ECON 208 Study Guide - Planned Economy, Scientific Method, Opportunity Cost

A2. Suppose that the price of good X increases from $3 to $4 while the price of good Y increases from $150 to $200. The relative price of X (in terms of Y) (A) (B) (C) (D) (E) cannot be determined from the above data. is completely unrelated to the price of good Y. has fallen. has risen. remained constant.

CLASS NOTES ARE LOCATED WHERE IT SAYS CLASS NOTES!

During the early 1700s, a sailing ship is wrecked on an uninhabited island in the Caribbean Sea. The passengers and crew survive but lose all their possessions. There is no source of fresh water on the island, but coconut palm trees are fairly abundant, and the survivors are able to drink milk harvested from coconuts. There are no mammals living on the island, but many birds roost there, and these become a source of meat. There are a number of mango trees that provide fruit. A long, tough form of sawgrass grows in a number of different places on the island. This grass can be woven into knee-length sleeveless shirts, which are the basic type of clothing for people of both genders. The people on this island have developed a simple system of direct market exchange. Currently, two mangos trade for five coconuts, six coconuts trade for a pound of meat, and three pounds of meat trade for four shirts.

1. Use a formula that was stated in class, and in my notes, to calculate the total number of distinct relative prices in the island’s economy. Note that when this formula is used to count relative prices, any given pair of goods is considered to have only one relative price. For example, if we count the price of a pound of meat in mangos as one relative price, then we don’t count the price of mangos in pounds of meat as a second relative price.

(Class Notes: In a barter economy with markets, each good should have a market price, per unit, in terms of each of the other goods: baskets of fish per bushel of apples, bags of coconuts per bushel of apples, etc. A price of this type – units of one good per unit of the other good – is called a relative price (alternatively, a barter price). If there are different goods traded in an economy, then there turn out to be relative prices for a merchant to keep track of, in each market he visits. Each of the n goods has unit prices: one for each of the other goods. We divide by two to avoid counting reciprocal duplicates: if it costs 2 bags of coconuts to buy a bushel of apples, then it costs 1/2 bushel of apples to buy a bag of coconuts, and so on. )

2. Use the price information you are given to calculate all the distinct relative prices. Remember that the prices we are interested in are unit prices. A unit price is the price of a single unit of one good in units of another good. For each pair of goods, use the order that produces the highest unit price. In the case of coconuts and shirts, for example, if the price of a shirt in coconuts is higher than the price of a coconut in shirts, then report the first price but not the second one. Note: In calculating unit prices, don’t worry about issues of divisibility. Assume that any good can be divided in any way, so that fractions or decimals can be components of unit prices.

3. For each relative price you just calculated, calculate the relative price if the order of the two items is switched. (In the scenario above, for example, you would now calculate the price of a coconut in shirts.) What very simple formula can you use to do this? Explain briefly.

4. Now suppose the people on this island start using mangos as money. The relative prices on the island do not change, and the absolute prices are consistent with them. a. Use a formula stated in class, and in my notes, to calculate the total number of absolute prices in the island’s economy. b. Report these absolute prices.

Class Notes: ( In a monetary economy, in contrast, each good has a single absolute price (alternatively, a money price), which is its unit price in terms of money: dollars per bushel of apples, etc. If we assume that one of the n goods is used as money, then a merchant only needs to keep track of absolute prices. As long as there are more than two different goods ( ), it turns out that , and the difference between these two numbers gets very big as n gets large. Even if there are only 10 different goods, then there are 45 relative prices and only 9 absolute prices. And if there are 100 different goods, which is a more realistic number, then there are 99 absolute prices but almost 5000 relative prices.)

5. Comment briefly on the potential advantages and disadvantages of using mangos as money, using our list of the desirable properties of money as a guide.

6. Suppose you are a merchant on this island, where mangos are used as money in the market (see Item 4 above). A competing merchant who dislikes using money in transactions is willing to trade coconuts for shirts (or vice-versa) directly, at a rate of five coconuts per shirt. Explain, carefully and completely, how you could use this merchant’s willingness to trade these two goods, at this rate, in order to make a profit of one unit of money for yourself by (1) using money to buy units of a good in the market, (2) trading those units of the good to this merchant, in exchange for units of another good, and (3) selling those units in the market for money. Identify the items traded and the quantities, and verify the amount of the profit. Finally, explain what you would need to do in order to make a larger profit (double, for example).

Answer the following 24 questions.

1. The elasticity that measures how sensitive the buyers of a good are to a change in the price of another good is called:

a. price-elasticity of demand

b. income-elasticity of demand

c. cross-price-elasticity of demand

d. price-elasticity of supply

2. 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.

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. 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 kinds of toothpaste 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 (broad vs narrow) of a market in determining the price elasticity of demand.

d. the time horizon in determining the price elasticity of demand.

4. Suppose that gasoline prices increase dramatically this month. 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

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.

c. the definition of a market in determining the price elasticity of demand.

d. the time horizon in determining the price elasticity of demand.

5. When a smartphone manufacturer introduces a phone with new features (like a more powerful camera, more storage, a screen with better definition, or being waterproof) and advertises them, it is

a. trying to decrease buyers' price-elasticity of demand by differentiating the goods relative to the competition so that consumers perceive it as having no close substitutes in the market.

b. trying to decrease buyers' price-elasticity of demand by differentiating the goods relative to the competition so that consumers perceive it as having more substitutes in the market.

c. trying to increase buyers' price-elasticity of demand by differentiating the goods relative to the competition so that consumers perceive it as having more substitutes in the market.

d. trying to increase buyers' price-elasticity of demand by differentiating the goods relative to the competition so that consumers perceive it as having no close substitutes in the market.

6. Consider the following two alternative scenarios.

1) In scenario 1, the price of all smartphones increases by 10%.

2) In scenario 2, the price of Samsung smartphones increases by 10% while the price of all other smartphones stays the same as before.

Which of the following is true?

a. The quantity demanded of Samsung phones in scenario 2 falls by more, in percentage terms, than the quantity demanded of all phones in scenario 1.

b. The quantity demanded of Samsung phones in scenario 2 falls by less, in percentage terms, than the quantity demanded of all phones in scenario 1.

7. As more electric car models appear in the market, the price elasticity of demand for the models already in the market should

a. Stay the same. In other words, buyers' sensitivity to changes in the price of the existing cars does not change.

b. Increase. In other words, buyers' sensitivity to changes in the price of the existing cars increases.

c. Decrease. In other words, buyers' sensitivity to changes in the price of the product of the car decreases.

8. Demand for a good is likely to be flatter if

a. the good has many substitutes

b. the good is narrowly defined

c. we are considering the long run rather than the short run

d. the good is a luxury.

e. All of the above.

9. If the price elasticity of the demand for ice-cream is equal to 1.5, then

a. a 1% increase in price will lead to a 1.5% increase in quantity demanded.

b. a 1% increase in price will lead to a 150% fall in quantity demanded.

c. a 1% increase in price will lead to a 15% fall in quantity demanded.

d. a 1% increase in price will lead to a 1.5% fall in quantity demanded.

10. If the price elasticity of demand for oil is 0.7, then

a. Demand is elastic, buyers are relatively sensitive to price, and the demand curve is relatively flat.

b. Demand is elastic, buyers are relatively insensitive to price, and the demand curve is relatively flat.

c. Demand is inelastic, buyers are relatively insensitive to price, and the demand curve is relatively steep.

d. Demand is inelastic, buyers are relatively sensitive to price, and the demand curve is relatively flat.

11. Note: this question is not about calculating elasticity, but about showing that you know how to calculate a % change using the midpoint method in any circumstance.

A biology class at Q State University initially had 205 students. After the first test, enrollment dropped to 195 students. Using the midpoint method, the % change in the number of students is equal to

a. 10%

b. approximately 5.12%

c. approximately 4.88%

d. 5%

12. When the price of a good is $5, the quantity demanded is 100 units per month; when the price is $7, the quantity demanded is 80 units per month. Using the midpoint method, the price elasticity of demand is approximately

a. 0.22.

b. 0.67.

c. 1.33.

d. 1.50.

13. If the price elasticity of demand for hamburgers is 0.4, then a 20% increase in the price of hamburgers will lead to

a. an 8% fall in quantity demanded.

b. a 20% fall in quantity demanded.

c. a 0.4% fall in quantity demanded.

d. a 4% fall in quantity demanded.

14. If the price elasticity of demand for cruises is 1.4, a 1% decrease in the price of cruises will lead to a

a. A 1.4% increase in quantity demanded.

b. A 1% increase in quantity demanded.

c. A 1.4% decrease in quantity demanded.

d. A 1% decrease in quantity demanded.

15. 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 existing 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. the mayor

b. the city manager

c. The answer depends on the price elasticity of demand.

d. The answer depends on the costs of construction of the new municipal swimming pool.

16. When demand is elastic, an increase in price will cause

a. an increase in total revenue.

b. a decrease in total revenue.

c. no change in total revenue.

d. not enough information.

17. Consider luxury weekend hotel packages in Las Vegas. When the price is $250, the quantity demanded is 2,000 packages per week. When the price is $280, the quantity demanded is 1,700 packages per week. Using the midpoint method, the price elasticity of demand is about

a. 1.43, and an increase in the price will cause hotels' total revenue to decrease.

b. 1.43, and an increase in the price will cause hotels' total revenue to increase.

c. 0.70, and an increase in the price will cause hotels' total revenue to decrease.

d. 0.70, and an increase in the price will cause hotels' total revenue to increase.

18. Suppose researchers at the University of Wisconsin discovered a new vitamin that increases the milk production of dairy cows. If the demand for milk is relatively inelastic, the discovery will

a. raise both price and total revenues.

b. lower both price and total revenues.

c. raise the price and lower total revenues.

d. lower price and raise total revenues.

19. When we calculate elasticities, whether the percent changes have a plus or a minus sign matters if we are calculating

a. Price elasticity of demand, because the signs give us information about whether the good is normal or inferior.

b. Income elasticity of demand, because the signs give us information about whether the good is normal or inferior.

c. Cross-price-elasticity of demand, because the signs give us information about whether the goods are substitutes or complements.

d. b and c are both correct.

20. Income elasticity of demand measures how

a. the quantity demanded changes as consumer income changes.

b. consumer purchasing power is affected by a change in the price of a good.

c. the price of a good is affected when there is a change in consumer income.

d. many units of a good a consumer can buy given a certain income level.

21. Last year, Carolyn bought 6 pairs of earrings when her income was $40,000. This year, her income is $52,000, and she purchased 7 pairs of earrings. Holding other factors constant, it follows that Carolyn's income elasticity of demand is about

a. 0.59, and Carolyn regards earrings as an inferior good.

b. 0.59, and Carolyn regards earrings as a normal good.

c. 1.7, and Carolyn regards earrings as an inferior good.

d. 1.7, and Carolyn regards earrings as a normal good.

22. Sandra purchases 5 pounds of coffee and 10 gallons of milk per month when the price of coffee is $10 per pound. She purchases 6 pounds of coffee and 12 gallons of milk per month when the price of coffee is $8 per pound. Sandra's cross-price elasticity of demand for milk with respect to the price of coffee

a. 0.82, and the goods are substitutes.

b. -0.82, and the goods are complements.

c. 1.22, and the goods are substitutes.

d. -1.22, and the goods are complements.

23. Supply of good is likely to be steeper (that is, more inelastic)

a. if sellers can cheaply make more units of the good on short notice.

b. in the long run.

c. in the short run.

d. if sellers have a large degree of flexibility to expand factory size.

24. When the price of a barrel of oil is $35, an oil fracking company is willing to produce 500 gallons per minute. If the price increased to $45, the company would be willing to produce 2500 gallons per minute. Using the midpoint method, calculate the company's price elasticity of supply.

 a. approximately 1.33

 b. 0.25

 c. approximately 5.33

d. approximately 0.188