Course Title: Principles of Economics – Micro
Course Code: ECON 201

Homework # 3

Question # 1 (10 points)

a) What is cross-price elasticity?
The percentage change in the quantity of one good that is demanded as a result of percentage change of another good. _________________

When cross-price elasticity has a positive sign what does that imply?
That the price of good B went up, causing the quantity demanded for good A to increase. ___________________________________

b) Discuss the relationship between price change, elasticity and revenue that business owners need to be aware of.
Elasticity measures the percent in change in price which leads to a change in percent in quantity demanded or supplied. A higher tax would lead to lower quantity demanded which leads to a lower tax revenue.

c) List the determinants of:
i) Price elasticity of Demand
-Availability of close substitutes ___________ ____________________

-Necessities versus luxuries _______________________

- Definitions of the markets ____________________________________

-Time horizon, short or long term ____________________________

ii) Price elasticity of Supply

-Time Period; short or long periods ______________________________

- Inputs availability- bigger ones are more available and smaller ones are harder to obtain. _________________________________

Question # 2 (10 points)

Silver Star Enterprise sells three main consumer goods, A, B and C in Grand Rapids, Michigan.

a) When the price of Good A was $9 per unit, the store sold 400 units weekly, however when price of rose to $12 per unit, weekly demand fell to 260 units. Use the midpoint method to calculate your price elasticity of demand of Good A. What can you conclude from the magnitude of this elasticity of demand?

>>> {(260-400)/(260+400)} X 100 >>> {(-140/(660)} X 100
>>> {($12-$9)/($12+$9)} X 100 >>> {($3)/($21)} X 100

>>> -21.21 ~|-1.5|
>>> 14.29

*It is greater than one meaning that Good A is price elastic

b) The store manager observed that at the same time when the price of good A went up, weekly quantity demanded of good B fell from 430 units to 400 units. Use the midpoint method to calculate the cross price elasticity of demand (CPED) of Good B when price of Good A went up. What does the sign of the CPED tell you about the nature of goods A & B?

PA1 = $9, QB1 = 430
PA2 = $12, QB2 = 400

>>>> {(400-430)/(400+430)} X 100 >>>> {(-30)/(830)} X 100 >>>> {($12-$9)/($12+$9)} X 100 >>>> {($3)/($21)} X100

>>> -3.6145 ~ |-0.253|
>>> 14.2857

* This means that it is not price elastic and non-responsive to price change.

c) The store manager noted that when average annual incomes of his customer base went up from $25,000 to $28,000, the weekly demand for good C went up from 320 to 400 units. Use the midpoint method to calculate the income elasticity of demand (IED) of Good C. What does the sign of the IED tell you about the nature of good C?

80/720 ~ |11.11| * The absolute value tells you that the nature of good C is not price
(3,000/53,000) elastic and non-responsive to price change.

Question # 3 (10 points)

i) Define economies of scale?

As the quantity of an output rises, the average total cost of a production falls.

ii) Define diseconomies of scale?

As the quantity of an output rises, the average total cost of a production rises.

iii) In the space below sketch and label correctly a graph showing economies and diseconomies of scale.

iv) Explain the difference between