econ201

ECON 201 –001, Assignment #4 Elasticity

Due Date: February 13, 2014 @ 1.00 p.m.

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Question 1: Elasticity and tax burden (40 points) The monthly demand and supply for beef is given by the following equations:

44 0.2 D

P Q= − , and 8 0.1 S

P Q= + , where P is the price per Kg in dollars, Q D

and

Q S are respectively the quantity demanded and the quantity supplied (in thousand

of Kgs).

1. Construct the Demand and Supply curves to scale. Calculate and show graphically the equilibrium price P* and quantity Q* for beef (12 points)

2. Consider that the government imposed an excise tax that is officially paid by beef producers. As a result of the tax, the quantity of beef reduced to

80 T

Q = thousand of kg. Calculate and show graphically the incidence of the

excise tax (i.e. the portion paid by consumers and the portion paid by producers), and indicate which party (consumers/producers) pays the heavier tax burden (10 points)

3. Using the standard formula (not the midpoint), calculate the price elasticity of demand ε

d , and the price elasticity of supply ε

s for this reduction and

indicate whether the demand/supply is elastic or inelastic on this portion of the curve (12 points).

4. Do the calculated elasticities in question 3, provide support for your findings regarding the incidence of tax in question 2? Explain fully the economic intuition behind this finding (6 points)

Question 2 (20 points) Sketch the demand curve for the following individuals and fully explain the demand relationship in each of the situations by considering the price elasticity of demand.

1. I would never buy a Britney Spears CD! You couldn’t even give me one for nothing.

2. I love coffee and I generally buy a bit more as price falls, but if price falls to $4/kg I will buy out the entire stock of the supermarket.

Question 3 (20 points) The price elasticity of demand changes along a linear demand curve. Consider a linear demand and a shift of the supply curve in each of the following scenarios. Show along which portion of the demand curve (that is, the elastic or the inelastic portion) the supply must have shifted in order to generate the event described. In each case, show on the diagram the quantity (sales) effect and the price effect.

ECON 201 –001, Assignment #4 Elasticity

Due Date: February 13, 2014 @ 1.00 p.m.

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a. Recent attempts to stop the flow of illegal drugs into Canada have actually benefited the drug dealers.

b. New construction increased the number of seats in the football stadium, and resulted in greater total revenue from ticket sale.

Hint: Consider an extreme case of price elasticity for S curve in situation described in 3b when you draw the graph. Question 4 Cross-price Elasticity of Demand (20 points) The following table lists the cross-price elasticity of demand for several goods, where the percent quantity change is measured for the first good of the pair and the percentage price change is measures for the second good.

Cross-price elasticity of Demand

Air Conditioning units and kilowatts of electricity -0.34 Coke and Pepsi +0.63 High fuel consuming SUV and Gasoline -0.28 McDonald’s burgers and Burger King burgers +0.82 Butter and margarine +1.54

a. Explain the sign of each of the cross-price elasticities. What does the sign imply about the relationship between the two goods in question? (10 points)

b. Compare the absolute values of the cross-price elasticities and explain their magnitudes. For example why is the cross price elasticity for McDonald’s and Burger King burgers less than cross price elasticity of butter and margarine? (5 points)

c. Use the information above to calculate how a 5% increase in price of Pepsi affects the quantity of Coke demanded (2.5 points)

d. Use the information above to calculate how a 10% fall in price of gasoline affects the quantity of SUVs demanded (2.5 points)