ECON 102 Study Guide - Lemonade, Economic Surplus, Cream Cheese

Suppose you know the following things about the market for peanut butter and the relationship between peanut butter and jelly:

Peanuts are an input used to produce peanut butter

Peanut butter is an income-inferior good.

Peanut butter and jelly are complements in consumption.

Grapes are an input used to produce jelly.

Use this information to answer what happens in the market for peanut butter in each of the following scenarios:

Scenario 1: Suppose because of a national drought the price of peanuts increases. In the market for peanut butter, the effect of this shock will be that the _____________ (Demand/Supply increase/decrease) and as a result the ______________ (Price Increase/Decrease) and the _____________. (Quantity Increases/Decreases)

Scenario 2: Suppose the economy enters a recession and household income decreases significantly. In the market for peanut butter the effect of this shock wil be that the _____________ (Demand/Supply increase/decrease) and as a result the ______________ (Price Increase/Decrease) and the _____________. (Quantity Increases/Decreases)

Learning Objective: In terms of macroeconomics; Be comfortable with what shifts the supply and demand curve, and how shifts in either supply or demand or both supply and demand change equilibrium quantity and equilibrium price.

You must answer both. Strategy: explain whether each factor changes supply or demand and in what direction.

1. Music compact discs are normal goods. What will happen to the equilibrium price and quantity of music compact discs if musicians accept lower royalties, compact disc players become cheaper, more firms start producing music compact discs, and music lovers experience an increase in income?

2. What would happen to the equilibrium price and quantity of peanut butter if the price of peanuts went up, the price of jelly fell, fewer firms decided to produce peanut butter, and health officials announced that eating peanut butter was good for you?

1. Anna owns the Sweet Alps Chocolate store. She charges $10 per pound for her hand made chocolate. You, the economist, have calculated the elasticity of demand for chocolate in her town to be 2.5. If she wants to increase her total revenue, what advice will you give her and why? Explain your answer.

2. If the cross elasticity of demand between peanut butter and milk is -1.11, then are peanut butter and milk substitutes or complements? Explain your answer.

3. A 10 percent increase in income brings about a 15 percent decrease in the demand for a good. What is the income elasticity of demand and is the good a normal good or an inferior good? Explain your answer.

4. If the price of a good increases by 8% and the quantity demanded decreases by 12%, what is the price elasticity of demand? Is it elastic, inelastic or unitary elastic?

5. Discount stores sell relatively elastic goods. Ceteris paribus, explain why selling at a relatively low price is profitable for them?