 0.35 and so it is elastic.
b. 0.43 and so it is inelastic.
c. 2.33 and so it is elastic.
d. 2.89 and so it is inelastic.
6. Using the midpoint method, the price elasticity of demand for a good is computed to be
approximately 0.75. Which of the following events is consistent with a 10 percent decrease in the
quantity of the good demanded?
a. a 7.5 increase in the price of the good
b. a 13.33 percent increase in the price of the good
c. an increase in the price of the good from $7.50 to $10
d. an increase in the price of the good from $10 to
$17.50
7. Studies indicate that the price elasticity of demand for cigarettes is about 0.4. A government
policy aimed at reducing smoking changed the price of a pack of cigarettes from $2 to $6.
According to the midpoint method, the government policy should have reduced smoking by
a. 30%.
b. 40%.
c. 80%.
d. 250%.
8. Suppose that demand is inelastic within a certain price range. 3 For that price range,
2
Recall that the midpoint method for calculating elasticities is convenient in
that it allows us to calculate the same value for the elasticity, regardless of
whether the price increases or decreases. According to the midpoint formula,
price elasticity of demand is computed as .

3
Recall that the elasticity of demand is closely related to the slope of the
demand curve. The more responsive buyers are to a change in price, the
flatter the demand curve will be. Conversely, the less responsive buyers are to
a change in price, the steeper the demand curve will be. Note that the
difference between slope and elasticity is that slope is a ratio of two changes,
and elasticity is a ratio of two percentage changes. Moreover, even though the
slope is constant along a linear (i.e. straight-line), downward-sloping demand
curve, the price elasticity of demand changes. For example, as we move
upward and to the left along a linear, downward-sloping demand curve, price
elasticity of demand always becomes larger.
2
a. an increase in price would increase total revenue because the decrease in quantity
demanded is proportionately less than the increase in price.
b. an increase in price would decrease total revenue because the decrease in quantity
demanded is proportionately greater than the increase in price.
c. a decrease in price would increase total revenue because the increase in quantity
demanded is proportionately smaller than the decrease in price.
d. a decrease in price would not affect total revenue.
9. Suppose that when the price of wheat is $2 per bushel, farmers can sell 10 million bushels.
When the price of wheat is $3 per bushel, farmers can sell 8 million bushels. Which of the
following statements is true? The demand for wheat is
a. income inelastic, so an increase in the price of wheat will increase the total revenue of
wheat farmers.
b. income elastic, so an increase in the price of wheat will increase the total revenue of wheat
farmers.
c. price inelastic, so an increase in the price of wheat will increase the total revenue of wheat
farmers.
d. price elastic, so an increase in the price of wheat will increase the total revenue of wheat
farmers.
10. Hilda’s Hair Hysteria earned $3,750 in total revenue last month when it sold 125 haircuts.
This month it earned $3,600 in total revenue when it sold 90 haircuts. The price elasticity of
demand for Hilda’s Hair Hysteria is
a. 0.33.
b. 0.88.
c. 1.14.
d. 7.98.
11. A city wants to raise revenues to build a new municipal swimming pool next year. The mayor
suggests that the city raise the price of admission to the current municipal pools this year to raise
revenues. The city manager suggests that the city lower the price of admission to raise revenues.
Who is correct?
a. Both the mayor and city manager would be correct if demand were price elastic.
b. Both the mayor and city manager would be correct if demand were price inelastic.
c. The mayor would be correct if demand were price elastic; the city manager would be
correct if demand were price inelastic.
d. The mayor would be correct if demand were price inelastic; the city manager would be
correct if demand were price elastic.
12. If the price elasticity of demand for aluminum foil is 1.45, then a 2.4% decrease in the price
of aluminum foil will increase the quantity demanded of aluminum foil by
3
a. 1.66%, and aluminum foil sellers' total revenue will increase as a result.
b. 1.66%, and aluminum foil sellers' total revenue will decrease as a
result.
c. 3.48%, and aluminum foil sellers' total revenue will increase as a result.
d. 3.48%, and aluminum foil sellers' total revenue will decrease as a
result.
13. Suppose an airline determines that its customers traveling for business have inelastic demand
and its customers traveling for vacations have an elastic demand. If the airline's objective is to
increase total revenue, it should
a. increase the price charged to vacationers and decrease the price charged to business
travelers.
b. decrease the price charged to vacationers and increase the price charged to business
travelers.
c. decrease the price to both groups of customers.
d. increase the price for both groups of customers.
14. Necessities such as food and clothing tend to have4
a. high price elasticities of demand and high income elasticities of
demand.
b. high price elasticities of demand and low income elasticities of demand.
c. low price elasticities of demand and high income elasticities of demand.
d. low price elasticities of demand and low income elasticities of demand.
15. You and your college roommate eat three packages of Ramen noodles each week. After
graduation last month, both of you were hired at several times your college income. Your
roommate still enjoys Ramen noodles very much and buys even more, but you plan to buy fewer
Ramen noodles in favor of foods you prefer more. When looking at income elasticity of demand
for Ramen noodles, yours would
a. be negative and your roommate's would be positive.
b. be positive and your roommate's would be negative.
c. be zero and your roommate's would approach infinity.
4
Recall that income elasticity of demand measures how the quantity
demanded of a good changes as consumer income changes. If an increase in
income results in an increase in the quantity demanded of a good, then for
that good, the income elasticity of demand is positive. Such goods are called
normal goods. On the other hand, if an increase in income results in a
decrease in the quantity demanded of a good, then for that good, the income
elasticity of demand is negative and such goods are called inferior goods.
Note that when calculating an income elasticity of demand, we hold the price
of the good, prices of related goods, and tastes constant. Mathematically, we
compute a consumer’s income elasticity for a good as the percentage change
in quantity demanded of that good by that consumer divided by the percentage
change in that consumer’s income.
4
d. approach infinity and your roommate's would be
zero.
16. The price elasticity of supply5 measures how responsive

a. equilibrium price is to equilibrium quantity.
b. sellers are to a change in buyers' income.
c. sellers are to a change in price.
d. consumers are to the number of substitutes.
17. A key determinant of the price elasticity of supply is the time period under consideration.
Which of the following statements best explains this fact?
a. Supply curves are steeper over long periods of time than over short periods of time.
b. Buyers of goods tend to be more responsive to price changes over long periods of time
than over short periods of time.
c. The number of firms in a market tends to be more variable over long periods of time than
over short periods of time.
d. Firms prefer to change their prices in the short run rather than in the long run.
18. If the price elasticity of supply for wheat is less than 1, then the supply of wheat is
a. inelastic.
b. elastic.
c. unit elastic.
d. quite sensitive to changes in income.
19. Suppose that two supply curves pass through the same point. One is steep, and the other is
flat. Which of the following statements is correct?
a. The flatter supply curve represents a supply that is inelastic relative to the supply
represented by the steeper supply curve.
5
Recall that price elasticity of supply measures how much the quantity
supplied responds to changes in the price of the good. Mathematically, a firm’s
price elasticity of supply is computed as the percentage change in that firm’s
quantity supplied divided by the percentage change in the product’s sale
price. If the quantity supplied responds only slightly to changes in price, then
supply is said to be inelastic. If the quantity supplied responds a lot to
changes in price, then supply is said to be elastic. More specifically, if the
price elasticity of supply is less than 1, then elasticity of supply is considered
inelastic; if it is more than 1, then it is considered elastic, and if it is equal to
1, then it is considered unit-elastic. Recall also that the elasticity of supply is
closely related to the slope of the supply curve. The more responsive sellers
are to a change in price, the flatter the supply curve will be. Conversely, the
less responsive sellers are to a change in price, the steeper the supply curve
will be. Moreover, even though the slope is constant along a linear (i.e.
straight-line), upward-sloping supply curve, the price elasticity of supply
changes. For example, as we move upward and to the right along a linear,
upward-sloping supply curve, price elasticity of supply always becomes larger.
5
b. The steeper supply curve represents a supply that is inelastic relative to the supply
represented by the flatter supply curve.
c. Given two prices with which to calculate the price elasticity of supply, that elasticity
would be the same for both curves.
d. A decrease in demand will increase total revenue if the steeper supply curve is relevant,
while a decrease in demand will decrease total revenue if the flatter supply cure is
relevant.
20. If a 25% change in price results in a 40% change in quantity supplied, then the price elasticity
of supply is about
a. 0.63, and supply is elastic.
b. 0.63, and supply is inelastic.
c. 1.60, and supply is elastic.
d. 1.60, and supply is inelastic.
21. A tax accounting firm produces 500 tax returns units when the market price is $150 per return
and produces 700 tax returns when the market price is $170 per tax return. Using the midpoint
method, for this range of prices, the price elasticity of supply is about
a. 2.67.
b. 0.67.
c. 0.4.
d. 0.125.
22. Suppose the price elasticity of supply for soccer balls is 0.3 in the short run and 1.2 in the
long run. If an increase in the demand for soccer balls causes the price of soccer balls to increase
by 20%, then the quantity supplied of soccer balls will increase by about
a. 0.67% in the short run and 0.17% in the long
run.
b. 3% in the short run and 1.2% in the long run.
c. 6% in the short run and 24% in the long run.
d. 66.7% in the short run and 16.7% in the long
run.
23. If marijuana were legalized, it is likely that there would be an increase in the supply of
marijuana. Advocates of marijuana legalization argue that this would significantly reduce the
amount of revenue going to the criminal organizations that currently supply marijuana. These
advocates believe that the
a. supply for marijuana is elastic.
b. demand for marijuana is elastic.
c. supply for marijuana is inelastic.
d. demand for marijuana is
inelastic.
6
24. Knowing that the demand for wheat is inelastic, if all farmers voluntarily did not plant wheat
on 10 percent of their land, then
a. consumers of wheat would buy more wheat.
b. wheat farmers would suffer a reduction in their total revenue.
c. wheat farmers would experience an increase in their total
revenue.
d. the demand for wheat would decrease.
25. A decrease in supply will cause the largest increase in price when
a. both supply and demand are inelastic.
b. both supply and demand are elastic.
c. demand is elastic and supply is
inelastic.
d. demand is inelastic and supply is
elastic.
Chapter 6:
26. Suppose the equilibrium price of a physical examination ("physical") by a doctor is $200, and
the government imposes a price ceiling of $150 per physical. 6 As a result of the price ceiling,
6
Recall that prices have several important functions in a market system
including serving as signals to buyers and sellers to help them make rational
economic decisions, coordinating economic activity, and balancing supply and
demand. Governments can alter the functioning of the price mechanism in
markets by policies such as price controls and taxes and subsidies. There are
two main types of price controls: price ceilings and price floors. A price ceiling
is a legal maximum on the price at which a good can be traded (as in rent
controls) and a price floor is a legal minimum on the price at which a good can
be traded (as in minimum wage laws). A price ceiling is binding (i.e. has an
effect) only if it is set below the equilibrium price and a price floor is binding
(i.e. has an effect) only if it is set above the equilibrium price. If a price ceiling
7
a. the quantity of physicals demanded increases.
b. there is shortage of physicals.
c. the quantity of physicals supplied decreases.
27. Suppose the government has imposed a price floor on cellular phones. Which of the following
events could transform the price floor from one that is binding to one that is not binding?
a. Cellular phones become less popular.
b. Traditional land line phones become more expensive.
c. The components used to produce cellular phones become less
expensive.
d. Firms expect the price of cellular phones to fall in the future.
28. A binding price floor will reduce a firm's total revenue

a. always.
b. when demand is elastic.
c. when demand is
inelastic.
d. never.
is binding, then there will be a shortage in the market whereas if a price floor
is binding, there will be a surplus in the market. Of course, when an existing
price control is removed, the opposite will occur. As long as binding price
controls are in place, the surpluses and/or shortages will persist because
price cannot adjust to the market equilibrium price. Price controls such as
rent controls are usually used by governments when they believe the
prevailing market (equilibrium) price is unfair. However, economic analysis
suggests that rent controls are a highly inefficient means of helping the poor;
a more efficient policy would be to pay a fraction of a poor family’s rent. Rent
controls are known to reduce both the quantity and quality of housing (and
more so in the longer run), cause shortages of housing, increase search times,
lengthen waiting lists, increase discrimination based on the landlord’s
subjective preferences about race, religion, gender, and race, and increase
bribery among other things. In fact, under rent control, bribery is nothing but a
rational (though not necessarily ethical) response by people to bring the total
price of an apartment (including the bribe) closer to the equilibrium price.
Swedish economist Assar Lindbeck went so far as to argue that rent control is
"the best way to destroy a city, other than bombing." On the other hand,
governments use taxes for two main purposes. The first is to raise revenue for
public goods and services. The second is to remedy market failures such as
those that arise as a consequence of market power, externalities, and income
and/or wealth inequality. Unlike taxes, price controls do not raise any revenue
for the government.
8
Figure 6-11
29. Refer to Figure 6-11. Which of the following statements is not correct?
a. A government-imposed price of $8 would be a binding price floor if market demand is
Demand A and a binding price ceiling if market demand is Demand B.
b. A government-imposed price of $10 would be a binding price ceiling if market demand is
either Demand A or Demand B.
c. A government-imposed price of $4 would be a binding price ceiling if market demand is
either Demand A or Demand B.
d. A government-imposed price of $10 would be a binding price floor if market demand is
Demand A and a non-binding price ceiling if market demand is Demand B.
Figure 6-15
30. Refer to Figure 6-15. Suppose a price ceiling of $2 is imposed on this market. As a result,
a. the quantity of the good supplied decreases by 30 units.
b. the demand curve shifts to the left so as to now pass through the point (quantity = 30, price
= $2).
c. buyers’ total expenditure on the good decreases by $75.
d. buyers’ total expenditure on the good falls by $15.
9
31. Minimum-wage laws7 dictate the
a. average price employers must pay for labor.
b. highest price employers may pay for labor.
c. lowest price employers may pay for labor.
d. the highest and lowest prices employers may pay for labor.
32. If the government removes a tax on a good, then the price paid by buyers will
a. increase, and the price received by sellers will increase.
b. increase, and the price received by sellers will decrease.
c. decrease, and the price received by sellers will increase.
d. decrease, and the price received by sellers will
decrease.
33. A tax imposed on the sellers of a good will
a. raise both the price buyers pay and the effective price sellers receive, and lower the
equilibrium quantity.
b. raise the price buyers pay, lower the effective price sellers receive, and lower the
c. lower the price buyers pay, raise the effective price sellers receive, and increase the
d. lower both the price buyers pay and the effective price sellers receive, and increase the
34. If the government levies a $1,000 tax per boat on sellers of boats, then the price paid by
buyers of boats would
7
The U.S. Congress first instituted a minimum wage in 1938 to ensure workers
a minimally adequate standard of living. Since 2012, the minimum wage
according to federal law has been $7.25 per hour. Some states mandate
minimum wages above the federal level. Many other nations have minimum-
wage laws as well. A minimum wage is typically set above a market's
equilibrium wage. Such a binding minimum wage will reduce the quantity
demanded and increase the quantity supplied of labor, thereby creating a labor
surplus. The surplus of labor increases the unemployment rate. The minimum
wage has its greatest impact on the market for teenage labor. In particular,
studies of the effects of the minimum wage typically find that a 10 percent
increase in the minimum wage depresses teenage employment by about 1 to 3
percent. Advocates of the minimum wage emphasize the low annual incomes
of those who work for the minimum wage. Opponents of the minimum wage
point out that the minimum wage encourages teenagers to drop out of school,
prevents some workers from getting needed on-the-job training, and
contributes to the problem of unemployment. In the US, the proportion of
minimum-wage earners who are in families with incomes below the poverty
line is less than one-third. Unlike minimum wage laws, wage subsidies raise
the living standards of the working poor without creating unemployment. The
Earned Income Tax Credit is an example of a wage subsidy. One disadvantage
of wage subsidies over minimum wage laws is that subsidies make higher
taxes necessary.
10
a. increase by more than $1,000 and the price received by sellers of cars would decrease by
less than $1,000.
b. increase by exactly $1,000 and the price received by sellers of cars would increase by less
than $1,000.
c. increase by less than $1,000 and the price received by sellers of cars would decrease by
less than $1,000.
d. decrease by an indeterminate amount.
35. Suppose sellers of perfume are required to send $1.00 to the government for every bottle of
perfume they sell. Further, suppose this tax causes the price paid by buyers of perfume to rise by
$0.60 per bottle. Which of the following statements is correct?
a. The effective price received by sellers is $0.40 per bottle less than it was before the tax.
b. Sixty percent of the burden of the tax falls on sellers.
c. This tax causes the demand curve for perfume to shift downward by $1.00 at each quantity
of perfume.
36. If a tax is levied on the sellers of a product, then the supply curve will
a. shift up, but the demand curve will not shift.
b. shift down, but the demand curve will not shift.
c. become flatter and the demand curve will become steeper.
d. not shift, but the demand curve will shift down.
37. Suppose there is currently a tax of $50 per ticket on airline tickets. Sellers of airline tickets
are required to pay the tax to the government. If the tax is reduced from $50 per ticket to $30 per
ticket, then the
a. demand curve will shift upward by $20, and the price paid by buyers will decrease by less
than $20.
b. demand curve will shift upward by $20, and the price paid by buyers will decrease by $20.
c. supply curve will shift downward by $20, and the effective price received by sellers will
increase by less than $20.
d. supply curve will shift downward by $20, and the effective price received by sellers will
increase by $20.
38. If the government levies a $5 tax per ticket on buyers of NFL game tickets, then the price paid
by buyers of NFL game tickets would
a. increase by less than $5.
b. increase by exactly $5.
c. increase by more than $5.
d. decrease by an indeterminate amount.
39. Suppose buyers of vodka are required to send $5.00 to the government for every bottle of
vodka they buy. Further, suppose this tax causes the effective price received by sellers of vodka to
fall by $3.00 per bottle. Which of the following statements is correct?
a. This tax causes the demand curve for vodka to shift downward by $5.00 at each quantity
of vodka.
b. The price paid by buyers is $2.00 per bottle more than it was before the tax.
c. Sixty percent of the burden of the tax falls on sellers.
11
40. When a tax is placed on the buyers of a product, the

a. size of the market decreases.
b. effective price received by sellers decreases, and the price paid by buyers increases.
c. demand for the product decreases.
41. If the government wants to reduce the burning of fossil fuels, it should impose a tax on
a. buyers of gasoline.
b. sellers of gasoline.
c. either buyers or sellers of gasoline.
d. whichever side of the market is less
elastic.
Figure 6-18
The vertical distance between points A and B represents the tax in the market.
42. Refer to Figure 6-18. The price that buyers pay and the effective price that sellers receive
after the tax is imposed are given, respectively, by
a. $8 and $4.
b. $10 and $6.
c. $16 and $12.
d. $24 and $10.
43. Refer to Figure 6-18. The amount of the tax per unit, the per-unit burden of the tax on
buyers, and the per-unit burden of the tax on sellers are, respectively,
a. $6, $4, and $2.
b. $8, $5, and $3.
c. $14, $8, and $6.
d. $18, $14, and $4.
12
44. The price paid by buyers in a market will decrease if the government
a. increases a binding price floor in that market.
b. increases a binding price ceiling in that
market.
c. decreases a tax on the good sold in that
market.
45. The price received by sellers in a market will increase if the government
a. decreases a binding price floor in that market.
market.
c. increases a tax on the good sold in that market.
d. imposes a binding price ceiling in that market.
46. The quantity sold in a market will increase if the government
a. decreases a binding price floor in that market.
market.
c. decreases a tax on the good sold in that
market.
d. More than one of the above is correct.
47. The mayor of Workerville proposes a local payroll tax to fund a new water park for the city. 8
The mayor proposes to collect half the tax from workers and half the tax from firms. The mayor
will be able to successfully divide the burden of the tax equally if the
a. demand for labor is more elastic than the supply of labor.
b. supply of labor is more elastic than the demand for labor.
c. demand for labor and supply of labor are equally elastic.
d. It is not possible for the tax burden to fall equally on firms and
workers.
8
A payroll tax is a tax on the wages that firms pay their workers. In the US, the
Federal Insurance Contribution Act (FICA) tax is an example of a payroll tax.
The federal government uses the revenue from the FICA tax to pay for Social
Security and Medicare. When there is a payroll tax, the wage received by
workers falls, and the wage paid by firms rises. When the FICA tax was first
enacted in 1935, the Congress intended that half the FICA tax be paid by
workers and half be paid by firms. However, who pays what share of a tax (tax
incidence) depends on the elasticities of supply and demand. In particular, the
incidence (burden) of a tax falls more heavily on the relatively inelastic side of
the market. Most labor economists believe that the supply of labor is more
inelastic than the demand, and, therefore, workers bear most of the burden of
the payroll tax. Thus, a key lesson from the payroll tax is that the true burden
of a tax cannot be legislated.
13
48. Suppose that the demand for picture frames is highly inelastic, and the supply of picture
frames is highly elastic. A tax of $1 per frame levied on picture frames will decrease the effective
price received by sellers of picture frames by
a. less than $0.50.
b. $0.50.
c. between $0.50 and $1.
d. $1.
49. The demand for salt is inelastic, and the supply of salt is elastic. The demand for caviar is
elastic, and the supply of caviar is inelastic. Suppose that a tax of $1 per pound is levied on the
sellers of salt, and a tax of $1 per pound is levied on the buyers of caviar. We would expect that
most of the burden of these taxes will fall on
a. sellers of salt and the buyers of caviar.
b. sellers of salt and the sellers of caviar.
c. buyers of salt and the sellers of caviar.
d. buyers of salt and the buyers of caviar.
14

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Basic Economic Theory, Econ 201, Drury University, Spring 2018

price elasticity of demand is computed as .

16. The price elasticity of supply5 measures how responsive

28. A binding price floor will reduce a firm's total revenue

40. When a tax is placed on the buyers of a product, the

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